2017 Tax Reform: Proposed Corporate Tax Changes

The Tax Cuts and Jobs Act was released on Thursday, November 2, 2017 and there are major changes that could impact the tax system if passed. This post will describe all the changes to corporate income taxation; please click here to see the impact on individual income tax changes.

Changes to Tax Rates & Brackets

The proposed Act would provide for a flat 20% corporate tax rate beginning in 2018 for non-personal service corporations, eliminating the current graduated rate system. Also under the proposed Act, all personal service corporations would be subject to a flat 25% corporate tax rate. A personal service corporation is a corporation the principal activity of which is the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, and such services are substantially performed by the employee-owners.

Cost Recovery Deduction

Under the proposed Act, bonus depreciation would be replaced with a new 100% cost recovery deduction. Taxpayers would now be able to fully and immediately expense 100% of the cost of qualified property acquired and placed in service after September 27, 2017. Qualified property would be any property that is the taxpayer’s first use and not real property. Please note, unlike current law, this means the property does not have to be new equipment, only the taxpayer’s first use of the equipment.

Increase in Section 179 Expensing

The proposed Act would increase Section 179 expensing to $5 million, up from the current $500,000, and the phase-out amount would be increased to $20 million, up from the current $2 million limit. Section 179 allows for corporate taxpayers to expense new, used, and non-first use non-real property. The proposed law would also allow for the expensing of qualified energy efficient heating and air-conditioning property permanently.

Small Business Accounting Method Reform

The Act proposes several new changes to simplify accounting methods for small businesses. One of the bigger changes is to the cash method of accounting. Under current law, a corporation or partnership may only use the cash method of accounting if its average gross receipts do not exceed $5 million for all prior years. Under the proposed Act, the limit would be increased to $25 million and the requirement that such businesses satisfy the requirement for all prior years would be repealed.

Under the proposed Act, businesses with average gross receipts of $25 million or less would be fully exempt from uniform capitalization (UNICAP) rules. UNICAP rules require businesses to include certain direct and indirect costs associated with manufactured property by a business to be included in inventory or to be capitalized. The current law allows taxpayers with gross receipts of $10 million or less to be exempt.

Limits on Business Interest Deductions

The Act proposes that businesses with average gross receipts of $25 million or more would be subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’ adjusted taxable income. Adjusted taxable income is a business’ taxable income computed without regard to business interest, net operating losses, and depreciation, depletion, and amortization. Any interest amounts disallowed would be carried forward to the succeeding five tax years.

Alternative Minimum Tax Repealed

Under the new proposal, the alternative minimum tax on corporations would be repealed.

Net Operating Loss Deduction Limited

Under the proposed Act, corporate taxpayers would only be able to deduct a net operating loss carryover or carryback to the extent of 90% of the taxpayer’s taxable income.

Business-Related Exclusions and Deductions

Under the new Act, like-kind exchanges would only be available for real property, and not to tangible personal property, as it is allowed under current law. Like-kind exchanges refer to the deferral of gain when similar property is exchanged.

Under current law, the gross income of a corporation or partnership generally does not include contributions to its capital. However, under the proposed law, the gross income of a corporation or partnership would include contributions to its capital, to the extent the amount of money and fair market value contributed exceeds the fair market value of any stock or partnership interest that is issued in the exchange.

Under the proposed Act, no deduction would be allowed for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes. The 50% limitation under current law would still apply for food or beverages and to qualifying business meals. In addition, no deduction would be allowed for transportation fringe benefits, benefits used for on-premises gym facilities, or amenities provided to an employee that are primarily personal in nature, except to the extent that such benefits are treated as taxable compensation to an employee.

Under the Act, tax-exempt entities would be taxed on the values of providing their employees with transportation fringe benefits and on-premises gym facilities by treating the funds used to pay for such benefits as unrelated business taxable income.

Under the Act, gain or loss from the disposition of self-created patents, inventions, models, designs, or secret formulas would be treated as ordinary in character and not capital, as current law applies.

Under the proposed Act, the domestic production activities deduction (DPAD) would be repealed.

Business Tax Credits

The following business tax credits would be repealed under the new Act: the employer-provided child care credit, the rehabilitation credit, the credit for clinical testing expenses for certain drugs for rare diseases or conditions, the work opportunity tax credit, the new markets tax credit, and the credit for expenditures to provide access to disabled individuals.

Compensation Related Changes

Under current law, the deduction for compensation paid or accrued with respect to a covered employee of a publicly held corporation is limited to $1,000,000. Under the Act, the exception to the $1 million deduction limitation would be repealed.

Also under the new Act, an employee would be taxed on compensation as soon as there is no substantial risk of forfeiture with regard to that compensation.

These proposals have not been finalized and we’re anticipating many changes to the proposed Act. If you have any questions, please feel free to contact David Zajac at The Ten Key Group at (234) 334-1966.