ARDMORE. Pa. — Are you ready for tax “reform?”
Thanks to the recently passed Tax Cuts and Jobs Act (TCJA), the tax rate for incorporated drycleaning businesses will be reduced from its current 35 percent to 21 percent — for the 2018 tax year and thereafter.
Although the business tax cuts are for the most part permanent, the tax cuts for individuals are only temporary, expiring in 2026.
Unfortunately, while regular, ‘C’ corporations will be taxed at a flat 21 percent tax rate, the majority of small businesses operating as pass-through businesses will face new personal tax rates higher than the corporate tax rate.
Pass-through businesses operating as partnerships, limited liability companies (LLC), S corporations and sole proprietorships, pass their income to their owners who pay tax at their individual tax rate.
QUALIFIED PROPERTY WRITE-OFFS GONE
The shorter depreciable lives that increased the annual write-off for leasehold improvements, retail and restaurant improvements has been eliminated along with the 15-year recovery period that so many dry cleaners benefited from.
Today, improvements are generally depreciable over 15 years using the straight-line method and the half-year convention, whether the improvements are property subject to a lease or placed in service more than three years after the date the building was first placed in service.
INTEREST EXPENSES
In the past, with a few exceptions, interest was usually tax-deductible in order to protect the ability of small businesses to write-off the interest on loans that were so important to their growth — or survival.
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% of the adjusted taxable income of a drycleaning operation or business.
A special rule applies to pass-through businesses that must make the 30% determination at the entity level rather than at the tax-filer level. In other words, at the partnership level instead of the partner level.
Other exceptions exist for small businesses, generally those with gross receipts that have not exceeded a $25 million threshold for a three-year period.
LIKE-KIND EXCHANGES
The tax law’s Section 1031 governing like-kind exchanges currently allow dry cleaners to defer the tax bill on the built-in gains of property 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, gains can be deferred for decades and ultimately escape taxation entirely.
Under the TCJA, like-kind exchanges will be limited to so-called “real” property (but not for real property held primarily for sale). The provision redefines like-kind exchanges and includes language that would limit Section 1031 exchanges to like-kind “real” property. This ensures real estate investors maintain the benefit of deferring capital gains realized on the sale of property.
ACCOUNTING SIMPLIFIED
Simplifying the rules governing the accounting method that must be used for tax purposes is a welcome option. Businesses with average annual gross income of less than $25 million may now use the simple cash-basis accounting method.
Accrual-basis taxpayers includes amounts in income when all the events have occurred that fix the right to receive income can be determined with reasonable accuracy. Cash-basis taxpayers generally include amounts in income when actually or constructively received.
With the cash method of accounting, dry cleaners may account for inventory as non-incidental materials and supplies. Or, as an alternative, a business with inventories using the cash method of accounting would be able to account for its few inventories using the method of accounting reflected on its financial statements or its books and records.
AUTO EXPENSES
New write-off limits for the cost of so-called “luxury” automobiles and personal use property were included in the TCJA.
For passenger automobiles and light trucks placed in service after Dec. 31, 2017, where the additional first-year depreciation deduction is not claimed, the maximum amount of allowable depreciation is increased to $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period.
For passenger automobiles placed in service after 2018, these dollar limits are indexed for inflation. And for those eligible for bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000.
Similar rules apply to not only passenger automobiles, but to any property used as a means of transportation or used for the purpose of entertainment, recreation, or amusement.
Computers and peripheral equipment have been removed from the definition of listed property and are no longer subject to the increased substantiation requirements applying to listed property.
LOSING ‘NOL’
A major benefit of Net Operating Loss (NOL) was the fact that they could be carried back to more prosperous years to create a refund of taxes paid in those earlier years and 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% of the drycleaning operation’s taxable income. Only in special cases will a NOL carry-back be permitted. There is no limit on how far forward NOL may be carried.
MORE TCJA
There are many more changes contained in the massive Tax Cuts and Jobs Act.
The newly-passed law provides immediate relief from the so-called “Death Tax” by doubling the estate tax exemption so it applies to fewer estates until it “sunsets” in 2026. The corporate Alternative Minimum Tax has been eliminated. The tax credit for rehabilitation expenses has been repealed as has the Disabled Access Credit.
Also, ‘S’ corporations attempting to convert to regular ‘C’ corporations will face new rules; Section 199, the deduction for so-called “domestic production activities,” has been repealed; and partnerships will no longer terminate upon the death or exit of a partner.
All in all, however, the TCJA appears to favor businesses over individuals with longer-lived tax savings. Unfortunately, with few exceptions, the potential savings won’t be seen by drycleaning businesses and their owners until the tax bill for 2018 comes due.
To read Part 1, go HERE.
Have a question or comment? E-mail our editor Dave Davis at [email protected].