Tax Cuts and Jobs Act

Article Dean Dorton

A new bill passed Congress in December 2019 with two major impacts on nonprofit organizations. The bill is expected to be signed by the President soon. The changes are considered positive for nonprofit organizations:

  1. The bill repeals new code section 512(a)(7), enacted under the Tax Cuts and Jobs Act (TCJA), to remove the increase to unrelated business income for certain fringe benefits related to qualified transportation expenses, including expenses related to parking facilities. The repeal is retroactive to the original date of enactment under the TCJA. Taxpayers who reported these expenses, incurred after December 31, 2017, as income on Form 990-T may file an amended Form 990-T to claim a refund for any taxes paid related to these fringe benefits. This is a long awaited repeal for the tax-exempt community!
  2. The Act also changes the Internal Revenue Code (IRC) section 4940 private foundation excise tax on net investment income to 1.39%. It eliminates the dual tax rate of 1% or 2% determined based upon the private foundation’s qualifying charitable distributions. The 1.39% rate will be effective for tax years beginning after the date of the Act’s enactment.

Article Dean Dorton

By Erica Horn, CPA, JD

While it is possible you missed it, it’s doubtful. The first major reform of the federal tax code in 30 years was enacted into law at the end of December. Promising tax cuts for everyone, the bill is called the Tax Cuts and Jobs Act (TCJA). This article highlights some of the changes made to individual income taxation.

Individual tax rates

Under the new tax law, the individual income tax brackets are structured as follows:

Tax Rate Single Married Filing Jointly
10% $0 – $9,525 $0 – $19,050
12% $9,526 – $38,700 $19,051 – $77,400
22% $38,701 – $82,500 $77,401 – $165,000
25% $82,501 – $157,500 $165,001 – $315,000
32% $157,501 – $200,000 $315,001 – $400,000
35% $200,001 – $500,000 $400,001 – $600,000
37% $500,001+ $600,001+

These rates are lower than the previous rates; however, not significantly lower. The big savings for individuals is to come through the near doubling of the standard deduction.

Personal exemptions and the standard deduction

The TCJA eliminates personal exemptions but compensates by increasing the standard deduction to $12,000 single and $24,000 married filing jointly (MFJ), indexed for inflation for tax years beginning after 2018. According to the Tax Foundation, nearly 70% of all filers take the standard deduction, meaning only 30% of filers itemize deductions. Therefore, even after the elimination of the personal exemption, when the lower rates are coupled with the increase in the standard deduction, the result should be a tax decrease for many taxpayers.

So what about the 30% that itemize deductions?

Every deduction on Schedule A has been modified to some extent. Accordingly, the 30% of taxpayers that have historically itemize deductions will be impacted.

Some of the more significant changes are described below. Unless otherwise noted, these changes are in effect for tax years beginning after December 31, 2017 and before January 1, 2026.Changes to deduction for medical and dental expenses

Under pre-TCJA tax law, the deduction for qualified medical expenses was allowed for qualified medical expenses exceeding 10% of adjusted gross income (AGI). This floor was reduced to 7.5% of AGI for taxpayers 65 and older; however, that provision expired on December 31, 2016. Under the TCJA, the 7.5% floor is extended through 2018.

Changes to state and local tax deduction

Under pre-TCJA law, taxpayers were entitled to a deduction, without limitation, equal to the state and local taxes (SALT) paid during the year. The deduction primarily consisted of state, local, and/or foreign real property and income taxes paid.

Under the new tax law, SALT deductions are capped at $10,000. Since this has traditionally been one of the largest itemized deductions, it is anticipated that it will have one of the greatest impacts on taxable income.Changes to mortgage interest deduction

Under the TCJA, mortgage interest on loans used to acquire a principal residence and/or a second home remains deductible, but only on debt up to $750,000. The limitation was $1 million under prior tax law. Taxpayers with debt acquired on or before December 15, 2017 remain subject to the $1 million limitation, as the new law is not applied retroactively.

Changes to charitable contributions deductions

Under the TCJA, the limit for cash contributions has been extended from 50% to 60% of the contribution base, which is generally a taxpayer’s AGI. However, payments made to a college or university in exchange for the right to purchase tickets to an athletic event are no longer deductible.

Changes to miscellaneous itemized deductions

Under the new law, all miscellaneous itemized deductions that are subject to the 2% of AGI floor are no longer deductible. Common miscellaneous itemized deductions included unreimbursed employee expenses, investment expenses (i.e. brokerage fees), and tax preparation fees.

