The Tax Cuts and Jobs Act, a $1.5 tril­lion tax cut pack­age, was signed into law on Decem­ber 22, 2017. The cen­ter­piece of the leg­is­la­tion is a per­ma­nent reduc­tion of the cor­po­rate income tax rate. The cor­po­rate rate change and some of the oth­er major pro­vi­sions that affect busi­ness­es and busi­ness income are sum­ma­rized below. Pro­vi­sions take effect in tax year 2018 unless oth­er­wise stated.

Corporate tax rates

  • Instead of the pre­vi­ous grad­u­at­ed cor­po­rate tax struc­ture with four rate brack­ets (15%, 25%, 34%, and 35%), the new leg­is­la­tion estab­lish­es a sin­gle flat cor­po­rate rate of 21%.
  • The Act reduces the div­i­dends-received deduc­tion (cor­po­ra­tions are allowed a deduc­tion for div­i­dends received from oth­er domes­tic cor­po­ra­tions) from 70% to 50%. If the cor­po­ra­tion owns 20% or more of the com­pa­ny pay­ing the div­i­dend, the per­cent­age is now 65%, down from 80%.
  • The Act per­ma­nent­ly repeals the cor­po­rate alter­na­tive min­i­mum tax (AMT).

Pass-through business income deduction

Indi­vid­u­als who receive busi­ness income from pass-through enti­ties (e.g., sole pro­pri­etors, part­ners) gen­er­al­ly report that busi­ness income on their indi­vid­ual income tax returns, pay­ing tax at indi­vid­ual rates.

For tax years 2018 through 2025, a new deduc­tion is avail­able equal to 20% of qual­i­fied busi­ness income from part­ner­ships, S cor­po­ra­tions, and sole proprietorships.

For those with tax­able incomes exceed­ing cer­tain thresh­olds, the deduc­tion may be lim­it­ed or phased out alto­geth­er, depend­ing on two broad factors:

  • The deduc­tion is gen­er­al­ly lim­it­ed to the greater of 50% of the W‑2 wages report­ed by the busi­ness, or 25% of the W‑2 wages plus 2.5% of the val­ue of qual­i­fy­ing depre­cia­ble prop­er­ty held and used by the busi­ness to pro­duce income.
  • The deduc­tion is not allowed for cer­tain busi­ness­es that involve the per­for­mance of ser­vices in fields includ­ing health, law, account­ing, actu­ar­i­al sci­ence, per­form­ing arts, con­sult­ing, ath­let­ics, and finan­cial services.

For those with tax­able incomes not exceed­ing $157,500 ($315,000 if mar­ried fil­ing joint­ly), nei­ther of the two fac­tors above will apply (i.e., the full deduc­tion amount can be claimed). Those with tax­able incomes between $157,500 and $207,500 (between $315,000 and $415,000 if mar­ried fil­ing joint­ly) may be able to claim a par­tial deduction.

“Bonus” depreciation

The cost of tan­gi­ble prop­er­ty used in a trade or busi­ness, or held for the pro­duc­tion of income, gen­er­al­ly must be recov­ered over time through annu­al depre­ci­a­tion deduc­tions. For most qual­i­fied prop­er­ty acquired and placed in ser­vice before 2020, spe­cial rules allowed an up-front addi­tion­al “bonus” amount to be deduct­ed. For prop­er­ty placed in ser­vice in 2017, the addi­tion­al first-year depre­ci­a­tion amount was 50% of the adjust­ed basis of the prop­er­ty (40% for prop­er­ty placed in ser­vice in 2018, 30% if placed in ser­vice in 2019).

The Act extends and expands first-year addi­tion­al (“bonus”) depre­ci­a­tion rules. Bonus depre­ci­a­tion is extend­ed to cov­er qual­i­fied prop­er­ty placed in ser­vice before Jan­u­ary 1, 2027. For qual­i­fied prop­er­ty that’s both acquired and placed in ser­vice after Sep­tem­ber 27, 2017, 100% of the adjust­ed basis of the prop­er­ty can be deduct­ed in the year the prop­er­ty is first placed in ser­vice. The first-year 100% bonus depre­ci­a­tion per­cent­age amount is reduced by 20% each year start­ing in 2023 (i.e., the first-year bonus per­cent­age amount will be 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026) until bonus depre­ci­a­tion is elim­i­nat­ed alto­geth­er begin­ning in 2027.

