Business tax deduction changes under the TCJA
Wednesday, January 30, 2019
Much of the mass media coverage of Tax Cuts and Jobs Act (TCJA) changes has focused on how they affect individual taxpayers. There are, after all, 150 million or so of us who, for the first time this filing season, are now dealing with the practical, real-life effects of the new law.
But let's be honest. Business taxes were the impetus behind the biggest tax reform measure in more than 30 years.
In this area, the 20 percent Section 199A tax deduction for certain small businesses has gotten the lion's share of coverage. It was added to the bill to provide pass-through entities a tax break in line with the TCJA's corporate income tax rate reduction from 35 percent to 21 percent.
The 199A write-off, however, isn't the only tax code rewrite of deductions for companies.
Below is an overview, based on information from the Internal Revenue Service's website, of eight business deductions that were changed by the TCJA. It offers highlights of how the new law differs from the pre-tax reform provisions, aka what was in effect for tax year 2017.
1. Deduction for qualified business income (QBI) of pass-through entities
2017 law: No previous law for comparison. This is a new provision.
What changed under TCJA: This new provision, popularly known as the Section 199A deduction, allows eligible businesses to deduct up to 20 percent of qualified business income. Limits apply based on income and type of business.
2. Limits on deduction for meals and entertainment expenses
2017 law: A business can deduct up to 50 percent of entertainment expenses directly related to the active conduct of a trade or business or incurred immediately before or after a substantial and bona fide business discussion.
What changed under TCJA: The TCJA generally eliminated the deduction for any expenses related to activities considered entertainment, amusement or recreation. However, under the new law, taxpayers can continue to deduct 50 percent of the cost of business meals if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant. The meals may be provided to a current or potential business customer, client, consultant or similar business contact. If provided during or at an entertainment activity, the food and beverages must be purchased separately from the entertainment, or the cost of the food or beverages must be stated separately from the cost of the entertainment on one or more bills, invoices, or receipts.
IRS Notice 2018-76 provides additional information on these changes. You also can find more in IRS Publication 535, Business Expenses.
3. New limits on deduction for business interest expenses
2017 law: The deduction for net interest is limited to 50 percent of adjusted taxable income for firms with a debt-equity ratio above 1.5. Interest above the limit can be carried forward indefinitely.
What changed under TCJA: The change limits deductions for business interest incurred by certain businesses. Generally, for businesses with 25 million or less in average annual gross receipts, business interest expense is limited to business interest income plus 30 percent of the business’s adjusted taxable income and floor-plan financing interest
There are some exceptions to the limit, and some businesses can elect out of this limit. Disallowed interest above the limit may be carried forward indefinitely, with special rules for partnerships.
4. Changes to rules for like-kind exchanges
2017 law: Like-kind exchange treatment applies to certain exchanges of real, personal or intangible property.
What changed under TCJA: Like-kind exchange treatment now applies only to certain exchanges of real property. For more information, see Form 8824, Like-Kind Exchanges, and its instructions, as well as Publication 544, Sales and Other Disposition of Assets.
5. Payments made in sexual harassment or sexual abuse cases
2017 law: No previous law for comparison. This provision dealing with sexual harassment lawsuit settlements is new.
What changed under TCJA: No deduction is allowed for certain payments made in sexual harassment or sexual abuse cases.
6. Changes to deductions for local lobbying expenses
2017 law: Although lobbying and political expenditures are generally not deductible, a taxpayer can deduct payments related to lobbying local councils or similar governing bodies.
What changed under TCJA: TCJA repealed the exception for local lobbying expenses. The general disallowance rules for lobbying and political expenses now apply to payments related to local legislation as well.
7. Excess Business Loss
2017 law: Excess farm losses (defined below) aren't deductible if the farmer receives certain applicable subsidies. This limit applies to any farming businesses, other than a C corporation, that received a Commodity Credit Corporation loan. Farming losses are limited to the greater of:
- $300,000 ($150,000 for a married person filing a separate return), or
- The total net farm income for the prior five tax years.
What changed under TCJA: Noncorporate taxpayers may be subject to excess business loss limitations. The at-risk limits and the passive activity limits are applied before calculating the amount of any excess business loss. An excess business loss is the amount by which the total deductions attributable to all of your trades or businesses exceed your total gross income and gains attributable to those trades or businesses plus $250,000 (or $500,000 in the case of a joint return).
A "trade or business" includes, but is not limited to, Schedule C and Schedule F activities, the activity of being an employee, and certain activities reported on Schedule E. (In the case of a partnership or S corporation, the limitation is applied at the partner or shareholder level.)
Business gains and losses reported on Schedule D and Form 4797 are included in the excess business loss calculation. Excess business losses that are disallowed are treated as a net operating loss carryover to the following taxable year. See Form 461 and instructions for details. For application of these rules to farmers, see also IRS Publication 225, Farmer's Tax Guide, and Schedule F instructions.
8. Net Operating Loss (NOL)
2017 law: Generally, if you have an NOL for a tax year ending in 2017, you must carry back the entire amount of the NOL to the two tax years before the NOL year (the carryback period), and then carry forward any remaining NOL. You can find more in the 2017 version of IRS Publication 536 (page 3, second column).
If your NOL is more than the taxable income of the year you carry it to (figured before deducting the NOL), you generally will have an NOL carryover to the next year. You can find more in the 2017 version of IRS Publication 536 (page 4, third column)
What changed under TCJA: Most taxpayers no longer have the option to carryback a net operating loss (NOL). For most taxpayers, NOLs arising in tax years ending after 2017 can only be carried forward. The two-year carryback rule in effect before 2018, generally, does not apply to NOLs arising in tax years ending after Dec. 31, 2017. Exceptions apply to certain farming losses and NOLs of insurance companies other than a life insurance company. For losses arising in taxable years beginning after Dec. 31, 2017, the new law limits the net operating loss deduction to 80 percent of taxable income (determined without regard to the deduction).
This overview also makes one other thing quite clear. The TCJA changes mean that most small businesses, like their individual taxpaying counterparts, could benefit greatly from getting some professional tax help in determining how the new laws apply to their enterprises.
You also might find these items of interest:
- Business tax deductions aren't hurt by IRS SALT rule
- 5 ways to maximize tax-deductible business meal expenses
- Millionaires, not smaller business owners, more likely to benefit from new 20% tax deduction
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