2018 Tax Reform for DealershipsLauren A. CarnesPrincipal, CPA, MST

Ryan J. McDonellTax Supervisor, CPA, MSA

Presented by:

Table of Contents

• Tax Reform Changes for Owners• Tax Reform Changes for C Corporation• Tax Reform Highlights

• Depreciation Changes• IRC 163(j): Interest Expense Limitation• IRC 199A: Qualified Business Income (20%) Deduction• 50% Meals & Entertainment Deduction

Tax Reform Changes for Owners

Tax Rates

• Individual Tax Brackets: 10%, 12%, 22%, 24%, 32%, 35%, 37%

• Highest rate applicable for income over $600,000 MFJ, $500,000 Single & HoH, $300,000 MFS

• Capital Gain and Qualified Dividend Tax Rates: 0%, 15%, 20% (no change)

• Highest rate applicable for taxpayers in highest individual tax bracket

• Estate and Trust Tax Brackets: 10%, 24%, 35%, 37%• Highest rate applicable for income over $12,500

• Kiddie Tax:• Children’s earned income taxed at individual rates,

unearned income taxed at estate and trust rates

Deductions & Credits

• Standard Deduction increased to $24,000 MFJ, $18,000 HoH, and $12,000 for other filers• Retained additional standard deduction for elderly and blind

• State and Local Tax Itemized Deduction limited to $10,000 of state and local property and income taxes

• Mortgage Interest Itemized Deduction limited for acquisition indebtedness greater than $750,000• Interest deductible on line of credit only when used for significant repairs or improvements• In the case of acquisition indebtedness incurred before December 15, 2017, the debt

limitation remains at $1,000,000

• Charitable Cash Contribution Deduction increased deductible limitation to 60% of AGI

• Medical Expense Deduction (2017 & 2018) limited to expenses exceeding 7.5% of AGI, regardless of age

• Child Tax Credit increased to $2,000 with up to $1,400 refundable per qualifying child under age 17

• $500 nonrefundable credit available for qualifying dependents other than qualifying children

Deductions & Credits

Suspended Exemptions & Provisions• Suspended exemptions & deductions

• Personal exemptions• Moving expenses deductions• Miscellaneous itemized deductions subject to 2% of AGI limitation• Casualty and theft loss deduction• Bicycle commuting reimbursement deduction

Other Changes & Provisions

• Estate and gift tax base exemption increased to $10M. Indexed for inflation, this is $11,180,000 in 2018.

• 2018 Gift $15,000 per person

• Alternative Minimum Tax for individuals retained, but with higher exemptions of $109,400 MFJ, $70,300 others

• Net operating losses will be limited for taxpayers other than corporations, with potential for loss carryforwards

• Qualified tuition programs (529 accounts) may be rolled over to ABLE accounts without penalty

• Individual responsibility payment penalty under Affordable Care Act reduced to $0 in 2019. Minimum health care coverage still required in 2018 to avoid penalties.

Other Changes & Provisions

• Alimony is not deductible for the payor, and is not includable in income of the payee. Effective for divorce or separation instruments executed after 12/31/18, or for those before that date, modified for the reform changes.

• Three-year holding period now required for income from “carried interest” or for those before that date, modified for the reform changes.

• Personal casualty losses in Presidentially declared disaster areas exceeding $500, which occurred between the dates of 12/31/15-1/1/18 are deductible without 10% AGI limitation, can be deducted even if not itemizing, and may be deducted in the current year or prior year.

Tax Reform Changes for C Corporations

Suspended Exemptions & Provisions• Tax Cuts and Jobs Act Corporate / Business

Changes• C Corporation Tax Rate now flat 21%• Fiscal Year Clients will have a transition

with blended rates• Corporate AMT repealed

Suspended Exemptions & Provisions• Like-Kind Exchange

• Limited to real property only• No longer allowed to defer gain on

equipment, vehicle, airplane, etc. exchanges

Tax Reform HighlightsDepreciation Changes

Bonus Depreciation

• 100% deduction allowed for qualified property acquired and placed in service after 9/27/17 and before 1/1/2023

• Phased down by 20% annually starting with property acquired and placed in service after 12/31/2022 and completely phased out by 2027.

• 2023 – 80%• 2024 – 60%• 2025 – 40%• 2026 – 20%

• Longer production property and certain aircraft receive an additional year of 100% bonus before the phase out begins.

Bonus Depreciation

• Applies to MACRS property that has a recovery period of 20 years or less.

• Now allowed for used property as long as the taxpayer or a predecessor has not previously held a depreciable interest in the property.

• Includes group asset acquisitions under sections 338 and 336(e).

• Section 743(b) adjustments now qualify for bonus depreciation (Partnership).

• Taxpayers may elect out of bonus by electing out for each separate class of property on their timely filed return (including extensions).

• Property used in a trade or business that has had floorplan financing indebtedness does not qualify for the additional first year depreciation deduction (No Bonus at all Dealerships).

