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Aug 27, 201901:09 PMOpen Mic

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One tax year later: Assessing the implications of the Tax Cut and Jobs Act

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The Tax Cut and Jobs Act of 2017 (TCJA) brought a reduction in tax rates and significant changes to deductions for individuals and corporations in 2018, but its impact was not uniform. After the new law’s first full year, many were surprised to find that the law had some unexpected impacts.

Implications for businesses

New lower corporate tax rates were welcome in 2018 for small and middle market businesses. Whether it was the lower corporate tax rate (now 21 percent) or the new 20 percent deduction for qualified business income (QBI) for pass through businesses, many believe lower corporate tax rates will help create a more level playing field for the United States relative to other countries. Often business owners want to expand within the United States instead of being forced to shift operations abroad in search of lower tax rates.

Immediately, the newly lowered tax rates made improved cash flows a reality. That additional free cash flow is important for business owners and lenders, as it increases a company’s ability to repay debt.

We saw businesses funnel tax savings into capital expenditures, but not everyone used the additional cash to purchase equipment or expand operations. Some used it to build their balance sheets, while others harnessed the cash flow to address an ongoing challenge — attracting and keeping a qualified labor force.

For example, businesses used the bonus depreciation feature of the TCJA to purchase equipment to help increase efficiency and productivity for workers. Others used the additional free cash flow to increase wages in order to attract and retain skilled labor.

Under the new law, middle market businesses were able to repatriate profits from overseas at a reduced rate of 15.5 percent on cash and 8 percent on other assets. Owners have taken advantage of this welcome opportunity to invest in their businesses, pay dividends, or buy back shares.

Surprisingly, the elimination of the deductibility of entertainment expenses didn’t immediately change business expenditures in this area. Most companies with tickets or sports suites plan to continue these investments for both client and employee entertainment. They typically enjoy supporting their local teams and communities and are doing well enough to continue without the deduction.

The new tax law has led many businesses to think carefully about how they are structured. Some are working with their accountants to compare the new QBI deduction to the tax treatment of a C corporation. The decision must factor in more than tax implications, with questions such as how proceeds might be distributed after a sale being an important consideration. We find that many businesses have used this year to evaluate, and few have rushed into making changes.

Looking ahead, businesses are watching trade discussions closely as many are or could be impacted by tariffs. While the overall effect of tax reform has been favorable, labor force issues remain of paramount importance.

Significant elements of the TCJA affecting businesses

  • Reduction in tax rate on C corporations to 21 percent from 35 percent
  • Qualified business income (QBI) deduction
    • Pass-through entities such as S corporations and LLCs are eligible for a QBI deduction of up to 20 percent (various limitations apply).
  • Repatriation provision
    • Reduced taxes on foreign earnings to a rate of 15.5 percent on cash and 8 percent on other assets.
  • Bonus depreciation/equipment depreciation extended
    • Businesses can immediately expense more under the new law, increasing available cash flow for many.
  • Elimination of the entertainment expense deduction
    • Business lunches are still deductible at 50 percent.
    • Entertainment expenses for the benefit of employees are still deductible.
  • Elimination of Domestic Production Activity Deduction (DPAD)
    • A deduction beneficial to small businesses doing domestic production has been eliminated.

(Continued)

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