Tax Cuts & Jobs Act

2017 Tax Cuts and Jobs Act-General Individual Items

Repeal of Rollover on public securities gains
NEW LAW IRC SECTION 1044

Effective for sales after 12/31/2017
Act Section 13313

• The bill repeals the election to roll over tax-free any capital gain realized on the
sale of publicly-traded securities to the extent of the taxpayer’s cost of purchasing
common stock or a partnership interest in a specialized small business investment
company within 60 days of the sale. The amount of gain that an individual may
elect to roll over under this provision for a taxable year is limited to (1) $50,000 or
(2) $500,000 reduced by the gain previously excluded under this provision. For
corporations, these limits are $250,000 and $1 million, respectively.

Patent sales loss of Capital Gains Treatment
NEW LAW IRC SECTION 1221

Effective for sales after 12/31/2017
Act Section 13314

• The new law treats certain self-created assets such as patents, inventions, models
and designs and secret formulas or processes which are held either by the
taxpayer who created the property or a taxpayer with a substituted or transferred
basis from the taxpayer who created the property (or for whom the property was
created) from the definition of a “capital asset.” Thus, gains or losses from the sale
or exchange of a patent, invention, model or design (whether or not patented), or
a secret formula or process which is held either by the taxpayer who created the
property or a taxpayer with a substituted or transferred basis from the taxpayer
who created the property (or for whom the property was created) will not receive
capital gain treatment.

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2017 Tax Cuts and Jobs Act-Alternative Minimum Tax

Alternative Minimum Tax Changes

NEW LAW IRC SECTION 53 and 55-59

Effective for years beginning after 12/31/2017 and before 1/1/2026
(Sec. 12003 of Act)

• The AMT exemption amount increases to $109,400 for married taxpayers filing a
joint return (half this amount for married taxpayers filing a separate return) and
$70,300 for all other taxpayers (other than estates and trusts). The phaseout
thresholds are increased to $1 million for married taxpayers filing a joint return and
$500,000 for all other taxpayers (other than estates and trusts). The exemption
and threshold amounts will be indexed for inflation.

Single 2017 AMT New Law 2017 AMT 2018 AMT
Joint or Exemption 2018 AMT Exemption Exemption
Surviving Exemption Phase-Out Phase-Out
Spouse $54,300 $120,700 $500,000
Separate $70,300
Estates & $84,500 $160,900 $1,000,000
Trusts $109,400
(Unchanged) $42,250 $80,450 $500,000
$54,700
$24,100 $80,450 $82,050
$24,600

COMMENTS AND CONCERNS

• Historically, AMT has been caused, in order of occurrence, by:

1. State and local income and property tax,
2. Personal exemptions,
3. Miscellaneous itemized deductions,
4. Net operating losses,
5. Incentive stock options,
6. Standard deduction,
7. Suspended passive losses,
8. Estate beneficiary’s deductions,
9. Private activity bond interest,
10. Post-1986 depreciation and basis adjustments.

• Thus, the 2nd and third most common causes will no longer apply, and the first is
greatly reduced. Combine this with the nearly 25% increase in the AMT exemption
and the much higher AMT exemption phaseout it may be unusual for many
taxpayers to pay AMT.

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2017 Tax Cuts and Jobs Act-Alternative Minimum Tax

• There has never been a lot of opportunity to plan for a reduction in AMT and it may
be even more difficult now!

Example: Anne and Steve (MFJ + 2 kids) had $170,000 of AGI in 2017 and 2018,
with everything being the same both years. Let’s see what will happen.

AGI 2017 2018
Personal exemptions $170,000 $170,000
State & Local Income Tax
Property Tax -16,200 -0
Mortgage interest -10,000 --
Equity Interest --
Or standard deduction -3,000 --
Taxable Income -6,000 --
Regular Tax -2,000 -24,000
Kiddie Credit $146,000
Dependent Credit -- $ 23,999
Net Regular Tax $132,800 -4,000
$ 24,678 -0
$ 19,999
-2,000
-0
$ 22,678

AMT Adjustments to Taxable Income $132,800 $146,000
Personal exemption addback +16,200 --
Standard deduction addback +12,600
State & local tax addback +13,000 24,000
Equity interest addback + 2,000 --
AMT Income $176,600 --
-AMT Exemption - 84,500
Net AMT Income $ 92,100 $170,000
AMT Tax @ 26% $ 23,946 -109,400
$ 60,600
$ 15,756

Summary, in 2018 AMT did not apply. At lower income levels it would not apply.
There is not as much room for changes in income or deductions or dependents
under the old law because of the dependency exemptions, tax deductions and
equity interest deductions, all of which are not allowed under the new Act. In
conclusion, we believe AMT will be less prevalent under new law than the old law.
Of course, individual circumstances will differ.

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2017 Tax Cuts and Jobs Act-Estate & Gift Tax

Estate and Gift Tax Changes

NEW LAW IRC SECTION 2001 and 2010

Effective for estates of decedents dying and gifts made after 12/31/2017 and
before 1/1/2026

(Sec. 11061 of Act)

• The act doubles the estate and gift tax exemption for estates of decedents dying
and gifts made after Dec. 31, 2017, and before Jan. 1, 2026. The basic exclusion
amount provided in Sec. 2010(c)(3) increased from $5 million to $10 million and
will be indexed for inflation occurring after 2011.

COMMENTS AND CONCERNS

• A lifetime exemption of $11,200,000 (based on the doubling of the pre-inflation
base amount of $5,000,000 plus inflation adjustments through 2018) and a 40%
gift tax rate on taxable gifts is available to all individuals in 2018-2025. If an
individual or couple makes taxable gifts of more than the limit, gift tax is incurred.
The individual or couple has the option of paying the gift taxes that year, or to use
some of the exemption that would otherwise reduce the estate tax. In rare
situations it may be advisable to pay the tax in advance to reduce the size of the
estate.

• The law determining basis of inherited property remains unchanged using fair
market value at the date of death, commonly called the step-up basis rule.

• Utilizing the portability election could provide a surviving spouse with a $22.4
million exclusion!

• The Joint Committee on Taxation estimates the number of taxable estates would
drop from 5,000 under current law to 1,800 under the new law in 2018.

• Be very careful to watch state estate and gift inheritance tax rules.

• This 8-year increase in the gift tax exclusion means that very wealthy taxpayers
need to utilize the new, temporary amounts by:

o Making gifts to existing or new irrevocable trusts, including generation-
skipping trusts,

o Leveraging gifts to support the funding of life insurance or existing sales to
trusts and

o Pairing gifts with philanthropy (such as a charitable lead trust).

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2017 Tax Cuts and Jobs Act-Estate & Gift Tax
Table courtesy of Davis, Polk and Wardwell, LLP www.davispolk.com

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2017 Tax Cuts and Jobs Act-Accounting Methods

Cash Method of Accounting

NEW LAW IRC SECTION 446

Effective for taxable years beginning after 12/31/2017
(Sec. 13102 of Act)

• The cash method will now be allowed for any business other than a tax shelter
whose average gross receipts for the three prior years are less than $25 million.

• The new limit also applies to companies for whom farming, manufacturing or the
sale of inventory is a material income producing factor.

• Qualified PSC’s as well as service-based businesses (other than C corporations)
are still allowed to also use the cash method without regard to the $25-million dollar
limits.

• Inventory may still not be deducted until it is sold under the non-incidental materials
and supplies rule of Reg. 1.162-3(a).

• The uniform capitalization rules of Section 263A now will use a small business
threshold of $25 million as well, thus not requiring 263A for these businesses.

• The percentage-of-completion method requirement for long-term (> 2 years)
contracts will also now use a $25 million gross receipts test.

• The $25-million amount is indexed for inflation after 2018. Any change made back
to cash from accrual is considered an “automatic change”

COMMENTS AND CONCERNS

Sales Sole LLC or S C Notes
Level or Proprietor
Factors Partnership Corporation Corporation Rev. Proc.
Cash OK 2001-10
Ave Cash OK Cash OK Cash OK
Revenue Cash OK PSC and
only if Cash OK Cash OK Accrual service
<$25 service only if only if Required businesses
million service service (Non-C
business unless Corp)
Ave. business business qualified always
Revenue allowed to
PSC use cash
>$25
million

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2017 Tax Cuts and Jobs Act-Accounting Methods

• Remember under any method of accounting for any size company, if
inventory is sold it must still be recorded on the books and only deducted
as sold. “If you account for inventoriable items as materials and supplies
that are not incidental, you will deduct the cost of the items you would
otherwise include in inventory in the year you sell the items, or the year you
pay for them, whichever is later.” (Rev. Proc. 2002-28)

• The aggregation rule requires members of a controlled group of corporations
treated as a single employer for tax purposes to aggregate their gross receipts for
this test.

• If a company fails to meet the $25-million dollar test, it must change methods of
accounting to accrual.

• If the business has not been in existence for 3 years, base the average on the
period it did exist, annualizing any short periods.

Example: Martinique, Inc has gross revenues in 2015, 2016 and 2017 of $9,000,000,
$9,500,000 and $11,000,000 for a three-year total of $29,500,000 or a 3-year average
of $9,833,333. They meet the $25,000,000 threshold test for 2018 and may continue to
use the cash method in 2018. The average receipts test uses the 3 prior years not
the current and two prior years!

• Changing from the accrual method back to the cash method is allowed and is
an “automatic approval”. However, the taxpayer may not use an automatic
change if they have changed an overall method of accounting in the last five
years ending with the year of change, with rare exception. Additionally, the
taxpayer cannot request an automatic change in its final year of business.

