Business Items from Tax Reform

Transcription

1 Business Items from Tax Reform SCACPA Spring Splash Greenville, South Carolina May 18, 2018 Presented By: W. Verne McGough, Jr. Rogers, Townsend, & Thomas, P.C Main Street, 14 th Floor Columbia, South Carolina T. (803)

2 Table of Contents Background on the Tax Cuts and Jobs Act. 1 General Business Items Reduction in Corporate Income Tax Rate. 2 Corporate Alternative Minimum Tax Repeal..2 Reduction in Dividends-Received Deduction. 2 Deduction for Qualified Business Income New 199A. 2 Expensing and Business Assets Increased 179 Expensing 7 First Year Bonus Depreciation ( 168(k)) 8 Increased Automobile Depreciation Limits ( 280F).. 8 Farm Equipment ( 168) 9 Recovery Period for Real Property ( 168) 9 Limitation on the Deduction of Business Interest ( 163(j)) 10 Employment-Related Modifications Fringe Benefits ( 274). 11 Employee Achievement Awards ( 274(j)). 11 Employer-Paid Family and Medical Leave Credit ( 45S). 12 Accounting Method Changes Year of Inclusion ( 451). 12 Cash Method ( 448). 12 Inventory ( 471).. 13 Miscellaneous Net Operating Losses ( 172).. 13 Excess Business Losses ( 461(l)).. 13 Like-Kind Exchanges ( 1031).. 13 Partnership Technical Terminations ( 708). 13 Nondeductible Fines / Penalties ( 162(f) and 6050X) 14 Nondeductible NDAs ( 162(q)). 14 This summary is for general information purposes only. The observations and discussion contained herein are not intended to be and do not constitute legal advice, nor do they take into consideration the particular objectives, facts or situations of any individual client. No representation or warranty is made regarding the accuracy or completeness of the information contained herein, though Rogers Townsend believes the sources used for the information is reliable. The information contained herein is current only as of the date indicated and are subject to change (as is anything Congress touches!).

3 Background on the Tax Cuts and Jobs Act Passage. The Tax Cuts and Jobs Act ( TCJA ), P.L , passed the House on December 19, The Senate parliamentarian ruled that several provisions in the House bill would not be appropriate for a bill passed by the reconciliation process. In response the Senate dropped the provisions from their final bill, which was passed on December 20, The Senate changes forced a revote in the House, which also occurred on December 20, President Trump signed the act into law on December 22, One of the changes made in response to the Senate Parliamentarian s objections was the renaming of the act (due to an objection of the use of the word jobs in the act. As such, the technical name of the act is An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year The name Tax Cuts and Jobs Act was rejected by the parliamentarian but continues to be broadly used, including by the Internal Revenue Service( IRS ) 1. The act will be referred to as the TCJA or tax reform in these materials. Effective Date. Most of the tax reform provisions are effective beginning in The business provisions of the TCJA are largely permanent, as is the change to the approach used to inflation index items in the Code 2. Most of the tax reform provisions to individual income and transfer taxes (which are largely not covered in this outline) are effective only for taxable years from 2018 through 2025 absent further action from Congress. IRS Guidance. Progress on additional guidance from the IRS on items from tax reform, particularly in the form of informal guidance (opposed to proposed regulations which will take time to be promulgated), has been slow. The IRS released a third quarter update to the Priority Guidance Plan on May 9, The plan lists guidance projects the IRS has targeted for completion from July 1, 2017 through June 30, Part 1 of the plan lists the following areas of guidance related to the items discussed in this outline which the IRS is currently working on: 5. Computational, definitional, and other guidance under new 163(j) (new interest expense limitations). 6. Guidance on new 168(k) (first year bonus depreciation). 7. Computational, definitional, and anti-avoidance guidance under new 199A (new pass through business deduction). 1 For example, the Internal Revenue Service s main landing webpage for tax reform information contains numerous references to the Tax Cuts and Jobs Act, including a link directly to the legislation utilizing the name. see Tax Reform accessed from (last accessed May 11, 2018). 2 Code as used herein shall refer to the Internal Revenue Code, 1986, as amended. 3 Accessible at (last accessed May 11, 2018). 1

