There have been a lot of articles written about the Tax Cuts and Jobs Act since it became law Jan. 1.

There are many provisions within the law that will change the way both individuals and business owners will plan for future tax filings and run their businesses. This article will review some of the provisions as they relate to business owners in the HVAC and sheet metal industry and provide some guidance on changes that may be appropriate for owners who plan to sell their businesses.

It will be less expensive to operate your business in 2018 than it was last year. Aside from other provisions, corporate and individual tax rates have dropped. C corporations will enjoy the greatest benefit as rates dropped from 34 percent to 21 percent. Individual tax rates will still have seven brackets, but each bracket has been reduced by 2 to 4 percentage points.

The income brackets have been slightly increased, so it will take more taxable income for an individual to move into the next highest bracket.

Pass-through entities (sole proprietors, partnerships, S corporation, and trusts and estates) will still be taxed at the individual income tax rates; however, there are provisions that can effectively eliminate 20 percent of the income from being taxed.

A key change that may affect business marketing in general is the elimination of the deduction for meals and entertainment expenses. The previous law allowed for a 50 percent deduction for any meals and entertainment expenses incurred in the normal course of a business’ sales cycle. This deduction has now been lost. Meals paid for the benefit of employees that are necessary for them to work beyond normal hours continue to be fully deductible.

A provision that does provide a benefit to a business owner’s tax situation is the increase of the Section No. 179 deduction. This deduction allows a business owner to fully expense the cost of a capital asset in the year it was placed in service. The previous deduction provided for a $500,000 limit on expensing. The new limit was raised to $1 million and the phase out was also increased from $2 million to $2.5 million. 

Eligibility

The definition of “eligible property” was also expanded. Here’s where the new provision can really help commercial HVAC companies increase revenue. The provision expands the definition of qualified real property eligible for Section No. 179 expensing to include improvements to non-residential real property. This expanded definition includes roofs, HVAC equipment, fire protection, alarm systems and security systems.

This means that commercial HVAC customers can now fully expense the cost of HVAC improvements to nonresidential real property up to $1 million, provided they do not acquire other tangible personal property that exceeds the $2.5 million cap. Previous law required the cost of construction for new equipment to be capitalized and depreciated over 39 years. In light of the industry’s efforts to get Congress to reduce an HVAC system’s depreciable life to one that more closely resembles its true economic value, this is a step in the right direction.

tax laws

There have been a lot of articles written about the Tax Cuts and Jobs Act since it became law Jan. 1.

In addition to the Section No. 179 deduction, the bonus depreciation rules were also expanded. This is one of the few changes that affect 2017 tax computations. The provisions allows for property acquired after Sept. 27, 2017, and placed in service prior to Dec. 31, 2022, to be expensed for 100 percent of the cost. Where this provision previously only allowed for expensing of new equipment, the new law expands the definition to include used equipment. The act clearly rewards business owners for making capital investments.

The other key provision in the act affects the pass-through entities. As discussed previously, the pass-through entities were also granted a further reduction to compete with the C corporation tax break.

Passing through

There is a specific provision in the act called the Section No. 199A deduction. This is the area of the law that provides for a 20 percent deduction for owners of pass-through entities. The general 20 percent deduction is applicable for single taxpayers with taxable income under $157,500 and joint filers with taxable income under $315,000. Both types of taxpayers will generally get the full 20 percent deduction. However, as income levels increase above these limits the formula deduction looks at wages reported on Internal Revenue Service form No. W-2 paid to employees and also at the depreciable property held by the pass-through entity. 

For these high-income taxpayers, in some cases the deduction gets limited to 50 percent of the W-2 wages paid by the entity or 25 percent of the wages paid by the entity plus 2.5 percent of the qualified property’s original cost. For the property to qualify it cannot be greater than 10 years old or past its last full year of depreciation. Income levels between the upper and lower limits gets a phase in of the W-2 and property requirements.

For those who conduct business in the personal service industry such as accountants, attorneys and consultants, they will lose the deduction altogether once their income exceeds the upper limits as previously discussed. There is an exception to this rule, however. Engineers and architects do not fall under the exclusion and would follow the ordinary business definition for application of the 199A deduction.

The question that is often asked is why not convert the pass-through entity to a C corporation? On the surface, one would think that this is a wise decision. However, it is important to note that anytime income is taken out of a C corporation, there is generally a second layer of taxes. For an “exiting owner,” there could be some good opportunities to utilize a C corporation as an exit tool and eliminate capital gains on the transaction while benefiting from a lower annual income tax rate. 

tax reform

Changes

There are some other key provisions that business owners should be aware of under the new act. The lifetime gift and estate tax exclusion has been doubled and now is $11.2 million per individual. Married couples with estates below $22.4 million be free of federal estate and gift taxes. 

Annual gift tax exclusion has been increased to $15,000 per donor per gift. Personal exemptions have been eliminated and are now covered under the increased $24,000 standard deduction. Miscellaneous itemized deductions have been eliminated: Investment fees are no longer deductible. Medical expenses are now deductible in excess of 7.5 percent of adjusted gross income.

Alimony payments for agreements entered after Dec. 31 are no longer deductible by the payer or includible as income by the recipient. Interest on home equity lines of credit are no longer deductible. Mortgage interest on loans in excess of $750,000 are no longer deductible.

Net operating losses generated from business, trust and estates that exceed current year income in excess of $250,000 for singles and $500,000 for joint filers cannot be fully deducted in the current year. It must be carried forward and subject to 90 percent of subsequent year’s income.

The alternative minimum tax has been repealed for C corporations. The individual AMT still exists; however, the exemption amount has been increased substantially.

When itemizing deductions, the tax deduction is capped at $10,000 annually. There is no cap on tax deductions for businesses. The 1031 gain deferral has been changed to eliminate personal property and now only applies to real estate transactions.

While many of the key tax changes have been highlighted, it’s important to see how they will affect your business. Once a thorough analysis has been completed there may be a need to make changes in your financial and legal strategies such as operating agreements, income allocation, wage and income distributions and estate tax documents.

Furthermore, it is important to understand that similar to previous tax bills that were enacted into law there are sunset provisions to consider. With the exception of the C corporation tax rates, many of the provisions of this law will expire Dec. 31, 2025.