• Most changes require the filing of Form 3115 (Instructions).

Preparer Tip: Be sure to use the latest version of Form 3115, which at manual date
was the December, 2015 version. Failure to use the latest version will generally cause
the change to be denied, at least temporarily.

HOW TO • Rev. Proc. 2015-13 provides guidance for how to file a Form 3115
FILE A 3115 change in accounting method for both automatic and non-automatic
changes. Revenue Procedure 2015-14 provides a list of the codes used
IN THIS to indicate to the IRS which pre-approved method the taxpayer is using
SECTION when applicable.

• An automatic approval change, such as discussed below for changing
from accrual to cash, does not require a user fee and generally provides
audit protection for the changed item.

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2017 Tax Cuts and Jobs Act-Accounting Methods

Step 1 • File the original Form 3115 with the return for the year of change, and
implement the change in that year under the 481 rules below. The
return must be filed by the due date (including extensions). See the
example below.

Step 2 • A signed copy of the original Form 3115 must be filed with the IRS in
Covington, Ky no earlier than the first day of the requested year of
change and no later than the date the taxpayer files the original Form
3115 with the federal income tax return for the requested year of
change. On February 20, 2015 the IRS changed the filing address, and
then changed it again in December, 2015 to:

Internal Revenue Service Form 3115 Filing Summary
File 1 Copy with return
201 West Rivercenter Blvd.
PIN Team Mail Stop 97 File 1 copy to IRS-Covington
Covington, KY 41011-1424

• The IRS does not acknowledge receipt of Form 3115 for automatic
change request procedures. It does notify the preparer if there are
problems with the application or if it is denied. Even though the
request is automatic it is still subject to IRS review. The IRS also
does not charge a user fee for automatic change requests.

• Common characteristics of automatic changes

• The change in accounting method is made on the first day of the taxable
year.

• A Form 3115 that is filed under the automatic change request
procedures is filed in duplicate. The original must be attached to the
filer's timely filed (including extensions) return for the year of change. A
copy of the Form 3115 must be filed with the IRS as noted no earlier
than the first day of the year of change and no later than when the
original is filed with the Federal income tax return for the year of
change.

• Audit protection is provided retroactively on the issue being changed
for prior taxable years (unless already under exam, in which case the
automatic change rules do not apply). See Section 8 of Rev. Proc.
2015-13.

• There is automatic IRS approval with no user fee. When
changing from accrual to cash make sure to write “Filed Under

Rev. Proc. 2015-13” at the top of Form 3115.

• The IRS does not send acknowledgments of receipt for automatic
change requests

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Step 3 2017 Tax Cuts and Jobs Act-Accounting Methods

• If the national office determines that a Form 3115 filed under this
revenue procedure is not properly completed, or if supplemental
information is needed, the national office will notify the taxpayer. The
notification will specify the information that the taxpayer needs to
provide and permit the taxpayer 30 calendar days (in the case of an
automatic change) from the date of the notification to furnish the
information. If the national office determines that the taxpayer failed to
provide additional information on a timely basis, the national office will
notify the taxpayer that the Form 3115 consent to make the change in
method of accounting is not granted (in the case of an automatic
change).

• The automatic change qualifiers will complete only Parts I, II and IV of
Form 3115, as well as Schedules A, B, C, D and E if applicable. All
attachments should include the filers name and FEIN and that it is a
Form 3115 attachment.

• The net amount of the change is called a 481(a) adjustment.

a. If the adjustment increases income it may normally be brought
into income ¼ of the adjustment per year for 4 years,
beginning with the requested year of change. If a positive
adjustment is less than $50,000 the taxpayer may elect to
include it all in the year of change. See Section 7, Par.03 (3)(c)
of Rev. Proc. 2015-13.

b. If the business is terminated any remaining 481(a) adjustment
is brought into income in the year of termination, but
conversion to an S or C corporation does not accelerate the
bring-in period. Conversion to an S corporation however
usually makes the adjustment subject to the built in gains tax.

c. The period to bring in a negative 481(a) adjustment is 1
year under Rev. Proc. 2015-13 Sec. 7, Par .03.

d. The Section 481(a) adjustment is reported as other income
when positive, and other expense when negative.

e. A schedule should be attached illustrating the 481(a)
adjustment calculation.

f. All deferred income is accelerated into the current year when
the company ceases to operate a business.

g. Section 13543 of the Bill requires a 6-year period of
adjustment (positive or negative) when an “S” corporation
terminates it’s election and reverts to a “C” corporation within
2 years of the enactment of the Bill.

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2017 Tax Cuts and Jobs Act-Depreciation

Section 179 Expense

NEW LAW IRC SECTION 179

Effective for property placed in service in taxable years beginning after 12/31/2017
(Sec. 13101 of Act)

• The Section 179 maximum expense amount per year increases to $1,000,000 for
taxable years beginning after 12/31/2017. The phaseout amount has also been
increased to $2,500,000.

• Both amounts as well as the $25,000 heavy SUV limit are indexed for inflation for
years beginning after 2018.

• Newly qualified assets include depreciable tangible personal property used
predominantly to furnish lodging, or in connection with furnishing lodging. IRC Sec.
50(b)(2) includes any facility where sleeping accommodations are rented.

• Other newly qualified assets include the following improvements to nonresidential
real property placed in service after the date the building was originally placed in
service:

o Roofs;
o Heating, ventilation, and air-conditioning property;
o Fire protection and alarm systems;
o Security systems.

COMMENTS AND CONCERNS

• Section 179 is normally available for assets in the 3,5,7 and 10-year life categories,
with a few special exceptions;

• Section 179 is taken by election in contrast to bonus depreciation which is
mandatory unless the taxpayer elects out;

• Section 179 is limited by an income requirement and by a dollar maximum;

• Section 179 is recaptured if the business use percentage drops to less than 50%;

• Section 179 may be preferable to bonus depreciation for small business because
of the ability to specifically determine the amount rather than utilize the “all or none”
approach of bonus.

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2017 Tax Cuts and Jobs Act-Depreciation

Bonus Depreciation

NEW LAW IRC SECTION 168K

Effective for property acquired and placed in service after 9/27/2017
(Sec. 13201 of Act)

• Note the effective date is late 2017 for property acquired and placed in service, or
specified plants planted or grafted “after 9/27/2017”;

• Used property now qualifies for bonus, i.e. the original use does not have to begin
with the taxpayer;

• The applicable bonus rate for is 100% (instead of 50%) for assets in service after
9/27/2017 and before 1/1/2023. The amount of allowable bonus depreciation will
then be phased down over four years: 80% will be allowed for property placed in
service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.

o Aircraft, certain plants and grafted plants, and longer production period
assets use 1/1/2024 as the cutoff.

• The additional $8,000 of bonus for luxury vehicles is still allowed;

• Bonus is now allowed for qualified film, television and live theatrical productions;

o Considered placed in service at the time of the initial release, broadcast or
live staged performance.

• The taxpayer may elect, for only the first year ending after 9/27/2017, to utilize the
50% bonus rate instead of the new 100% rate;

• New non-qualified property includes any property which is primarily used in the
trade or business of the furnishing or sale of (1) electrical energy, water, or sewage
disposal services, (2) gas or steam through a local distribution system, or (3)
transportation of gas or steam by pipeline, if the rates for such furnishing or sale,
as the case may be, have been established or approved by a State or political
subdivision thereof, by any agency or instrumentality of the United States, by a
public service or public utility commission or other similar body of any State or
political subdivision thereof, or by an electric cooperative;

• In addition, the provision excludes from the definition of qualified property any
property used in a trade or business that has had floor plan financing
indebtedness, unless the taxpayer with such trade or business is not a tax shelter
prohibited from using the cash method and is exempt from the interest limitation
rules.

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2017 Tax Cuts and Jobs Act-Depreciation

COMMENTS AND CONCERNS

• Bonus depreciation normally applies to assets in the 3, 5, 7, 10, 15 and 20-
year life depreciation categories;

• Because bonus depreciation is mandatory, the taxpayer must attach an
election to the tax return to elect out. The election is made on a class life by
class life and applies to all purchases made within that class life. It is not an
asset by asset election. To make an election, attach a statement to the return
indicating what election you are making and the class of property for which you
are making the election.
o This mandatory deduction can cause real problems for a taxpayer by
causing losses without benefit (such as self-employment tax), NOL
amounts which are not totally usable and write-offs that do not match
cash flow payments of loans

• Once made, an election out cannot be revoked without IRS consent. An
election out must be made by the due date (including extensions) of the return
for the tax year in which the bonus depreciation property is placed in service
(Reg. 1.168(k)-1(e)(3)(i)).

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2017 Tax Cuts and Jobs Act-Depreciation

• A taxpayer who files a timely return without making an election out can make
the election by filing an amended return within 6 months of the due date of the
return (excluding extensions). Write "Filed pursuant to section 301.9100-2"
on the amended return (Form 4562 instructions).

• A taxpayer who made an election out may also revoke that election without
IRS consent by filing an amended return within six months (excluding
extensions) of the due date of the return on which the election out was made if
the taxpayer's original return was timely filed. If this rule does not apply,
revocation is available only with IRS consent obtained by filing a letter ruling
request (Reg. §1.168(k)-1(e)(7)).