Bonus Depreciation

• Effective 12/31/17, the Qualified Leasehold Improvement Property, Qualified Restaurant Property, and Qualified Retail Improvement Property categories have been eliminated.

• Property previously falling under these categories are now classified as Qualified Improvement Property which has a 39-year life.

• QIP Will remain with a 39-year life and not qualify for bonus depreciation until congress issues a technical correction.

15-Year Property

Qualified Improvement Property

• Qualified Improvement Property includes any improvement to the interior of a building, must be nonresidential real property, and is placed in service after the building is placed in service.

• Excludes enlargement of the building, elevators and escalators, and internal structural framework.

• Qualified Real Property includes Nonresidential Real Property located on the outside of the building.

• Includes roofs, HVAC’s, fire prevention and alarm systems, and security systems.• Beginning in 2018, section 179 can be elected on Qualified Improvement Property and Qualified

Real Property.

• The maximum Section 179 expense allowable for 2018 is $1,000,000.

• Phaseout Begins at $2,500,000 of section 179 property placed in service during the year.

• Deduction is completely phased out at $3,500,000 of additions.

• Limitations continue to apply at both the entity and shareholder level.

• Remains available to businesses with floor plan financing indebtedness.

Section 179

• Depreciation limits for Luxury Automobiles placed in service in 2018:

• An additional $8,000 of bonus depreciation may be taken in the first year for a total first year deduction of $18,000.

Year 1 $10,000

Year 2 $16,000

Year 3 $9,600

Years 4 & Later $5,760

Luxury Automobiles

Tax Reform HighlightsIRC 163(j): Interest Expense Limitation

IRC 163(j) Limitation on Business Interest• Limits the deduction of business interest

expense to the sum of:• Business interest income• 30% of adjusted taxable income• Floor plan financing interest (fully

deductible)

Exempt from Limitation

• Businesses with average annual gross receipts in prior three-year period of $25 million or less (small business test)

• Electing real property trades or businesses • Electing farming businesses • Regulated utilities trades or businesses• Service employees

Exempt from Limitation:Real Property Trade or Business• A business engaged in one of the below eleven

(11) categories may elect out of the interest limitation (interest expense will be fully deductible)

• Real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business

• The election is irrevocable• If no election is made, the entity is subject to the

limitation rules

Exempt from Limitation:Real Property Trade or Business• In order to elect out of the limitation, a real property

trade or business has to use a different depreciation method on certain assets:

• Residential real estate: 30yrs versus 27.5yrs• Non-residential real estate: 40yrs versus 39yrs• Qualified improvement property: 20yrs versus

15yrs*• Electing businesses cannot take bonus depreciation on

qualified improvement property

Calculating the Limitation

• Adjusted Taxable Income: • Equals the taxable income of the taxpayer, less:

• Income, gain, deduction, or loss not allocable to a trade or business (i.e. investments)• Business interest expense or income• NOL deduction• 199A qualified business income deduction• Depreciation, amortization, and depletion (for tax years before 1/1/2022)

• Excess taxable income can be used by shareholders / partners

Disallowed Interest

• Treated as being paid in the succeeding year• Carries forward at entity-level for C corporations &

S corporations• Disallowed interest reduces earnings & profits

for a C corporation• Disallowed interest does not reduce S

corporation stock basis• Carries forward at partner-level for partnerships

• Disallowed interest reduces partner’s basis in partnership

Basic Example

• Facts • X Co. has taxable income of $25,000. Included in that amount is $20,000 of interest

income, $50,000 of floor plan financing interest expense, $150,000 of other business interest expense, $150,000 of depreciation, and $20,000 of amortization.

• Adjusted taxable income• $25,000 - $20,000 + $50,000 + $150,000 + $150,000 + $20,000 = $375,000

• Total limitation• (Adjusted taxable income x 30%) + business interest income

($375,000 x 30%) + $20,000 = $132,500

Basic Example

• Solution• Interest expense limitation of $132,500

is less than other business interest expense of $150,000. Only $132,500 is deductible.

• The remaining excess business interest of $17,500 carries forward indefinitely.

• The $50,000 of floor plan financing interest is fully deductible.

Tax Reform HighlightsIRC 199A: Qualified Business Income (20%) Deduction

IRC 199A Qualified Business Income (20%) Deduction• Allows sole proprietors and passthrough

owners to deduct up to 20% of qualified business income from qualifying trades or businesses

• Deduction cannot exceed 20% of taxpayers taxable income, less capital gains

• Taxpayers reaching certain income thresholds have deduction limited

• Deduction phases-out for specified service trades or businesses

Qualified Business Income

• Net amount of qualified income, gain, deduction, and loss from a U.S. trade or business

• Does not include investment income, capital gain or loss, or foreign income

• Officer compensation and guaranteed payments are not eligible for the deduction

Basic Example

• Facts• Taxpayer receives $50,000 of wages income and is the owner of passthrough

entities A and B which report QBI of $200,000 and $150,000, respectively. Taxpayer files a joint return and has taxable income, including $10,000 capital gains, of $310,000.