Is there more?

Yes, there is much more, but just three additional changes are discussed here.

Expanded use of Section 529 account funds: For distributions after December 31, 2017, “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school, and various expenses associated with home schooling, up to a $100,000 limit per tax year.

Individual alternative minimum tax (AMT): The TCJA doesn’t repeal the AMT for individuals as was hoped for, but it does increase its exemption amounts. Before the TCJA, the individual AMT exemption for MFJ was $86,200 and that amount was reduced by 25% of the amount by which the couple’s alternative taxable income exceeded $164,100. The TCJA increases the AMT exemption amount to $109,400 MFJ and that amount is reduced by alternative taxable income above $1 million.

Child tax credit: Under pre-TCJA tax law, individuals could claim a maximum child tax credit (CTC) of $1,000 for each qualifying child under the age of 17. The CTC was phased out for taxpayers with AGI above certain threshold amounts.

The TCJA modifies the CTC by increasing the credit amount to $2,000 per qualifying child and increasing the threshold amounts for the phase-out to $400,000 MFJ and $200,000 for all other returns. Additionally, $1,400 of the CTC is refundable.

The talk has just begunMuch is yet to be determined about the changes enacted by the TCJA. There will be many more articles and discussions as issues and unintended consequences appear and regulations are issues. Be sure and stay tuned.

As originally published in Kentucky CPA Journal

Article Dean Dorton

Stock market analysts and commentators have credited the Tax Cuts and Jobs Act with boosting market prices during late 2017 and early 2018. As we have discussed in previous articles, the tax code reform has many nuances with unique consequences for each business. We would like to isolate one significant change in the tax code and discuss its impact on business value — the Federal corporate income tax rate cut from 35% to 21%.

As detailed in a previous valuation article, three methods are commonly used to value a business. We focus here on the income approach, which reflects the fact that the value of a business is equal to the sum of its future cash flows discounted to present value. Clearly, a lower corporate income tax rate directly increases the future cash flows of a business, as shown in the example below.

Corporate Tax Rate 35% 21% % Increase
Pre-tax income $1,000,000 $1,000,000
Taxes (350,000) (210,000)
Free cash flow $650,000 $790,000 21.5%

Regardless of the amount of pre-tax income selected, the 21.5% increase to free cash flows stays constant. As such, the Federal corporate tax rate decrease from 35% to 21% increases the free cash flows of a corporation by 21.5%, assuming all other factors are held constant.

The next step of the income approach is to discount the free cash flows to present value. Assuming the discount rate (i.e. rate of return) an investor would accept/demand for an investment in the business remains the same, the 21.5% increase in cash flows results in a 21.5% increase in company value. Accordingly, we conclude that, all other things being equal, the decline in the corporate tax rate from 35% to 21% increases value by 21.5%.

Though this article focuses on the direct impact on value of the corporate tax rate change in isolation, it should be noted that the decline in the rate could have indirect impacts on value, as well. For example, after-tax borrowing costs will increase as a result of the federal tax rate decline, which may impact the weighted average cost of all capital, which in turn impacts a company’s value. In addition, other provisions of the new tax law may also impact value. For example, the more favorable depreciation rules associated with the new law could lower the effective tax rate of a company, resulting in increased cash flows, and thus increased value. In general, and all other factors being equal, we believe that the value of most companies will increase as a result of the new tax law, but just how much is a function of several (perhaps many) factors, several of which are difficult to evaluate.

For more information or questions about business valuation, please contact David Angelucci at 859.425.7695 or dangelucci@deandorton.com or Shelby Clements at 502.566.1052 or sclements@deandorton.com.

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Article Dean Dorton

In the first two parts of this Tax Cuts and Jobs Act QBI deduction series, we discussed the computation of the deduction and the businesses and income that qualified for the deduction. In Part 3, we will discuss special rules applicable to specified service businesses and other provisions. (Please note that the discussion below is based on the statute and committee explanations and is subject to change with additional guidance.)

As noted in Part 2, the qualified business income deduction generally does not apply to the specified service businesses listed in the article. However, there is an exception for otherwise nonqualifying businesses if the owner’s taxable income is below a certain amount. The owner of a specified service business can claim the full deduction otherwise available for a qualified trade or business if the owner’s taxable income does not exceed $315,000 on a joint return and $157,500 on all other returns. If the owner’s taxable income is between $315,000 and $415,000 on a joint return, or between $157,500 and $207,500 on all other returns, then the owner can claim a reduced deduction. The deduction is equal to the deduction otherwise available for a qualified trade or business multiplied by the applicable percentage. If the owner’s taxable income exceeds the upper amount, no deduction is allowed.