• If a taxpayer fails to make an election out, depreciation deductions on the
qualifying property must be computed as if the bonus deduction had been
claimed on the return, whether or not the bonus allowance was in fact claimed.
A taxpayer cannot make an election out by filing a request to change
accounting method (Reg. §1.168(k)-1(e)(5)).

• Bonus depreciation is not allowed for property placed in service and disposed
of during the same taxable year.

Example 1-New Rules: Dale buys a new tractor for $20,000. The entire amount
qualifies for bonus depreciation. If Dale decides to trade in his old tractor (remaining
basis $6,000, FMV $10,000) plus $10,000 in cash, $20,000 will qualify for bonus
because the like-kind exchange rules no longer apply to equipment, so Dale is treated
as selling the old tractor for $10,000 and buying a new tractor for $20,000.

Example 2-New Rules: Dale buys a new tractor for $200,000. The entire amount
qualifies for bonus depreciation as well as Section 179, but the Section 179 deduction
is limited to $100,000 from his business income. If Dale wishes to maximize depreciation
he would calculate it as follows:

Asset Cost $200,000
Less: Maximum Sec. 179 limited by income -100,000
Remaining basis $100,000
100% Bonus depreciation -100,000
Remaining basis $0

Total Depreciation in year of purchase: $100,000
Section 179 100,000
Bonus depreciation $200,000
Total

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2017 Tax Cuts and Jobs Act-Depreciation

Luxury Vehicle Expense

NEW LAW IRC SECTION 280F

Effective for property placed in service in taxable years beginning after 12/31/2017
(Sec. 13202 of Act)

• The base amount of depreciation (before allowed bonus) has been increased after
12/31/2017 and indexed for inflation after 2018.

New 2018 Old 2017
280F(a)(1)(a) Amount

Year 1 $10,000 $3,160

Year 2 $16,000 $5,100

Year 3 $9,600 $3,050

Year 4 and $5,760 $1,875

After

Note, where business use percentage is <50% no additional

bonus is allowed.

• Computers and peripheral equipment that is not already exempted from the listed
property rules are now exempted from those rules. Computers and peripherals
used at a regular business are already exempt under 280F(d)(4)(B).

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2017 Tax Cuts and Jobs Act-Depreciation

COMMENTS AND CONCERNS

• Note that luxury cars do not include vehicles used substantially all for hire such as
cabs, limo’s, etc.

• IRC Sec. 168(k)(2)(F)(i) allowing an additional $6,400 of bonus depreciation for a
luxury vehicle for 2018 is not modified, thus the first-year amount of total
depreciation allowed would be $16,400 ($10,000 new base plus $6,400 of bonus).

Year 1 New 2018 Plus additional Total
Year 2 280F(a)(1)(a) Bonus Allowed allowable
Year 3 Base Amount
Year 4 and $6,400 2018
After vehicles Depreciation
purchased
after 12/31/17 $16,400

$10,000

$16,000 0 $16,000

$9,600 0 $9,600

$5,760 0 $5,760

• The limitations apply to four-wheeled vehicles that are manufactured primarily for
use on public streets, roads, and highways, and that are rated at 6,000 pounds
gross vehicle weight (GVW) or less (except for trucks and vans, a vehicle's
"unloaded" GVW rating is used).

• Any depreciation disallowed because of these annual limitations is allowed in years
past the end of the usual depreciation schedule, though still subject to the annual
limitations.

• Note that there is a complete exclusion from the annual depreciation limitations for
“qualified nonpersonal use vehicles”—these are described in regulations as vans
and light trucks whose design makes them “not likely to be used more than a de
minimis amount for personal purposes.”

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2017 Tax Cuts and Jobs Act-Depreciation

Farm Property Lives and Methods
NEW LAW IRC SECTION 168

Effective for property placed in service in taxable years beginning after 12/31/2017
(Sec. 13203 of Act)

• The law shortens the recovery period from 7 to 5 years for any machinery or
equipment (other than any grain bin, cotton ginning asset, fence, or other land
improvement) used in a farming business, the original use of which commences
with the taxpayer and is placed in service after December 31, 2017.

• The law also repeals the required use of the 150-percent declining balance method
for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property).
The 150-percent declining balance method will continue to apply to any 15-year or
20-year property used in the farming business to which the straight-line method
does not apply, or to property for which the taxpayer elects the use of the 150-
percent declining balance method.

COMMENTS AND CONCERNS

• The new law effectively now requires farmers to use 200% declining balance just
like other taxpayers for 3, 5, 7 and 10-year property.

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2017 Tax Cuts and Jobs Act-Depreciation

Real Property Lives and Methods

NEW LAW IRC SECTION 168

Effective for property placed in service in taxable years beginning after 12/31/2017
(Sec. 13204 of Act)

• The new law eliminates the separate definitions of qualified leasehold
improvement, qualified restaurant, and qualified retail improvement property and
now calls all of them qualified improvement property;

• The law allows section 179 expensing for qualified improvement property without
regard to whether the improvements are property subject to a lease, placed in
service more than three years after the date the building was first placed in service,
or made to a restaurant building.

• The law also requires a real property trade or business electing out of the limitation
on the deduction for interest to use ADS to depreciate any of its nonresidential real
property, residential rental property, and qualified improvement property.

• All qualified improvement property now will use a 15-year life.

• The term ‘qualified improvement property’ means any improvement to an interior
portion of a building which is nonresidential real property if such improvement is
placed in service after the date such building was first placed in service. It does
not include enlargements, elevators, escalators or the interior structural
framework.

• The law requires straight line depreciation for all qualified improvement property.

COMMENTS AND CONCERNS

• This is a needed change because of the confusing nature of 4 different special
definitions for certain real estate property, with some qualifying for bonus only,
some qualifying for Section 179 only, and different lives.

• It will have a potential negative effect on restaurant property because prior to 2018
restaurant property included new construction, expansions, etc. New restaurant
construction or expansion after 2017 will revert to a 39-year life.

• Now, all special real estate property utilizes a 15-year life, with both Section 179
and bonus depreciation allowed.

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2017 Tax Cuts and Jobs Act-Depreciation

Qualified Real Property Rules-Property Purchased & Placed in Service

After 12/31/17

Description Depreciable Life Qualify for 179? Qualify for

100% Bonus?

*Leasehold 15 Year Yes Yes
Improvement 15 Year Yes Yes
*Restaurant 15 Year Yes Yes
Property
*Retail Property

Improvement 15 Year Yes Yes

Property

• Separate definition now eliminated, all are now qualified improvement property.

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2017 Tax Cuts and Jobs Act-Depreciation

Farm Property Depreciation Methods
NEW LAW IRC SECTION 168

Effective for property placed in service in taxable years beginning after 12/31/2017
(Sec. 13205 of Act)

• The provision requires an electing farming business, i.e., a farming business
electing out of the limitation on the deduction for interest, to use ADS to depreciate
any property with a recovery period of 10 years or more (e.g., property such as
single purpose agricultural or horticultural structures, trees or vines bearing fruit or
nuts, farm buildings, and certain land improvements).

Citrus Tree Replanting Costs Depreciation
NEW LAW IRC SECTION 263A

Effective for property placed in service in taxable years beginning after date of
enactment

(Sec. 13207 of Act)
• The provision modifies the special rule for costs incurred by persons other than the

taxpayer in connection with replanting an edible crop for human consumption
following loss or damage due to casualty. Under the provision, with respect to
replanting costs paid or incurred after the date of enactment, but no later than a
date which is ten years after such date of enactment, for citrus plants lost or
damaged due to casualty, such replanting costs may also be deducted by a person
other than the taxpayer if (1) the taxpayer has an equity interest of not less than
50 percent in the replanted citrus plants at all times during the taxable year in which
the replanting costs are paid or incurred and such other person holds any part of
the remaining equity interest, or (2) such other person acquires all of the taxpayer’s
equity interest in the land on which the lost or damaged citrus plants were located
at the time of such loss or damage, and the replanting is on such land.

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2017 Tax Cuts and Jobs Act-General Business Items

Corporate Tax Rates

NEW LAW IRC SECTION 11 and 243

Effective for taxable years beginning after 12/31/2017
(Sec. 13001 of Act)

• All regular (C) corporations will pay a flat tax rate of 21%, including PSC’s.
o This change also changes the R&D credit,
o This change reduces the built-in gains tax rate,

• The dividend received deduction is reduced from 70% to 50%;

o If the ownership is 20% or more, it is reduced from 80% to 65%

COMMENTS AND CONCERNS

• This change will make “C” corporations very popular again. See our discussion of the

considerations.

C Corporation Tax Rates Years Beginning
Years 2003-2017 after 12/31/2017

$0 $50,000 15% 21%
50,000 75,000 25% 21%
75,000 100,000 34% 21%
100,000 335,000 39% 21%
335,000 10,000,000 34% 21%
10,000,000 15,000,000 35% 21%
15,000,000 18,333,333 38% 21%
18,333,333 ……….. 35% 21%

Main Advantages of “C” corporation: Fringe Benefit Deductions, low tax rates, ability
to utilize small C corporation to benefit from low rate with fringe deductions while paying
dividend income out at zero or low capital gains rates to owner. An individual is in the 0%
capital gains rates on dividends up to about $50,000 of income for a single person and
$100,000 of taxable income for a married couple filing jointly. A C corporation must be
considered as an organizational alternative for a profitable small business.

