Let's Take a Closer Look at New Business Tax Reforms

Copyright 2018

The Tax Cuts and Jobs Act (TCJA) provides businesses with more than just lower  income tax rates and other provisions you may have heard about. Here's an overview  of some lesser-known, business-friendly changes under the new law, along with a  few changes that could affect some businesses adversely.

Good News

Many  of the new law's provisions will reduce the amount of taxes your business will  owe, starting in 2018. Here are four examples that you might not be familiar  with:

1. Faster Depreciation for Certain  Real Property

For  property placed in service after December 31, 2017, the separate definitions of  qualified leasehold improvement property, qualified restaurant property and  qualified retail improvement property are eliminated. Under the TCJA, those  items are now lumped together under the description of qualified improvement  property, which can be depreciated straight-line over 15 years.

2. Faster Depreciation for New  Farming Machinery and Equipment

The  TCJA shortens the depreciation period from seven years to five years for new  machinery and equipment that is placed in service after December 31, 2017, and  used in a farming business (other than grain bins, cotton ginning assets,  fences or other land improvements). In addition, the faster double-declining  balance method can be used to calculate annual depreciation deductions for  these types of machinery and equipment.

3. New Credit for Employer-Paid  Family and Medical Leave

For  wages paid tax years beginning after December 31, 2017, and before January 1,  2020, the TCJA allows employers to claim a general business tax credit equal to  12.5% of wages paid to qualifying employees while they're on family or medical  leave. There's a hitch: You must pay the employee at least 50% of his or her  normal wage while on leave.

Additionally,  the credit rate increases by 0.25% for each percentage point that the wage rate  paid while on leave exceeds 50% of the normal rate. However, the maximum credit  rate is 25%. For example, if you pay an employee 60% of her normal wage rate  while on leave, you could qualify for a general business credit equal to 15%  (12.5% + (10 x 0.25%)), if all other conditions are met.

Important: To be eligible for the credit, the employer must provide all  qualifying full-time employees at least two weeks of annual paid family and  medical leave. Part-time employees must be given proportional leave time.

4. Accounting Change for Long-Term  Construction Contracts

Under  prior law, construction companies were generally required to use the  less-favorable percentage-of-completion method (PCM) to calculate annual  taxable income from long-term contracts for the construction or improvement of  real property. However, construction companies with average annual gross  receipts of $10 million or less in the preceding three tax years were exempt  from this requirement.

The  TCJA expands this exemption to cover contracts for the construction or  improvement of real property if they:

  • Are expected to be completed within two years, and
  • Are performed by a taxpayer with average annual gross  receipts of $25 million or less for the preceding three tax years.

This  beneficial change is effective for contracts entered into in 2018 and beyond.

Bad News

The  tax breaks provided by the TCJA will cost the federal government a significant  amount of revenue. As a result, the bill needed to raise revenue through other tax  law changes. Here are two examples:

1. Less Favorable Treatment of  Carried Interests

Historically,  private equity funds and hedge funds have been structured as limited  partnerships. Under prior law, carried interest arrangements allowed private  equity fund and hedge fund managers to give up their right to receive current  fees for their services and, instead, receive an interest in future profits  from the private equity/hedge fund partnership. These arrangements are called "carried  interests" because a private equity/hedge fund manager doesn't pay anything for  the partnership profits interest. To add to the appeal, the private  equity/hedge fund manager isn't taxed on the receipt of the carried interest (because  it's not considered to be a taxable event).

The  tax planning objective of carried interest arrangements is to trade current fee  income for partnership profits interest. Current fee income would be treated as  high-taxed ordinary income and subject to federal employment taxes. But a  partnership profits interest is expected to generate future long-term capital  gains that will be taxed at lower rates.

For  tax years beginning after 2017, carried interest arrangements face a major  hurdle: The TCJA imposes a three-year holding period requirement in order for  profits from certain partnership interests received in exchange for the  performance of services to be treated as low-taxed, long-term capital gains.

2. Self-Created Intangible Assets No  Longer Treated as Capital Assets

Effective  for dispositions in 2018 and beyond, the TCJA stipulates that certain  intangible assets can no longer be treated as favorably-taxed capital gain  assets. This change affects:

  • Inventions,
  • Models and designs (whether or not patented), and
  • Secret formulas.

The  change will cover the above types of intangibles that are 1) created by the  taxpayer, or 2) acquired from the creating taxpayer with the new owner's basis in  the intangible determined by the creating taxpayer's basis. The latter  situation could happen if the creating taxpayer gifts an intangible to another  individual or contributes an intangible to another taxable entity, such as a  corporation or partnership.

Need Help?

If you're feeling overwhelmed by the new tax law,  you're not alone. The TCJA is expected to have far-reaching effects on business  taxpayers. Contact your tax advisor to review the substance of the bill and how  your company can manage the impact.