The tax reform bill passed by the United States Congress known as the Tax Cuts and Jobs Act, impacts Business Interest Deduction, Net Operating Loss, 1031 Exchange, Meals, Entertainment, Membership Dues, Carried Interest, Partnerships Technical Termination, Research Spending, Fringe Transportation, Accrual Tax payers, and Section 199 Deduction. Details are as follows:
Deduction limits on Business Interests:
- Interest in this context (as per Sec 163(d)) is defined as the amount that is accrued or to be paid as interest towards loans taken for trade or business. While before interest was simply counted as a business expense, under the new Act deductions on business interests has been capped at 30% of Earnings before Interest, depreciation and amortization (Ebitdpa).
- Gross Receipts test: If a business grosses $25M or less annually for three prior tax years it satisfies this test. All businesses satisfying this criterion are exempt from business interest deduction limits.
- Limits are also not mandatory for farming related businesses and do not apply for any Real estate related trade or business.
Net Operating Losses (NOLs) Deductions:
When a business’s tax deductions eligibility exceeds its taxable income, it is said to be in a NOL. The tax reform limits the deductions on these NOLs to 80% of its taxable income, where indefinite carryforward is allowed whereas the provisions for 2-year carryback is repealed for the taxpayer. Farming businesses are the exception and are allowed a 2-year NOL carryback.
1031 Exchange redefined:
1031 or Like-Kind Exchanges usually allow tax payers to replace a sold asset with an acquired one without generating a tax liability on the sale. As per the Act, the assets that can be exchanged have been limited to include only real estate property that is not already on primary sale. This provision comes into effect after Dec 31st, 2017.
Meal Deduction limits:
Business or trade related food and beverage costs remain 50% deductible. Food and beverage services provided by businesses to employees through an eating facility (satisfying de minimis fringe criteria) is a fully deductible expense in current policy. As a result of the reform, for the time period of 31st Dec 2017 to 31st Dec 2025 any such expenses incurred for the employer is only 50% deductible. Moreover, after 31st Dec 2025 these expenses are not deductible.
Entertainment and membership expenses:
Deductibles are not allowed on expenses related to (a) entertainment such as sports tickets, shows, etc. and (b) club membership fees related to entertainment, business, recreation and social activities and (c) any facilities connected to the same.
Partnerships – Technical Terminations:
As per rule 708(b)(1)(B) of the tax code, as part of a partnership during a 12 month period, when there is an exchange or sale of more than 50 percent of partnership capital or profit, the partnership is deemed terminated. This is also known as a “Technical Termination”. Under the reform, this rule is being repealed while rule 708(b)(1)(A), which terminates partnerships in the absence of financial, business or venture activity is being maintained.
Carried Interest holding periods:
The current holding period by an investment manager defined for a long term equity investment is 1 year. In an attempt to shift the focus of investments to long term capital gain, under the new Act, this has been increased to 3 years for which a lower tax rate is imposed.
Research Spending – Amortization period:
The new Act requires that for any research or experimental spending to be carried out within the United States, the expenditure capitalization and amortization is required to be done for a period of 5 years. For any related expenditures traceable to work done outside the United States, expenditure capitalization and amortization is required to be done for a period of 15 years.
Accrual Tax payers – Item inclusion:
As part of the new Act, all tax payers subject to the All-events test*, using the accrual method of accounting are required to include all the items contributing to their income in the year as a part of the financial statement for the same year.
*All-events test: All events causing an income or expense to an accrual method tax payer must occur prior to reporting of the taxpayer’s expense or income.
Fringe Transportation deductions:
Deductions are not allowed on fringe transportation expenses incurred by the employer for the employee unless it involves safety of commute (or) commute of employee between home and workplace.
Section 199 deduction: Under the new Act, domestic production deductions for production and manufacturing carried out by businesses within the US is being repealed.