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Net Operating Losses
NEW LAW IRC SECTION 172

Effective for taxable years beginning after 12/31/2017
(Sec. 13302 of Act)

• Net operating losses arising after 12/31/2017 are limited to an 80% of taxable income
limit, with an unlimited carry-forward. All special carryback periods as well as the
normal two-year carryback are repealed for losses arising after 12/31/2017, except
farmers who are still allowed a two-year carryback.

COMMENTS AND CONCERNS

• This change will do away with the requirement to make the “Election to waive the
carryback” tax return attachment for years after 2017. Do not forget to make the
election for 2017 by 10/15/2018 if the carryback is not desired.

• This change will apply to NOL’s on Forms 1120 and Form 1040.
• NOL’s do not apply to self-employment tax for the current, prior, or future years.
• A net operating loss may be carried to a closed year (more than 3 years since due

date).
• NOL’s from before 2018 will continue to carry forward and expire in twenty years under

existing rules. They will continue to apply at 100% of taxable income.

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Like Kind Exchanges

NEW LAW IRC SECTION 1032

Effective for exchanges completed after 12/31/2017
(Sec. 13303 of Act)

• After 2017, tax-free like kind exchanges will only be available to non-inventory real
property.

• However, an exception is provided for any exchange if the property disposed of by the
taxpayer in the exchange was disposed of on or before Dec. 31, 2017, or the property
received by the taxpayer in the exchange was received on or before that date.

• It is intended that real property eligible for like-kind exchange treatment under present
law will continue to be eligible for like-kind exchange treatment under the provision.
For example, improved real estate and unimproved real estate are generally
considered to be property of a like kind. See Treas. Reg. sec. 1.1031(a)-1(b).

COMMENTS AND CONCERNS

• This would preclude real estate “flippers” from utilizing questionable like-kind
exchange rules, as well as requiring gain calculations on all equipment trade-ins.

• The Section 1031 tax deferred treatment of capital gains is one of the best real estate
investor vehicles for preserving and building real estate wealth: This provision of the
Internal Revenue Code allows property owners to exchange their property for other
like-kind property without recognition of capital gains. It makes it possible to transfer
the financial gain that is realized from the sale of a property into another property
without federal capital gains tax at the time of the sale.

• Now, every time a client trades a piece of equipment for another piece of equipment,
the trade-in value given for the old equipment will be reflected as sales price, with
depreciation recapture, and the full purchase price will qualify for bonus and Section
179.

• Additionally, the outright sale of a piece of equipment followed within 180 days by a
re-purchase of similar equipment, is now considered a taxable sale and a new
purchase rather than a tax-free like-kind exchange.

• An unexpected advantage? Depreciation schedules will now be cleaner!

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Entertainment & Transportation Deduction

NEW LAW IRC Sec. 274

Bill Effective for years beginning after 12/31/2017
(Sec. 13304 of Act)

• The act disallows a deduction for (1) an activity generally considered to be
entertainment, amusement, or recreation; (2) membership dues for any club organized
for business, pleasure, recreation, or other social purposes; or (3) a facility or portion
thereof used in connection with any of the above items.

• This change eliminates the current 50% deduction for entertainment, amusement or
recreation that is directly related to the active conduct of the taxpayer’s trade or
business.

• In addition, the law disallows a deduction for expenses associated with providing any
qualified transportation fringe (IRC Sec. 132(f)) to employees of the taxpayer, and
except as necessary for ensuring the safety of an employee, any expense incurred for
providing transportation (or any payment or reimbursement) for commuting between
the employee’s residence and place of employment.

• Taxpayers may still generally deduct 50 percent of the food and beverage expenses
associated with operating their trade or business (e.g., meals consumed by employees
on work travel). For amounts incurred and paid after December 31, 2017 and until
December 31, 2025, the provision expands this 50 percent limitation to expenses of
the employer associated with providing food and beverages to employees through an
eating facility that meets requirements for de minimis fringes and for the convenience
of the employer. Such amounts incurred and paid after December 31, 2025 are not
deductible.

• Taxpayers may also still deduct 100% of expenses paid or incurred by the taxpayer,
in connection with the performance of services for another person (other than an
employer), under a reimbursement or other expense allowance arrangement if the
taxpayer accounts for the expenses to such person

COMMENTS AND CONCERNS

• The Sec. 274 transportation fringes eliminated after 12/31/2017 by this change are:
o Commuter highway vehicle rides ($255 monthly);
o Transit passes ($255 monthly);
o Qualified parking ($255 monthly); and
o Bicycles ($20 monthly).

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Other Changes Affecting Small Business

• Domestic Production Activities Deduction (IRC Sec. 199, Sec. 13305 of Act) (Effective
for years beginning after 12/31/2017 for non-corporate taxpayers, after 12/31/2018 for
C Corporation taxpayers)
• This deduction, called the DPAD or the Manufacturer’s Deduction, or the
Production Deduction, has been repealed! It was a deduction at a rate of 9%
for various activities.

• Coincidentally, the 20% flow-through entity deduction discussed later is very
similar.

• Employee Achievement Awards: (IRC Sec. 74 and 274) (Sec. 13310 of Act) (Effective
for amounts paid or incurred after 12/31/2017)

• A slight definition change was made to ensure that these non-taxable awards
are non-cash and do not include cash, cash equivalents, gift cards, gift
coupons or gift certificates (other than arrangements conferring only the right
to select and receive tangible personal property from a limited array of such
items pre-selected or pre-approved by the employer), or vacations, meals,
lodging, tickets to theater or sporting events, stocks, bonds, other securities,
and other similar items.

• Partnership Technical Terminations (IRC Sec. 708(b)) (Sec. 13504 of Act) (Effective
for partnership taxable years beginning after 12/31/2017)

• The act repealed the Sec. 708(b)(1)(B) rule providing for technical terminations
of partnerships under specified circumstances. The provision does not change
the rule of Sec. 708(b)(1)(A) that a partnership is considered to be terminated
if no part of any business, financial operation, or venture of the partnership
continues to be carried on by any of its partners in a partnership.

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• Business Credits

• Credits that were originally scheduled for repeal which were not repealed or
modified include: disabled access; employer provided child-care; new
markets; tips credit; work opportunity; unused business credit carryforward.

• The original Bills repealed many business credits. The final bill modified only
these credits:

▪ The amount of the Sec. 45C credit for clinical testing expenses for
drugs for rare diseases or conditions is reduced to 25% (from the prior
50%) (Sec. 13401 of Act).

▪ The act modified the Sec. 47 rehabilitation credit to repeal the 10%
credit for pre-1936 buildings and retain the 20% credit for certified
historic structures. However, the credit must be claimed over a five-year
period. (Effective for amounts paid or incurred after 12/31/2017) (Sec.
13402 of Act)

▪ The act allows eligible employers to claim a new family leave credit
under new IRC Sec. 45S equal to 12.5% of the amount of wages paid
to a qualifying employee during any period in which the employee is on
family and medical leave if the rate of payment under the program is
50% of the wages normally paid to the employee. The credit is
increased by 0.25 percentage points (but not above 25%) for each
percentage point by which the rate of payment exceeds 50%. The
maximum amount of family and medical leave that may be taken into
account for any employee in any tax year is 12 weeks. However, the
credit is only available in 2018 and 2019. (Sec. 13403 of Act)

An eligible employer is one who has in place a written policy that allows
all qualifying full-time employees not less than two weeks of annual paid
family and medical leave, and who allows all less-than-full-time
qualifying employees a commensurate amount of leave on a pro rata
basis.

• Regular “C” Corporation Alternative Minimum Tax (IRC Sec. 38, Sec. 12001 of Act)
(Effective for taxable years beginning after 12/31/2017)

• Corporate alternative minimum tax is repealed

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• Interest Deduction: (IRC Sec. 163j), Sec. 13301 of Act) (Effective for tax years
beginning after 12/31/2017 and before 1/1/2022)

• Any taxpayer that meets the $25 million gross-receipts test is exempt from the
interest deduction limitation. The limitation will also not apply to any real
property development, redevelopment, construction, reconstruction,
acquisition, conversion, rental, operation, management, leasing, or brokerage
trade or business. Farming businesses are allowed to elect out of the limitation.

• For these purposes, business interest means any interest paid or accrued on
indebtedness properly allocable to a trade or business. Business interest
income means the amount of interest includible in the taxpayer’s gross income
for the tax year that is properly allocable to a trade or business. However,
business interest does not include investment interest, and business interest
income does not include investment income, within the meaning of Sec.
163(d).

• For businesses with average revenues >$25 million, the deduction is limited to
the sum of (1) business interest income; (2) 30% of the taxpayer’s adjusted
taxable income for the tax year; and (3) the taxpayer’s floor plan financing
interest for the tax year. Any disallowed business interest deduction can be
carried forward indefinitely (with certain restrictions for partnerships).

• Floor plan financing interest means interest paid or accrued on indebtedness
used to finance the acquisition of motor vehicles held for sale or lease to retail
customers and secured by the inventory so acquired.

Partnership Interest Received for Work Performed

NEW LAW IRC SECTION 83

Effective for taxable years beginning after 12/31/2017
Act Section 1061

• The law treats as short-term capital gain taxed at ordinary income rates the amount
of the taxpayer’s net long-term capital gain with respect to an applicable
partnership interest for the taxable year that exceeds the amount of such gain
calculated as if a three-year (not one-year) holding period applies. In making this
calculation, the provision takes account of long-term capital losses calculated as if
a three-year holding period applies.

This rule makes the receipt of a partnership interest in return for services taxable
(it always has been) AND makes it a capital gain after 3 years, not 1.

