By Elizabeth Baran & Stephanie Kiewiet, CPA
2018 is a year of major tax law change following the passage of the Tax Cuts and Jobs Act (TCJA). As a business owner, you may be concerned about the changes to the deductions your business may take. Here is a brief overview of the changes that could impact your business the most.
The maximum deduction for Code Sec. 179 property will increase from $500,000 to $1 million, meaning qualified fixed asset purchases up to $1 million will be allowed full depreciation in their first year of service. This deduction phases out when new property placed into service exceeds $2.5 million, up from $2 million previously. Eligible property must have been placed in service in tax years beginning after December 31st, 2017. Additionally, qualified improvements made to nonresidential real property after the property was first placed into service will now be eligible deductions under Code Sec. 179.
For qualified property placed into service between September 27, 2017 and January 1, 2023, 100% bonus depreciation is allowed, up from 50% previously. Additionally, the definition of “eligible property” has expanded to include used qualified property, so long as the taxpayer did not use it prior to acquiring it and did not acquire it from a related party. For passenger vehicles placed into service after December 31, 2017, the following depreciation limits apply: $10,000 for the first year, $16,000 for the second year, and $5,760 for each year until the automobile is fully depreciated. If 100% bonus depreciation is claimed, the first-year limit on passenger vehicles is $18,000. If you choose to use a standard mileage rate rather than actual expenses and depreciation, the new rate is 54.5 cents per mile. Section 1031 like-kind exchanges are no longer allowed for automobiles and are now only allowed for real estate exchanges.
Machinery and Equipment used in a farming business acquired after December 31, 2017 will be depreciated over a 5-year life, instead of a 7-year life. Previously acquired property will continue to be depreciated over seven years.
Domestic Production Activities Deduction (DPAD)
DPAD, the 9% deduction on qualified production activities, has been repealed and replaced with the much more substantial and broader Qualified Business Income Deduction. This new deduction allows certain owners of pass-through entities and sole proprietors a 20% deduction on qualified business income depending on their tax situation.
Net Operating Losses
Net operating losses (NOLs) occur when the expenses of a business exceed their revenue. Previously, corporations could carry NOLs back two years and carry them forward twenty years until the loss was fully utilized. TCJA changed the years available for utilization, and limits the per year deduction.
For tax years beginning in 2018 and onward, net operating losses can no longer be carried back two years and must only be carried forward. The carry forward is no longer limited to twenty years but is available indefinitely until years of income exist. Corporations can still carry forward the NOLs until fully used; however, the annual application of the deduction is limited to 80% of the corporation’s income. This means that a net operating loss can no longer be used to fully eliminate total income in a single tax year.
Meals, Entertainment, and Fringe Benefits
For tax years 2017 and preceding, non-compensatory meals and entertainment expenses with direct relation to active conduct of a taxpayer’s trade or business have generally been limited to 50% deductibility. Additionally, certain meal expenses were deductible in full, such as those provided on the employer’s business premises to employees for the convenience of the employer, fringe benefits, and reimbursed expenses. The Tax Cuts and Jobs Act changes the deduction for certain meals and entertainment, including those associated with entertaining current or prospective clients.
Meals and entertainment that maintain their full deductibility include the compensatory meals and entertainment included as wages or non-employee compensation, firm events for the benefit of non-highly compensated employees, and de minimis fringe benefit food and beverages. Meal expenses incurred for employee or shareholder meetings and employee travel meals maintain their 50% deductibility, while meals for the convenience of an employer have been added to this list through 2025. The 50% deductibility for travel meals extends to those incurred by and for employees while working out of town. Meals and entertainment expenses that are not deductible are likely to include meals and entertainment with current or potential clients and virtually all entertainment expenses. We are still waiting on further guidance from the IRS to more clearly illustrate the changes.
Fringe benefits are a form of compensation to an employee for the performance of services. An example is tax-free qualified transportation benefits, which include transit passes, qualified parking, commuting transportation in a commuter highway vehicle, and qualified bicycle commuting reimbursement. Prior to TCJA, tax-free transportation benefits were deductible in full. The Act removes the tax-free status of bicycle commuting and repeals the deductibility of these fringe transportation benefits. In its plain language, it appears that all these items are no-longer deductible as an expense. However, if treated as taxable W-2 wages to your employee, a business can continue to take the deduction in the form of compensation expense.
For corporations and pass-through entities with gross receipts averaging over $25 million for a trailing 3-year period, a limitation to interest expense deductibility applies. Under the updated law, the business interest expense deduction allowed is limited to business interest income plus 30% of the taxpayer’s adjusted taxable income.
Navigating the changes from TCJA can be daunting, but with efficient bookkeeping and the guidance of a tax professional the transition doesn’t need to be. Maintaining separate general ledger accounts for the various expenses, particularly meals, will be of key importance in tracking the varying deductibility. As questions arise, please don’t hesitate to reach out for clarification.