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House and Senate Tax Reform: Year-End Strategies for Manufacturers and Distributors
On December 22, President Trump signed the tax reform bill into law. View our tax reform chart to compare the new law with the current tax law.
The Senate passed its version of tax reform legislation on December 2, 2017. The approved bill differs from both the bill passed by the House and the bill originally introduced by the Senate.
Notable differences include the proposed individual and pass-through tax rates, limitations on the deductibility of mortgage interest, and repeal of the estate tax.
Many of the Senate provisions — including all of the individual tax reform provisions — sunset by the end of 2025. This is because of the Byrd Rule, which prevents the Senate from passing a reconciliation bill with major policy changes that are extraneous and increase the budget deficit beyond the 10-year budget window.
Summary of House’s and Senate’s plans
We offer some year-end tax strategies for your business and yourself below, based on what we think will be the likely outcome for 2018. But before we get into that, this table summarizes the key aspects of both the House’s and Senate’s tax reform plans (as of December 2), compared to current law.
|Current law||House Tax Bill||Senate Tax Bill|
|Personal tax rates||Seven tax brackets: 10%, 15%, 25%, 28%, 33%, 35%, 39.6%||Four tax brackets: 12%, 25%, 35%, and 39.6%, and a 6% surtax on a portion of income in excess of $1.2 million ($1 million for single filers)||Seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, 38.5%|
|Personal long-term capital gains and qualified dividend tax rates||Up to 23.8%||Up to 23.8%||Up to 23.8%|
|Maximum pass-through tax rate||39.6%||Passive business: maximum 25% plus net investment income tax; Active business: generally 30% of income subject to 25%, and 70% of income subject to 39.6%; Personal service business: maximum 39.6%||Ordinary rates with deduction of 23% of qualifying domestic income; limited deduction for income from lower-income service businesses|
|Maximum corporate tax rate||35%||20% (25% for personal service corporations)||20% effective for years beginning after 2018|
|Personal standard deduction||Married filing jointly: $12,700
Head of household: $9,350
|Married filing jointly: $24,400
Head of household: $18,300
|Married filing jointly: $24,000
Head of household: $18,000
|Child tax credit||$1,000 per child||$1,600 per child and a $300 credit for taxpayer, spouse, and non-child dependents||$2,000 per child; $500 for non-child dependents|
|Medical expenses||Deductible to the extent they exceed 10% of AGI||Not deductible||Deductible to the extent they exceed 10% of AGI (7.5% of AGI for 2017 and 2018)|
|Depreciation||Fixed assets are generally capitalized and depreciated; In some cases, Section 179 immediate expensing of up to $500,000 is available||Immediate expensing of most new and used property (excluding structures) through 2022; Section 179 limit increased to $5 million||Immediate expensing of most new property (excluding structures); Section 179 limit increased to $1 million|
|Depreciable life of buildings||39 years for most non-residential buildings; 27.5 years for residential rentals||39 years for most non-residential buildings; 27.5 years for residential rentals||25 years|
|Mortgage interest||Deductible on up to $1.1 million of debt; interest on second home deductible||Deductible on up to $500,000 of debt; no second home or home equity interest||Deductible on up to $1.0 million of debt (including interest on debt to acquire a second home); no home equity interest deduction|
|Personal state income, sales tax, and property tax||Allowable as an itemized deduction||Property tax capped at $10,000; income and sales tax deduction repealed||Same as House plan except unlimited carryover|
|Individual Alternative Minimum Tax (AMT)||Imposed when minimum tax exceeds regular income tax||Repealed after 2017; AMT credits refundable from 2019 through 2022||Increases AMT exemption amounts and phase-out|
|Business interest||Generally deductible||Generally limited to extent interest exceeds 30% of income; unlimited for small business||Same as House plan except unlimited carryover|
|Cash method of accounting||Generally limited to business with less than $1 million, $5 million, or $10 million in receipts depending on facts||Expanded to include businesses with less than $25 million in receipts||Expanded to include businesses with less than $15 million in receipts|
|Domestic production activities deduction||Domestic producers eligible for a deduction equal to 9% of their qualifying income||Repealed after 2017||Repealed after 2017 (2018 in the case of C corporations)|
|Corporate AMT||20% corporate AMT||Repealed after 2017; AMT credits refundable from 2019 through 2022||Retains current law|
|Net operating losses (NOL)||Generally carried back 2 years and forward 20 years||Carryback repealed except farms (one year); carryover deduction limited to 90% of pre-net operating loss income||Carryback repealed except farms (two years), carryover deduction limited to 90% of pre-net operating loss income|
|Gift and estate tax||Tax of up to 40% imposed on gifts and estates, subject to a $5.49 million lifetime exemption per spouse||Lifetime exemption doubled; estate tax repealed after 2024; gift tax remains in effect with 35% rate in 2024; step-up continues||Lifetime exemption doubled; estate tax remains in effect|
Year-end tax strategies for your business
Given the possibility that some form of this legislation will become effective in 2018, there are unique opportunities for you and your tax advisors to collaborate and strategize as 2017 draws to a close, particularly in the areas affecting small businesses. Keeping in mind that the final tax reform act will likely be different than it is as currently proposed, we suggest that manufacturers and distributors consider these year-end tax strategies now.