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Sexual Harassment Settlements

NEW LAW IRC SECTION 162Q

Effective for amounts paid or incurred after 12/22/2017
Act Section 13307

• No deduction is allowed for any settlement, payout, or attorney fees related to
sexual harassment or sexual abuse if such payments are subject to a
nondisclosure agreement.

Built in Losses in Transfer of Partnership Interests

NEW LAW IRC SECTION 743

Effective for transfer of partnership interests after 12/31/2017
Act Section 13502

• The provision modifies the definition of a substantial built-in loss for purposes of
section 743(d), affecting transfers of partnership interests. Under the provision, in
addition to the present-law definition, a substantial built-in loss also exists if the
transferee would be allocated a net loss in excess of $250,000 upon a hypothetical
disposition by the partnership of all partnership’s assets in a fully taxable
transaction for cash equal to the assets’ fair market value, immediately after the
transfer of the partnership interest.

For example, a partnership of three taxable partners (partners A, B, and C) has
not made an election pursuant to section 754. The partnership has two assets, one
of which, Asset X, has a built-in gain of $1 million, while the other asset, Asset Y,
has a built-in loss of $900,000. Pursuant to the partnership agreement, any gain
on sale or exchange of Asset X is specially allocated to partner A. The three
partners share equally in all other partnership items, including in the built-in loss in
Asset Y. In this case, each of partner B and partner C has a net built-in loss of
$300,000 (one third of the loss attributable to asset Y) allocable to his partnership
interest. Nevertheless, the partnership does not have an overall built-in loss, but a
net built-in gain of $100,000 ($1 million minus $900,000). Partner C sells his
partnership interest to another person, D, for $33,333. Under the provision, the test
for a substantial built-in loss applies both at the partnership level and at the
transferee partner level. If the partnership were to sell all its assets for cash at their
fair market value immediately after the transfer to D, D would be allocated a loss
of $300,000 (one third of the built-in loss of $900,000 in Asset Y). A substantial
built-in loss exists under the partner-level test added by the provision, and the
partnership adjusts the basis of its assets accordingly with respect to D.

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Basis Reduction in Partnership from Charitable Contributions

NEW LAW IRC SECTION 740

Effective for transfer of partnership interests after 12/31/2017
Act Section 13503

• The provision modifies the basis limitation on partner losses to provide that the
limitation takes into account a partner’s distributive share of partnership charitable
contributions (as defined in section 170(c)) and taxes (described in section 901)
paid or accrued to foreign countries and to possessions of the United States. Thus,
the amount of the basis limitation on partner losses is decreased to reflect these
items. In the case of a charitable contribution by the partnership, the amount of the
basis limitation on partner losses is decreased by the partner’s distributive share
of the adjusted basis of the contributed property. In the case of a charitable
contribution by the partnership of property whose fair market value exceeds
its adjusted basis, a new special rule provides that the basis limitation on
partner losses does not apply to the extent of the partner’s distributive share
of the excess.

New Allowed ESBT Beneficiaries

NEW LAW IRC SECTION 1361

Effective 1/1/2018
Act Section 13541

• The law now allows a nonresident alien individual to be a potential current
beneficiary of an ESBT.

New S to C conversion rule when changing accrual back to cash

NEW LAW IRC SECTION 481

Effective 12/23/2017 until 12/21/2019
Act Section 13543

• The normal 1 and 4 year periods used to bring accounting method changes into
income is adjusted to 6 years for S corporations converting to C corporations that
were S corporations before 12/22/2017 and which revokes its S election by
12/21/2019.

• No change in shareholders is allowed to utilize this rule.

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New Post Termination Transition Period S to C corporation Rule
NEW LAW IRC SECTION 1361

Effective 12/23/2017
Act Section 13541
• Normally an “S” corporation converting back to a C corporation has a one-year
period of time to withdraw, tax-free, the accumulated earnings balance from S
corporation income years. Under this new rule distributions after the one year
period in a ratio of (AAA + E&P)/ Total Retained earnings.

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Deduction of a Portion of Pass Through Income of Qualified
Businesses

NEW LAW IRC SECTION 199A

Effective for years beginning after December 31, 2017 and before January 1, 2026
(Sec. 11011 of Act)

Author note. After reading this section of the Tax Cut and Jobs Bill several times, it is clear the
deduction for pass through income under IRC '199A was largely patterned after the IRC '199
domestic production activities deduction. For example, in just one of several provisions that
overlap, the definition wages under IRC '199 is exactly the same as the definition used in new
IRC '199A. Until the IRS issues guidance specific to '199A, practitioners may consider reviewing
published guidance on '199 for insight on how the IRS will administer the law on '199A.

I. Introduction. IRS statistics show that the vast majority of businesses in the United States
are sole proprietorships, partnerships and S corporations. In 2016, C corporations made
up only 6% of all business tax returns filed. A major emphasis of the Tax Cuts and Jobs
Act was the reduction of tax rates for business entities. For C corporations, the rate
reduction was relatively simple as the maximum C corporation tax rate was reduced from
35% to 21%. For pass through entities, the House and the Senate each created their own
respective plans to reduce the tax burden on the owners of pass through businesses. The
House proposed the implementation of a maximum individual tax rate that could be
assessed on pass through business income reported on an individual's Form 1040. The
Senate, on the other hand, proposed a more complex formula whereby taxpayers would
be allowed a deduction from taxable income for a portion of any pass-through business
income. In the end, the Senate proposal, with minimal modifications, was adopted by the
Joint Committee and approved in the final bill. The new law essentially provides a
deduction of up to 20% of “domestic qualified business income” from the taxable income
of pass through entity owners, which include partners of partnerships, S corporation
shareholders, and sole proprietorships (Sch. C, Sch. E and Sch. F filers) who are
individuals or estates or trusts. Qualified business income may also include REIT
dividends, cooperative dividends, and publicly traded partnership income. A similar
deduction is also available to specified agricultural or horticultural cooperatives (explained
later). Like all areas of tax law, simplicity was not a concern when this deduction was
decided upon.

II. Determining the amount of the deduction ('199A(a)). At its very core, the deduction
allowed under '199A will normally equal the lesser of 20% of business income or 20% of
taxable income. However, the calculation used to derive the actual amount of the
deduction is much more complex.

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A taxpayer's qualified business income deduction (QBID) for the taxable year is equal to the sum
of:

A. The lesser of:
1. 20% of the taxpayer’s qualified trade or business income plus 20% of
qualified REIT dividends plus 20% of qualified publicly traded partnership
income for the taxable year; or
2. 20% of taxable income after eliminating net capital gains and qualified
cooperative dividends;

PLUS

B. The lesser of:
1. 20% of the taxpayer’s qualified cooperative dividends, or
2. Taxable income (reduced by net capital gain).

Example. Harvey, a single person, has Sch. C income of $100,000 and his taxable income
for 2018 is $88,000 ($100,000 less $12,000 standard deduction). Harvey does not have
any capital gains or co-op dividends. Harvey is entitled to a '199A deduction of $17,600,
which is calculated:

1. $17,600 (lesser of 20% of $100,000 or 20% of $88,000); plus
2. $0 (lesser of $0 or taxable income $88,000)

Sum of 1. and 2. above is $17,600.

Variation. Harvey, a single person, has Sch. C income of $100,000, wages of $40,000
and capital gains of $10,000 in 2018. Harvey’s 2018 taxable income is $138,000
($100,000 + $40,000 + $10,000 less $12,000 standard deduction). Harvey does not have
any co-op dividends. Harvey is entitled to a deduction under '199A of $20,000, which is
calculated:

1. $20,000 (lesser of 20% of $100,000 or 20% of $128,000); plus
2. $0 (lesser of $0 or taxable income of $128,000)

Sum of 1. and 2. above is $20,000.

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Variation #2. Harvey, a single person, has Sch. C loss of $25,000 and $60,000 of wage
income. Harvey’s 2018 taxable income is $23,000 ($60,000 wages less $25,000 loss less
$12,000 standard deduction). Harvey has no co-op dividends. Harvey’s 2018 '199A
deduction is $0, which is calculated:
1. $0 (lesser of 20% of $25,000 loss or 20% of $23,000); plus
2. $0 (lesser of $0 or taxable income of $23,000)
Sum of 1. and 2. above is $0.

Preparer note: Regardless of all calculations, the '199A deduction can never exceed the
taxpayer's taxable income for the year (reduced by net any capital gains).

III. Taxpayers having 2 or more trade or business activities ('199A(b)). Individual
taxpayers who own more than one trade or business activity must combine the income
and losses from all activities to arrive at combined qualified business income for the year.
If the net amount from all activities is a loss, the loss is treated as a qualified trade or
business loss in the succeeding taxable year. This requires the taxpayer to reduce the
current year '199A deduction by 20% of the amount of any net loss used to calculate
taxable income in the most recent prior year, regardless if a tax benefit was received.

Example. In 2018 Sarah has Sch. C qualified business income of $40,000 and a Sch. E
qualifying business loss of $60,000. Sarah’s combined qualified business loss for 2018 is
$20,000. She is not allowed a deduction under '199A for 2018 and she must carry over
the $20,000 combined loss to 2019.
In 2019, Sarah has Sch. C income of $50,000 and a Sch. E loss of $20,000. Sarah
calculates her 2019 '199A deduction to be $6,000 based on her combined qualified
business income of $30,000 (Sch. C profit $50,000 less Sch. E loss $20,000) multiplied
times 20%. However, Sarah must reduce her 2019 '199A deduction by 20% of the
deductible loss from her 2018 tax return ($20,000 x 20% = $4,000), leaving her a
deduction of only $2,000.

