We are approaching the year-end rather quickly, and we need to make sure we understand how some of the tax laws changes may impact your tax liability for the year and seek for opportunity for any planning to minimize tax cost and maximize tax benefit. Here are some of the key provisions high net worth individuals should pay attention to:
Excess Business Loss Limitation
In addition to the tax basis limitation, at-risk limitation and passive activity loss limitation, non-corporate taxpayers are now subject to a new limitation on the deductibility of business losses from pass-through entities (such as partnership, S-corporation and sole-proprietorship). A taxpayer’s loss from trade or business in total is now limited to $500,000 for joint filers (or $250,000 for single filer) for the tax years 2018 through 2026. Disallowed excess business losses will be treated as net operating loss and carried forward.
The following example can demonstrate this provision’s detrimental impact. Tom and Jessica, a married couple, have wage income of $2,000,000 and ordinary loss of $3,000,000 from an S-corporation. Tom and Jessica also invested in a rental real estate partnership and received a K-1 showing a $500,000 of passive loss. Let us assume that Tom and Jessica have sufficient tax basis and no at-risk limitation issue for the S-corporation flow through loss. Under the new tax law, Tom and Jessica would report $1,500,000 of taxable income, as opposed to $0 taxable income under the old tax law. See the computation below.
| 2018 Income (Loss) | Under New Tax Law | Under Old Tax Law | |
| Wage income | 2,000,000 | 2,000,000 | 2,000,000 |
| S-Corporation loss | (3,000,000) | (3,000,000) | (3,000,000) |
| Excess business loss disallowed | 2,500,000 | ||
| Passive loss | (500,000) | (500,000) | (500,000) |
| Net passive loss disallowed | 500,000 | 500,000 | |
| Total income (loss) | (1,500,000) | 1,500,000 | (1,000,000) |
The provision would have a severe impact to the tax computation for 2018, as demonstrated above. Accordingly, taxpayers who previously sheltered his/her tax from the trade or business loss may need to do a thorough year-end planning to minimize the provision’s adverse impact.
Excess Business Interest Deduction Limitation
Generally, under the new tax law, business interest deduction is limited to 30% of taxable income before interest, depreciation and amortization. This provision may adversely impact heavily debt-financed businesses, such as real estate investment companies and private equity fund owned entities. An exception is provided if average annual gross receipt for the three previous tax years is lesser than $25M. For purpose of applying this exception, certain aggregation rules apply. Therefore, we advise that you consult with your tax advisor regarding the implications.
Rethink Entity Choice
With the reduced corporate income tax rate, to a flat 21%, and the 20% deduction allowed to a qualified business income from pass-through entities (such as S-corporation, partnership and sole-proprietorship), choosing an entity type for a business is less obvious from tax perspective. Provided that a business you own through a pass-thru entity qualifies for the 20% qualified business income deduction, your effective tax rate is reduced from 37% to 29.6% on the business income. In contrast, if your business is held under a C-corporation, the income would be subject to 21% corporate tax and the after-tax income would be subject to 20% dividend tax. This effectively yields 37 tax rate in total.
As demonstrated above, the rate difference of structing business under pass-through or C-corporation became insignificant, and one needs to consider other factors in deciding to invest or operate through a corporate or pass-through entity.
Tax Incentive for US Exporters
Starting in 2018, a domestic C-corporation that export goods or services may benefit from a special deduction on income earned from non-US markets. This provision may reduce the corporation’s tax rate from 21% to 13% on qualifying income. If your business exports goods or provide services outside of US, please consult with your tax advisor regarding this incentive.
Subpart F Provisions
US shareholders of a controlled foreign company (CFC) may be subject to various deemed dividend inclusion provisions under Subpart F. The new tax law expanded the definition of US shareholders subject to Subpart F inclusion. Prior to the change, US shareholder was defined as an US shareholder of a foreign company who owns 10% or more of its voting stock. However, under the new law, US shareholder who owns 10% or more of voting or value of stock is subject to the Subpart F inclusion. Additionally, the new tax law added a new category of Subpart F income, known as Global Intangible Low-Taxed Income (GILTI). Please see our tax newsletter http://www.kyjcpa.com/news-updates/gilti-beat-in-plain-language/ for further detail.
Bonus Depreciation
As previously discussed in our tax newsletter http://www.kyjcpa.com/news-updates/proposed-regulations-under-sections-168k-bonus-depreciation/, the new tax law extended and modified bonus depreciation, allowing businesses to immediately deduct 100% of the cost of qualified property. The qualified property now includes used properties and assets with tax life of 20 years or less. A financed acquisition prior to the year end may provide immediate deduction of the full cost of the acquired asset in the year of acquisition and provide a tool to manage cash flow.