A sweeping new law, the Tax Cuts and Jobs Act (TCJA), was passed in late 2017 with significant implications for businesses. Lenders need to be aware of these changes and understand the potential ramifications for their borrowers — both positive and negative — so that they can help customers take full advantage of any new tax breaks and minimize the adverse effects of provisions that will generate additional revenue for the IRS.
What is the corporate rate?
Under prior law, C corporations paid graduated federal income tax rates as follows: 15% on taxable income of $0 to $50,000, 25% on taxable income of $50,001 to $75,000, 34% on taxable income of $75,001 to $10 million, and 35% on taxable income over $10 million. Personal service corporations (PSCs) paid a flat 35% rate.
For tax years beginning in 2018 or later, the TCJA establishes a flat 21% corporate rate. That rate also applies to PSCs. Both rate cuts are permanent, unless Congress changes the law.
Prior to the TCJA, the corporate alternative minimum tax (AMT) was imposed at a 20% rate. However, corporations with average annual gross receipts of less than $7.5 million for the preceding three tax years were exempt. For tax years beginning in 2018 or later, the new law repeals the corporate AMT.
What about pass-throughs?
Under prior law, net taxable income from pass-through business entities — including sole proprietorships, partnerships, S corporations, and limited liability companies (LLCs) that are treated as sole proprietorships or as partnerships for tax purposes — was simply passed through to the owners’ personal tax returns. It was then taxed at the owners’ standard rates.
For tax years beginning in 2018 through 2025, the TCJA establishes a new deduction based on a noncorporate owner’s qualified business income (QBI). This new tax break is available to individuals, estates and trusts that own interests in pass-through business entities. The deduction generally equals 20% of QBI, subject to a limit based on W-2 wages paid and the cost of qualified property that can apply at higher income levels.
Finally, the QBI deduction generally isn’t available for income from specified service businesses if an individual owner’s taxable income exceeds the applicable threshold. For example, this deduction isn’t allowed for most professional practices, other than engineering and architecture firms, or for businesses that involve investment-type services such as brokerage and investment advisory services.
Have business interest deductions been affected?
Subject to some restrictions and exceptions, under pre-TCJA law, interest paid or accrued by a business was fully deductible. Under the TCJA, for tax years beginning in 2018 or later, affected corporate and noncorporate businesses generally can’t deduct interest expenses in excess of 30% of “adjusted taxable income.” For S corporations, partnerships and LLCs that are treated as partnerships for tax purposes, this limit is applied at the entity level rather than at the owner level.
For tax years beginning in 2018 through 2021, adjusted taxable income is calculated by adding back allowable deductions for depreciation, amortization and depletion. After 2021, these amounts aren’t added back in calculating adjusted taxable income.
Business interest expense that’s disallowed under this limitation is treated as business interest arising in the following taxable year. Amounts that can’t be deducted in the current year can generally be carried forward indefinitely.
Taxpayers (other than tax shelters) with average annual gross receipts of $25 million or less for the three previous tax years are exempt from the interest deduction limitation. Some other taxpayers are also exempt.
For example, real property businesses that elect to use a slower depreciation method for their real property with a normal depreciation period of 10 years or more are exempt. Another exemption applies to interest expense from dealer floor-plan financing (financing by dealers to acquire motor vehicles, boats or farm machinery that will be sold or leased to customers).
How can you get up to speed?
Obviously, this is just the tip of the iceberg. The TCJA is a large, and exceedingly complex, new law. And it will take time for the IRS to issue guidance to clarify its nuances and for practitioners and business owners to fully grasp all of its potential benefits and drawbacks. We can help you stay on top of these developments and how they might affect your borrowers. Please contact Mark Abrams for questions.