

By Ann M. Rieger & Mark J. Andres
Tax season is upon us. Individuals and businesses are collecting year-end tax statements and have begun the task of completing 2017 income tax returns. These returns will be filed under the “old” rules which predate the adoption of the Tax Cuts and Jobs Act that was passed by Congress and signed by President Trump in late December 2017 (the “2017 Act”). This annual tax reporting ritual may serve as an opportunity for taxpayers to consider the impact the 2017 Act will have upon their tax situation in 2018. Below is a brief summary of key provisions of the 2017 Act that will apply commencing with the 2018 tax year.[1]
The 2017 Act retained seven tax brackets but adjusted them downward. Tax brackets for 2018 ordinary income under the 2017 Act will be as follows:
This represents a reduction from the prior brackets which had been at 10%, 15%, 25%, 28%, 33%, 35% and 39.6%.
The 2017 Act increases the standard deduction from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples. However, the personal exemption is eliminated. The net effect is a modest increase in the overall tax savings for those taxpayers who did not previously itemize deductions. By way of example, prior to the 2017 Act, a married couple without children would have been able to claim a $13,000 standard deduction and two personal exemptions of $4,150 each (total of $8,300), resulting in an aggregate offset of $21,300.
The increase in the standard deduction and the elimination or limitations placed on various itemized deductions as outlined below, is expected to result in significantly fewer taxpayers who itemize deductions.
Charitable Deduction Implications. The 2017 Act did not eliminate deductions for charitable contributions other than those made in consideration for university seating rights associated with athletic events. Prior to the Act, charitable contributions made in consideration for the ability to purchase tickets to collegiate sporting event were 80% deductible. Deductions for contributions in consideration of such seating rights are now eliminated. While the 2017 Act made few changes to the deductibility of contributions[2] in other situations, the increase to the Standard Deduction noted above, will result in fewer taxpayers benefiting from the deductibility of charitable contributions on an annual basis. This is because a charitable deduction only provides a tax benefit to a taxpayer who itemizes deductions. Individuals who will not typically accumulate deductions in excess of the standard deduction, but who wish to obtain a tax benefit from ongoing charitable contributions, may wish to consider “bunching” deductions for multiple years into a single tax year or utilizing donor advised funds. A donor advised fund permits a taxpayer to make a large donation into a fund that will be used to facilitate contributions to donor recommended charities in the future. The contribution to the donor advised fund is deductible when made notwithstanding the fact that charitable distributions may be made over time.
The 2017 Act adds Section 199A of the Internal Revenue Code (“Section 199A”), which provides for tax favored treatment of business income from pass-through entities. Section 199A addresses the wide discrepancy of the top rates at which business income would be taxed, depending on whether a business is taxed as a corporation or pass through entity. This section allows for individual taxpayers to deduct up to 20% of “qualified business income” derived from a “qualified trade or business”. This deduction is available to individuals who itemize as well as individuals who claim the standard deduction.
Qualified Business Income ("QBI”) includes the net domestic business taxable income, gain, deduction, and loss with respect to any qualified trade or business. QBI specifically excludes investment-type income such as dividends, investment interest income, short-term and long-term capital gains, and similar items. QBI also excludes reasonable compensation of a taxpayer in the case of an S corporation. In the case of a partnership, it excludes guaranteed payments for services and payments to a partner outside of his or her capacity as a partner. A taxpayer who has a net loss when computing QBI, can carry the loss forward and treat it as a loss from a qualified trade or business in the following year.
A qualified trade or business for purposes of Section 199A includes any trade or business other than a “specified service trade or business”. The deduction does not apply to specified service businesses in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Furthermore, the deduction does not apply to service businesses that involve investing and investment management, trading or dealing in securities, partnership interests, or commodities. The deduction cannot be claimed if an individual is performing services as an employee.[5]
The Section 199A deduction is limited at the lesser of (1) 20% of qualified business income or (2) the greater of 50% of taxpayer’s allocable share of the W-2 wages paid in respect of such qualified trade or business or (b) the sum of 25% of taxpayer’s allocable share of the W-2 wages paid in respect of such qualified trade or business plus 2.5% of the unadjusted basis immediately after acquisition of qualified property used in such qualified trade or business. The total amount of the Section 199A deduction claimed in any taxable year cannot exceed the taxpayer’s taxable income (less net capital gain) for the year.
The Section 199A deduction can be claimed by taxpayers with taxable income of less than $157,500 (or $315,000 in the case of a joint return) without regard to the nature of their business and without regard to wage or asset based limits. However, limitations on the Section 199A deduction are phased in as taxable income increases above those income thresholds. Limitations on the Section 199A deduction become fully applicable to individuals with taxable income that exceeds $207,500 (or $415,000 in the case of a joint return).
The 2017 Act provides for increased expensing under Section 179 of the Internal Revenue Code. The limitation on immediate expensing of Section 179 “qualifying property” is generally increased to $1 million (from $500,000). The phase-out threshold for Section 179 deductions is increased to $2.5 million (from $2 million). There is also increased expensing under Section 168(k) of the Internal Revenue Code. First year bonus depreciation is increased from 50% to 100% for qualified assets.
The corporate alternative minimum tax (AMT) has been repealed. However, unused AMT credit carryforwards are refundable for tax years beginning after 2017 and before 2022.
Opportunities for Businesses with Changes in Corporate Taxes
Given the changes to corporate tax provisions, almost all businesses are presented with a tax advantaged environment to build and grow their respective businesses. However, particular attention should be given to the choice of business entity, to fully realize the tax advantages of the flat 21% corporate tax rate or the benefits of the Section 199A Qualified Business Income deduction. In particular, business owners will want to be mindful of the level of their taxable income and the extent of W-2 wages paid to employees, if they are to operate as a pass through entity and claim the Section 199A deduction. Further tax saving opportunities are presented to all businesses through increased expensing, credits, and deductions. A thorough review of business entity structure and related tax advantaged business opportunities, should be undertaken in light of the new corporate tax provisions. Please contact your Davis & Kuelthau attorney, the authors noted above or any member of our Tax Team for further information on the 2017 Tax Cuts and Jobs Act.
[1] Most of the individual changes highlighted in this article will expire December 31, 2025, at which time the 2017 tax law will once again become the law of the land. [2] The previous limitation on deductible cash contributions to public charities has been increased from 50% to 60% of the Internal Revenue Code (IRC) defined “contribution base” which is largely tied to Adjusted Gross Income with a few modifications. More importantly to those individuals who are college sports aficionados, the 2017 Act eliminated any deduction for charitable contributions for university athletic seating rights. [3] Married individuals filing separately are limited to a $5,000 SALT deduction. Note that this creates a marriage penalty when compared to the available $10,000 SALT deduction for unmarried persons. [4] This change in the corporate tax rate is permanent and not set to expire, unlike the changes in the individual tax rates which expire in 2025. [5] The Section 199A Deduction does not apply to amounts paid as reasonable compensation to shareholders as W-2 salary or guaranteed payments paid to members in a partnership. These payments to employee-owners are excluded under the definition of QBI that is subject to the Section 199A Deduction.