The Tax Cuts and Jobs Act (TCJA) was the most thorough overhaul of federal taxes in a generation. The provisions included in this new law, passed at the end of last year, touch on nearly all major aspects of tax planning. For owners of private businesses, Grant Thornton’s Year-end tax guide 2018: Privately held businesses
can be an indispensable tool to avoid pitfalls and realize new opportunities in planning your company’s finances.
Our new guide covers a broad array of tax changes, with helpful planning tips and insightful descriptions of the most important individual changes. Those changes, more fully described in the guide, are briefly outlined here.
The new top tax rate for individuals was cut from 39.6% to only 37%, a far cry from the corporate rate slashing from 35% to 21%. However, lawmakers sought to bring more relief to businesses organized as pass-throughs and created a 20% deduction for individuals and trusts receiving certain kinds of pass-through business income. If fully realized, the 20% deduction lowers the top rate effectively to 29.6%. As a general rule, domestic business income sources, including rent, qualify for the deduction, while investment income such as interest, capital gains and dividends do not.
“The 20% deduction is a complex provision, with limits that will curb the benefit for many taxpayers. Given the modest rate cut for pass-through business income, it’s critical that pass-through businesses structure their operations efficiently to get every last penny they can out of the incentive,” said Dustin Stamper, a managing director at Grant Thornton.
Because C corporations received a much more generous rate cut, private business owners must consider the choice to reorganize as a C corporation. Our guide contains a complete analysis that should inform that choice. Because of the steep corporate tax cut, pass-through business owners should be at least tempted to make this conversion.
“The corporate rate is attractive, but the analysis has to go well beyond rate. Businesses should also consider how much earnings they plan distribute and a number of other critical factors,” Stamper said.
It’s important to keep in mind some of the benefits of staying put. Pass-throughs have advantages in estate planning and in exiting a business. When putting a business up for sale, C corporations often cannot offer valuable depreciation deductions that come with an asset sale without adding another tax layer. There may be costs to the conversion itself. Also, pass-throughs are eligible for certain rules, like the cash method of accounting, not available to C corporations.
On the other hand, if your business generates foreign income, a C corporation structure is much more favorable. In addition, C corporations can still fully deduct state taxes.
A powerful new tax reform provision increases the bonus depreciation rate to 100%, allowing a business owner to fully expense business property placed in service through the end of 2022. However, more than two dozen popular tax provisions known as extenders, extended retroactively for 2017, have not been extended for this year. These provisions include:
- Tax credits for biofuels
- Energy-efficient new homes and commercial buildings
- Film and television product expensing
- Depreciation for racehorses
- Cost recovery for motor sports venues
- Advanced mine safety equipment
Despite its name, the TCJA included some provisions intended to raise revenue through the loss of some itemized deductions. These include a $10,000 limit on the deduction for state and local taxes, capping the mortgage interest deduction at $750,000 of debt.
Other types of taxes could often figure into business owners’ and investors’ plans. The alternative minimum tax (AMT) exemption and phase-out was increased by the TCJA, limiting the number affected by it. The most common way AMT will be triggered is by long-term capital gains and qualified dividends, incentive stock options and private activity bonds. Employment taxes that fund Social Security and Medicare and the net investment income tax that applies when adjusted gross income (AGI) exceeds $200,000 for single filers ($250,000 for joint filers) also need to be considered.
There are ways private companies can use their money to take advantage of tax credits created by the new law. Opportunity zones were created by the TCJA to allow private business owners to defer capital gains recognition if within six months of selling assets, they are in turn invested in an opportunity zone fund.
“The opportunity zone incentives represent the most powerful tax break Congress has ever given to encourage investments in specific geographic areas. There are more than 8,000 zones throughout the country, with all major cities having multiple qualifying areas. Private businesses should consider these new incentives in their investment plans,” Stamper said.
Tax reform also impacted compensation and benefits. The TCJA created a new qualified equity grant program allowing deferment of income recognition from stock options and restricted stock units, or RSUs. The election is allowed for incentive stock options and grants under an employee stock purchase plan. However, the TCJA also limited deductions for business meals, entertainment and transportation.
Private business owners also have the unique issue of transitioning their business and investment assets to the next generation. In the realm of estate planning, the TCJA doubled the estate, fit and generation-skipping transfer tax exemptions to $11.2 million this year, with subsequent years indexed for inflation. But because of the need to sunset provisions to pass the law, this provision is set to expire in 2026.
The IRS has spent all of 2018 interpreting the provisions of the TCJA, so just reading the bill’s contents won’t begin to explain all the nuances of this major piece of tax legislation. Grant Thornton’s Year-end tax guide 2018: Privately held businesses
can be the tool to help a private business owner make the right financial and tax planning decisions for a successful future.