As we have advised our clients about the opportunities available applying the game-changing Tax Cuts and Jobs Act of 2017, what have we learned so far? Following are 8 key tax reform takeaways, one year later:
This provision benefits all sizes of qualified businesses, providing qualifying individual taxpayers a 20% pass-through deduction based upon their aggregate Qualified Business Income, or QBI. Qualifying income includes income earned by S Corporations, Partnerships (including LLCs taxed as partnerships) and Sole Proprietorships (including single member LLCs treated as such).
C Corporations now pay a flat 21% income tax rate, which helps growth-stage businesses seeking efficiently reinvested earnings. However, taxpayers must still consider the double taxation consequence of C Corporations. Earnings are first taxed at the corporate level, then taxed again if distributed as dividends to the owners. For newly-formed businesses, owners may also consider the benefits of Qualified Small Business Stock, a provision allowing sellers of C Corporation stock to exclude gains up to $10 million from taxation.
Opportunity zones create a development tool helping low-income areas generate economic growth and add jobs using private investments. Qualified Opportunity Zone investors may defer or minimize capital gain tax by investing their gain proceeds in a fund or zone investment. While the tax benefits may be significant, taxpayers should still evaluate the underlying investment’s economic facts and risk.
The deduction for all combined state and local (e.g. income, real estate, personal property, etc.) taxes paid is now $10,000. Higher income taxpayers and taxpayers in higher tax jurisdictions are learning this provision’s impact is significant. The lost deduction is somewhat mitigated by a favorable Alternative Minimum Tax (AMT) change. Previously, AMT limited the SALT deduction for taxpayers with substantial state and local tax deductions. The Tax Cuts and Jobs Act increased the AMT exemption amount significantly, subjecting fewer taxpayers to AMT and therefore to the SALT limitation.
Certain businesses interest deductions may be limited to 30% of taxable income. While a small business taxpayer exception applies, certain businesses generating a loss in a given year may not qualify for this protection. Planning around this limitation will require analyzing whether a business is capitalized using debt or equity, as well as whether to use available accelerated depreciation and expensing methods under the code.
Most taxpayers over 70 ½ years old may exclude from taxable income a direct trustee-to-trustee IRA transfer to a qualifying charity. While no charitable deduction is allowed, the distribution is excluded from gross income. For many taxpayers the increased standard deduction makes this an effective tax planning strategy, which is even more valuable in states like Connecticut which do not allow itemized deductions. The QCD, limited to $100,000 per year, may also satisfy a taxpayer’s required minimum IRA distributions (RMD).
Significant modifications to these provisions are as follows:
Qualified small business taxpayers may now adopt the cash basis as their overall accounting method. This may eliminate inventory accounting (other than for materials and supplies), or permit long-term contract accounting under the completed contract method. This provision may offer some taxpayers a significant one-time benefit, and may also simplify their overall recordkeeping burden.