Of all the changes in the tax reform bill that Congress passed and the president signed at the end of 2017, some provisions stand out more than others as having a significant impact on the logistics industry. Many of the changes have the potential to be quite positive and lucrative. However, without proper planning, businesses could miss out on tax-saving opportunities or even be negatively impacted from the new tax provisions.
The most notable changes that stand to benefit businesses and corporations in the transportation and logistics industries include the reduction of the federal corporate tax rate from 35 percent to 21 percent and the repeal of the corporate Alternative Minimum Tax (“AMT”). For example, leaders at Hormel report the reduced corporate tax rate will provide them with an estimated additional cash flow of $110 million to $140 million in fiscal year 2018.
In addition to these corporate tax changes, there are other, more detailed ways the industry stands to gain from tax reform—with proper planning.
Expensing of Capital Investments and Bonus Depreciation
Businesses can now choose to write off 100 percent of qualified capital expenditures in one year instead of writing them off over the course of many years using a depreciation schedule. The new bonus depreciation rules apply to qualified tangible personal property placed into service after Sept. 27, 2017, and before Jan. 1, 2023. The old rules required property to be new to qualify for bonus depreciation. New provisions allow property to be new or used, as long as the property is being used by the taxpayer for the first time.
Businesses can now also write off larger purchases. The maximum amount a taxpayer can expense has been increased $1 million, and the new phase-out threshold is $2.5 million.
The first-year bonus depreciation percentage will start to phase down beginning Jan. 1, 2023, and will sunset Dec. 31, 2026. These provisions are great news if you have capital expenditures planned over the next few years for items such as manufacturing, processing or warehouse equipment.
Qualified Improvement Property
The changes to this area of the law should be welcome news if you’re planning to make improvements to qualified real property. The first thing to know is that the definition of qualified real property has been simplified. The definition previously was broken down into three categories: qualified leasehold property, qualified restaurant property and qualified retail improvement property. Now, the categories have been combined into simply qualified improvement property.
Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property, if the improvement is placed in service after the date the building was first placed in service. Certain improvements are excluded from this definition, including enlargements to the building, improvements to elevators and escalators, and work on the internal structural framework of the building. Other improvements have been added to this definition, such as roofs, HVAC property, fire protection and security systems.
Now, qualified improvement property placed in service on or after Jan. 1, 2018, may be eligible for straight line depreciation over 15 years, Internal Revenue Code section 179 expensing and first-year bonus depreciation. It’s worth talking to a tax advisor to plan the best strategy or strategies to use. Due to the hurried drafting of the law, however, a key provision was omitted from the final bill that permits a 15-year depreciable life. Congressional leaders and staffers have indicated that it was their intent to establish the 15-year life, and the missing provision should be added in a technical corrections bill later.
Business Interest Expense Deduction
As a trade-off for being able to expense 100 percent of eligible capital expenses, the deduction for business interest expenses has been restricted. In short, interest expense is now limited to 30 percent of adjusted taxable income. Before 2022, adjusted taxable income will include the add-back of interest, depreciation, amortization and depletion. For later tax years, the definition changes, and no adjustments will be made for depreciation, amortization and depletion. Any interest expense that is not deductible in the current year is carried forward indefinitely. The analysis to determine how much interest is allowed under the new law is made by the business entity (e.g., partnership, S-corporation). Businesses with less than $25 million in annual revenue will not be subject to the limit on business interest expense deductions.
Research and Development (R&D) Credit
The R&D credit survived. The costs of designing, developing or improving products, packaging, processes, delivery methods and other eligible R&D activities (and there are many) qualify you for this credit. It doesn’t matter how small the change or improvement may seem. If you are a qualified start-up, then you may be able to monetize this credit to offset up to $250,000 of payroll tax liabilities.
One change to this credit is that for tax years beginning after Dec. 31, 2021, specified research and experimentation expenses must be capitalized and amortized ratably over a five-year period. The amortization period is extended to 15 years for research conducted outside the United States. Expenses for software development are eligible.