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Preparer note: The IRC definition of “trade or business” is very broad and includes any
activity that is engaged in on a regular and continuous basis and the taxpayer’s motive in
the activity to achieve a profit (Groetzinger v. Comm.). The Tax Cut and Jobs Act
specifically excluded certain activities from the calculation of the '199A deduction, but real
estate rental activities were not excluded and, therefore, would appear to qualify, even if
the underlying rental activity is passive. IRS may take the view that rental income needs
to rise to the level of an "IRC Section 162 Trade or Business" and require "significant
services" to be "domestic qualified business income

Preparer note: Only net losses included or actually deducted in calculating taxable
income are considered in the subsequent year. For example, suspended passive losses
that are carried forward would not impact the qualified combined business income
deduction in the subsequent year ('199A(c)(3)(A)(ii)).

Example. Sean and Jessi reported taxable income of $200,000 on their 2019 jointly filed

return. Sean owns BPS, a sports apparel retail store that he operates as a sole

proprietorship. Jessi is a partner with EJI, which is not a specified service business. Sean

and Jessi have a carryover qualified business loss of $50,000 from 2018. Sean's 2019

qualified business income from BPS is $150,000. EJI passes through a qualified business
loss of $40,000 to Jessi for 2019. As Sean and Jessi’s taxable income is below the

$315,000 threshold amount for joint filers, the wage limit is not applicable. Sean and
Jessi’s combined qualified business income amount is calculated:

Sean’s qualified business income ($150,000 x 20%) $ 30,000
Jessi’s qualified business loss ($40,000 x 20%) ($ 8,000)
($10,000)
Carryover business loss from 2018 ($50,000 x 20%)

'199A deduction allowed in full in 2019 $ 12,000

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IV. Taxpayers with relatively “high” taxable income are subject to additional limitations
before claiming '199A deductions ('199A(b)(3)). Taxpayers whose taxable income (not
AGI) exceeds specified thresholds are required to navigate two additional limitations
before they are allowed any deductions under '199A: 1) the W-2 and capital limitation, and
2) the specified service business limitation. For taxpayers filing married joint returns, the
threshold starts at taxable income of $315,000 and is fully phased in at $415,000. For all
other filers, the threshold starts at taxable income of $157,500 and is fully phased in at
$207,5001.

A. W-2 wages and capital limitation. Taxpayers whose taxable income (not AGI)
exceeds the thresholds are required to limit their '199A deduction to the greater of:

1. 50% of W-2 wages paid with respect to the qualified trade or business, or
2. 25% of W-2 wages paid with respect to the qualified trade or business plus

2.5% of the unadjusted basis of qualified property used for production of
income in the underlying business. Qualified property is depreciable
property used in the qualified trade or business at the close of the taxable
year and for which the depreciable period has not ended before the close
of the taxable year2.

B. W-2 wages defined. W-2 wages are defined as the total of all wages subject to
wage withholding, plus elective deferrals and deferred compensation paid by the
qualified trade or business. W-2 wages do not include any amount which is not
properly allocable to the qualified business income as a qualified item of deduction.
W-2 wages only include amounts that are reported to the Social Security
Administration on a timely basis (on or before the 60th day after the due date,
including extensions, of the info return).

1Beginning in 2019 the thresholds will be annually adjusted for inflation.
2The “depreciable period” means the period beginning on the date the property is first placed in
service by the taxpayer and ending on the later of (a) the date 10 years after that date, or (b) the last day
of the last full year in the applicable recovery period that would apply to the property under '168 (without
regard to '168(g)).

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Example. Ed operates a manufacturing business as a sole proprietor that has a profit of

$250,000 in 2020. Ed paid payroll of $120,000 and he had equipment with unadjusted
basis of $350,000 as of Dec. 31, 2020. Ed’s 2020 taxable income (business income-

standard deduction) exceeds $207,500 (250,000 Sch C + 24,000 interest and dividends-

24,000 standard deduction=250,000), so his '199A deduction may be limited as a result
of the wage limitation. Ed’s '199A deduction for 2020 is calculated:

a. 20% of his qualified business income $50,000
b. Greater of: 50% of W-2 wages ($120,000 x 50%) $60,000

or $38,750
Sum of 25% of W-2 wages ($30,000)
plus 2.5% of qualified basis ($350,000 x 2.5% = $8,750)

Greater of two amounts $60,000
'199A deduction - lesser of a. or b. $50,000

Preparer note: Taxpayers such as Ed in the above example are required to consider the
wage limitation whenever their taxable income exceeds the threshold amount. However,
it is important to note that the wage limitation will never apply if the calculated deduction
based on qualified business income is less than the wage limit. The wage limitation is not
considered binding in such situations.

Example 2. Ed operates a manufacturing business as a sole proprietor that has a profit
of $250,000 in 2020. All of Ed’s equipment is more than 10 years old, so he decides to

buy a new machine to automate his manufacturing operations at the cost of $100,000.
Ed’s new machine was placed in service in 2020, a year when Ed had no payroll. Ed’s

taxable income for 2020 exceeds $207,500 so he is required to calculate the wage

limitation to determine his 2020 '199A deduction. The deduction is calculated:

a. 20% of his qualified business income $50,000
b. Greater of: 50% of W-2 wages ($0 x 50%) $0

or $ 2,500
Sum of 25% of W-2 wages ($0)
plus 2.5% of qualified basis ($100,000 x 2.5% = $2,500)

Greater of two amounts $ 2,500

'199A deduction - lesser of a. or b. $ 2,500

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Example 3. Dave owns a 100-unit apartment complex with an unadjusted basis of

$6,500,000. The apartments generate a profit of $350,000 in 2018 and Dave does not pay
any wages. Dave’s deduction under '199A is calculated:

a. 20% of his qualified business income $ 70,000
b. Greater of: 50% of W-2 wages ($0 x 50%) $0

or $162,500
Sum of 25% of W-2 wages ($0)
plus 2.5% of qualified basis ($6,500,000 x 2.5% = $162,500)

Greater of two amounts $162,500

'199A deduction - lesser of a. or b. $ 70,000

Planning note. Wages paid to related parties, including owners, are included for purposes
of the wage limitation. Sch. C filers with no employees should consider hiring family
members to work in the business or reorganizing as an S corporation and paying
themselves wages to allow '199A deduction.

C. Phase-in of wage limit. The application of the wage limit phases in for a taxpayer
with taxable income in excess of the $315,000 and is fully phased at $415,000.
For all other taxpayers, the wage limit phase in begins at $157,500 and is fully
phased in at $207,500. For taxpayers with taxable in between the beginning and
fully phased out amounts, the wage limit varies based on the following formula.

The taxpayer first compares qualified trade or business income to wages paid:

1. 20% of the taxpayer's qualified business income, and
2. 50% of the W-2 wages paid by the qualified trade or business.

If the amount determined under 1. is less than that determined under 2., no further
action is necessary. The deduction calculated under 1. is the deductible amount.
However, if the amount determined under 2. (the wage limit) is less than the
amount determined under 1. (business income limit), the wage limit is binding. The
taxpayer is required to compute the '199A deduction by reducing the amount from
1 (business income limit) by the same proportion as the difference between the
two amounts as the excess of the taxable income of the taxpayer over the
threshold amount bears to $50,000 ($100,000 in the case of a joint return). This
calculation can best be illustrated using an example.

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Example. Jim and Kathy file a joint return on which they report taxable income of

$350,000. Kathy has a qualified trade or business with total income in 2018 of $75,000,

giving her $15,000 of qualified business income ($75,000 x 20%). Kathy paid wages of

$20,000 in 2018, giving her $10,000 of qualified wages ($20,000 x 50%). If Kathy and
Jim’s taxable income exceeded the $415,000 maximum threshold Kathy’s '199A

deduction would be $10,000, the lesser of $15,000 or $10,000. However, because Kathy
and Jim’s taxable income exceeds the $315,000 threshold amount, but not the maximum

threshold of $415,000, she must limit her based on the wage limit phase in. The amount

of the limit is calculated:

20% of pass through income ($75,000 x 20%) $15,000
50% of qualifying wages ($20,000 x 50%) $10,000
Difference (how much of this amount can she deduct?) $ 5,000

Taxable income in excess of threshold ($350,000 less $315,000) $35,000

Excess income as a % of the phaseout ($35,000  $100,000) 35%

Reduction in dollars ($15,000 - $10,000) x 35% $ 1,750

'199A deduction ($15,000 less $1,750 reduction) $13,250

Example #2. Josh, who is single, receives a K-1 from an S corporation showing his share
of business profit is $125,000 in 2018. The K-1 also reports that Josh’s share of wages
paid by the S corporation were $40,000. Josh’s 2018 taxable income is $187,500. Josh

calculates his '199A deduction:

20% of pass through income $25,000
50% of qualifying wages $45,000
Difference $20,000

Josh may stop his calculation here at this point. The wage limit is not binding in this
situation because the qualified business income amount is less than the wage limit. No
further action is necessary and Josh is allowed to claim a '199A deduction of $25,000.

Preparer note: Congress tasked the IRS with writing regulations to address various
situations such as those in the last few examples. Future guidance is expected to address
applying the various limitations in cases of a short taxable year where the taxpayer
acquires, or disposes of, the major portion of a trade or business during the year, property
acquisitions from related parties, basis determination when qualifying property is acquired
via a like-kind exchange or involuntary conversions, as well as providing anti-abuse rules.