4 8. Guidance adopting new small business accounting method changes under 263A, 448, 460, and Definitional and other guidance under new 451(b) and (c) (limits on year of inclusion of income for accrual method taxpayers). Most of the guidance released by the IRS as of early May 2018 has been related to the international provisions of the TCJA. The Joint Committee on Taxation publishes bluebooks containing its description and analysis of recent changes in tax law, traditionally at the end of a two-year session of Congress. The last bluebook was issued in February 2017 regarding tax legislation enacted in Reporting in January 2018 suggested the committee would be issuing a bluebook on the TCJA. The bluebook following tax reform in 1986, which was enacted into law on October 22, 1986, was issued on May 4, General Business Items Reduction in Corporate Income Tax Rate. The TCJA replaced the corporate income tax brackets with a corporate tax rate of 21%. Corporate Alternative Minimum Tax Repeal. The alternative minimum tax, previously a concern for C corporations with average annual gross receipts of greater than $7.5 million, has been repealed effective for tax years beginning after December 31, This repeal is permanent (not scheduled to sunset). Reduction in Dividends-Received Deduction. Prior law permitted a corporation to deduct a portion of the dividends received from other domestic corporations subject to federal income tax. The TCJA reduced the deduction for the dividend-receiving corporation to 50% of the dividend if the receiving corporation owns less than 20% of the stock in payor corporation (down from 70%) and to 65% of the dividend received if the receiving corporation owns 20% or more of the stock in payor corporation (down from 80%). Members of affiliated groups continue to receive a 100% deduction for the dividend received from another member of the group. Deduction for Qualified Business Income New 199A Despite the primary goal of simplifying the tax code, several provisions of tax reform added significant complication. Chief among these provisions is new 199A, which provides certain owners of pass through businesses a deduction against qualified business income. The system 2

5 set up by 199A is a typical tax provision containing a basic rule with numerous limitations and exceptions to the limitations. The purpose of 199A is to reduce the wide gap between the corporate income tax rate (21%) and the top individual income tax rate under the TCJA (37%). Subject to the limitations and exceptions contained in 199A, the top rate on pass through business income will be 29.6%. Definitions. An understanding of several definitions is important in analyzing the deduction: Qualified Business Income ( QBI ). QBI means the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer. QBI is determined separately with respect to each qualified trade or business of a taxpayer. QBI does not include any item of income, deduction or loss allocable to: (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) Reasonable compensation paid to the taxpayer for services rendered with respect to the trade or business; Guaranteed payments described in 707(c) paid to a partner for services rendered with respect to the trade or business; To the extent provided in regulations, any payment described in 707(a) to a partner for services rendered with respect to the trade or business; Certain investment income (qualified REIT dividends, qualified cooperative dividends, or qualified publicly traded partnership income 4 ); Capital gains or losses (short-term and long-term); Dividends, income equivalent to dividends, or payments in lieu of dividends; Any interest income other than interest income which is properly allocable to a trade or business; Excess of gains over losses from commodities transactions other than (i) commodity hedging transactions (see 954(c)(5)(A)), or (ii) active business gains if substantially all of the business commodities are stock in trade which would properly be included in inventory, property held for sale in the ordinary course of business, property used in the business and subject to depreciation under 167, or supplies regularly used or consumed in the ordinary course of business. Excess of foreign currency gains over foreign currency losses from 988 transactions unless the gains are directly related to the business needs of the trade or business. Net income from notional principal contracts (other than those entered into as hedging transactions and treated as ordinary income under 1221(a)(7)); or Any amount received from an annuity which is not received in connection with the trade or business. 4 However, note that pursuant to 199A(b)(1)(B) and 199A(a)(2) there is a straight 20% deduction for these items (subject to the general deduction cap of taxable income minus net capital gain). 3

