Corporate Tax Changes Under New Law
Businesses and corporations will see some major changes under the new tax law including the replacement of the graduated corporate tax rate at 35% for income over $10 million with a flat corporate tax rate of 21%. The new rate took effect Jan. 1, 2018. In addition to the reduced corporate tax rate, the Act also repealed the corporate alternative minimum tax.
The changes imposed by the Tax Cuts and Jobs Act impacts certain types of businesses:
- The tax burden by pass-through companies, like sole proprietorships, partnerships, S corporations, and limited liability companies has been lowered via a 20% deduction. Under the Act, a business’s taxable income would be reduced by 20%. However, married individuals who own service-based businesses like law and accounting firms can only receive the 20% deduction if they make under $315,000 per year ($157,500 if single).
- The Act imposes a 21% excise tax on nonprofit employers for salaries they pay to executives above $1 million.
- The Act expanded the list of taxpayers that are eligible to use the cash method of accounting by allowing taxpayers that have average annual gross receipts of $25 million or less in the three prior tax years to use the cash method.
With respect to expenses and deductions, the new Act provides:
- Interest deduction limitation: The deduction for business interest is limited to the sum of (i) business interest income; (ii) 30% of the taxpayer’s adjusted taxable income for the tax year; and (iii) the taxpayer’s floor plan financing interest for the tax year. Any disallowed business interest deduction can be carried forward indefinitely (although there are certain restrictions on partnerships). The interest deduction limitation, however, does not apply to a taxpayer that meets a $25 million gross-receipts test, or a taxpayer that is a real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.
- Net operating losses: The Act limits the deduction for net operating losses (NOLs) to 80% of taxable income for losses (property and casualty insurance companies are exempt from this limitation). Taxpayers are allowed to carry NOLs forward indefinitely. Except for farming businesses, the two-year carryback and special NOL carryback provisions were repealed.
- Like-kind exchanges: Under the Act, like-kind exchanges under Sec. 1031 will be limited to exchanges of real property that are not primary residential property. This provision generally applies to exchanges completed after Dec. 31, 2017. However, an exception is provided for any exchange if the property disposed of by the taxpayer in the exchange was disposed of on or before Dec. 31, 2017, or the property received by the taxpayer in the exchange was received on or before that date.
- Domestic production activities: The Act repealed the domestic production activities deduction.
- Entertainment expenses: The Act disallows a deduction for (i) an activity generally considered to be entertainment, amusement, or recreation; (ii) membership dues for any club organized for business, pleasure, recreation, or other social purposes; or (iii) a facility or portion thereof used in connection with any of the items mentioned in (i) or (ii).
- Meals: Under the Act, taxpayers are still generally able to deduct 50% of the food and beverage expenses associated with operating their trade or business (for instance, meals consumed by employees on work travel). For amounts incurred and paid after Dec. 31, 2017, and until Dec. 31, 2025, the Act expands this 50% limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer.
- Partnership technical terminations: The Act repealed the Sec. 708(b)(1)(B) rule providing for technical terminations of partnerships under specified circumstances.
- Carried interests: The Act provides for a three-year holding period for certain net long-term capital gain for applicable partnership interest held by the taxpayer.
- Amortization of research and experimental expenditures: Under the Act, amounts defined as specified research or experimental expenditures must be capitalized and amortized over a five-year period. Specified research or experimental expenditures that are attributable to research that is conducted outside of the United States must be capitalized and amortized over a 15-year period.
The Act modified a number of credits available to businesses, such as the Orphan Drug Credit and Rehabilitation Credit. For 2018 and 2019 only, the Act allows eligible employers to claim a credit equal to 12.5% of the amount of wages paid to a qualifying employee during any period in which the employee is on family and medical leave if the rate of payment under the program is 50% of the wages normally paid to the employee. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%. The maximum amount of family and medical leave that may be taken into account for any employee in any tax year is 12 weeks.
The new law provides a 100% deduction for the foreign-source portion of dividends received from “specified 10% owned foreign corporations” by domestic corporations that are U.S. shareholders of those foreign corporations. No foreign tax credit or deduction will be allowed for any taxes paid or accrued with respect to a dividend that qualifies for the deduction. A domestic corporation will not be permitted a deduction for any dividend on any share of stock that is held by the domestic corporation for 365 days or less during the 731-day period beginning on the date that is 365 days before the date on which the share becomes ex-dividend with respect to the dividend. The Act generally requires that, for the last tax year beginning before Jan. 1, 2018, any U.S. shareholder of a specified foreign corporation must include in income its pro rata share of the accumulated post-1986 deferred foreign income of the corporation.
With the Act, the U.S. is switching to a territorial system of taxation, which means companies will not be subject to federal taxes on income they earn overseas. Under the Act, multinationals with deferred taxes on earnings can repatriate those earnings at a special one-time, low rate of 15.5% or less.
Attorney Kim Spotts-Kimmel is a member of the firm’s Business Services Group and Chairs the firm’s Tax Law Group, providing counsel to businesses of all sizes.