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D. Specified service trade or business limitation ('199A(d)). A taxpayer engaged
in a “specified service trade or business” and whose taxable income exceeds the
fully phased in threshold amounts of $415,000 (MFJ) or $207,500 (all others) are
not allowed to claim a deduction under '199A, regardless of the amount of wages
paid or equipment bought. For these purposes, the definition a specified service
trade or business means any trade or business involving the performance of
services in the fields of:

1. Health
2. Law
3. Consulting
4. Accounting
5. Performing arts
6. Actuarial services
7. Athletics
8. Financial services
9. Brokerage services (investing and investment management trading, etc.)
10. Any trade or business where the principal asset of such trade or business

is the reputation or skill of one or more of its employees or owners.

Example. Judy is an accountant who is single and earned $110,000 from her accounting
firm in 2018. Judy doesn’t have any payroll. Her taxable income for 2018 is $125,000.
Judy is allowed a deduction under '199A of $22,000 ($110,000 x 20%) for 2018. The fact
that Judy is engage in a specified service business is irrelevant as her taxable income is
below the minimum threshold of $157,500. The wage limit is also irrelevant.

Example 2. In 2019, Judy’s accounting business rapidly grows, and she reports income
of $310,000. Judy hired employees in 2019 and paid them wages of $150,000. Although
Judy has adequate payroll to qualify for the full '199A deduction, accounting is a specified
service trade or business. Because Judy’s taxable income for 2019 is more than $207,500
(the threshold of $157,500 plus the full $50,000 phase in amount), Judy may not claim any
deduction under '199A for 2019.

Preparer note: The final bill excluded engineering and architecture from the definition of
specified service trades or businesses. Presumably, taxpayers in these types of
businesses will qualify for the '199A deduction regardless of the amount of taxable income.
This is consistent with the treatment of engineers and architects under the domestic
production activities deductions, where these two service professions were separated
from all other service providers.

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E. Phase-in of specified service business limitation. Taxpayers who have income
from a specified service business and whose taxable income is less than the base
threshold amounts ($315,000 MFJ; $157,500 for all others) are allowed the full
'199A deduction in the same manner as any other taxpayers.

Taxpayers with taxable income in excess of the fully phased in amounts ($415,000
MFJ; $217,500 for all others) are not allowed any '199A deduction. Taxpayers
whose taxable income is between the base threshold and the fully phased in
amounts are required to perform a separate calculation to determine the amount
of specified service business income that may be used to determine the allowable
'199A deduction.

The amount is determined by considering only the applicable percentage of
qualified items of income and deduction and of allocable W-2 wages. The
applicable percentage for a given year is 100% reduced by the percentage equal
to the ratio of the excess of the taxable income of the taxpayer over the threshold
amount bears to $100,000 (MFJ) and $50,000 for all others. This calculation is
best illustrated in an example.

Example. Liam, a single taxpayer, has taxable income of $187,500 in 2018, of which

$100,000 is attributable to his work as an attorney. Liam paid wages of $50,000 to
employees who worked in his law firm. Liam’s calculates his applicable percentage:

Taxable income in excess of the threshold ($187,500 - $157,500) $30,000
Phase out range for single individual $50,000
% of income in excess of threshold ($30,000  $50,000)
Applicable % allowable when calculating deduction (100% - 60%) 60%
40%

Liam determines his qualified business income and related wages: $40,000
Applicable business income ($100,000 total business income x 40%) $20,000
Applicable wages ($50,000 x 40%)

Liam calculates his '199A deduction: $ 8,000
a. Qualified business income deduction ($40,000 x 20%) $ 10,000
b. Qualified wage deduction ($20,000 x 50%)

Lesser of a. or b. $ 8,000

Liam may claim a '199A deduction of $8,000 on his 2018 tax return.

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V. Reasonable compensation and guaranteed payments ('199A(c)(4)). Qualified
business income does not include any amount paid by an S corporation that is treated as
reasonable compensation of the taxpayer. Similarly, qualified business income does not
include any guaranteed payment for services rendered with respect to the trade or
business, and does not include any amount paid or incurred by a partnership to a partner
who is acting other than in his or her capacity as a partner for services.

Preparer note: Congress anticipates that these limitations and related threshold amounts
will serve to deter high-income taxpayers from attempting to convert wages or other
compensation for personal services to income eligible for the 20% '199A deduction. Not
sure they are correct!

VI. Other clarifying provisions of '199A. There are several other provisions that clarify the
rules of IRC '199A. The more important of these clarifications include the following.

A. Deduction against taxable income, not AGI. The conference committee report
makes it clear that the '199A deduction reduces taxable income, not AGI or self-
employment income. Further, the conference committee clarifies that the
deduction is available to all taxpayers, regardless if they choose to itemize
deductions. Presumably there will be a new line on Form 1040 to input the
deduction in the appropriate place on Form 1040.

B. Partnerships and S Corporations. For partnerships or S corporations, the '199A
deduction is applied at the partner or shareholder level, not at the entity level. The
entity is required to report to each partner or shareholder his or her allocable share
of each qualified item of income, gain, deduction, and loss, W-2 wages and
unadjusted basis of property.

C. Coordination with AMT ('199A(f)(2)). The '199A deduction is allowed for against
AMT income without any adjustments.

D. U.S. based income only used in calculations. Qualified items of income, gain,
deduction, and loss must be effectively connected with the conduct of a trade or
business within the United States to qualify under '199A. No foreign source income
is allowed in the calculation.

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E. Investment income. Most investment income items are not qualified
business income items. Specifically, qualified items of income, gain,
deduction and loss do not include:

1. Short and long-term capital gains;
2. Dividends or payments in lieu of dividends;
3. Interest income unless properly allocable to a trade or business;
4. Gains from commodity transactions unless such gains arise from

the normal course of the trade or business or with respect to
property held primarily for sale to customers in the ordinary course
of the trade or business, property used in the trade or business, or
supplies regularly used or consumed in the trade or business;
5. Most foreign currency gains from '988 transactions;
6. Net income from notional principal contracts, other than clearly
identified hedging transactions that are treated as ordinary (i.e., not
treated as capital assets); and
7. Amount received from an annuity that is not used in the trade or
business.

VII. Cooperative dividends, REITs, and publicly traded partnerships ('199A(b)). A
'199A deduction is allowed for 20% of a taxpayer's aggregate amount of qualified
cooperative dividends, qualified REIT dividends, and qualified publicly traded
partnership income for the taxable year. For this purpose:

A. Qualified cooperative dividends are defined as any: 1) patronage
dividend, 2) per-unit retain allocation, or 3) qualified allocation from a
qualified organization.

B. Qualified REIT dividends include any dividend from a real estate
investment trust received during the taxable year which is not a capital gain
dividend and is not qualified dividend income

C. Qualified publicly traded partnership income is defined as the net
amount of a taxpayer's allocable share of each qualified item of income,
gain, deduction, and loss from a publicly traded partnership plus any gain
recognized upon the disposition of the taxpayer=s interest in the
partnership to the extent any gain is treated as an amount realized from the
sale or exchange of property other than a capital asset (i.e., hot assets).

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VIII. Deduction allowed to specified agricultural or horticultural cooperatives
('199A). A “specified agricultural or horticultural cooperative” is an organization 1)
engaged in the manufacturing, production, growth, or extraction of any agricultural
or horticultural product, 2) the marketing of agricultural or horticultural products
which its patrons have so manufactured, produced, grown, or extracted, or 3)
which provide supplies, equipment, or services to farmers or to organizations
described in 1) or 2). Generally, specified agricultural or horticultural cooperatives
are allowed a deduction in under IRC '199A equal to the lesser of:
A. 20% of the excess (if any) of:
1. The gross income of a specified agricultural or horticultural
cooperative, over
2. The qualified cooperative dividends paid for and during the taxable
year, or
B. The greater of:
1. 50% of the W-2 wages of the cooperative with respect to its trade
or business, or
2. The sum of 25% of the W-2 wages of the cooperative with respect
to its trade or business, plus 2.5% of the unadjusted basis
immediately after acquisition of all qualified property of the
cooperative.
Preparer note. As with other qualifying organizations, the amount of any '199A
deduction cannot exceed the taxable income of the specified agricultural or
horticultural organization for the taxable year.

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IX. Additional clarifying examples.

Example. Mark and Kris reported taxable income of $365,000 on their jointly filed
2018 tax return. Mark is a partner in Clark LLC, a construction company. Kris owns
Tax Too, sole proprietorship that provides tax services, a specified service
business. Mark and Kris also received $10,000 in qualified REIT dividends during
the tax year. Mark's allocable share of qualified business income from Clark was
$200,000. Mark's allocable share of wages from Clark are $70,000. As Mark and
Kris’s taxable income is above the $315,000 threshold amount, and as the wage
limitation is binding in this example, Mark must calculate the phased in wage limit
on the income he received from for Clark. The amount is calculated:

Qualified business income limit ($200,000 x 20%) $ 40,000
Wage limit ($70,000 x 50%) $ 35,000
Difference $ 5,000

Taxable income in excess of threshold ($365,000 - $315,000) $ 50,000
50%
Excess income as a % of the phaseout ($50,000  $100,000)
$ 2,500
Reduction in dollars ($40,000 - $35,000) x 50% $ 37,500
Mark’s '199A deduction ($40,000 less $2,500 reduction)

Kris's qualified business income and W-2 wages from Tax Too are $190,000 and
$150,000, respectively. Kris is also required to partially restrict her '199A deduction
because her business is a specified service business.

