by H2R CPA

The start of 2019 means the 2018 income tax filing season will soon be upon us. After year end, it’s generally too late to take action to reduce 2018 taxes. Business owners may, therefore, want to shift their focus to assessing whether they’ll likely owe taxes or get a refund when they file their returns this spring, so they can plan accordingly.

With the biggest tax law changes in decades — under the Tax Cuts and Jobs Act (TCJA) — generally going into effect beginning in 2018, most businesses and their owners will be significantly impacted. So, refreshing yourself on the major changes is a good idea.

Taxation of Pass-Through Entities
These changes generally affect owners of S corporations, partnerships and limited liability companies (LLCs) treated as partnerships, as well as sole proprietors:

• Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37%
• A new 20% qualified business income deduction for eligible owners (the Section 199A deduction)
• Changes to many other tax breaks for individuals that will impact owners’ overall tax liability

Taxation of Corporations
These changes generally affect C corporations, personal service corporations (PSCs) and LLCs treated as C corporations:

• Replacement of graduated corporate rates ranging from 15% to 35% with a flat corporate rate of 21%
• Replacement of the flat PSC rate of 35% with a flat rate of 21%
• Repeal of the 20% corporate alternative minimum tax (AMT)

Tax Break Positives
These changes generally apply to both pass-through entities and corporations:

• Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets
• Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million
• A new tax credit for employer-paid family and medical leave

Tax Break Negatives
These changes generally also apply to both pass-through entities and corporations:

• A new disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
• New limits on net operating loss (NOL) deductions
• Elimination of the Section 199 deduction (not to be confused with the new Sec.199A deduction), which was for qualified domestic production activities and commonly referred to as the “manufacturers’ deduction”
• A new rule limiting like-kind exchanges to real property that is not held primarily for sale (generally no more like-kind exchanges for personal property)
• New limitations on deductions for certain employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation

Preparing for 2018 Filing
Keep in mind that additional rules and limits apply to the rates and breaks covered here. Also, these are only some of the most significant and widely applicable TCJA changes; you and your business could be affected by other changes as well. ​We can help  you learn precisely how you might be affected as well as provide help preparing for your 2018 tax return filing and planning for 2019, too.

​Contact H2R CPA at 412-391-2920 or team@h2rcpa.com if you have questions about your individual or business tax planning.

by H2R CPA Team
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In April 2018, the IRS released temporary guidance on the amended limit on deductions for business interest expense for tax years beginning in 2018. Taxpayers were allowed to rely on that guidance while waiting for regulations. The IRS has now published proposed regulations that taxpayers can rely on until final regulations are released.

The proposed regulations significantly expand on the temporary guidance. They include, among other notable provisions, a broader definition of interest than businesses have applied in the past.

The deduction limit — then and now
Before the Tax Cuts and Jobs Act (TCJA) was enacted, corporations were prohibited from deducting “disqualified interest” expense. This occurred when the borrower’s debt equaled more than one and one-half times its equity and net interest expenses exceeded 50% of its adjusted taxable income (ATI), as computed without regard to deductions for net interest expense, net operating losses, domestic production activities, depreciation, amortization and depletion.

Taxpayers could carry forward excess interest (meaning any interest that couldn’t be deducted due to the 50% of ATI limit) indefinitely. Any excess limit (the excess of 50% of the borrower’s ATI over its net interest expense) could be carried forward for three years.

For tax years beginning after 2017, the TCJA amended Section 163(j) of the Internal Revenue Code to limit the deduction for business interest incurred by both corporate and non-corporate taxpayers to the sum of:

• Business interest income for the taxable year,
• 30% of the taxpayer’s ATI for the tax year, and
• The taxpayer’s floor plan financing interest paid by vehicle dealers for the tax year.

The limit applies to all taxpayers with business interest expense, except those with average annual gross receipts of $25 million or less (adjusted annually for inflation); real estate or farming businesses that elect to exempt themselves; certain regulated utilities; and certain trades or businesses, including those performing services as an employee.

The amended rules allow for the indefinite carryforward of any business interest not deducted because of the limit. With limited exceptions, taxpayers can’t carry forward “excess” limit amounts to years beginning after December 31, 2017.

The new definition of “interest”
The proposed regulations define “interest” as “any amount paid or accrued as compensation for the use or forbearance of money under the terms of an instrument or contractual arrangement, including a series of transactions.” The definition also includes amounts treated as interest under other tax code provisions or tax regs (for example, original issue discounts and accrued market discounts).

The far-reaching definition encompasses interest on conventional debt instruments as well as interest associated with transactions that are debt in substance, if not in form. The definition includes as interest certain amounts that are closely related to interest and affect the economic yield or cost of funds in a transaction involving interest, regardless of whether the amounts are compensation for the use or forbearance of money on a standalone basis. Examples include substitute interest payments, certain debt issuance costs and certain commitment fees.

