Starting early on your 2018 tax planning is especially critical this year, as tax reform has substantially changed the tax environment. Tax planning helps determine the total impact new laws may have on your particular scenario and identifies proactive tax strategies that make sense for you this year, such as the best way to time income and expenses. From this analysis, you may decide to deviate from tax approaches that worked for you in previous years and implement a new game plan.

Many variables

A tremendous number of variables affect your overall tax liability for the year. For example, the timing of income and deductible expenses can affect both the rate you pay and when you pay. By reviewing your year-to-date income, expenses and potential tax, you may be able to time income and expenses in a way that reduces, or at least defers, your tax liability.

Act now

Under the TCJA tax reform legislation, most of the provisions affecting individuals are in effect for 2018–2025 and additional major tax law changes are not expected in 2018.

Starting sooner will help prevent you from making costly assumptions under the new tax regime. It will also allow you to take full advantage of new tax-saving opportunities.

A large number of variables affect your overall tax liability for the year. It is especially critical this year because tax reform has substantially changed the tax environment. Planning early in the year can give you more opportunities to reduce your 2018 tax bill.

If you own a business, this is particularly important for the new qualified business income (QBI). New strategies are available to help you time income and expenses to minimize tax liability.

Now and throughout the year, seek your business adviser to help you determine how tax reform affects you and what strategies you should implement to minimize your tax liability.

The Tax Cuts and Jobs Act (TCJA) imposes a limit on deductions for business interest for taxable years beginning in 2018. The limit, like other aspects of the law, has raised some questions for taxpayers. In response, the IRS has issued temporary guidance that taxpayers can rely on until it releases regulations. While the guidance provides some valuable information, it also leaves some questions unanswered.

The prior-law limit rules

Prior to the TCJA, corporations could not deduct “disqualified interest” expense if the borrower’s debt equaled more than one and a half times its equity and net interest expense exceeded 50% of its adjusted taxable income. Disqualified interest included interest paid or accrued to:

Previously, taxpayers could carry forward excess interest indefinitely. And any excess limit could be carried forward three years.

These rules were for the so-called “earnings stripping” rules. They were intended to prevent corporations from wiping out their taxable income by deducting interest payments on debt owed to certain parties.

The new-law limit

For tax years beginning after 2017, the deduction for business interest incurred by both corporate and noncorporate taxpayers is limited to the sum of:

The limit applies to all taxpayers, except those with average annual gross receipts of $25 million or less, real estate or farming businesses that elect to exempt themselves and certain regulated utilities.

The amended rules allow for the indefinite carryforward of any business interest not deducted because of the limit. Excess limit, however, cannot be carried forward.

C-corporation business interest income and expense

The IRS announced it will issue regulations clarifying that, for purposes of Section 163(j) only, all interest paid or accrued on a C corporation’s debt is business interest. All interest on debt held by a C corporation and includable in its gross income is business interest income.

In addition, the regulations will address the proper treatment of interest paid, accrued or includable in gross income by a noncorporate entity (e.g., a partnership) in which the C corporation holds an interest. And the regulations will clarify that the disallowance and carryforward of a deduction for a C corporation’s business interest expense will not affect whether and when such an expense reduces the corporation’s earnings and profits.

Treatment of consolidated groups

For groups of affiliated corporations that file a consolidated tax return, forthcoming regulations will clarify that the business interest deduction limit applies at the group level. For example, a consolidated group’s taxable income for purposes of calculating its adjusted taxable income will be its consolidated taxable income. Intercompany obligations (e.g. debt between affiliated corporations) will not count when determining the amount of the limitation.

The regulations also will address several other issues related to the application of the limit to consolidated groups. These include the allocation of the limit among group members, the treatment of disallowed interest deduction carryforwards when a member leaves the group and the treatment of a new group member’s carryforwards. The regulations are not expected to treat an affiliated group that doesn’t file a consolidated tax return as a single taxpayer for purposes of the interest expense deduction limit.

Electing to be exempt from the interest expense deduction limit

Real estate and farm businesses can elect to exempt themselves from the Section 163(j) interest expense deduction limit. At first glance, making the election may seem like a no-brainer — but the election, which is irrevocable, can backfire.

Businesses that make the election must use the alternative depreciation system (ADS) for certain property (generally, real or farm property with a recovery period of 10 years or more) used in the business, regardless of when the property was placed in service. ADS depreciation is over longer periods, so an electing taxpayer’s annual depreciation deductions are reduced if the election is made. Electing businesses also can’t claim first-year bonus depreciation. Businesses should weigh the advantage of avoiding the interest expense deduction limit by making the election against the detriment of slower depreciation deductions if the election is made.