Excess income as a % of the phaseout (see calculation above) 50%

Kris’s applicable business income ($190,000 business income x 50%) $ 95,000

Kris’s applicable wages ($150,000 wages x 50%) $ 75,000

Kris calculates her '199A deduction: $ 19,000
a. Qualified business income deduction ($95,000 x 20%) $ 37,5003
b. Qualified wage deduction ($75,000 x 50%)

Lesser of a. or b. $ 19,000

Kris may claim a '199A deduction of $19,000 on her 2018 tax return.

Mark and Kris’s combined qualified business income of amount of $58,500 is
comprised of the deductible amount for Clark of $37,500, the deductible amount
for qualified business Tax Too of $19,000, and 20% of the $10,000 qualified REIT
dividend.

3Although Mark and Kris's taxable income is above the threshold amount for a joint
return, the wage limit is not binding as the $19,000 of qualified business income from Kris’s
business is less than the $37,500 of includable W-2 wages. The wage limit is only binding when it
is less than the qualifying business income limit.

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Entity Choice Analyses

The decision to change an entity’s type of tax filing, including the decision to convert an
existing entity to a C corporation is one which must be carefully analyzed for both operating
and income tax issues. The following tables provide guidance on many of the initial
decisions.

After the table analyses we will analyze some case studies on conversion to look at net
numbers. Before we get there, let’s look at some initial issues of converting an S
corporation to a C Corporation, and converting an LLC taxed as a partnership to a C
corporation. We will then end this chapter with an example of an S corporation conversion.

Converting an existing S corporation back to a C Corporation-initial issues
Terminating an S election in an existing LLC or C Corporation that is taxed as an S
corporation has an immediate consideration: A retroactive termination of an S election
by a corporate entity for 2018 must be made no later than March 15, 2018. Although
the case studies below will examine many of the operating issues, there is usually no
immediate tax effect on conversion and there is no built in gains tax, but the post
termination transition period will be an issue, the actual termination election must be
properly filed with the IRS, and a clear comparison of the net total tax effect of actual cash
to the owners must be performed.

Some considerations often overlooked in the conversion decision include
• Is the individual stockholder in a 0% capital gains bracket and therefore able to
best use C corporation dividends taxed at a 0% rate?
• Are both existing and additional fringe benefits available to be paid by the C
corporation?
• Is the C corporation shareholder’s salary established at an optimal amount to
maximize retirement and Social Security benefits, minimize additional FICA tax
and capitalize on the ability to pay a lower salary without current challenge to a C
corporation?
• Does the S corporation qualify for the new 20% flow-through deduction?
• A conversion at any time other than the 1st day of the year will require 2 returns for
the year of conversion: a short period S corporation return and a short period C
corporation return.
• Once an existing S corporation terminates its S-election, it may not re-elect S
status for 5 years.
• The post termination transition period allows a former S corporation 1 year to pay
out any previously taxed income to shareholders in a tax-free manner.

Converting a 1065 filer to a C Corporation-initial issues
There are no significant tax issues upon converting an entity taxed as a partnership to an
entity taxed as a C corporation other than a potential, rarely encountered, negative basis
at the corporate level. If, while taxed as a partnership, 1 or more individuals used debt
basis (other than direct loans by them) to deduct losses, upon conversion to a C
corporation any debt basis reduction would be taxable to the shareholders. Basis from
debt is not allowed in a corporate entity, nor is zero basis, so the affected individuals
would report taxable income for any debt basis (other than direct loans by them) utilized
to deduct losses. The decision to change an entity’s type of tax filing, including the decision
to convert an existing entity to a C corporation is one which must be carefully analyzed for
both operating and income tax issues. The following tables provide guidance on many of
the initial decisions.

Entity Choice Analyses

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Entity Choice Analyses

Factors to Consider in Choosing a Business Form-2018 Tax Law
Discuss with client, note client’s desired entity by factor

Factor Sole General Single Limited S C or Regular
Proprietor Partnership Owner Liability Corporation Corporation
Default Form 1065 Company
Tax Schedule LLC Form Form 1120
Form C or F Unlimited to Schedule Form 1120S
the extent of all C, E or F 1065 Limited to the
Owner Unlimited to assets owned Limited to amount of
Liability the extent of Limited to Limited to the amount investment
None the the amount of and
IRS Form all assets investment guarantees
to owned No-Flows to amount of of and
owners invest- investment guarantees Employer ID
Establish None # Form SS-4
ment and and Employer ID
Income No-Flows guaran- guarantees # Form SS- Yes
Taxed to to owners
tees None 4, S
Entity None Corporation
No-Flows
No- to Owners Election
Flows to Form 2553
Owners
No-Flows
to Owners

SE Tax? Yes Yes Yes Maybe No No

State No No Yes Yes Yes Yes
Organiza No Yes Yes
No No-but Yes in Yes in Yes Yes
tion suggested most most
Forms cases cases
Required
No No No
Written
Operating

Agree-
ment
Required

?

Annual
Board

and
share-
holder
meetings
required

Double Tax No No No No No Yes
Issues-1 at
entity, 1 to

owners

Entity Choice Analyses

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Entity Choice Analyses

Factor Sole General Single Limited S C or Regular
Proprietor Partnership Owner Liability Corporation Corporation
Profit Company
Distribu- Ordinary Ordinary LLC Ordinary Ordinary Capital
tion tax 37% Max 37% Max 37% Max 37% Max 0-20%
Ordinary
rates No 37% No Yes No
Excluded Max 1-Unlimited
owners 1 2- 1-100 Unlimited
because No No Unlimited
Life of Lesser of Unlimited Any
of tax Owner 2-Unlimited 1 Agreement
rules? or change 12/31, No
Range of 12/31 Lesser of Lesser other
Agreement of of more under No
# of No, but on or change of than 1/3 special
Owners 1040 more than Agree- owner rules Deduct on
Duration 50% owner ment or interest No, flows 1120
Yes life of 12/31, to owners
of interest owner Deduct on
Existence Take on other No 1120
1040 as SE 12/31, other 12/31 under
Year End under special Add to Box 1
health rules of W-2,
20% Flow deduction special rules No, flows
Thru to owners deduct on
unless No, flows to No, but 1120S,
Deduction spouse owners on 1040 No unless
on Form? employed, only owners deduct on
then on No unless Yes are husband 1040 as SE
Minor Schedule only owners
child Deduct on are husband and wife health
wage schedule if and wife
benefit spouse Add to Add to Box 1
available employed, Add to Take on guaranteed of W-2,
otherwise guaranteed 1040 as payments,
106 Health Schedule A payments, SE health deduct on deduct on
Insurance deduct on deduction 1040 unless 1120S,
for owner only 1040 unless unless non-owner
treatment non-owner spouse deduct on
employed, spouse Schedule A
105 HRA spouse then on employed,
and employed, Schedule
then on 1065 then on
Medical 1065
Reimburse Add to Deduct on
ments for guaranteed schedule if Add to
payments guaranteed
owners unless non- spouse payments
owner spouse employed, unless non-
employed, otherwise owner spouse
then on 1065 Schedule employed,
then on 1065
A only

Entity Choice Analyses

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Entity Choice Analyses

Factor Sole General Single Limited S C or Regular
Owner Liability Corporation Corporation
Proprietor Partnership Company
LLC No No
Home Yes Yes as Yes as
office unreimbursed, Yes unreimbursed,
deduction All amounts only by written only by written
allowed at risk All
agreement amounts agreement
Basis of
owners Investment at risk Investment Investment Investment
plus share of plus share of plus direct
recourse and None
qualified non- recourse loans to
recourse debt N/A and non- entity
recourse
N/A
debt
No
Penalty A None None B, F C, D, E,
Taxes: N/A Yes
(A) AMT, N/A Yes Yes No N/A
(B) BIG,
(C)Accum. Yes See Rare-See No
Earnings, Step Up 338 Class Yes
(D) PSC,
(E) PHC, Basis
(F) Excess
Passive
Income

Allocate
income
other
than as
owners’

%

Special
step-up

basis
election
on buyout

Special No No No Yes
351 rules

for
formation

apply?

Treatment Exempt Exempt Exempt Exempt Taxed at Taxed at
of non- after 2 FMV to FMV to
cash after 2 years years both corp both corp &
distribu- individual
tions N/A &
individual
Unreason-
able High N/A N/A N/A N/A Yes
Compen-
sation
Issues

Entity Choice Analyses

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Entity Choice Analyses

Factor Sole General Single Limited S C or Regular
Proprietor Partnership Owner Liability Corporation Corporation
Inadequate Company
Compen- No No LLC Possible No
sation No Possible
Issues Average Minimal as regards Minimal Average
Average
IRS Audit Draw Guaranteed SE tax W-2 W-2
Concern Yes Payments Draw Minimal No
Owners Yes
Payment N/A Yes Yes Guaranteed Taxable to
for Payments shareholder Taxable to both
Services Poor Nontaxable to Nontaxable corp &
State Tax extent of basis to extent of No Average
Uniformity Yes shareholder
Liquidation Poor basis Nontaxable to No Excellent
Poor extent of basis
Fringe Yes No
Benefit Yes Poor
Usage
Leveraged Yes
loss
deduction
from loan
basis

Entity Choice Analyses

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