For pass-through businesses – S Corporations, partnerships, LLCs and sole proprietorships – the Tax Cuts and Jobs Act (TCJA) provides significant changes that will impact tax planning and compliance.
Companies in some industries will fare better than others, but nearly all pass-through businesses will benefit from one of the most notable provisions of the TCJA – a 20 percent deduction off “qualified business income.”
Qualified business income is a new concept, defined in the TCJA as ordinary income for a pass-through entity, but excluding capital gains/losses, dividends and interest, annuity payments, foreign currency gains/losses, reasonable compensation paid to the owner, and guaranteed payments to partners.
Once QBI is determined, owners of pass-through entities get to do something novel – lop off 20 percent from the top. Since the income from pass-through entities “passes through” to their owners’ personal income tax returns, they do not benefit from the dramatic reduction in corporate tax rates contained in the TCJA. The 20 percent deduction off QBI levels the playing field, somewhat, between corporations and pass-through businesses.
While the 20 percent deduction off QBI is significant, construction and real estate businesses will find other significant changes in their tax situations due to the TCJA, as the 2019 tax season gets under way.
Signed in late 2017, the TCJA is the biggest federal tax overhaul in more than 30 years, and most of its provisions became effective for the 2018 tax year. Summarized below are provisions in the law that will impact most businesses this tax season.
Some of the TCJA provisions that most directly benefit construction and real estate companies involve allowable accounting methods. In the past, a small construction company or contractor with gross receipts averaging more than $10 million per year in the prior three-year period was exempt from using the cash basis accounting method. The TCJA raised the exemption threshold to $25 million per year in gross receipts, calculated by averaging income over the last three years. Not only is the cash accounting method typically simpler to use, it also means your income won’t be taxed until it’s actually in your bank account.
Changes to depreciation provisions could change the way your business makes decisions about big-ticket equipment purchases. The TCJA increased bonus depreciation from 50 percent to 100 percent for new and used property (i.e. business and office equipment) acquired between September 27, 2017 and January 1, 2023. Bonus depreciation is still 50 percent for property put into service before January 1, 2018.
Another change makes used property eligible for a 100 percent bonus depreciation as well, which means businesses no longer have to purchase new machinery and equipment in order to take advantage of depreciation. The definition of Section 179 property has also been expanded to include roofs, HVAC, fire protection systems, alarm systems and security systems.
More TCJA Changes
- Under TCJA, most taxpayers no longer have the option to carryback a net operating loss (NOL). For most taxpayers (except for certain farming operations and insurance companies), NOLs arising after 2017 can only be carried forward. And the most significant change is that NOLs may now only be used to reduce taxable income by up to 80 percent. Losses that have been carried forward from before 2018 may still offset income at 100 percent.
- Under old law, a partnership would be technically terminated if 50 percent of the partnership’s capital and profits were exchanged or sold over the course of a 12-month period. That rule was repealed.
- Property resellers were exempt from the old uniform capitalization (UNICAP) rules, provided their average annual gross receipts were under $10 million. Under the TCJA, both producers and resellers are exempt if their average annual gross receipts are under $25 million.
- The TCJA also slashed the corporate income tax rate from 35 percent to 21 percent. Individual tax rates are also going down for some brackets, with the previous top rate of 39.6 percent dropping to 37 percent.
These are just some of the highlights of the Tax Cuts and Jobs Act, but it’s a huge bill that covers a lot of different nuanced areas of tax law.
Depending on your business’ size, structure and current tax strategies, the TCJA could prove to be extremely beneficial to your company’s bottom line. Is your construction or real estate business taking advantage?