Tax projection season is upon us and is a completely new ballgame! The Tax Cuts and Jobs Act (“TCJA”) was adopted at the end of 2017 with most of it effective January 1, 2018. This legislation was the most sweeping reform of the tax code in more than 30 years. I will highlight several provisions that will be of particular importance to LICA members.
One of the biggest changes from the TCJA for flow-through entities is a deduction, against income, of up to 20% of Qualified Business Income (“QBI”). Flow-through entities (S-Corporation’s or LLC’s) are the typical structure for contractors. These types of entities do not pay taxes at the entity level. The owners report the income and the taxes are paid on their individual returns along with their personal income tax. This deduction could result in an effective tax rate of 29.6% on QBI. This is a big decrease in the tax rate from where we were. The highest individual rate before this legislation was 39.6%. If your income is considered to be QBI, then you are qualified for the deduction. The determination of the 20% deduction is an involved analysis based on 50% of total wages paid by the flow-through entity, or based on 25% of the wages and 2.5% of the unadjusted basis in qualified property.
Another big change from the TCJA is related to the depreciation rules on the purchase of fixed assets. LICA members typically have large investments in machinery and equipment and these changes will be helpful. There are two ways to immediately expense machinery and equipment purchases for tax purposes; utilizing section 179 or utilizing bonus depreciation. They are both more valuable under the new rules.
Section 179 – The old rules allowed a $510,000 deduction for eligible assets. The new rules allow for deducting of $1 million of assets purchased during the year, which will be adjusted for inflation. There is a limitation on utilizing section 179 based on the total amount of eligible property purchased during the year. The good news is that the start of the limitation has increased as well from $2 million to $2.5 million. The equipment can be financed or purchased outright.
Bonus depreciation – The change for bonus under the new rules is dramatic with an increase from a 50% expensing of assets purchased to 100% for assets purchased through January 1, 2023. There are no limitations on how much you purchase in a year when utilizing bonus depreciation. The limitations revolve around the assets themselves as it was implemented to spur economic activity. The assets must be new or qualified used property.
The TCJA reduced the tax rate for C-corporations from a graduated structure with a top rate of 35% to a flat tax rate of 21%. This 14% reduction in the rate required a discussion with our clients to determine if changing from a flow-through entity to a C-corporation would be advantageous. In most instances, the conversion to a C-corporation resulted in a short-term gain from the reduction in the tax rates, but the tax savings were lost when the long-term goals for the owners were incorporated into the analysis.
Many changes affected individuals under the TCJA. Here are a few of the items that are notable. The individual tax rates have been reduced with the top rate going down from 39.6% to 37%.
The Alternative Minimum Tax (“AMT”) has impacted many Long Islanders due to our high income and real estate taxes. The income floor, where the AMT applies , has been increased and the income level, where the floor begins to lower, has been increased—having much less of an impact.
State and local taxes (“SALT”) – State income and real estate taxes have been deducted as an itemized deduction—this is changing in a big way! Under the new rules the SALT deduction is limited to $10,000 in total.
As with anything tax related, your facts will be different than everyone else’s and you should consult with your tax advisor to address your specific situation.