6 In the event a qualified trade or business produces a loss, such loss will be carried forward and treated as a loss from the trade or business in the succeeding taxable year. Qualified Trade or Business. A qualified trade or business is any business other than a specified service trade or business or the trade or business of performing services as an employee. Specified Service Trade or Business. A specified service trade or business means a business: (a) involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, (b) where the principal asset of the business is the reputation or skill of one or more of its employees or owners, or (c) which involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities Overall Limitation. The QBI deduction is only available for pass through business income (sole proprietorships, partnerships and S corporations) and is unavailable for income from a C corporation. Additionally, new 199A places an overall limitation on a taxpayer s QBI deduction the deduction may not exceed taxable income minus net capital gains. The deduction is equal to: (a) (b) The lesser of 20% of: (i) the taxpayer s QBI, or (ii) the taxpayer s taxable income minus net capital gain minus qualified cooperative dividends; plus The lesser of: (i) 20% of qualified cooperative dividends, or (ii) the taxpayer s taxable income minus net capital gain. Analysis of Deduction. There are four items which must be analyzed regarding the deduction: (a) a limitation based on W-2 wages paid by the trade or business or an alternative wage limitation calculation for capital intensive businesses, (b) discrimination against income from specified service trades or businesses, (c) an exception from the W-2 and specified service business rules for lower income taxpayers, and (d) an income phase-in for application of the W-2 wage and specified service rules. Several of these items may apply simultaneously to a single taxpayer. Due to the combination of these limitations and exceptions, there are numerous ways to analyze the QBI deduction (based on which limitation you analyze first). The deduction may be most easily analyzed by looking at taxpayers in different income bands (starting the analysis with the lower income exclusion): (a) Taxpayers with taxable income less than $315,000 (married joint return) or $157,500 (other taxpayers); (b) Taxpayers with taxable income between $315,000-$415,000 (married joint return) or $157,500-$207,500 (other taxpayers); and 4

7 (c) Taxpayers with taxable income above $415,000 (married joint return) or $207,500 (other taxpayers). Category 1 - Taxable Income Less Than $315,000 / $157,500. The wage limitation discussed below does not apply to taxpayers in this category. Additionally, the disfavored treatment of specified trades or businesses does not matter to taxpayers in this category (they receive the deduction if otherwise applicable not matter what type of business produces the QBI). Note that the applicable benchmark is taxable income - after the new $24,000 standard deduction (married joint) or itemized deductions and after reduction for 50% of self-employment taxes. Category 2 - Taxable Income Between $315,000-$415,000 / $157,500-$207,500. The wage limitation discussed below does apply to taxpayers in this category subject to the phase-in provision. However, the disfavored treatment of specified trades or businesses does not matter to taxpayers in this category (they receive the phased-in deduction if otherwise applicable no matter what type of business produces the QBI). This category is the only category of taxpayer to which the phase-in is applicable. Category 3 - Taxable Income Over $415,000 / $207,500. The wage limitation does apply to taxpayers in this category and the elimination of the deduction for QBI from specified service trades or businesses does apply to taxpayers in this category. If the business producing the QBI is a specific service trade or business, the taxpayer is permitted no QBI deduction for such income. W-2 Wage Limitation. The 20% QBI deduction otherwise available to a taxpayer who is subject to the wage limitation will be capped at the greater of: (i) 50% of the W 2 wages with respect to the qualified trade or business, or (ii) the sum of 25% of the W 2 wages plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property. Qualified property is tangible property subject to depreciation under 167 and which (a) is held by and available for use in the qualified trade or business at the close of the tax year, (b) is used at any point during the tax year in the production of QBI, and (c) was acquired not more than 10 years before the end of the tax year or the last day of the recovery period under 168 has not passed by the end of the tax year. For purposes of this limitation, W-2 wages means total amount of wages under 3401(a) (remuneration for services performed by an employee for an employer subject to some exclusions) plus the total amount of elective deferrals (under 402(g)(3)) and deferred compensation under 457 (including the amount of designated Roth contributions under 402A). The W-2 wages must be allocable to the QBI for the trade or business in question. If the business fails to file its wage report with the Social Security Administration within 60 days after the due date (including extensions), any wages on the report will not count for purposes of the W-2 wage limit calculation. This provides yet another excellent reason for taxpayers to file their returns timely. 5