• Solution• Taxpayer's deduction is $60,000, or the lesser of 20% of QBI ($200,000 +

$150,000) or taxable income, less capital gains ($310,000 - $10,000).

Qualifying Trade or Business

• Defined under IRC 162, an activity engaged in continuously for profit

• Includes rental property related to a qualifying trade or business if the rental and business are commonly controlled

Limitation

• Deduction is limited when taxpayer’s taxable income exceeds $315,000 married filing joint ($157,500 other filers)

• Deductible amount is the lesser of:1. 20% of the qualified business income, or2. The greater of –

• 50% of W-2 wages, or• 25% of W-2 wages, plus 2.5% of the unadjusted basis of depreciable

property

Reporting Requirement

• Entities are required to report the shareholder’s / partner’s portion of qualified business income, W-2 wages, and unadjusted basis of qualified property on Schedule K-1

Specified Service Trade or Business (SSTB)

• Includes the performance of services in the following fields:• Health, law, accounting, actuarial science, performing arts, consulting,

athletics, financial services, brokerage activities• Any business where the principal asset of the trade or business is the

reputation or skill of employees or owners• Investing and investment management, trading, or dealing in securities,

partnership interests, or commodities

Phase Out for SSTB’s

• Deduction begins to phase-out for specified service trades or businesses if taxpayer’s taxable income exceeds $315,000 married filing joint ($157,500 other filers)

• No deduction if taxable income reaches $415,000 married filing joint ($207,500 other filers)

Aggregating Businesses for the Deduction• Grouping businesses is allowed but not

required, and is done on the taxpayer’s individual tax return

• Allows taxpayers to combine QBI, W-2 wages and unadjusted basis of property from multiple entities to maximize the deduction

Aggregating Businesses for the Deduction

• To qualify for grouping, the businesses must meet the following:• Common majority ownership and cannot be a SSTB. Must also meet two of

three tests:1. providing products and services customarily provided together; 2. share facilities or centralized business elements such as accounting, legal, purchasing,

HR, or IT; or 3. are operated in coordination with or reliance on one another, such as a supply chain

structure

Tax Reform Highlights50% Meals & Entertainment Deduction

Meals & Entertainment

• Old law• Meals & entertainment 50% deductible if

associated with taxpayer’s trade or business

• New law• Entertainment expenses non-deductible• Meals expenses remain 50% deductible

in certain situations

Meals 50% Deductible• Recent IRS Notice 2018-76 outlines five (5) requirements to deduct 50% of meals

expenses:1. The expense is an ordinary and necessary expense under § 162(a) paid or incurred during the

taxable year in carrying on any trade or business;

2. The expense is not lavish or extravagant under the circumstances;

3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;

4. The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and

5. In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.

Meals 50% Deductible Example #1

• Facts• Taxpayer A invites B, a business contact, to a baseball game. A purchases tickets for A and B

to attend the game. While at the game, A buys hot dogs and drinks for A and B.

• Solution• The baseball game is entertainment and, thus, the cost of the game tickets is an

entertainment expense and is not deductible by A.

• The cost of the hot dogs and drinks, which are purchased separately from the game tickets, is not an entertainment expense. Therefore, A may deduct 50 percent of the expenses associated with the hot dogs and drinks purchased at the game.

Meals 50% Deductible Example #2

• Facts• Taxpayer C invites D, a business contact, to a basketball game. C purchases tickets for C and D

to attend the game in a suite, where they have access to food and beverages. The cost of the basketball game tickets, as stated on the invoice, includes the food and beverages.

• Solution• The basketball game is entertainment and, thus, the cost of the game tickets is an

entertainment expense and is not deductible by C.

• The cost of the food and beverages, which are not purchased separately from the game tickets, is not stated separately on the invoice. Thus, the cost of the food and beverages also is an entertainment expense. Therefore, C may not deduct any of the expenses associated with the basketball game.

Meals 50% Deductible Example #3

• Facts• Taxpayer C invites D, a business contact, to a basketball game. C purchases tickets for C and D

to attend the game in a suite, where they have access to food and beverages. The invoice separately states the cost of the basketball game tickets from the cost of food and beverages.

• Solution• The basketball game is entertainment and, thus, the cost of the game tickets is an

entertainment expense and is not deductible by C.

• The cost of the food and beverages, which is stated separately on the invoice from the game tickets, is not an entertainment expense. Therefore, C may deduct 50 percent of the expenses associated with the food and beverages provided at the game.

Contact Us

Lauren A. Carnes PrincipalCPA, MST

Phone: 617.471.1120Email: lcarnes@ocd.com

Ryan J. McDonellTax Supervisor

CPA, MSAPhone: 617.471.1120

Email: rmcdonell@ocd.com