Many of the provisions of the Tax Cuts and Jobs Act, that took effect on January 1, 2018, will significantly affect the tech industry. Below is an overview of the top three changes likely to be of greatest interest to technology companies alongside a few other impactful changes.
The Tax Cuts and Jobs Act (“Act”) lowers the corporate tax rate to 21%, down from 35%, which was among the highest in the industrialized world, to incentivize US investment and allow US companies to be more competitive. The new laws also require a “blended” tax rate for fiscal year taxpayers for their fiscal year that includes January 1, 2018.
However, in order provide a similar incentive to owners of flow-through entities (partners, S corporation shareholders and sole proprietors), the Act gives a tax break to certain business owners within these entities. Certain qualified sole proprietors, S corporation shareholders and partners in a partnership will be allowed a deduction equal to 20% of their allocable share of business income.
The 20% deduction has significant limitations, including:
Neither the W-2 limitations nor the service business limitations apply if the taxpayer’s taxable income is less than $157,500 (if single; $315,000 if married filing jointly). The exception to the W-2 limit and the general disallowance of the deduction to personal service businesses is phased out over a range of $50,000 of income for single taxpayers and $100,000 for married taxpayers filing jointly. Thus, by the time income reaches $207,500 (if single; $415,000 if married filing jointly), the W-2 limitation will apply in full, and owners of personal service businesses will receive no portion of the 20% deduction.
The exercise of certain options may be a taxable transaction to the holder of the option. New §83(i) provides tax benefits to employees of certain start-up companies. Generally, an employee may make a special election with respect to qualified stock transferred to them, so that no amount is included in income for the first taxable year in which the rights of the employee in such stock are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. Income taxation can be deferred by the employee until the earlier of (a) five years, or (b) the occurrence of a specified event, such as the stock of the company being readily tradable on an established securities market, or revocation of the election. A written plan must provide that at least 80% of the employees of the company are granted stock options or restricted stock units (RSUs) with the same rights and privileges. The 80% eligibility requirement is met only if affected employees (new hires or existing employees) are either granted stock options or RSUs for that year, and not a combination of both.
The research credit is retained without modification. However, research and experimental expenses, as determined under Section 174, must be amortized over five years, with R&E conducted outside the US amortized over 15 years. R&E specifically includes expenses for software development. Amortization is required for expenses incurred in tax years after 2021.
Below is a quick look at other business changes under the Tax Cuts and Jobs Act, as they compare to prior law:
|Prior Law||Current Law|
|Availability of cash method for C corporations||avg receipts < $5M||avg receipts < $25M|
|Availability of cash method for taxpayers with inventory||limited to Rev. Proc. 2001-10 and Rev. Proc. 2002-28||avg receipts < $25M|
|Exclusion from Section 263A||limited to resellers with avg. receipts < $10M||avg receipts < $25M|
|Section 179 limitation||$510,000||$1,000,000|
|100% expensing||n/a||through 2022, then phase down over five years|
|Interest expense deduction||unlimited||limited to 30% of adjusted taxable income if avg receipts > $25M|
|Net operating losses||carry back 2 years, forward 20||no carry backs, carry forwards limited to 80% of taxable income|
|Section 199 deduction||allowed for domestic production||eliminated|
It is important to note that the ability to deduct 100% of the cost of qualifying assets is effective retroactive to September 27, 2017. Thus, businesses need not wait until 2018 to benefit from these rules.
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