Net Operating Losses (NOLs) and Excess Business Losses
NOLs can now be carried forward indefinitely, but they can no longer be carried back. Before tax reform, most NOLs were limited to a two-year carryback period and a 20-year carryforward period. Under the old rules, NOLs could be used to offset 100 percent of a taxpayer’s taxable income, barring any other limitations. However, under the new law, NOLs incurred after Dec. 31, 2017, can only offset 80 percent of taxable income.
Historically, individual owners of pass-through entities (i.e., sole proprietorships, S-corporations and partnerships) have had basis and at-risk limitations restricting their ability to deduct losses from their trade or business activities. However, if basis or at-risk rules didn’t apply, the losses could reduce non-business income without limitation. The new tax law restricts the use of business losses for non-corporate taxpayers. Beginning in 2018, taxpayers can only deduct $250,000 (single) or $500,000 (married filing jointly) of these losses, hence the term “excess business losses.” Any disallowed loss as a result of these limitations will be treated as a NOL and carried forward to subsequent years, subject to the new 80 percent limitation previously mentioned.
Changes in Accounting Methods
Businesses with less than $25 million in average annual revenue are now permitted to use the cash method of accounting, simplified inventory accounting methods and the completed contract accounting method for long-term contracts. These accounting methods create more flexibility in tax planning and will provide for easier recordkeeping and tax reporting requirements.
No More Like-kind Exchanges for Tangible Personal Property
Like-kind exchanges and the deferred taxable gain resulting from these exchanges now only apply to real property as of Jan. 1, 2018. The gain on any like-kind exchange or trade-in on tangible property, such as equipment or vehicles, is now taxable based on the value received in the exchange. The flip side is that while the gain is taxable, the depreciable basis of the new property won’t be reduced by the gain (since it’s no longer deferred). The property should be eligible for 100 percent bonus depreciation on the full cost of the property, or section 179 expensing of the net purchase price after trade, or possibly both, barring any other limitations.
Company Driver Per Diem Expense Repealed with Other Schedule A Deductions
With the increase in the standard deduction ($12,000 for single, $24,000 for married filing jointly, $18,000 for head of household), many personalized Schedule A deductions have been repealed. Company drivers (W-2 wage employees) can no longer claim the miscellaneous itemized tax deduction for unreimbursed meals and lodging. The deduction was limited to 2 percent of an employee’s adjusted gross income and per diem rates set by the Department of Transportation. Companies that have a per diem or reimbursement program for meals and lodging for drivers may still deduct those costs.
International Tax and Repatriation of Profits
If you’re a multinational corporation or have multinational partners, there are few ways to escape the cost that the deemed repatriation of international profits is likely to take out of any earnings in the 2018 tax year. On the other hand, other rules may make filing simpler and more cost effective, such as new rules that change the tax treatment of intellectual property (“IP”). Proceeds from IP used to be taxed as royalties at a rate of 35 percent. The new law taxes IP income at a rate of 13.125 percent for the next seven years and 16.4 percent after that. The new rules surrounding international taxes, including the base erosion anti-abuse tax (“BEAT”), which is seen as a sort of minimum tax for multinationals, are complex and could take up volumes on their own, so it’s best to talk to an international tax specialist about your situation.
What Should Your Plan Be?
You can’t make any decisions on these new rules in a vacuum. Remember to consider all these variables at once. For example, if you consider the size and the depreciation schedule of your capital investments combined with any deductions you can take for NOLs, it might make more sense to claim the interest expense deduction rather than 100 percent bonus depreciation. On the other hand, if you’re a smaller business or partnership and you claim any income as a pass-through, you may want to accelerate deductions, since many provisions for pass-throughs and individual taxpayers are scheduled to sunset in approximately five to seven years, depending on the provision.
Depending on the complexity of your situation, an audit of your tangible property holdings, your investment plans for the next several years, and your accounting methods should uncover some clear answers as to what your next moves should be under the new tax law.
David W. Appel, CPA is managing partner of the South Florida practice of Cherry Bekaert. With more than 30 years of experience, Appel provides tax planning and consulting services to publicly-traded and privately-held corporations, including comprehensive strategic tax planning in closely-held entities, S corporations, partnerships, controlled groups and individuals.