Reconciling To Tax Reform 2017 Style
Are you ready for tax reform? Well on its way to becoming a reality, the Tax Cuts and Jobs Act has passed both the House and the Senate. The only thing standing between the president’s promised signature and this massive legislation is the matter of reconciling the two different bills.
When it comes to reducing the corporate tax rate, the House and the Senate agree: Both chambers want to see the tax rate lowered to 20 percent from its current tax rate of 35 percent. However, because the Senate measure would delay implementation of the rate cut for one year, whether this reduced rate will impact the 2018 or 2019 tax year of incorporated self-storage businesses remains uncertain.
Unfortunately, the income of owners of so-called “pass-through” businesses, such as sole proprietorships, partnerships, limited liability comanines, and S corporations that pass their earnings to their owners, is taxed at their individual rates, which is as high as 39.6 percent. Thus, if a regular C corporation is taxed at a flat 20 percent tax rate while the majority of small businesses doing business as pass-through business entities might soon see a flat 25 percent tax rate under the proposed “reforms,” a switch to incorporation might be in order.
On the one hand, the House plan would reduce the personal income tax rate from 39.6 percent to 25 percent for all pass-through income after 2017, with a nine percent rate for some small business income. Under the Senate’s version, not everyone would be able to take advantage of the full 17.4 percent deduction offered. If, for instance, half of a taxpayer’s wage is lower than 17.4 percent, that would be the applicable deduction.
Among the other provisions included in the draft bills currently undergoing “reconciliation” are:
- REPEAL OF THE REHABILITATION AND DISABLED ACCESS CREDITS: Any self-storage facility that retrofits or plans to fix their premises to be handicapped friendly, may lose the tax credit associated with that expense. The Senate would like to repeal the tax credit, so many businesses have claimed when fixing up their business premises. On a related note, the disabled access credit that helped many make their businesses ADA compliant has also been repealed, at least in the Senate’s version of tax “reform”.
- LIKE-KIND EXCHANGES: The like-kind exchange rules, the tax law’s Section 1031, currently allow self-storage developers and operators to defer tax on the built-in gains in property by exchanging it for similar property. With multiple exchanges, gains essentially may be deferred for decades and ultimately escape taxation entirely if the property’s basis is stepped up to its fair market value upon the death of the owner.
Under the proposed version of Section 1031, like-kind exchanges would be limited to so-called “real” property, but not for real property held primarily for sale. This ensures that real estate investors retain their ability to defer capital gains realized on the sale of property.
- INTEREST EXPENSES: In an attempt to “level the playing field” between businesses that capitalize through equity and those that borrow, both the House and Senate bills would cap the interest deduction to 30 peercent of adjusted taxable income. Exceptions would exist for small businesses to protect their ability to write off the interest on loans that help them start or expand a business, hire workers, and increase paychecks.
- COST RECOVERY – INCREASED EXPENSING: Under current law, when a self-storage business purchases new equipment, its cost must be deducted over a period of several years. Both the House and Senate vesions would allow businesses to immediately expense 100 percent of the cost of any equipment purchased. The immediate expensing of capital assets is appealing because, unlike 50 percent bonus depreciation, the use of the equipment doesn’t have to commence with the self-storage facility or business.
- SECTION 179: In an effort to promote business investment and growth, lawmakers created Section 179 of the tax law that currently allows a self-storage facility or business to treat some equipment purchases as an immediately deductible expense. Under the House version, the Section 179 expensing limit would be raised to $5,000,000. In the Senate version, the small business expensing limitation under section 179 would be increased to $5 million and the phase-out amount would be increased to $20 million. In addition to being indexed for inflation, the new rules would modify the definition Section 179 property to include qualified energy efficient heating and air-conditioning property permanently, effective for property acquired and placed in service after Nov. 2, 2017.
- PARTNERSHIPS: The pastnerships used by so many self-storage developers and operators as both an operating entity for their business and in joint ventures, face several potential rule changes. For one, the technical termination of a partnership rule would be repealed under the Senate bill. Thus, the partnership would be treated as continuing even if more than 50 percent of the total capital and profit interests of the partnership are sold or exchanged and new elections would not be required or permitted. The provision would be effective for tax years beginning after 2017.
- SMALL BUSINESS ACCOUNTING METHOD AND SIMPLIFICATION: Businesses with average annual gross income of up to $25 million may be able to use the cash method of accounting, allowing more self-storage facilities and businesses to use the simple cash-basis accounting method. Under the provision, the current $5 million threshold for corporations and partnerships with a corporate partner would be increased to $25 million, and the requirement that such businesses satisfy the requirement for all prior years would be repealed.
- NOLs: Both bills modify the rules for net operating losses (NOLs), allowing losses to be carried forward indefinitely. NOLs could not be carried back, but could be carried forward indefinitely. The Senate version eliminates the carry-back and carry-forward tax strategies now used by many self-storage facilities to reduce past and future tax liabilities using net operating losses. The House version tightens the rules around their use but allows a carryback for eligible disaster losses.
- ACA: The 2010 Affordable Care Act, popularly known as Obamacare, contained a provision requiring individuals to buy health insurance or pay a federal penalty. The Senate bill adds a key feature not in the House version: repeal of the Affordable Care Act’s requirement that everyone in the U.S., even small business owners, have health insurance.
Tucked away in the pages of the reform bills, are provisions that would repeal the deduction for local lobbying expenses. Both the House and Senate of the Tax Cuts and Jobs Act contain a number of other provisions that will impact every self-storage facility and its developer or operator, such as:
- The revised rules for contributions to capital in exchange for stock,
- The elimination of the employee business expense deduction,
- The reduction and ultimate repeal of the estate tax, and
- Establishment of strong safeguards to distinguish between individual wage income and “pass-through” business income to ensure fair treatment for small business owners.
Reconciling the differences between the House and Senate versions of reform may be a complicated process. While it’s hard to say how much of this ultimately becomes law, the key is to understand how these changes may impact the self-storage operation’s balance sheet, financial plans and, of course, tax stragegy.
Mark E. Battersby is a freelance writer, columnist, author and lecturer based in Philadelphia, Pennsylvania. He specializes in reporting developments within the tax and financial arenas.