What to Know About the Tax Cuts and Jobs Act
By Mark Battersby
on Mar 15, 2018
Thanks to the just-passed Tax Cuts and Jobs Act, the tax rate for incorporated metal service centers and toll processors will be reduced from its current 35 percent to 21 percent for the 2018 tax year and thereafter. Among the other headline-grabbing provisions is the 100 percent immediate write-off for some equipment and business property. In addition to this bonus tax write-off, the amount of Section 179, first-year expensing, has increased significantly.
Cost Recovery – Increased Expensing
Unlike in past years when a service center was required to spread the recovery of their equipment costs over several years, many can now fully and immediately deduct the cost of certain equipment. What’s more, this provision has been made retroactive to Sept. 27, 2017.
Of course, the faster write-off of equipment costs is only temporary. It is at the 100 percent level for expenditures between that date and Jan.1, 2023. After 2023 and before 2025, the deductible drops to 60 percent, with a further decrease to 40 percent after 2025 and to 20 percent after 2026. On Jan. 1, 2027, the equipment cost write-off disappears
Section 179The differences between bonus depreciation and the tax law’s Section 179 have narrowed with both offering 100 percent write-offs for new and used property. Section 179, with the immediate write-off or expensing of capital assets, remains an improved option because the use of equipment doesn’t have to begin with the service center, unlike with bonus depreciation.Prior to the tax law changes, a distributor or processor could write-off the cost of a business asset to the tune of $510,000 in 2017. The maximum deduction was reduced, dollar for dollar, as additional assets placed into service exceeded $2,030,000. Under the new law, a metals service center will be able to expense up to $1 million, with the new phase-out amount at $2.5 million.
Unfortunately, while regular C corporations will be taxed at a flat 21 percent tax rate, the majority of small businesses operating as pass-through entities will face personal tax rates higher than the new corporate tax rate.
Pass-Through BusinessesPass-through businesses operating as partnerships, limited liability companies, S corporations and sole proprietorships pass their income to their owners, who pay tax at their individual rate. The TCJA created a 20 percent deduction that applies to the first $315,000 of income earned by distributors and processors operating as pass-through businesses. All businesses under the income thresholds can take advantage of the 20 percent deduction. For pass-through income above this level, the new law also provides a deduction for up to 20 percent, but only for business profits. The TCJA contains strong safeguards to ensure that wage income does not receive the lower marginal tax rates for business income. Thus, that 20 percent deduction applies only to business income that has been reduced by the amount of reasonable compensation paid the owner, a term that has not yet been defined.
The Corporate Alternative Minimum TaxLawmakers long-ago created a unique, parallel tax system with a 20 percent tax rate to limit tax benefits and prevent large-scale tax avoidance. Under the corporate Alternative Minimum Tax system, incorporated businesses were required to calculate both their ordinary tax and the AMT tax, paying whichever was higher. Fortunately, the AMT has been eliminated, lowering taxes and eliminating the confusion and uncertainty that surrounded it in the past.
Interest ExpensesIn the past, with a few exceptions, our tax laws permitted small businesses to write off the interest paid on borrowed money. Today, in an attempt to level the playing field between businesses that capitalize through equity and those that borrow, the TCJA caps the interest deduction to 30 percent of the adjusted taxable income of most metals service centers.Every business is subject to disallowance of a deduction for net interest expense in excess of 30 percent of the operation’s adjusted taxable income. A special rule applies to pass-through entities that requires the 30 percent determination to be made at the entity level rather than at the tax filer level. In other words, at the partnership level instead of the partner level. Designed to protect the ability of small businesses, generally those with gross receipts that have not exceeded a $25 million threshold for a three-year period, another exception allows them to write off the interest on loans that help them start or expand a business, hire workers and increase paychecks.
Accounting Methods and SimplificationSimplifying the method of accounting that can be used by service center executives will help ease their accounting burdens. Metals service centers with average annual gross income of less than $25 million may now use the easier cash-basis method of accounting.Under the cash method of accounting, the business may treat inventory as non-incidental materials and supplies. Also, a metals distributor or processor with inventories that uses the cash method of accounting can account for its inventories using the accounting method used on its financial statements or its books and records.The former $5 million threshold for corporations and partnerships with a corporate partner has been increased to $25 million. The requirement that a metal service center or toll processor satisfy the $25 million ceiling for all prior years has been repealed. The average gross receipts test has also been indexed to inflation.
Like-Kind Exchanges, Swaps and Trade-insThe tax law’s Section 1031 governing like-kind exchanges currently allows metals service centers and businesses to defer the tax bill on gains realized when equipment or business property is sold, swapped or traded by exchanging it for similar property. Although more a strategy for deferring a tax bill when business assets are sold or otherwise disposed of, with multiple exchanges most gains can be deferred for decades and ultimately escaped taxation entirely.Under the TCJA, like-kind exchanges will be limited to real property (but not for real property held primarily for sale). The provision redefines like-kind exchanges and includes language that will limit Section 1031 exchanges to strictly like-kind real property. This ensures real estate investors maintain the benefit of deferring capital gains realized on the sale of property.
NOLsOne of the benefits of net operating losses was the fact they could be carried back to more prosperous years to create a refund of taxes paid in those earlier years, thus providing an immediate infusion of badly-needed cash. Today, the NOL deduction has been severely limited. The write-off is now limited to only 80 percent of an operation’s taxable income, and only in special cases will a NOL carryback be permitted. Of course, there is no limit on how far forward NOLs may be carried.
More, Oh, So Much MoreAccording to our lawmakers, the TCJA modernizes our international tax systems making it less expensive to do business abroad and easier and less costly for U.S. businesses to bring home foreign earnings. The international provisions of the JCTA also prevent U.S. jobs, headquarters and research from moving overseas by eliminating incentives.Obviously, there are many more changes contained in the massive Tax Cuts and Jobs Act. For example, the newly passed law disallows deductions for entertainment expenses while the 50 percent limit on the deductibility of business meals has been expanded to include meals provided in-house. S corporations attempting to convert to regular C corporations will face new rules; Section 199, the deduction for domestic production activities has been repealed; and partnerships will no longer terminate upon the death or exit of a partner. On the subject of death, the TCJA provides immediate relief from the “Death Tax” by doubling the exemption so it applies to fewer estates. The higher thresholds would sunset in 2026.All-in-all, the Tax Cuts and Jobs Act appears to favor businesses over individuals with longer-lived tax savings. Unfortunately, with few exceptions, the potential savings won’t be seen by metal service centers and toll processors until the 2018 tax bill comes due.