With the new tax law changes, it may be important to quickly understand how the new US Federal Tax Bill that was recently passed into law will impact you and your company. While this law primarily impacts US companies and individuals, there are also international considerations such as a new US system of international taxation that could impact non-US based entities.
Below, I’ve tried to glean and condense the most relevant elements of an extensive and complex topic to provide insight and actionable info. If you made it this far, but are ready to be done with this topic(!) - then perhaps the best ‘life hack’ at this point is to reach out to your tax provider and ask them what you should do before year-end, and in the year to come.
With that said, after considering the below Disclaimer*, I hope that the following summary helps provide you with an understanding of some of the more significant aspects of this new tax law, and how they may impact you and your business:
- A Holiday Gift? - The new tax law (passed 12/20/2017) is considered the most significant change to the US tax code in over 30 years.
- While polls show that only 33% of Americans approve of this Republican tax bill, there will be a variety of implications that, for both better and worse will impact virtually everyone for some time to come.
- Overall taxes to companies are expected to decrease by $1.5 trillion (over 10 years), however this is largely expected to be ‘funded’ by a $1.1 trillion increase in the National Debt, and the vast majority of tax cut benefits will be received by large corporations and individuals in the top income tiers.
- Most will receive some benefit from tax cuts in the short-run; some quite significantly. However as personal tax rate decreases are temporary (expiring after 8 years) and numerous deductions have been eliminated, individual taxes for many will increase over time.
- While the new law may ‘simplify tax preparation’ for some individuals by eliminating deductions, it complicates planning for others as they will need to understand new regulations and determine the best financial and operational strategy to not lose ground.
- Everyone’s financial/tax situation will be different - There will quite likely be both ‘good’ and ‘bad’ implications of the new tax law for you and your company. To optimize your financial position, it is important to consider and plan for the various changes relative to your specific business and personal situations.
- It isn’t just you! If you feel overwhelmed by the implications of the new tax law - passed a few days before year-end at an otherwise busy time of year - you’re not alone. The new tax law (and tax code in general) can be inherently confusing due to the extent of changes as well as ambiguous and vague information. This can create challenges when attempting to determine options or the best course of action relative to specific individual or company situations. Some of the confusion will be resolved by subsequent bill clarifications and IRS interpretations in the days to come. In other cases the need to interpret and apply ‘best judgement’ will remain.
- C-Corps Tax Rates Decrease – Perhaps the most significant provision of the new law is the large 2018 decrease in the C-Corp tax rate from 35% to 21%. This is the single largest ‘tax benefit’ provided by the new tax bill.
- Taxation of “Pass-through Entities” Income - The new “Pass-through” provision will add considerable complication, and have significant tax impacts for owners of certain “Pass-through Entities” (e.g., S-Corps, LLC’s, and partnerships) which make up 95% of US business.
- As this provision is poorly written, vague, and complicated – it isn’t yet fully clear as to which businesses, and what income, will and won’t qualify under this provision. It is all but certain that the IRS will be providing significant clarification and guidance.
- Key elements that are known include:
- The stated intent of this bill is to lower the tax burden on certain pass-through business owners through the deduction of up to 20% of certain earnings. The calculation of the deduction involves somewhat complicated calculations and phase-outs.
- Certain ‘Professional Service Businesses’ such as doctors, attorneys, financial services companies, and consultants – ‘where the principal asset of the business is the reputation or skill of the employees or owners’ - are not expected to benefit from this deduction. Others who lobbied better such as engineers and architects are expected to benefit.
- The impact on certain other service businesses such as marketing, PR, branding, and other creative firms is still uncertain and may end up depending upon how the activities of a given business are characterized.
- As the status of this important, yet complex deduction isn’t yet clear – we’ll be watching closely for further guidance and analysis. We plan to follow-up further when it is available.
- Elimination of Entertainment Expenses – The new law eliminates the 50% deduction for ‘entertainment…or recreation’ – apparently even if incurred in conjunction with marketing activities to attract new clients. Historically, this deduction has often been available for sports and event tickets. The extent to which this will apply still needs to be clarified.
- Business Meal Limitations - While the 50% deduction for the cost of business meals remains, meals provided on the company premises will no longer be 100% deductible, but rather a 50% deduction rate will now apply.
- Elimination of Subsidized Parking & Transit Reimbursement – Employers were eligible to deduct up to $225/mo. (tax free) to subsidize parking and other transit costs. Beginning in 2018 this deduction is gone. That said, there is a different, more complex employee deduction available.
- Business Loss Limitations – Beginning in 2018, excess business losses (which can be significant for some startups) may only be carried forward, but may no longer be carried back to prior years.
- Research & Experimentation Expenses – Deduction for certain R&E expenses is still allowed, but certain R&E expenses must now be capitalized and amortized over 5 years.
- Credit for Employer-Paid Family & Medical Leave (FML) – For 2018 – 2019, businesses may claim a credit for 12.5% of wages paid to employees on FML (assuming = 50%+ of normal wages).
- Accrual Accounting Method Requirements Eased – The threshold requiring Accrual Method Accounting is increased from $5 million, to $25 million of receipts. In addition, the Cash Method Accounting may be used by most ‘Pass-through’ ‘personal service companies’ without a $ receipts limitation test as long as ‘use of the method clearly reflects income’.
- The new tax law significantly changes the US system of international taxation.
- Currently US based taxpayers are taxed on their “Worldwide Income”, regardless of where it is earned - but they are allowed to defer paying U.S. tax on their foreign profits until they ‘bring the money home’ (aka ‘repatriation’).