Treatment of pre-2018 interest carryforwards

According to the temporary guidance, the IRS will issue regulations clarifying that taxpayers with interest carryforwards from the last taxable year beginning before 2018 can carry them forward as business interest to their first taxable year beginning after 2017. The regulations will clarify that this business interest that is carried forward will be subject to potential disallowance under amended Section 163(j) in the same manner as any other business interest otherwise paid or accrued in a tax year beginning after 2017.

The regulations also will address the treatment of pre-2018 business interest under the TCJA-created IRC Section 59A, the base erosion and anti-abuse tax. The base erosion tax applies only to businesses with average annual gross receipts of at least $500 million.

Next steps

The IRS has requested comments on the rules outlined in its interim guidance. It also expects to issue regulations providing additional guidance on issues not yet covered and requested comments on which issues those regulations should address. Comments are due by May 31, 2018.

When President Trump signed the massive federal income tax overhaul into law on December 22, 2017, much was made of nonprofits’ understandable concern that the higher standard deduction would reduce incentives for charitable giving. The concern is, of course, extremely important, but the new law also includes several other provisions that may affect nonprofits.

Calculating unrelated business taxable income

The Tax Cuts and Jobs Act (TCJA) has substantially lowered the corporate tax rate to 21%, a significant benefit to any nonprofits already paying unrelated business income tax, which is imposed at the corporate rate. But when it comes to calculating the income that is subject to this tax, the new law brings a significant change for nonprofits.

The TCJA requires nonprofits to compute unrelated business taxable income (UBTI) separately for each unrelated business activity and pay tax on any activity with net income. That means nonprofits cannot use a loss from one unrelated business to offset income from a different unrelated business for the same tax year.

They may, however, use one year’s losses on an unrelated business to offset profits in a different year for that business, subject to certain restrictions. For example, if your nonprofit incurred a loss in its bookstore business in 2018, it can use that loss to offset bookstore profits in 2019.

The TCJA also makes certain fringe benefits includable in UBTI. These include qualified transportation benefits (for example, transit passes), qualified parking benefits and access to any on-site athletic facility.

Compensating executives

The TCJA also imposes a 21% excise tax on “excessive” executive compensation. The tax applies to the sum of any compensation (including most benefits) in excess of $1 million paid in the tax year to a covered employee plus certain large payments to that employee upon his or her departure from the organization (known as “excess parachute payments”).

A “covered employee” means a current or former employee reported as one of the five highest paid employees for any taxable year beginning after 2016. Licensed medical professionals are not covered employees for this tax.

But what is an “excess parachute payment?” A payment generally is considered an excess parachute payment if two conditions are met:

  1. It is contingent on the employee’s departure
  2. The present value of the payments equals or exceeds three times the base amount, which is the employee’s average annual compensation for the preceding five years.

The excess parachute payment subject to the excise tax is the amount of the parachute payment less the base amount.

Discouraging donations?

The increase in the standard deduction — it is expected to reduce the number of taxpayers who itemize and, thus, can deduct charitable contributions — is not the only change that may affect giving.

For example, the TCJA doubles the estate tax exemption to $10 million (indexed for inflation) through 2025. With fewer wealthy individuals at risk of paying this tax, fewer people may make the generous donations that have been partly motivated by a desire to shrink their taxable estates. Plus, the TCJA eliminates any deduction for donations made in exchange for the right to buy season tickets to college athletic events.

The TCJA does raise the limit on cash donation deductions from 50% of adjusted gross income to 60%. But cash donations at this level are uncommon, so the higher limit may not stimulate much additional giving.

Obtaining financing

Some nonprofits issue tax-exempt bonds to finance construction and other capital activities. These bonds typically pay lower interest rates than other bonds. But investors are willing to accept the lower rates because they are not required to pay income taxes on the interest.

The TCJA, however, repeals the tax-exempt treatment for interest paid on a bond issued to refinance another tax-exempt bond. An “advance refunding bond” is used to pay principal, interest or redemption price on a prior bond issued more than 90 days before redemption of the refinanced (refunded) bond.

Let’s say you issue tax-exempt bonds at 4% interest but later discover you can refinance the bonds at 3% interest. Under the TCJA, the interest payments on the 3% advance refunding bonds will not be tax-exempt for investors — that means you will need to pay a higher interest rate because of the new bonds not being tax-exempt as recompense for the investors’ increased tax liability.

Charting the course ahead

Despite the advantage of a lower tax rate on unrelated business income, the new income tax law may reduce overall charitable giving while simultaneously increasing some nonprofits’ costs. Your CPA may help identify the potential impact of charitable giving on your nonprofit as well as chart the best course forward.