The proposed regulations also include an anti-avoidance rule to prevent transactions that are essentially financing transactions from avoiding the limit. It treats as interest expense any expense or loss predominantly incurred based on the time value of money when a taxpayer secures the use of funds for a period of time. Amounts associated with time-value components that weren’t previously treated as interest now would be deemed interest. A swap transaction with significant non-periodic payments, for instance, would be treated as two separate transactions — an on-market, level payment swap and a loan.

The IRS acknowledges that, in some cases, certain items could be tested under the business interest limit that aren’t treated as interest under other tax law provisions. For example, an amount that was previously fully deductible as a business expense under Section 162 could now be tested as a business interest expense subject to limitation.

This likely will make it more difficult to negotiate financing deals with lenders that are structured to increase the borrower’s deductible costs and reduce its costs subject to limit. For example, in the past, a business might negotiate a lower interest rate in exchange for a higher loan commitment fee that it could fully deduct. Now, however, that fee could be considered interest expense. The impact will, of course, be greater as a company takes on more debt or interest rates edge higher.

Computation of ATI
ATI is calculated by computing the taxable income for the year as if all business interest expense is deductible and applying certain adjustments, as either additions or subtractions. The proposed regulations include both the adjustments already specified in Sec. 163(j) and several additional adjustments not provided in the tax provision.

Sec. 163(j) requires adjustments for:

• Any item of income, gain, deduction or loss that isn’t properly allocable to a trade or business,
• Business interest and business interest income,
• Net operating loss deductions,
• Deductions for qualified business income, and
• Deductions for depreciation, amortization and depletion for taxable years beginning before January 1, 2022.

The IRS has added adjustments to prevent double counting and other distortions. For example, the proposed regulations require the addition of capital loss carrybacks or carryovers.

Allocation of expense and income to excepted businesses
The proposed regulations include rules for determining the amount of a taxpayer’s interest expense and income that should be allocated to a business that’s subject to the business interest deduction limit when the taxpayer also is engaged in an “excepted” business that isn’t.
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The taxpayer generally must compare its basis in the assets used in the included business with its basis in the assets used in the excepted business to determine the portion that should be allocated. Several exceptions and special rules apply, including rules related to allocation among members of a consolidated group.

Much to ponder
The proposed regulations address a range of additional issues, including the application of the rules to consolidated groups, partnerships and partners, S corporations, and controlled foreign corporations. We can help you understand the proposed regulations and how they might affect your business.

Contact H2R CPA at 412-391-2920 or team@h2rcpa.com if you have questions about your individual or business tax planning.

by Kathy D. Sisler, CPA, CGMA
 
Before the Tax Cuts and Jobs Act, owners of pass-through entities and sole proprietors embraced the idea of a retirement plan for their employees, since it provided them with a tax deduction and permitted them to set aside retirement money for themselves. If you’re a professional firm, a retirement plan contribution might be an even better idea than before.
 
There’s been a lot of discussion around the new Qualified Business Income (QBI) tax deduction since the passage of the tax bill. But how does that impact your retirement plan if you are a pass-through business owner like an S-Corporation, an LLC or a sole proprietor? What if you are a specified service business?
 
The 20% deduction is limited in 2018 for owners with income greater than $315,000 (married) or $157,500 (single). Once income exceeds $415,000 (married) or $207,500 (single) the deduction is completely eliminated. Remember, if your income is under the threshold, you get the entire deduction, regardless if you are in a service industry or not. Making a retirement plan contribution can drive income down, allowing not only money to be set aside for your retirement, but driving your income under the threshold for the 20% deduction.
 
For example, Rob is 50 years old, married and is a partner in a service firm. His share of the profits are $375,000. By maxing out his 401(k) contribution and maximizing his profit sharing contribution of $60,000, his income drops to $315,000 and he is now entitled to a 20% QBI deduction of $63,000. Federal income tax on his taxable income is $43,299 instead of $66,468 computed without the 20% deduction. Rob has saved $23,169 in income tax, contributed $60,000 to his retirement and has reduced his taxable income by $93,232.
 
Members of firms with even higher profits might benefit from other types of plans which permit them to contribute larger amounts to their retirement. Of course, establishing a new plan entails time and money, but the savings could well outweigh the effort and cost.
 
There is just about one month left to establish a plan for 2018 and each person’s circumstances are unique, requiring some planning and decision making and a signed plan document before December 31st.

Contact H2R CPA at 412-391-2920 or team@h2rcpa.com if you have questions about your individual or business tax planning.