Year one under the new tax law known as the Tax Cuts and Jobs Act (TCJA) brings significant changes for 2018 individual and business tax filings. Businesses are still processing the effects of the TCJA in 2019, particularly its potential ramifications on long-term planning. Below are four particularly important TCJA provisions for 2019.
Pass-Through Entity Deductions
The tax deduction for pass-through entities provides a business owner up to a 20 percent deduction against qualified business income (QBI) received from a qualified business. The deduction requires an evaluation of the nature of business activities and the sources of income from the business. Specified service trades or businesses, such as consulting, financial services, and athletics are generally excluded. QBI must be generated domestically, and excludes partner or shareholder compensation and investment income. The deduction is subject to several limitations, one of which is the lesser of 50 percent of W-2 wages (including bonuses, elective deferrals and deferred compensation) or 25 percent of W-2 wages plus 2.5 percent of qualified property.
The IRS published proposed regulations to clarify many ambiguities inherent in the provisions, but questions remain. One involves how the deduction applies to partner compensation that is received for non-partner capacity work. Another involves whether ineligible businesses can still take advantage of the deduction by implementing other strategies, such as funding retirement plans. Businesses will need to work with their tax advisors to ensure their pass-through entity deductions are calculated appropriately.
Limitation on Business Interest
The TCJA modified Section 163(j) of the Internal Revenue Code by capping the amount of business interest a taxpayer can deduct. The new limitation is equal to the sum of business interest income plus 30 percent of adjusted taxable income (essentially tax-basis EBITDA before 2023, or tax-basis EBIT thereafter). Businesses carry forward unused business interest indefinitely.
Certain types of businesses, including auto dealers, have exclusions from the limitation. Real estate, construction, and other real property businesses can elect out of the limitation, but they must depreciate their real property using slower ADS rules, which also disqualifies them for the TCJA’s enhanced bonus depreciation provisions. Fortunately, any business with average gross receipts for the prior three tax years under $25 million is exempt from the limitation.
The IRS published proposed regulations that partly address how consolidated groups should apply the limitation, and further define the types of income and expense treated as interest and therefore subject to the limitation calculation. Businesses will continue to work through the nuances of the limitation in 2019.
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