With the enactment of the Tax Cuts and Jobs Act in December of 2017, there were many changes to existing tax provisions that will affect those businesses within the manufacturing and distribution umbrella. Below are some of the most important changes to look out for in this upcoming tax year.
Modification of the Limitation on Cash Method of Accounting
Under previous law, limitations applied to corporations and partnerships with corporate partners, whereby these taxpayers were prohibited from using the cash method of accounting for tax purposes unless their average annual gross receipts were $5 million or less. Under the TCJA, for tax years beginning after December 31, 2017, the threshold was increased to $25 million (indexed for inflation), regardless of the type of entity or the industry of the taxpayer.
Any change in accounting method made pursuant to this provision is considered an accounting method change allowing the taxpayer to recognize ratably taxable income resulting from the method change over a four year period. Losses would be recognized immediately.
Exemption from Uniform Capitalization (UNICAP) Requirements
Previously, a taxpayer was required to either include in inventory or capitalize certain direct costs, and an allocable portion of indirect costs related to real or tangible personal property either produced by the taxpayer or acquired by the taxpayer for resale. Resellers of personal property were exempt from this capitalization requirement if their average annual gross receipts were $10 million or less.
Under the TCJA, for tax years beginning after December 31, 2017, the $10 million threshold is increased to $25 million (indexed for inflation), regardless of entity structure or industry. Any change in accounting method made pursuant to this provision is considered an accounting method change, allowing the taxpayer to recognize ratably the taxable income resulting from the method change over a four year period. Losses would be recognized immediately.
Exemption from Inventories
Under previous law, generally, taxpayers with inventory were required to use the accrual method of accounting. Some exceptions to this rule were (1) businesses with inventory that had average annual gross receipts of $1 million or less; and (2) certain businesses with average annual gross receipts of $10 million or less that treated the inventory as non-incidental materials and supplies, therefore not being required to follow the accrual method.
Under the TCJA, for the tax years beginning after December 31, 2017, taxpayers with average annual gross receipts of $25 million or less (indexed for inflation) are not required to account for inventory and have the option to either:
- Treat the inventory as non-incidental materials and supplies;
- Conform to the taxpayer’s method of accounting reflected in the taxpayer’s applicable financial statements; or
- If the taxpayer does not have applicable financial statements, the taxpayer conforms to the books and records prepared in accordance with the taxpayer’s accounting procedures.
Any change in accounting method made pursuant to this provision is considered an accounting method change, allowing the taxpayer to recognize ratably the taxable income resulting from the method change over a four year period. Losses would be recognized immediately.
Long-Term Construction Contract Exception Limit
Long-term construction contracts, those which are started in one year and end in a later year, are accounted for using either the completed contract method or percentage of completion method. Before the 2018 tax year, companies with average gross receipts of $10 million or less for the three prior years did not have to use the percentage of completion method (although this calculation was still required for AMT purposes). For the 2018 tax year, the average gross receipt base has increased to $25 million or less for the three prior years.
The maximum deduction for Section 179 expense has increased from $500,000 to $1,000,000 with the phaseout also increasing from $2,000,000 to $2,500,000. The new law will also allow the taxpayer to elect to include certain improvements made to nonresidential real property after the date when the property was first placed in service. These changes apply to property placed in service in taxable years beginning after December 31, 2017.
Bonus depreciation has increased from 50% to 100% for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023.
The definition of property eligible for 100% bonus depreciation was expanded to include used qualified property acquired and placed in service after September 27, 2017 in certain limited circumstances.
The new law eliminated qualified improvement property acquired and placed in service after December 31, 2017 as a specific category of qualified property.
The general recovery periods of 39 years for nonresidential real property and 27.5 years for residential rental property has remain unchanged. However, there were changes to the alternative depreciation system recovery period for residential rental property from 40 years to 30 years. Qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property are no longer separately defined and no longer have a 15-year recovery period under the new law.
Limitation on Like-Kind Exchanges
For exchanges of property completed after December 31, 2017, only real property (such as land and buildings) will qualify for like-kind exchange treatment. Personal property will no long qualify for that treatment.
Meals & Entertainment Deduction
The meal expense deduction expands the 50% limitation to include food and beverages provided to employees in all aspects of the workpapers unless they are being served as part of an event that would fall under employee recreation.
Entertainment expense deductions are virtually eliminated for businesses who pay for business entertainment expenses, either directly or through reimbursement.
Repeal of Corporate AMT
The Corporate AMT has been repealed for tax years beginning after December 31, 2017. For any corporations that have an AMT credit carryforward, they will be allowed to offset their regular tax liability, and also may be allowed to receive a partial refund of the AMT credits.
Limitation on NOLs Generated in 2018 and Later
Net operating losses (NOLs) generated after December 31, 2017 will now be allowed to be carried forward indefinitely (which has been extended from the original 20 years). However, there will no longer be a carry back period available, except for farming and some insurance companies. There will now be a limitation on the amount of the NOL allowed to be utilized. The limitation will be either the lesser of all NOL carryovers and carrybacks or 80% of the taxable income computed without regard to the NOL deduction.
Note though, that these rules only apply to those losses generated after December 31, 2017. Any losses previous to that date will still allowed to be carried back 2 years and forward 20 years. They will also be allowed to be utilized 100% and not subject to the 80% limitation.
Reduction of Corporate Tax Rate
For tax years beginning after December 31, 2017 the corporate tax rate will be a 21% flat rate. The corporate graduated rate structure will no longer be used.
For more detailed information on any of the above changes, please reach out to a Mazars USA representative.