The Tax Cuts and Jobs Act (TCJA) made many favorable tax changes for businesses, including a drop in the corporate tax rate to a flat 21 percent, repeal of the corporate AMT, a new 20 percent qualified business deduction for owners of pass-through entities, greater write-offs for buying equipment and machinery and making certain improvements to property, and a new tax credit for paid family and medical leave. However, this same law also eliminated a number of write-offs that businesses have come to know and love. Here is a roundup of deductions and other tax breaks that can no longer be used for 2018 returns.
Through 2017, 50 percent of the cost of entertaining customers, clients, and others associated with a trade or business, such as taking them to a sporting event or theater before or after a business meeting, was deductible. The TCJA repealed this deduction, so no write-offs can be claimed for entertainment expenses paid or incurred on or after Jan. 1, 2018 (Code §274(a)(1)).
The big question that tax professionals are asking is whether repeal applies to business meals (i.e., are business meals entertainment costs). It is common business practice to take a customer or prospect out to lunch and discuss business, but the language of the new law appears to lump business meals into the entertainment category. Did Congress intend this result?
The AICPA has sent a letter to the IRS asking that it confirm whether “business meals which (1) take place between a business owner or employee and a current or prospective client; (2) are not lavish or extravagant under the circumstances; and (3) where the taxpayer has a reasonable expectation of deriving income or other specific trade or business benefit from the encounter,” are or are not disallowed by the repeal of the entertainment expense deduction. Until there is clarification it is essential for businesses to continue recordkeeping for business meals, which is needed for any deduction to be claimed if the IRS clarifies that business meals are not entertainment costs.
The TCJA also reduced from 100 percent to 50 percent a deduction for certain employee meal costs. These include meals and beverages that are de minimis fringe benefits, meals provided at an eating facility, and meals provided on premises for the convenience of the employer.
Business Interest Expense
Until now, businesses have been able to fully deduct interest expenses, assuming they pass a debt-equity test to ensure the payments are really interest. For tax years beginning after 2017, businesses may not be able to deduct all of their interest expenses. The deduction is limited to the sum of business interest income and 30 percent of adjusted taxable income (plus floor plan financing for car dealerships and other businesses using this type of financing) (Code §163(j)). Thus, a portion of business interest may not be claimed in the current year; it can be carried forward.
However, small businesses are exempt from this interest deduction limitation. “Small” for this purpose means having average annual gross receipts in the three prior years not exceeding $25 million.
For corporations, all interest is treated as business interest and subject to this new limitation (unless they are small corporations). For other businesses, the limitation applies only to business interest (unless they are small businesses); it does not apply to investment interest.
Net Operating Losses
Until now, net operating losses (NOLs) could fully offset taxable income in carryback and carryforward years. For NOLs arising in tax years ending after 2017, an NOL can only offset 80 percent of taxable income (Code §172).
What’s more, the carryback is eliminated (except for farming losses and specified liability losses from product liability or certain other situations). This means that businesses with a current NOL cannot obtain a refund of prior year taxes through a carryback and will have to wait for a tax benefit from the NOL when reducing future year tax bills.
It is not entirely clear how pre-2018 NOLs that are carried forward can be used. It appears they can offset 100 percent of taxable income because they arose in a tax year ending before 2018, but clarification is needed. What is clear is the need to track pre- and post-2018 NOLs to apply them properly. The TCJA did not change the rule requiring NOLs to be applied in chronological order.
TCJA eliminated deductions for certain fringe benefits.
Commuting fringe benefits. Employers cannot deduct the cost of free parking, monthly transit passes, and van pooling (Code §274(a)(4)). They may continue to offer these benefits to employees who can receive them tax free up to $260 per month in 2018. No deduction is allowed for bicycle commuting and employees cannot exclude the benefit if paid by the employer in 2018 through 2025.
Moving expenses. Employers reimbursing employees for the cost of job-related moving cannot deduct the cost of this benefit through 2025 (Code §132(g)). Employees cannot exclude the benefit if companies continue to pay relocation costs. (There is an exception for military personnel relocating to a permanent station of duty.)
Employee achievement awards. These continue to be tax deductible by employers and tax free to employees, but the definition of what constitutes an award has changed. TCJA tightens the category of awards for this purpose, permitting only tangible personal property. Awards given in cash, cash equivalents, gift cards, gift coupons, gift certificates, vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, or similar items are not deductible by employers (Code §274(j)(3)(A)(ii)).
Domestic Production Activities Deduction
The 9 percent deduction for qualified domestic production activities that applied to domestic manufacturers and other businesses has been repealed as of Dec. 31, 2017 (Code §199).
Various other types of payments are no longer deductible:
Fines and penalties. Amounts paid or incurred after Dec. 31, 2017, are not deductible where the complainant or investigator is a government or government entity (Code §162(f)(1)). The only exceptions are for certain restitution, amounts paid to come into compliance with the law, amounts paid to satisfy a court order where the government is not a party, and amounts paid for taxes due.
Payments for sexual harassment or sexual abuse. Settlements and payments made after Dec. 22, 2017, for sexual harassment or sexual abuse are not deductible if subject to a nondisclosure agreement (Code §162(q)).
Local lobbying expenses. No deduction can be claimed for the expenses of local lobbying paid after Dec. 22, 2017 (Code §162(e)(2) eliminated by TCJA).
While the tax breaks created by the TCJA are substantial, they are ameliorated somewhat by the elimination or restriction of certain write-offs. The net tax benefit to businesses from the TCJA will not be known fully until there is clarification by the IRS, technical corrections from Congress, and completion of 2018 returns.