Are you ready for tax “reform?”
Thanks to the recently passed Tax Cuts and Jobs Act (TCJA), the tax rate for incorporated shooting sports retailers will be reduced from its current 35 percent to 21 percent for the 2018 tax year and thereafter. Although the business tax cuts are, for the most part, permanent, the tax cuts for individuals are only temporary, expiring in 2026.
Unfortunately, while regular, “C” corporations will be taxed at a flat 21 percent tax rate, the majority of tactical retailers operating as pass-through businesses may face new personal tax rates that are, in some cases, higher than the new, flat corporate tax rate.
Pass-through businesses operating as partnerships, limited liability companies (LLCs), S corporations or sole proprietorships, pass their income to their owners who pay tax at their individual tax rate. The TCJA created a 20 percent deduction that applies to the first $315,000 of income, half that for single taxpayers, earned by firearms dealers operating as pass-through businesses.
Thus, all businesses under the income thresholds, regardless of whether they’re service professionals or not, can take advantage of the 20 percent deduction. For pass-through income above this level, the TCJA places limits on who can qualify for the pass-through deduction, with strong safeguards to ensure that so-called “wage income” does not receive the lower marginal tax rates for business income.
Above the threshold, as mentioned, the new law provides a deduction for up to 20 percent, but only for “business profits,” reducing the owners effective marginal tax rate to no more than 29.6 percent. That 20 percent deduction applies only to business income that has been reduced by the amount of “reasonable compensation” paid to the business’s owner. Although lawmakers know what is “excessive,” “reasonable” compensation has yet to be defined by them or the Internal Revenue Service.
The Corporate Alternative Minimum Tax
Lawmakers long-ago created a unique 20 percent tax rate as part of a parallel tax system that limited tax benefits to prevent large-scale tax avoidance. Under this system, incorporated businesses were required to calculate both their ordinary tax bill and the AMT, paying whichever tax bill was higher. Fortunately, the corporate AMT has been eliminated, lowering taxes and eliminating the confusion and uncertainty that surrounded it in the past.
Cost Recovery – Increased Expensing
Unlike in past years when tactical retailers and other businesses were required to claim depreciation, spreading the recovery of their equipment costs over several years, many retailers will be able to fully and immediately deduct the cost of most equipment, fixtures and other business property. What’s more, this provision has been made retroactive to September 27, 2017.
Of course, the faster write-off of equipment costs is only temporary. It is at the 100 percent level for expenditures between September 27, 2017 and January 1, 2023. After 2023 and before 2025, the amount deductible drops to 60 percent with a further decrease to 40 percent after 2025 and to 20 percent after 2026. On January 1, 2027, the equipment cost write-off disappears.
Bigger Section 179 Write-Offs
Despite the narrowing of differences between bonus depreciation and the tax law’s Section 179, first-year expensing, the Section 179 expensing allowance remains a much improved option. The immediate write-off, or “expensing” of capital assets is appealing because, unlike so-called “bonus” depreciation, the use of equipment doesn’t have to begin with the tactical retailer.
Section 179 allows up to $1 million (up from $500,000 in 2017) of expenditures for business equipment and property to be treated as an expense and immediately deducted. The ceiling after which the Section 179 expensing allowance must be reduced dollar-for-dollar has also been increased from $2 million to $2.5 million.
And now, improvements including roofs, heating, ventilation, air conditioning systems, fire prevention, alarms and security systems qualify under the new Section 179 rules, providing another opportunity for firearms dealers and shooting sports retailers who actually need equipment.
Rehabilitation And Disabled Access Credits Repealed
The increased benefits of 100-percent write-offs and the Section 179, first-year expensing might, in part, compensate for the loss of two important tax credits — the rehabilitation and disabled access credits. Before the TCJA, a 20 percent tax credit existed for rehabilitation expenditures for certified historical structures. A 10 percent credit existed for rehabilitated building expenditures, which generally meant a building that was first placed in service before 1936.
Under the TCJA, the 10 percent credit for qualified rehabilitation expenditures for pre-1936 buildings has been repealed. The 20 percent credit for qualified rehabilitation expenditures for certified historic structures can still be claimed, ratably, over a five-year period, beginning in the tax year when the rehabilitated structure is placed in service.
