The Tax Reform and Jobs Act of 2017 slashes corporate rates, offers full expensing on qualifying new and used equipment purchases, repeals like-kind exchanges on revenue equipment and other personal property — including tractors and trailers — and repeals the itemized deduction for unreimbursed employee driver expenses. These changes are complex, require detailed analysis and provide tax-planning opportunities.
Many tax decisions made during 2018 will have a long-term economic impact. Before you act, you should understand the nuances of the bill and how each item will affect your business.
The biggest impact for C corporations is the reduction in the federal tax rate to 21%. The individual income tax rate applying to income from pass-through entities such as S corporations, partnerships and LLCs was reduced to just 37%, but the income may qualify for a 20% deduction on the taxable income of the pass-through, subject to certain limitations. Pass-through entities generally do not pay income tax at the entity level, but rather the income is passed through to the owners of the entity and taxed at the owner level.
The final legislation allows the 20% deduction for both active and passive owners, as well as trusts and estates. Shareholders of the qualifying pass-through entities eligible for the full 20% deduction would see an effective rate of approximately 29.6% against the 37% rate. The tax rate differential between a C corporation and the pass-through rate requires that companies re-examine their entity choice.
While the lower C corporation rate may be tempting on the surface, several factors should be analyzed when deciding which entity type is best for your company and its shareholders:
• If you distribute earnings to your owners, is the benefit from the lower C corporation rate enough to offset the corporate double taxation “penalty” on dividends? C corporations pay income tax at the entity level and dividends paid to the owners also are taxed at the owner level, resulting in what is generally known as “double taxation.” Pass-through entities pass their income through, resulting in only one level of tax.
• Is your company eligible for the 20% deduction on qualified business income, and how will it impact your owners at the individual level?
• How soon do you plan to sell some or all of the business, and how does entity choice impact a potential buyer and the ability to maximize your value and after-tax cash?
• How will estate-planning options be impacted if the company converts to a C corporation?
• What if the company converts to a C corporation and the tax rates increase in the future? Can you convert back to a pass-through entity and, if so, can you do it tax-efficiently?
Analysis of each applicable consideration and modeling of the impact of tax reform should be performed by each company and tax adviser. Companies must consider the long-term impact of entity choice to set themselves up for future success.
Regardless of entity choice, companies should still consider tax accounting method opportunities before filing 2017 tax returns. Any deferrals of income or acceleration of deductions create permanent tax savings as a result of the decrease in tax rates. It’s not too late to take advantage of automatic tax accounting method changes and tax-planning opportunities for 2017.
There also have been significant changes to the tax treatment surrounding fixed assets. Most notably, the bill provides 100% bonus depreciation for qualifying property placed in service after Sept. 27, 2017 and before Jan. 1, 2023. The bonus depreciation rate will then phase out by 20% each year over the five succeeding years until it is completely phased out in the 2027 tax year.
Used property also will be eligible for bonus depreciation, providing significant savings opportunities for trucking companies buying used equipment. The favorable depreciation rules provide an enormous opportunity to minimize taxable income over the next five years.
Meanwhile, there are a few disadvantages of tax reform, one of which relates to the like-kind exchange program. Companies can no longer defer gains on exchanges of revenue equipment and personal property after 2017. Like-kind exchanges are now limited to exchanges of real property only. This may not be as significant in the near term with full expensing, but it must be planned for the longer term as the favorable bonus depreciation terms sunset.
During deliberations of the bill, there was uncertainty surrounding the deductibility of driver per-diem. In the final version, the deduction at the entity level for employee drivers remained intact at 80%. The itemized deduction at the individual level, however, was repealed. Any per-diem or other unreimbursed business expense will no longer be allowed as an itemized deduction by employee drivers on their personal tax returns. Without a company driver per-diem program, this change could push employee drivers to seek other employment opportunities either as an independent contractor or as an employee for a company that has a driver per-diem program in place.
Tax reform offers many favorable aspects to trucking, but it also could present traps to those who don’t consider its short- and long-term effects. It’s important to undertake analysis and planning for the impact of the legislation to current and future cash flow to avoid surprises.
Norris is national transportation and logistics practice leader for Grant Thornton, a leading tax, audit and advisory firm that serves public and private clients in the transportation industry. Grant Thornton’s Randolph Smith, transportation, logistics, warehousing and distribution national practice leader, and Lincoln Hampshire contributed to this article.