8 Note that guaranteed payments from partnerships to partners for services rendered on behalf of the business (or any equivalent transaction under 707(a) pursuant to yet-to-be issued regulations) are excluded from the definition of QBI as they are essentially in lieu of wages. This disallows the QBI deduction for any amount of such payments. Despite this exclusion from QBI, partnership payments are not considered W-2 wages for purposes of the wage limitation. The result of this exclusion may create incentives for higher income taxpayers with sole proprietorships and partnerships to form an S corporation and pay themselves a wage in order to qualify for the deduction. Phase-In. The phase-in provision provides for a limitation on the deduction. The method for calculating the phase-in is a sliding scale application of the wage limitation to taxpayers in Category 2 (a recognition that the wage limitation does not apply to Category 1 taxpayers and applies 100% to Category 3 taxpayers). The phase-in first requires a calculation of the deduction without limits (20% of QBI) and a calculation of the W-2 wage limited deduction (50% of W-2 wages or 25% of wages plus 2.5% of unadjusted basis of qualified property). If the wage limit amount is greater than 20% of QBI the analysis stops there there is no phase-in limitation. This is the correct result as the wage limitation rules have provided no actual limitation of the deduction (the deduction will still be 20% of QBI). If 20% of QBI is greater than the wage limit amount, the statute calculates the difference (called the excess amount ). The excess amount equals 20% of QBI minus the wage limit amount. The excess amount is then multiplied by the percentage along the Category 2 range where the taxpayer s taxable income falls. For example, if married filing joint taxpayers taxable income was $390,000 the percentage used in the calculation would be 75% ( [$390,000 - $315,000] $100,000 ). The deduction will be reduced by the result of multiplying the excess amount by the calculated percentage. Additional Procedural Penalty. In order to curb potential abuses of the QBI deduction, Congress inserted a special provision in the substantial understatement penalty under The substantial understatement penalty under 6662 is equal to 20% of the underpayment. The provision ( 6662(d)(1)(C)) reduces the threshold for a substantial understatement from 10% of the tax required to be shown on the return to 5%. This provision applies to any taxpayer who claims the QBI deduction (no matter the size of the deduction taken). The reduction applies to all items affecting the tax required to be shown on the return. As a result, a taxpayer who claims a $2,000 QBI deduction and has an understatement between 5% and 10% stemming from an item unrelated to the business could be subject to the penalty. Note that a taxpayer can escape the penalty by showing they had substantial authority for their position, the position had a reasonable basis and was disclosed on the return, or the taxpayer had a reasonable basis for the erroneous reporting. Taxpayers frequently attempt to escape 6

