By Mary Jane Pieroni & Stephen J. Lenivy
Businesses of all sizes, across all industries, have been impacted by the monumental changes to the federal tax code. Tax planning should consider all possibilities to lower your total tax liability effectively.
Due to the complexities of the tax law changes, the following are only summaries of these provisions. Please consult your tax adviser for guidance on applying these reforms to your business.
MARGINAL TAX RATES
The marginal tax rate is the rate applied to your next dollar of income or deduction. The maximum marginal federal tax rate has been reduced to 21 percent for C Corporations from the previous maximum marginal rate of 35 percent. Fiscal year tax filers may be eligible for a blended rate for the 2017 tax year.
CASH VERSUS ACCRUAL METHOD OF ACCOUNTING
Tax reform expands the number of taxpayers eligible to use the overall cash method to calculate taxable income. Under the new law, C Corporations (except for farming businesses and certain qualified personal service corporations) and partnerships that have a C Corporation as a partner may use the cash method of accounting if their average annual gross receipts for the three prior taxable years do not exceed $25 million.
For federal income tax purposes, the use of the overall cash method may benefit taxpayers that generate accounts receivable that significantly exceed the accrued expenses and accounts payable. Because income is reported only when actually or constructively received, the cash method enables a deferral of income until the accounts receivable amounts are received.
INTEREST EXPENSE DEDUCTION LIMITATION
For taxable years beginning after Dec. 31, 2017, the deductibility of business interest expense is limited to the sum of business interest income plus 30 percent of the adjusted taxable income of the taxpayer for the tax year. Additionally, dealers of vehicles, boats, farm machinery, or construction machinery may include the floor plan financing interest. For the purposes of this limitation, adjusted taxable income is equal to the taxable income of the taxpayer without including:
- any nonbusiness income, gain, deduction, or loss;
- business interest and business interest income;
- any net operating loss (NOL) deduction; or
- any deduction allowable for depreciation, amortization, or depletion.
The rules for deductibility vary slightly by type of entity (C Corporation, S Corporation, or Partnership). Businesses should discuss the limitation with their tax adviser to determine its effect.
The timing of asset acquisitions is critical to maximizing depreciation deductions. From time to time, Congress has enacted “bonus” depreciation provisions to give businesses additional first-year depreciation deductions that provide significant incentives for making new investments in depreciable tangible property and computer software. The 2017 tax reform increases such bonus depreciation allowances from 50 percent to 100 percent for qualified property acquired and placed in service after Sept. 27, 2017, and before 2023. In effect, the new rule permits “full expensing” of purchases of qualifying property.
With certain exceptions, bonus depreciation is now permitted for both new and used property acquired by purchase provided the property was not used by the taxpayer or a related party before the taxpayer acquired it (i.e., the taxpayer did not have a depreciable interest in the property prior to acquisition).
Businesses should plan purchases of eligible property to ensure maximum use of this annual asset expense election and bonus depreciation, as the 100 percent bonus depreciation deduction ends after 2023. The ability to claim 100 percent bonus depreciation on new and used qualified property benefits taxpayers that acquire assets that constitute a trade or business rather than acquisitions of stock, because the buyer can potentially deduct much of the purchase price in the year of purchase.
Business tax planning is very complex and involves more than just focusing on lowering taxes for the current and future years. How each potential tax-saving opportunity affects the entire business must also be considered. Also, planning for closely held entities requires a delicate balance between planning for the business and planning for its owners.
This article cannot cover every tax-planning opportunity that may be available to you and your business. Since taxes are among your largest expenses, we urge you to contact your tax adviser for a comprehensive review of the tax-saving opportunities appropriate to your particular situation. Also, additional information on tax reform is available at BDO Knows Tax Reform (bdo.com).