The past couple years have brought along many changes for accountants. The new revenue recognition and leasing standards alone have increased workloads. Then there are some of us who are lucky enough to tackle the changes in the new tax law under the Tax Cuts and Jobs Act! As the end of the year approaches, the IRS has been busy clarifying the changes. So, let’s take a break from the accounting standards and jump into some interesting tax developments!
One of the biggest headlines of the new tax law was the limitation of the State and Local Tax (SALT) deduction. The new tax law limits the SALT deduction to $10,000, which is included when calculating itemized deductions on an individual return. This was bad news for residents of states with a high income tax! Some states are not happy and are fighting back. Multiple states have sued the federal government, and are working to implement workarounds for this issue.
Pass-through entities, such as partnerships and S corporations, are not taxed at the entity level, rather the tax liability is passed through to the entity owner’s individual tax returns. Since the owner’s income is taxed by states at the individual level, the potential deduction is included in the individual’s Schedule A (Itemized Deductions). It is unfortunate that for states with high income taxes, individuals may never be able to deduct the total taxes paid to state tax jurisdictions with the SALT deduction maxing out at $10,000.
In response, some states are changing their tax laws to help businesses save money.Instead of taxing the owners of pass-through entities on the entity’s income, states hope to tax the entity itself. This would create a business tax deduction that can be included on the entity’s tax return as an ordinary and necessary business expense. If these laws do become effective, it will be interesting to see if the states see an increase in their state’s apportionment percentages on pass-through entity tax returns!
In the tax world, depreciation laws typically vary from year to year. But life is about to get much easier! The Tax Cuts and Jobs Act has modified bonus depreciation, allowing taxpayers to immediately deduct 100% of eligible property until 2022. On top of that, now used property is eligible for the deduction. This change will result in generous tax savings for businesses.
Section 179 was also updated to benefit more taxpayers. The maximum Section 179 deduction increased from $500,000 to $1 million, with the phase-out threshold also increasing to $2.5 million. Qualified improvement property will now likely qualify for this deduction, along with roofs, HVAC systems, and security systems. Under both of these depreciation methods, there are still some exceptions and maximum deductions, which have been summarized by the IRS.
The most notable change in the tax overhaul was the reduction of the corporate tax rate to 21%. C corporations are taxed at the entity level, while pass-through entities are taxed at the individual business owner level. Even though many pass-through entities will be eligible for a 20% Qualified Business Income (QBI) deduction, many companies have opted to change their legal structure to a C corporation. The IRS released Rev. Proc. 2018-44 for companies that revoked the S corporation election and now must change their method of accounting from the cash method to the accrual method, in accordance with the requirements for C corporations.
When the Tax Cuts and Jobs Act was first released, there were talks about most pass-through entities considering a switch to a C corporation. However, this is certainly not a “one size fits all” solution. The QBI deduction, also known as the Section 199 deduction, is complicated and will not apply to all entities. The type of industry matters, as specified services businesses are prohibited from claiming the QBI deduction. On top of that, various states have different tax laws for each type of entity. An entity would also want to factor in the taxable income brackets when making the decision to switch to a C corporation legal structure! Here is a great summary for what the QBI deduction is all about and how it is calculated.
Busy season for tax accountants will likely be challenging this year! So now is the time to plan ahead. Consider your clients, and what impact the Tax Cuts and Jobs Act will have on their businesses and individual returns. As always, contact us with any questions you have!
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