9 penalties by showing reasonable reliance on their tax return preparer. If successful, the preparer may be at risk of the tax return preparer penalty under Issues Which Require Guidance (and likely controversy). Numerous issues have already arisen which require guidance from the IRS and which will almost certainly result in controversy as taxpayers engage in business tax planning 5 : 1. Will the IRS seek to apply reasonable compensation standards to the QBI deduction? These standards are used against taxpayers owning S corporations to enforce the employment tax rules. There are currently no similar rules applicable to partners in partnerships with respect to payments for services a partner renders to the business. These payments are exceptions from the definition of QBI and would not be included in calculating the deduction. 2. How will 199A apply to entities which operate more than one trade or business? The Code section reads as though the rules are to be applied at the trade or business level, regardless of the legal form of the business (other than the exclusion for any deduction on C corporation income). 3. May a taxpayer separate specified service activities from non-specified services activities within one legal entity or will entity restructuring be required in order for the taxpayer to receive the QBI deduction (or receive a larger deduction) with respect to the non-specified service income? 4. Will trades or businesses which operate in similar industries be aggregated for purposes of the rules? What if a taxpayer owns 5 franchise restaurant locations in separate pass through entities? Will a taxpayer be allowed or required to aggregate the QBI from the restaurants in calculating the deduction? 5. Whether real property rental income is qualified business income? 6. What if a partnership or S corporation converts a non-owner employee into an owner in order to expand the overall QBI deductions obtainable by the owners (possibly with a compensation reduction to the non-owner employee)? Sunset. Finally, this deduction is scheduled to be repealed at the end of The sunsetting of this deduction will require additional analysis and may cause some taxpayers to pause on a corporate change they may otherwise have made. Expensing and Business Assets Increased 179 Expensing. Under pre-tcja law, a taxpayer could immediately expense up to $500,000 (indexed for inflation) in depreciable tangible personal property purchased for use in 5 See Letter from Annette Nellen, Chair, AICPA Tax Executive Committee to The Honorable David J. Kautter, Assistant Secretary for Tax Policy, and William Paul, Principal Deputy Chief Counsel and Deputy Chief Counsel (Technical), dated January 29, 2018, available at downloadabledocuments/ aicpa-guidance-request-on-pub-l-no pdf (last accessed May 11, 2018). 7

10 a trade or business and certain real property used in a trade or business (qualified leasehold and retail improvements and qualified restaurant property). The deduction was limited by the amount qualifying property placed in service in a given tax year exceeded $2 million. The TCJA expanded expensing to permit a deduction of up to $1 million in property with a phaseout threshold beginning at $2.5 million. Additionally, the definition of qualified real property was expanded to include roofs, HVAC systems, fire protection and alarm systems, and security systems, provided such expenses were incurred with respect to nonresidential real property. Passenger vehicles are eligible for expensing to the extent of dollar limits contained in 280F (covered below). Maximum expensing for SUVs with a vehicle weight rating between 6,000 and 14,000 pounds is $25,000 such vehicles are exempt from the 280F limits. First Year Bonus Depreciation ( 168(k)). Prior 168(k) permitted an additional first-year depreciation deduction in the amount of 50% of the adjusted basis of qualified property placed in service before Following tax reform, 168(k) now provides for a 100% deduction for qualified property acquired and placed in service after September 27, 2017 and prior to January 1, The phase-down of the prior 50% limit (which applied to property placed in service before 2020) has effectively been repealed for property acquired and placed in service after September 27, The TCJA expanded bonus depreciation to used property acquired and placed in service by a taxpayer (prior law limited taxpayers to new property). Congress unintentionally removed qualified improvement property from first year bonus depreciation in the TCJA. Qualified improvement property is The TCJA provides for a new phasedown period the deduction for first year bonus depreciation is limited as follows: Year Deduction % % % % % First year bonus depreciation is repealed (sunsets) for property placed in service after Special first year bonus depreciation rules (not covered here) apply to certain property with longer production periods and certain plants bearing fruits or nuts. Increased Automobile Depreciation Limits ( 280F). 280F provides limitations to the amount of depreciation allowable on certain passenger automobiles. Amended 280F applies to passenger automobiles placed in service beginning in 2018 and for which the additional first 8