On a related note, the TCJA has also repealed the tax credit so many tactical retailers claimed when retrofitting or fixing-up their premises to be handicapped friendly. The Disabled Access Credit that helped make so many shops, stores, offices and businesses ADA compliant, has also been repealed.
In an attempt to “level the playing field” between businesses that capitalize through equity and those that borrow, the TCJA caps the deduction for interest expense to 30 percent of the tactical retailer’s adjusted taxable income.
Every tactical retailer is subject to “disallowance” of any deduction for net interest expense in excess of 30 percent of the operation’s adjusted taxable income. A special rule applies to pass-through entities that requires the 30 percent determination to be made at the entity level rather than at the tax filer level. In other words, at the partnership level instead of the partner level.
Other exceptions exist for small businesses, generally those with gross receipts that have not exceeded a $25 million threshold during the previous three-year period. Mainly, to protect their ability to write off the interest on loans that help them start or expand a business, hire workers and increase paychecks.
Small Business Accounting Method And Simplification
The simplification of the rules governing the method of accounting that must be used for tax purposes is a welcome option. Under the TCJA, businesses with average annual gross income of less than $25 million may now use the simple cash-basis accounting method.
Accrual basis taxpayers include amounts in income when all the events have occurred that fix the right to receive that income can be determined with reasonable accuracy. Cash basis taxpayers generally include amounts in income only when actually or constructively received.
With the cash method of accounting, a tactical retailer may account for inventory as non-incidental materials and supplies. Or, as an alternative, a qualifying business with inventories using the cash method of accounting would be able to account for its inventories using the method of accounting reflected on its financial statements or on its books and records.
And, those firearms retailers who are required to change their accounting method because of these new rules, will find the change treated as initiated by the taxpayer and made with the IRS’s consent. What’s more, the adjustment period will be six years.
LOSING MORE WITH NOLs
One of the main benefits of net operating losses (NOLs) was the fact that they could be carried back to more prosperous years to create a refund of taxes paid in those earlier years and provide an immediate infusion of badly-needed cash. Today, the NOL deduction has been severely limited. The write-off is now limited to 80 percent of taxable income and only in special cases will a NOL carryback be permitted. There is no limit on how far forward NOLs may be carried.
Fringe Benefit Limits
The new law “disallows” deductions for entertainment expenses, eliminating the necessity of attempting to prove whether such expenses are sufficiently business-related. The 50 percent limit on the deductibility of business meals has been expanded to include meals provided through an in-house cafeteria or otherwise on the premises of the shooting sports equipment business.
A tactical retailer’s deduction for fringe benefits such as transpiration (e.g., parking and mass transit) is no more, although such benefits received by an employee, even the business’s owner or key employee, can continue to be excluded from the recipient’s income.
More, Oh, So Much More
Obviously, there are many more changes contained in the massive, Tax Cuts and Jobs Act. The newly passed law provides immediate relief from the so-called “Death Tax” by doubling the estate tax’s exemption so it applies to fewer estates. Furthermore, the higher thresholds will sunset in 2026.
S-Corporations attempting to convert to regular “C” corporations will face new rules; the deductions for local lobbying expenses has been eliminated; and partnerships will no longer terminate upon the death or exit of a partner.
According to our lawmakers, the TCJA modernizes our international tax systems making it easier and far less costly for U.S. businesses to bring home foreign earnings. The International provisions of the TCJA also prevent U.S. jobs, headquarters and research from moving overseas by eliminating incentives.
All-in-all, however the Tax Cuts and Jobs Act appears to favor businesses over individuals with longer-lived tax savings. Unfortunately, with few exceptions, the potential savings won’t be seen by tactical retailers until the tax bill for 2018 comes due.
Mark E. Battersby is a freelance writer who has specialized in taxes and finance for the past 25 years. Working from offices in the suburban Philadelphia community of Ardmore, PA, Mr. Battersby currently writes for publications in a variety of fields, syndicates two weekly columns that appear in more than 65 publications and has written four books.