🔒How federal tax reform will impact your business

On Dec. 22, President Trump signed into law the Tax Cuts and Jobs Act (the Act), which makes significant changes to the tax law pertaining to both businesses and individuals.

It would be impossible to cover all the provisions contained in the new law, so this article will outline what is most important to individuals and business owners in Connecticut.

Since these tax law changes are complicated and can have different consequences for each taxpayer, you should meet with your tax advisor to determine how these changes will affect you.

Individual provisions

The standard deduction is increasing to $24,000 from $12,700 for married couples filing jointly, and from $6,350 to $12,700 for single taxpayers.

The individual rates and brackets have been revised, and overall rates are generally lowered, with the top rate dropping from 39.6 percent to 37 percent. These tax cuts are scheduled to expire after 2025. There is no change to the preferential long-term capital gains tax rate.

The new law limits an individual's itemized deduction for state and local taxes to $10,000 in 2018. For many individuals, this limitation could significantly increase their federal income tax liability; for others, it may have limited impact if they were subject to the alternative minimum tax (AMT) whereby they were not receiving a benefit of state tax deductions anyway.

Mortgage interest deductions for new purchases of first or second homes will be capped at $750,000 in mortgage debt for mortgages incurred after Dec. 15, 2017. There are no changes for current mortgages in place under prior rules. However, home equity loan interest will no longer be deductible, even for existing debt.

The individual alternative minimum tax exemption has increased and, coupled with the limitation of state tax deductions, likely reduces the number of taxpayers subject to AMT.

For eligible taxpayers, the child tax credit is increased from $1,000 to $2,000, and a $500 credit is provided for certain non-child dependents.

Distributions from 529 Plans can be used to fund tuition and various expenses at elementary, secondary and religious schools. Historically, distributions were limited to postsecondary education. 

Business provisions

Pass-through businesses, such as S corporations, LLCs, partnerships, and sole proprietors, will receive a 20 percent deduction equal to 20 percent of “qualified business income.” However, there are several limitations, including a limitation based on W-2 wages and assets relative to the qualified business.

This benefit will be phased out for professional service businesses owned by individuals with taxable income of more than $157,500 (single filers) or $315,000 (joint filers).

The tax rate for C corporations is now 21 percent (down from 35 percent) effective Jan. 1, 2018. Additionally, the corporate AMT has been repealed.

Taxpayers can now, subject to certain limitations, deduct 100 percent of the costs of certain assets acquired to be used in a trade or business. This 100 percent deduction or “bonus depreciation” would apply to qualified property placed in service on or after Sept. 28, 2017. Qualified property is expanded to include used property.

For 2018, the maximum Section 179 deduction, which allows you to deduct certain depreciable assets, is increased from $500,000 to $1 million. There is a phase-out of such deduction for assets placed in service during the year, from $2 million to $2.5 million.

Qualified property will now also include qualified improvement property and improvements to non-residential rental property placed in service after the property was first placed in service, such as roofs, HVAC, fire protection and alarm systems.

The limitations relating to the use of the cash method of accounting have been modified so that taxpayers with annual average gross receipts under $25 million (historically under $5 million) — known as small taxpayers — will be permitted to use the cash method of accounting. Small taxpayers will no longer be required to account for inventory. Also, small taxpayers utilizing long-term contract accounting methods would no longer be required to use the percentage of completion method of accounting.

Other changes

Research and development costs must be capitalized and amortized over five years.

Interest expense is limited to business interest income, plus 30 percent of “adjusted taxable income.” The new law contains numerous exceptions to this rule, as well as special rules relating to flow-through entities.

Net operating loss (NOL) usage will be limited to 80 percent of taxable income. The law also eliminates the two-year carryback, but increases the NOL carryforward from 20 years to until the NOL is used. Additionally, for individuals, business losses can now only be used to offset business income plus $250,000 for single taxpayers and $500,000 for married couples filing jointly.

In addition, most entertainment expenses will no longer be deductible.  Business meals would still be deductible subject to the existing rules (50 percent limitation).

Brian Newman is a CPA and tax partner at accounting-consulting firm CohnReznick.