11 year depreciation under 168(k) is not claimed. The revised law provides for the following maximum depreciation amounts (indexed for inflation): Year Depreciation Limit Pre-TCJA Limit 1 (placed in service) $10,000 $3,160 2 $16,000 $5,100 3 $9,600 $3,050 4 or later $5,760 $1,875 First year bonus depreciation (discussed in detail above) for eligible passenger auto remains capped at $8,000. Finally, special rules apply to listed property under 280F. Such property must be depreciated straight-line depreciated and 179 expensing in unavailable if the property is not used more than 50% for business. If business use initially qualifies and subsequently falls below 50%, a portion of the depreciation is subject to recapture. Following tax reform, listed property includes passenger autos, other property used as transportation, and property of a type generally used for entertainment, recreation, or amusement. Notably, computer or peripheral equipment was removed from the definition of listed property. Farm Equipment ( 168). Prior law provided that many depreciable assets used in agricultural activities were assigned a recovery period of 7 years. Farm property (other than non-residential real property, residential rental property, and trees or vines bearing fruits or nuts) was subject to the 150% declining balance method. Tax reform shortened the recovery period to 5 years for most new machinery and equipment used in farming and placed in service after December 31, 2017 and repealed the 150% declining balance depreciation method for such property. The 150% declining balance method continues to apply to 15-year or 20-year property used in farming to which the straight-line method does not apply and to property for which the taxpayer elects the use of the 150% declining balance method. Thus, most farm property is now depreciable under the 200% declining balance method except for (1) buildings and trees or vines bearing fruits or nuts (straight-line), (2) property for which the taxpayer elects straight-line or 150% declining balance, (3) 15- or 20- year property that has to be depreciated under the 150% declining balance method, and (4) property subject to the accelerated depreciation system ( ADS ). Recovery Period for Real Property ( 168). Prior law provided for several categories of qualified real property interests subject to depreciation - qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property. The TCJA repealed these separate definitions for property placed in service after December 31, 2017 and provided a 10-year recovery period and straight-line depreciation for qualified improvement property. The TCJA provides a 20-year ADS recovery period for qualified improvement property. 9

12 Qualified improvement property is any improvement to the interior of a non-residential building if the improvement is placed in service after the date the building was first placed in service. It does not include any improvement attributable to a building enlargement, an elevator or escalator, or the building s internal structural framework. Finally, the TCJA shortened the ADS recovery period for residential rental property to 30 years. Prior law provided for a 40-year recovery period under ADS. Limitation on the Deduction of Business Interest ( 163(j)) Prior law provided that interest was generally deductible by businesses subject to limitations. For non-corporate taxpayers, the deduction for debt allocable to property held for investment (investment interest) was limited to the taxpayer s net investment income. Corporate interest deductions were disallowed if the corporation s debt-to-equity ratio exceeded 1.5-to-1 and the corporation s net interest expense exceeded 50% of adjusted taxable income. Under the TCJA, business interest deductions are now limited to the sum of: (a) the taxpayer s interest income, (b) 30% of the taxpayer s adjusted taxable income ( ATI ), and (c) any floor plan financing interest incurred by the taxpayer. The definition of ATI depends on the tax year in question: Tax Years Beginning Before 2022 After 2021 Definition of ATI Taxable income allocable to a trade or business increased by deductions for interest, taxes, depreciation, and amortization ( EBITDA ) Taxable income allocable to a trade or business increased by deductions for interest and taxes ( EBIT ) Any interest which is over the limitation ( excess business interest ) will not be deductible and will be carried forward and treated as interest expense incurred by the taxpayer in the following tax year. Exemptions. The business interest limitation will not apply to: (a) taxpayers with average annual gross receipts for the 3-year period ending with the prior tax year which do not exceed $25 million (unless the taxpayer is involved in a tax shelter), (b) certain regulated public utilities and electric cooperatives, (c) a real property trade or business if it uses the alternative depreciation system ( ADS ) on its real property, (d) farming businesses which use the ADS on any property used in the business with a recovery period of 10 years or more, and (e) interest expense related to floor plan financing. 10