Cash method accounting
The cash method of accounting is popular with small manufacturing and distribution businesses, given its simplicity and flexibility. Cash method taxpayers have the opportunity to defer taxation until payments are received and to accelerate payment of expenses. You can evaluate strategies to defer income to 2018 and accelerate deductions in the last couple months of 2017. For example, while it is not recommended to make expenditures for the sake of managing taxable income, identify planned purchases related to any non-incidental materials and supplies that could be completed in 2017, rather than deferred to early 2018.
Prior year capital expenditures
Beginning in 2016, the PATH Act created a new category of bonus depreciation-eligible property: qualified improvement property, or QIP. QIP is property that meets all the following criteria:
Any improvement to an interior portion of a building, which is nonresidential real property
The improvement is placed in service after the building was first placed in service
The improvement is not attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building.
This effectively allows 50 percent bonus depreciation on certain 39-year building improvements placed in service after January 1, 2016. You should evaluate major capital expenditures placed in service after 2015 and make sure you didn’t miss any opportunities to carve out such expenditures as QIP. If you did, these could be corrected as a voluntary accounting method change, for which net negative adjustments are claimed in the year of change.
Current year capital acquisitions
Depreciation begins when the asset is in a state of readiness, available for its specifically assigned function. The tax benefit and time value of deductions for large capital expenditures could be more favorable in a higher tax-rate environment. Therefore, you should look to establish facts to indicate the capital expenditure is in a condition or state of readiness (i.e., ready and available for regular operation and income-producing use) related to certain year-end purchases.
Methods of accounting generally refer to the regular practice or procedure for determining when to recognize items of income or expense. Voluntary accounting method changes could be strategically evaluated in light of a changing rate environment. Changes in accounting methods generally require a Section 481(a) adjustment, which identifies the accumulated amount of income or deduction at the beginning of the year of change; this is necessary to prevent duplication or omission of income/deduction as your business converts from the former to new method of accounting. The adjustment is computed based on the opening balance sheet for the year of change. A net positive (unfavorable) adjustment to voluntarily correct an impermissible accounting method is spread over four years; a net negative adjustment is claimed in the year of change. However, if the IRS imposes an accounting method change, the net positive adjustment is recognized in a single year and in the earliest year being reviewed by the IRS. Many changes may be implemented without the imposition of IRS user fees under the automatic consent procedures, using form 3115.
For any unfavorable methods, the benefits of making a change in 2017 could be two-fold. First, making an accounting method change generally provides audit protection for prior years, assuming the scope limitations of the revenue procures are met. Second, the adjustment is spread over four years. Therefore, while part of the adjustment would be picked up under the current rate structures, 75 percent of the adjustment would be spread to the three subsequent years and potentially taxed at lower rates.
For favorable methods, the benefit of a change in 2017 would be taking the deduction against income in 2017. The cumulative deduction may have greater tax benefit in the current rate environment compared to proposed future tax regimes.
Pass-through entity basis
If your company is a pass-through entity, you can deduct your allocated share of losses to the extent of your basis (debt and equity). Careful planning should be taken in 2017 to achieve sufficient basis to deduct allocable losses passed through from the partnership or S corporation, rather than carrying losses to a future year, where the losses may have less tax benefit in a lower tax rate regime.
The research credit is one of the few business credits that the legislation’s framework proposes maintaining. The research credit is a federal income tax incentive providing a dollar-for-dollar reduction against a company’s computed federal tax liability. For flow-through entities, the benefit passes through to the shareholders and reduces their individual tax liabilities.
The research credit was enacted to keep jobs in the United States and to encourage companies to continually invest in new technologies. Federal research credits offer eligible companies significant tax and financial benefits, including reduced federal effective tax rates, increased cash flow, and the ability to fund future or additional research activities.
Year-end tax strategies for yourself
With a $24,000 joint/$12,000 single standard deduction, and eliminations and limitations with respect to several categories of itemized deductions, most taxpayers would not be able to itemize deductions. If this aspect of the legislation appears likely to become effective in 2018 and you currently itemize deductions, consider these prepayment options:
Prepaying (by December 31, 2017) state income tax projected to be payable with the 2017 return
Prepaying real estate taxes in late 2017, to the extent permitted under the timing of local property tax due dates
Prepaying one or more years of anticipated charitable contributions in 2017 by contributing to a self-directed donor-advised fund
How we can help
It’s clear that manufacturers and distributors are eager for changes in tax regulations and want to know what the proposed legislation has in store. The first phase of the tax act has attracted a good deal of media attention, but remember that there is still a lot of negotiating to be done among House and Senate committees. So, while we recommend considering the anticipatory strategies we’ve outlined above, we also note that any strategies you implement prior to the completion of the tax reform process should be evaluated to determine the merit of the changes under current law.
CLA’s manufacturing and distribution professionals are keeping up with all the act’s developments and can help with education and planning as the tax reform legislation unfolds.