- On the other hand, most foreign countries use a “Territorial System” whereby they don’t tax their citizens/companies for earnings they make offshore.
- The new tax law switches the U.S. to a Territorial System, with some additional provisions, including one that allows for ‘repatriation’ of existing foreign subsidiary earnings to the US at a very low tax rate.
- There are more international provisions that apply to individuals, but they are beyond the scope of this update.
- The decrease in the US C-Corp tax rate from 35% to 21% will have significant international implications as it is more in line with the rates of other countries. Practically, it may end up impacting the tax strategies and transfer pricing of companies with US and foreign operations, as well as ‘make the US more competitive’.
- Tax Rates Change –
- Tax rates will temporarily decrease for most, but unlike the ‘permanent’ corporate tax cuts, they expire in 2025.
- For many, the benefit of tax rate decreases will be offset by a reduction or elimination of deductions.
- Standard Deduction Increases - It roughly doubles in 2018 from $13,000 (Married Filing Jointly (MFJ)) / $6,500 (Single (S)) to $24,000 (MFJ) / $12,000 (S). An important implication of this increased standard deduction is that it won’t make sense for many people to choose the alternate method of itemizing deductions.
- Personal Exemption Eliminated – For many, the elimination of the Personal Exemption ($16,200 for a Married family of 4) more than offsets the potential benefit of the increased Standard Deduction.
- Itemized Deduction Changes – Due to the higher standard deduction thresholds, many popular itemized deductions for individuals have been curtailed. In short, for some this may make certain activities such as making charitable giving and/or investments in real estate less financially beneficial. On the other hand, the overall limitation on itemized deductions has been repealed.
- Itemized deductions eliminated or reduced include:
- State & Local Tax Changes:
- State & Local Income Taxes – This common deduction has been eliminated in 2018 except as noted. The loss of this deduction may be particularly costly to those in high tax rates states like CA & NY.
- State & Local Property and Sales Taxes - Eliminated in 2018 except as noted.
- State & Local Tax Exception >> In 2018 a taxpayer may still claim an itemized deduction up to $10,000 (MFJ) / $5000 (S) for a combination of the following:
- State & Local Income Taxes - Paid and Accrued during the tax year
- State & Local Property and Sales Taxes
- Mortgage Interest Deduction Reduced:
- Purchase Mortgages - The interest deduction limits on new ‘purchase mortgages’ of first and second homes was reduced to $750,000 of principal (previously $1,000,000) beginning in 2018.
- Home Equity Loans - This commonly used element of mortgage interest deductions is eliminated beginning in 2018.
- Impact: The loss of this deduction disproportionally impacts those living in areas like the coasts with high real estate costs. This reduced deduction is also set to be completely eliminated in 2025.
- Radical Changes to Alimony - For the last 75 years, alimony has been deductible to the spouse making the payments, but included in the income of the recipient. However, for divorces or separations after the end of 2018, a ‘Divorce Penalty’ provision was added such that the ex-spouse that pays the alimony, effectively pays the taxes for the other ex-spouse that receives their alimony payments tax free.
- 2018 may be an interesting year for spousal relations!
- Unreimbursed Employee Expenses – Best to prepay as their deductibility will largely be eliminated beginning in 2018.
- Casualty & Theft Losses – Casualty & Theft loss deductions have been eliminated beginning in 2018, unless the loss occurs within a disaster relief area declared by the president. Historically this deduction has benefited individuals impacted by fires, floods, hurricanes, robberies, etc. Moving forward this is likely to only help those that happen to be in large disaster zones.
- Tax Preparation Fees & Other Miscellaneous Deductions - in short…they have largely been eliminated
- Health Insurance - The ‘individual mandate’ (a requirement to purchase health insurance or pay a penalty) has been eliminated. It is estimated that 13 million more people will be uninsured in a decade as a result of this provision which is intended to eliminate the Affordable Care Act which has been credited with reducing the number of uninsured by tens of millions.
- Deferred Stock Option Compensation – An employee (of a non-public company) receiving employer stock options or restricted stock options (RSU’s) can elect to defer the recognition of income tax (but not FICA or FUTA) on qualified stock transferred and settled after December 31, 2017. It is important to note that this election must be made within 30 days of first vesting.
- Moving Expense Deduction – This deduction which has benefited those in transition (and didn’t require itemizing) has been eliminated after 2017.
- Estate Tax Exemption Doubled - The estate tax exemption increases to $11 million (single) and $22 million (Married Filing Jointly). In short, this currently exempts all but 0.2% of estate transfers.
- Section 529 Plans – These education savings plans, which have historically been limited to college education have been expanded such that they can now also pay for Kindergarten through 12th grade tuition.
- Alternative Minimum Tax Remains - The alternative minimum tax remains intact, although with a higher exemption amount.
*Important Disclaimers & Considerations: It is hard to add enough disclaimers to this topic without making it longer than the actual content. While I and the Richtr Financial Studio team specialize in financial operations and strategy, and regularly interface with tax matters – we are not income tax specialists and we don’t know the specifics of your tax situation. Some of the above information has been simplified, and there are important caveats to consider. Also, while I have tried to use accurate and objective sources, it is possible, particularly due to the evolving nature of these recent changes, that all of the above information isn’t 100% accurate. Please let me know if that is the case. As such we need to emphasize that we can’t be responsible for the accuracy or outcomes of any of the above tax information. It is critical that you take full responsibility for any business or personal tax/legal decisions relative to your specific situation (including different legal and tax jurisdictions), and upon consultation with your tax and legal advisors as needed.