13 Business Interest Expense in Partnerships and S Corporations. With respect to a partnership the limitation will be applied at the entity level and the excess business interest (the nondeductible portion) will be allocated to the partners in the same manner as the profits or losses of the partnership. Partners will carry excess business interest forward to be netted against future excess taxable income allocated to such partner. Excess business interest will also apply to reduce the partner s outside basis in the partner s partnership interest (not below $0). A special rule provides for an increase in the partner s outside basis immediately before a disposition of the partnership interest. 163(j)(4)(D) provides that rules similar to the partnership rules shall apply with respect to any S corporation and its shareholders. However, the excess business interest will not be allocated to the shareholders of an S corporation, nor will the shareholders receive a basis adjustment. Employment-Related Modifications Fringe Benefits ( 274). The TCJA eliminated the deduction for expenses of a trade or business related to (a) entertainment, amusement, or recreation activities, or (b) membership dues to any club organized for business, pleasure, recreation or other social purposes. Under prior law such expenses were deductible subject to a 50% limitation. The TCJA did not eliminate the 50% limitation for meal deductions related to the trade or business. The deduction for business meals was expanded to include meals provided on employer premises or through an in-house cafeteria and the exclusion from income for the employee s receipt of the benefit was retained. The deduction for meals provided for the convenience of the employer on business premises or through an employer-operated facility will be repealed for tax years beginning after Tax reform also repealed the employer s deduction for employee transportation fringe benefits (parking and mass transit) and for expenses which are the equivalent of commuting for employees (except as provided for the safety of the employee). However, the employee s exclusion from income for receipt of such benefits was retained. Employee Achievement Awards ( 274(j)). Employers may deduct employee achievement awards valued at up to $400 per employee or $1,600 for a qualified plan award. The award is excluded from the income of the employee. An employee achievement award is an item of tangible personal property given in recognition of length of service or safety achievement and presented as part of a meaningful presentation. The TCJA added a limitation on the term tangible personal property, which now specifically excludes cash, cash equivalents, gifts cards, gift coupons, most gift certificates, vacations, meals, lodging, tickets for theatre or sporting events, stock, bonds or similar items. 11

14 Employer-Paid Family and Medical Leave Credit ( 45S). The TCJA added a new tax credit for employers. Employer s now receive a credit for payments to qualifying employees during any period in which the employee is on FMLA family or medical leave if the payment is equal to at least 50% of the wages which would have been paid to the employee if they were not on leave. The credit is limited to payments made in tax years beginning after December 31, 2017 and before January 1, 2020 (2018 and 2019 tax years). The base credit is 12.5% of the payment made to the employee during leave, increased by 0.25% for each percentage point the payment is above the 50% mark. The credit is limited to the compensation which would have been payable to the employee had they not been on leave and may be taken by the employer for up to 12 weeks of leave (per employee). The employer must also have written policies in place providing for at least 2 weeks of annual paid family and medical leave (or a pro rata portion of the leave for qualifying part-time employees). Accounting Method Changes Year of Inclusion ( 451). The TCJA provides that taxpayers are now required to recognize income not later than the tax year during which the income is placed on an applicable financial statement. Applicable financial statements include GAAP-prepared financial statements which are: (a) 10-Ks or annual statements required to be filed with the Securities and Exchange Commission, (b) audited financial statements used for credit purposes, shareholder/partner reporting purposes, or any other substantial nontax purpose, or (c) file with a federal agency for non-tax purposes. The deferral method of accounting for advance payments detailed in Revenue Procedure was also codified. This method permits taxpayers to defer inclusion of income associated with advance payments for goods and services until the end of the tax year following the year of receipt, provided the taxpayer also defers the payment for financial statement purposes. Cash Method ( 448). Prior law limited use of the cash method of accounting by corporations or partnerships with a corporate partner. The entity was required to have average annual gross receipts of not more than $5 million in the preceding 3 tax years. Qualified personal service corporations (corporations in certain service industries primarily owned by employees, retired employees, estates or beneficiaries of deceased employees) were permitted to use the cash method without meeting the gross receipts test. The TCJA now permits use of the cash method by any taxpayer, other than a tax shelter, with average annual gross receipts not exceeding $25 million for the 3 prior tax years. As in prior law, qualified personal service corporations, partnerships with no C corporation partner, S 12

