At an estimated projected revenue cost over 10 years of $1.46 trillion, the reduction of the corporate income tax rate in the Tax Cuts and Jobs Act, H.R. 1, is the bill's largest single item by forecast negative effect to the federal budget, according to the Joint Committee on Taxation's estimate (JCX-47-17). But the bill contains many other provisions that would affect a large number of businesses, if enacted.
The corporate tax rate cut is offset by hundreds of billions of dollars in revenue savings from provisions of the bill affecting businesses, the largest of which is a new limitation on deductions for interest paid, which would raise $172 billion in additional revenue.
The rate reduction's revenue cost is highlighted by the current rate structure's relatively low threshold for a relatively high 34% rate. Taxable corporate income over $75,000 is subject to it, with a 35% rate that phases in at incomes between $15 million and $18,333,333. The Tax Cuts and Jobs Act's flat 20% rate on C corporations thus should represent a significant rate cut for most corporations. The only corporations with a lower rate currently are those with taxable income under $50,000, which is subject to a 15% rate.
The Ways & Means Committee's Republican tax staff summarized the change as intended to increase American companies' growth prospects and competitiveness in a global economy, hampered now, it stated, by "the highest combined Federal and State tax rate in the industrialized world." The Organisation for Economic Co-operation and Development (OECD) states that this combined rate is 38.91% in 2017, with the next highest among the OECD's 35 member countries that of France, at 34.43%.
While personal service corporations would be subject to a higher flat rate of 25% under the bill, this, too, represents a cut, since these businesses currently must use the top 35% rate. Under Sec. 448(d)(2), these are corporations whose principal activity is performing personal services performed by employee-owners in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, and similar services.
The bill would repeal the alternative minimum tax as it applies to corporations.
Full expensing, higher Sec. 179 limits are temporary
The bill's 100% expensing provision is not entirely new; it replaces the current 50% "bonus" first-year depreciation provisions of Sec. 168(k). It does not change the general Sec. 168(k)(2)(A)(i) requirements for types of qualified property eligible for expensing, i.e., property that has a recovery period of 20 years or less, is computer software, is water utility property, or is qualified improvement property. The bill would except from qualified property, under new a Sec. 168(k)(2)(G), property used in a real property trade or business or by a regulated public utility company. Under the bill, the expensing provision would be available both for property the original use of which begins with the taxpayer, and for property that meets certain acquisition requirements.
The 100% expensing provision applies for only five years, similar to previous bonus depreciation and full expensing provisions.
Also temporary, for five years, is the bill's increase in the threshold amount that may be expensed under Sec. 179 from $500,000 currently to $5 million, and the increase in the phaseout threshold from $2 million to $20 million. Sec. 179 expensing, which generally allows full deduction of the cost of property in the year it is placed in service, is not rendered moot by 100% expensing under Sec. 168(k), as the definition of "Sec. 179 property" differs from that of qualified property eligible under Sec. 168(k), and because of other differences.
Interest deduction limited
The interest deduction limitation, Section 3301 of the bill, imposes a disallowance on all businesses, regardless of their form, of a deduction for any portion of business interest expense that exceeds the sum of their business interest income plus 30% of adjusted taxable income, with an exemption for businesses with average gross receipts of $25 million or less. "Business interest" is interest paid or accrued on indebtedness properly allocable to a trade or business but does not include investment interest. Likewise, "business interest income" does not include investment income.
The Ways & Means staff description states that the disallowance would be determined at the tax-filer level, e.g., at the partnership level rather than the partner level. Adjusted taxable income is income computed without regard to interest expense; business interest income; net operating losses (NOLs); and depreciation, amortization, and depletion. This provision would not apply to real property trades or businesses or certain public utilities.
NOLs face restrictions
Just as the interest limitation likely would affect certain highly leveraged businesses, the bill's limitation on deductions of NOLs could chiefly affect those with loss years. Weighing in at a prospective revenue gain of $156 billion over 10 years, the bill's provision would limit NOL recognition as a carryback or carryforward to no more than 90% of taxable income (determined without regard to the NOL deduction). Instead of the current 20-year limit on carryforwards, businesses with excess NOLs would be able to carry them forward indefinitely, and they would be increased by an interest factor to preserve their value.
Carrybacks, currently allowed to the two previous tax years, would generally not be available. The only carrybacks allowed would a one-year carryback for small businesses and farms in the case of certain casualty and disaster losses. A small business for purposes of the NOL one-year carryback is a corporation or partnership that has no more than $5 million in average gross receipts for the previous three tax years, or a sole proprietorship that would meet that test if it were a corporation. Both small businesses and taxpayers engaged in the trade or business of farming would be allowed to carry back eligible disaster losses, which are those attributable to a federally declared disaster.
Cash method expanded
Corporations and partnerships with a corporate partner currently cannot use the cash method of accounting if their average gross receipts exceed $5 million in any prior year. This threshold would be increased to $25 million under the bill (and indexed for inflation). The requirement that the business satisfy the requirement for all prior years would be repealed.
Also, businesses with average gross receipts under $25 million would be allowed to use the cash method even if the business has inventories.
—Paul Bonner (Paul.Bonner@aicpa-cima.com) is a Tax Adviser senior editor.