As an example, assume that joint filers operate a specified service business and have taxable income of $375,000 for 2018, which is $60,000 over the threshold. Also assume that the deduction allowable for a qualified trade or business with the same business income, wages, and property is $50,000. Since this is a specified service business the otherwise allowable deduction is 40% (the applicable percentage) of this amount or $20,000 (100% – $60,000 / $100,000 = 40%). As one may note from the computation in Part 1 and this computation, between the threshold amounts and the threshold amounts plus $100,000 or $50,000, depending on the filing status, the wage and property limitations are phased in and the specified service business deduction is phased out. The final deductible amount, after combining all separate business deductions and 20% of REIT and publicly-traded partnership income, is then subject to the taxable income limitation.

As noted in Part 2, there is some uncertainty as to how broadly the definition of specified service trade or business will be implemented. Additionally, if a sole proprietorship or other pass-through entity conducts both a qualified trade or business and a specified service business, there is currently no guidance on how to determine the business income, wages, and property allocable to each. If a taxpayer has both types of businesses in separate entities but there are transactions among the entities, such as rent, interest, or management fees, will this require adjustments in determining business income subject to the deduction?

The qualified business income deduction does not reduce the amount of income subject to self-employment tax, nor would it appear to reduce the net income for purposes of calculating contributions to self-employed retirement plans, although no guidance in this area has been issued. The deduction reduces the taxpayer’s taxable income, not the taxpayer’s adjusted gross income, and the deduction is not included in itemized deductions. The deduction is not adjusted in arriving at alternative minimum taxable income.

One area of uncertainty is the interaction of this deduction with the passive activity limitations. The passive activity regulations permit a taxpayer to treat certain activities as separate activities or to group activities based on regulatory criteria. Since the qualified business income provisions do not reference the passive activity rules and do not permit the grouping of businesses, guidance will be needed to determine the relationship between these provisions, and planning for individuals with multiple activities and businesses may need to be reconsidered.

The qualified business deduction is also impacted by other provisions of the Tax Cuts and Jobs Act. The Act created a new limitation on the deductibility of business interest expense by individual taxpayers conducting business as sole proprietors, partners, or S corporation shareholders. Although the qualified business income deduction does not reduce the deduction for interest, the interest limitation will impact the amount of business income subject to the qualified business income deduction. We will discuss the interest limitation in an upcoming article.

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Article Dean Dorton

The fifth and final installment is somewhat of a smorgasbord of information that is relevant to the real estate industry, but not as tax law intensive as our previous installments.

Like-kind exchanges

Previously, taxpayers could elect to defer gains on the sale of assets used in a trade or business by making a qualified like-kind exchange (LKE), and following specific guidelines issued by the IRS. After December 31, 2017, LKEs are limited to real property not held primarily for sale, and tangible personal property no longer qualifies. While this seems like great news for those in real estate, it may add levels of complexity related to transactions in which there were previous cost segregations that pulled out tangible personal property from the purchase or construction of a building. Buyers and sellers may consider allocation of purchase price to interior items more closely, as it is possible there may be assets included in the sale that do not qualify for a like-kind exchange.

Rehabilitation credit

Under prior law, there was a 20% credit for qualified expenses to certified historic structures or structures in certified historic district, and a 10% credit for expenses related to a qualified rehabilitated building, subject to specific rules and reporting requirements.

Under the new Tax Cuts and Jobs Act, for amounts paid and incurred after December 31, 2017, the 10% credit is repealed, and the 20% credit is only eligible for certified historic structures. There is a transition rule for buildings that were owned prior to January 1, 2018 that may have qualified under the old law.

Qualified opportunity fund deferral of income

A new gain deferral was created by the new Act. Effective December 22, 2017, there is a temporary deferral from inclusion in income for gains that are reinvested in a “qualified opportunity fund” (QOF), and a permanent exclusion of gains on the sale of an investment in a QOF.

A qualified opportunity fund is an investment created for the purpose of investing in qualified opportunity zone property, and at least 90% of the assets in the fund is qualified opportunity zone property.

The Act designates certain low-income community population census tracts as qualified opportunity zones. Once designated, it remains in effect until the end of the tenth calendar year beginning on or after designation. A list of the census tract zones is located at https://www.huduser.gov/portal/sadda/sadda_qct.html.

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