15 corporations and other pass-through entities may continue using the cash method without regard to the $25 million test. Inventory ( 471). Prior to tax reform, taxpayers required to use an inventory method were also generally required to use the accrual method. The cash method was only available for taxpayers with average annual gross receipts of not more than $1 million. These small taxpayers accounted for inventory as non-incidental supplies. The TCJA allows taxpayers who meet the $25 million gross receipts test to account for inventory using a method which either: (1) treats inventory as non-incidental supplies, or (2) conforms to the taxpayer s financial accounting treatment of inventory. Miscellaneous Net Operating Losses ( 172). Prior law permitted taxpayers to fully deduct net operating losses. NOLs could generally be carried back 2 years and carries forward 20 years. The TCJA limits the deduction for NOLs arising in tax years ending after December 31, 2017 to 80% of a taxpayer s taxable income (determined without regard to the NOL deduction). NOL carrybacks were eliminated except with respect to certain farming losses and property and casualty insurance companies (which retain a 2-year carryback). The TCJA now permits indefinite carryforwards except with respect to property and casualty insurance companies (which retain a 20-year carryforward). Excess Business Losses ( 461(l)). The TCJA adds new 461(l), which limits the overall business losses permitted to a taxpayer. The new limit is $250,000 ($500,000 for joint filers) above the taxpayer s aggregate gross income attributable to trades or businesses. Disallowed excess business losses are carried over to succeeding tax years as NOLs. This new limitation expires at the end of Like-Kind Exchanges ( 1031). Under prior law, taxpayers avoided gains (or losses) on property held for productive use in a trade or business or held for investment if they exchanged such property for property of a like-kind which was held for similar uses. The TCJA limits tax-free like-kind exchange treatment for transfers after December 31, 2017 to real property that is not held primarily for sale. Transition rules provide relief for exchanges where the taxpayer disposed of the relinquished property or acquired the replacement property before January 1, Partnership Technical Terminations ( 708). Prior law provided for the technical termination of a partnership following a sale or exchange of more than 50% of the total interests in the partnership s capital and profits within a 12-month period. The TCJA repealed this provision of 708. Technical terminations previously had the potential to result in unexpected tax 13

16 consequences for the remaining partners, including: (a) taxable income for a partner in the new partnership if they had a negative capital account in the old partnership, (b) the termination of old partnership s tax elections with the need for new partnership to re-elect, (c) the filing of 2 partnership tax returns, and (d) the resetting of the depreciable period for the new partnership s assets (using the new partnership s depreciable basis potentially depreciated carryover basis from old partnership). Nondeductible Fines / Penalties ( 162(f) and 6050X). Prior law disallowed deduction for payments to government entities which constituted a fine or penalty. The TCJA now provides that any amount paid to or at the direction of a government entity in relation to the violation of any law or the investigation by a government entity into a potential violation of law shall not be deductible. Exceptions to the new non-deducibility rule are (a) amounts paid for restitution or to come into compliance with any law which was violated, and (b) restitution for failure to pay federal taxes if such amount would be deductible as a tax. Additionally, the non-deductibility provision does not apply to any amount paid as a tax due. This provision is aimed at making settlements with government entities (in lieu of actual fines or penalties) non-deductible. Prior law may have allowed deductions for these payments as they were not technically a fine or penalty. Finally, government agencies are now required to report to the IRS the amount of each settlement agreement or court order where the aggregate amount paid to or at the direction of the government is at least $600. These information returns will separately state amounts for restitution or correction for non-compliance with the law. Nondeductible NDAs ( 162(q)). Prior law allowed deductions for ordinary and necessary expenses, under which taxpayers may previously have deducted amounts paid for attorneys fees or settlements related to sexual harassment or sexual abuse. New 162(q) provides that any such deduction will now be disallowed if the payments are subject to a nondisclosure agreement. 14