TAX BENEFITS ASSOCIATED WITH OPPORTUNITY ZONES
Qualified Opportunity Zones were established as part of tax reform, and they allow investors to defer or minimize tax on a capital gain by investing in a fund or zone investment. Assuming a taxpayer sells a stock and recognizes a $200,000 gain, investing that gain in a qualified investment within 180 days, coupled with a tax return election, will allow for deferral of the payment of tax until the earlier of the date the zone investment is sold or December 31, 2026. Additionally, zone investments funded with deferred gains and held for 5 years receive an elimination of 10% of the gain deferred, and investments held an additional two years receive an additional 5% gain forgiveness. Lastly, if the zone asset is held for 10 years, any appreciation in the asset recognized upon a sale of the investment is forgiven. While the tax benefits are terrific, the investment must make economic sense considering all facts and circumstances.
THE $10,000 CAP ON THE DEDUCTION FOR STATE AND LOCAL INCOME TAXES AND REAL ESTATE TAXES
There is a provision under the Tax Cuts and Jobs Act that limits the total combined deduction of income tax and real estate taxes to $10,000. In previous years, many taxpayers were paying the Alternative Minimum Tax (AMT), and therefore did not receive a full benefit for the tax deduction. This may lessen the impact of the SALT limitation. Additionally, the AMT exemption amount under the Tax Cuts and Jobs Act increased significantly, so we foresee fewer taxpayers being subject to AMT.
SECTION 199A’S BENEFIT TO SMALL BUSINESS TAXPAYERS
This provision is applicable to qualified businesses of all sizes and provides for a 20% deduction for the amount of Qualified Business Income, or QBI. The deduction is available to income earned by S Corporations, Partnerships (including LLCs taxed as partnerships) and Sole Proprietorships (including single member LLCs treated as such). The deduction is calculated at the individual, trust or estate level, and certain service businesses will not be allowed the deduction for those at high income levels. It is extremely important that taxpayers review their entity classification in order to maximize the benefit of Section 199A, as C Corporations do not qualify, and businesses without employees may also see their benefit of the deduction reduced. Manufacturers organized as pass-through entities may see a big benefit here.
LIMITS TO BUSINESS INTEREST DEDUCTIONS
Certain businesses may see their interest deductions limited to 30% of taxable income. While a small business taxpayer exception applies, certain businesses operating at a loss in any given year will not be able to avail themselves of this protection. Avoiding this limitation will require some analysis as to how a business is capitalized, whether via debt or equity and will also require an analysis of the use of accelerated depreciation and expensing methods under the code.
QUALIFIED CHARITABLE DEDUCTIONS
We consider Qualified Charitable Distributions (QCDs) a viable tax planning strategy. Available to taxpayers over 70 ½ years old, the provision generally allows for a trustee to trustee transfer from the IRA custodian to the charity. No itemized deduction is allowed, but the distribution is excluded from gross income, a benefit in a state such as Connecticut which does not allow itemized deductions. The QCD, limited to $100,000 per year, can also be used to satisfy a taxpayer’s required minimum distributions from an IRA.
RE-EVALUATING CHOICE OF ENTITY IN LIGHT OF TAX REFORM
C Corporations are now subject to a flat tax rate of 21%, which is very appealing for businesses that are in a growth stage and need to efficiently reinvest their earnings in the business. Compare this rate with an S Corporation owned by an individual in the highest tax bracket of 37%. Even with a deduction for 20% of business income, the federal tax rate on such business income is still 29.6%. However, one must also consider the double taxation aspect of C Corporations; earnings are taxed at the corporate level and taxed again when distributed as dividends to owners. For newly formed businesses, owners must also consider the benefits of Qualified Small Business Stock, a provision which allows sellers of C Corporation stock to exclude up to $10 million in gain from taxation. No analysis can be completed without “running the numbers” and using assumptions. A crystal ball showing the future of the US Tax system would also be helpful.
BUSINESS EXPENSING PROVISIONS MODIFIED UNDER THE TAX BILL
There were significant modifications to these provisions. First, 100% bonus depreciation was reinstated, and was modified to include used property. Second, the categories of qualified real property were reduced to one category: qualified improvement property. Due to a technical glitch, this property category is not eligible for bonus depreciation, and property in this category is depreciated over 39 years. A technical correction would fix this issue, but no one knows when that may happen. Section 179 expensing is up to $1 million, and certain real estate structural components now qualify. Lastly, depreciating a business vehicle in 2018 will more closely mirror the economic life of the vehicle. Many states have “decoupled” from these rules, so use caution when preparing state tax plans. Review Capital budgets to maximize expensing through 2022.
THE NEW ACCOUNTING METHOD CHANGES UNDER THE ACT
Qualified small business taxpayers may be able to change their overall method of accounting to the cash method, eliminate inventory accounting (other than for materials and supplies), or account for long-term contracts under the completed contract method of accounting. We think this is a big benefit in many cases, and may simplify a taxpayer’s overall record keeping burden.