22 | RKL 2018 Year-End Tax Planning Guide RKL 2018 Year-End Tax Planning Guide | 23 PERMANENT CORPORATE TAX REFORM Corporations profits are subject to tax twice at the federal level: once on corporate business income and again on profits paid out to shareholders as dividends. Tax reform keeps these two levels of taxation, but it changed the previous top graduated rate from 35 percent to a flat 21 percent. This means that many C Corporations may pay significantly less tax under the new law. In addition, this will have a significant impact on the value of many company’s deferred tax assets and liabilities. The corporate tax rules have changed significantly for net operating losses, depreciation, interest deductibility, and for companies doing business outside the U.S. These provisions will be explored in the coming pages. Another big development is the elimination of corporate AMT. These and other business components of tax reform are permanent. Changes to Net Operating Losses Tax reform created some unfriendly changes to net operating loss (NOL) rules. Under one of the new rules, NOLs arising in tax years that begin after December 31, 2017, will be limited to offsetting no more than 80 percent of taxable income in each subsequent year. Businesses with NOLs arising in years that begin before December 31, 2017, can use them to offset 100 percent of future taxable income. These rules will require additional diligence in tracking NOL generation and usage by year. Another rule eliminates the ability to carryback NOLs to the two years prior to the year the NOL was generated. The date for this rule is tied to when the tax year ends. In this case, the two-year carryback rule is applicable to NOLs generated in tax years that end on or before December 31, 2017, meaning that taxpayers with NOLs generated in tax years that end after 2017 are not able to carry those losses back and claim refunds. Losses arising in years that end after 2017 have an indefinite carryforward period. Losses that end on or before December 31, 2017, have a 20-year carryforward period limitation. Special attention is required by fiscal year taxpayers. The rule eliminating the two-year carryback and 20-year carryforward limitations are applicable to NOLs generated for fiscal years ending in 2018. NOLs generated from a fiscal year ending in 2018 can be carried forward indefinitely. A special carve-out was made for farming business taxpayers. The post-2017 NOLs generated in a farming business are able to utilize the two-year carryback provisions. Post-2017 NOLs generated in a farming business can be carried forward indefinitely. Expanded Access to Accounting Methods The new tax rules will now allow businesses up to $25 million in gross receipts to take advantage of accounting methods that used to only apply to much smaller businesses. Your business may now be eligible to report on cash basis or avoid accounting for inventories. Previously, the cash receipts/cash disbursement method of accounting could only be used by C Corporations or Partnerships with a C Corporation partner with average annual gross receipts of less than $5 million over the prior three-year period. For all types of businesses in which inventory is a material income producing factor (not just C Corporations or Partnerships with C Corporation partners), the cash method was only an option if average annual gross receipts (based on the prior three tax years) were less than $1 million or $10 million in certain cases. Taxpayers were also required to account for long-term contracts using the percentage-of-completion method of accounting, with exceptions for small contractors, home construction contracts and residential construction contracts. Under tax reform, C Corporations, Partnerships with a C Corporation partner and businesses in which inventory is a material income producing factor can now use the cash method if their annual gross receipts are less than $25 million. SHOULD I CHANGE my business entity type? Does the reduction of the corporate tax rate mean every pass-through should elect to be taxed as a C Corporation? In short, probably not. While the corporate tax rates were reduced, tax reform created a brand-new section of law designed to create a fairer playing field for pass-through business owners, too. Read more about the Section 199A on page 28 of this guide. There are a few other factors business owners should consider before changing their choice of entity. These include the Section 1202 stock rules which permit certain corporate taxpayers to sell stock held for more than five years and pay zero percent tax on the gain. State tax implications, especially for Pennsylvania businesses, must also be evaluated. The PA tax rate for C Corporations is 9.99 percent while the individual tax rate applicable for pass-through entity owners is only 3.07 percent.