For qual­i­fied prop­er­ty acquired before Sep­tem­ber 28, 2017, pri­or bonus depre­ci­a­tion lim­its apply — if placed in ser­vice in 2017, a 50% lim­it applies; the lim­it drops to 40% if the prop­er­ty is placed in ser­vice in 2018, and to 30% if placed in ser­vice in 2019.

Note that the time­lines and per­cent­ages are slight­ly dif­fer­ent for cer­tain air­craft and prop­er­ty with longer pro­duc­tion periods.

Internal Revenue Code (IRC) Section 179 expensing

Small busi­ness­es may elect under IRC Sec­tion 179 to expense the cost of qual­i­fied prop­er­ty, rather than recov­er such costs through depre­ci­a­tion deduc­tions. The Tax Cuts and Jobs Act increas­es the max­i­mum amount that can be expensed in 2018 from $520,000 to $1,000,000, and the thresh­old at which the max­i­mum deduc­tion begins to phase out from $2,070,000 to $2,500,000. Both the $1,000,000 and $2,500,000 amounts will be increased to reflect infla­tion in years after 2018. The new law also expands the range of prop­er­ty eli­gi­ble for expensing.

Foreign income

Under pre-exist­ing cor­po­rate tax rules, U.S. com­pa­nies were taxed on world­wide prof­its, with a cred­it avail­able for for­eign tax­es paid. If a U.S. cor­po­ra­tion earned prof­it through a for­eign sub­sidiary, how­ev­er, no U.S. tax was typ­i­cal­ly due until the earn­ings were returned to the Unit­ed States, gen­er­al­ly in the form of div­i­dends paid. This sys­tem con­tributed to some domes­tic cor­po­ra­tions mov­ing pro­duc­tion over­seas, and may have led some multi­na­tion­al com­pa­nies to keep prof­its out­side the Unit­ed States.

The new law fun­da­men­tal­ly changes the way multi­na­tion­al com­pa­nies are taxed, mak­ing a shift from world­wide tax­a­tion of income to a more ter­ri­to­r­i­al approach. Under the new rules, qual­i­fy­ing div­i­dends from for­eign sub­sidiaries are effec­tive­ly exempt­ed from U.S. tax. This is accom­plished by allow­ing domes­tic C cor­po­ra­tions that own 10% or more of a for­eign cor­po­ra­tion to claim a 100% deduc­tion for div­i­dends received from that for­eign cor­po­ra­tion, to the extent the div­i­dends are con­sid­ered to rep­re­sent for­eign earnings.

The new law also forces cor­po­ra­tions to pay U.S. tax on pri­or-year for­eign earn­ings that have accu­mu­lat­ed out­side the Unit­ed States in for­eign sub­sidiaries, through a one-time “deemed repa­tri­a­tion” of the accu­mu­lat­ed for­eign earn­ings. U.S. share­hold­ers own­ing at least 10% of a spec­i­fied for­eign cor­po­ra­tion* may be sub­ject to a one-time tax on their share of accu­mu­lat­ed untaxed deferred for­eign income; deferred income that rep­re­sents cash will be taxed at an effec­tive rate of 15.5%, oth­er earn­ings at an effec­tive rate of 8%; the result­ing tax can be paid in install­ments. The tax applies for the for­eign cor­po­ra­tion’s last tax year that begins before 2018. The one-time tax is also not lim­it­ed to C cor­po­ra­tions; it can apply to all U.S. share­hold­ers, includ­ing indi­vid­u­als (spe­cial rules apply to S cor­po­ra­tions and REITs). After pay­ing the one-time deemed repa­tri­a­tion pay­ment, for­eign earn­ings can be brought back to the Unit­ed States with­out pay­ing any addi­tion­al tax.

*Includes con­trolled for­eign cor­po­ra­tions (CFCs) and non-CFC for­eign cor­po­ra­tions (oth­er than pas­sive for­eign invest­ment com­pa­nies, or PFICs) if there is at least one 10% share­hold­er that is a U.S. corporation.

Con­tent pro­vid­ed by: Broad­ridge Finan­cial Solu­tions, Inc.

Jan­u­ary 2018