Six Hidden Business Changes In The House Tax Bill

The GOP has long discussed limiting interest expense, for three reasons:

1. It helps pay for the rate cuts by raising $170 billion in revenue over the next ten years,
2. It (hopefully) reduces the current corporate dependency on debt, and shifts it towards equity, and
3. Adds simplicity to the law by eliminating the need for complicated rules designed to prevent earnings strippings, whereby a U.S. corporation borrows money from a low-tax foreign affiliate and "strips" earnings out of the U.S. in the form of interest payments.

So kiss your interest expense goodbye. At least, that is, until the Wall Street lobbyists show up in D.C. and the GOP folds faster than Yu Darvish.

Give: Full Expensing is Here (At least for a While) 

Purchase an asset, and you'll spend almost as much coin paying your tax preparer to figure out how to depreciate the thing as you did to buy it in the first place. First, you've got to figure out if you can use the $5,000 (or $2,500) safe harbor deduction under Reg. 1.263(a)-1(f). If you can't, you gotta' check out Section 179. Failing that, you'll be kicking the tires on bonus depreciation. All of those steps are predicated, of course, on you first being able to figure out the proper useful life, which is no small task.

For the next five years, the House bill will allow businesses to immediately expense the full cost of most assets; really, anything with a life of 20 years or less. This should allow for the expansion of capital investment, and most economists are confident that the move will do as much to boost the economy as any single change in the proposal.

Take: Limited Utilization of Net Operating Loss Carrybacks and Carryforwards

If there's one bright side to losing a ton of money as a corporation, it's that if you're patient, those losses will eventually come around and do their part. That's because a corporate loss -- or net operating loss, in tax parlance -- may be carried forward to offset income for twenty years.

In addition, net operating losses can be carried back two years to offset income recognized in the past and generate a refund of previously paid taxes.

The NOL rules would be altered under the House plan. Carrybacks of net operating losses incurred in 2018 and beyond would no longer be permitted. And in addition, the carryforward of any 2018 or later NOL would only be allowed to be used against 90% of a corporation's taxable income. Yes, that means that a corporation could have $900,000 of income in 2019, a $1 million net operating loss from 2018 available to offset that income, and still end up paying tax on $90,000 of income on its 2019 tax return.

Give: Wider Availability of the Cash Method 

If you're a business, you'd generally prefer to be on the cash method. The cash method works the way it sounds -- you recognize income when cash is received and take deductions when cash is paid. It's nice and simple. The other alternative -- the accrual method -- is not so nice and simple. It requires you to generally recognize income on the earlier of the date the income is 1. earned, 2. due, or 3. received. Expenses are only deductible when 1. the fact of the liability is fixed, 2. the amount of the liability can be determined with reasonable accuracy, and 3. economic performance has occurred. If you just read those previous two sentences and found yourself thinking: "I know all of those words individually, but the way you put them together makes no sense," well, you're not alone. Hence, the desire for the cash method.

Unfortunately, Section 448 prohibits the use of the cash methods by 1. C corporations, and 2. partnerships with a C corporation partner, when the C corporation in either scenario has average annual gross receipts for the previous three years in excess of $5 million.

In addition, businesses of all vintages must use the accrual method when they are required to account for inventories. Thus, an S corporation or partnership with $5 million of receipts, which normally would be free to use the cash method, will find itself forced to use the accrual method to account for purchases and sales of inventory. There are some narrow exceptions to this rule -- namely, Revenue Procedures 2001-10 and 2002-28 -- which allow for small businesses to use the cash method even when inventory is present, but those exceptions don't apply once average receipts exceed $10 million.

The House bill would greatly expand the applicability of the cash method by allowing C corporations and partnerships with a C corporation partner to use the cash method until average gross receipts exceed $25 million, as opposed to the current $5 million. Any corporation whose accounts receivables routinely exceed its accounts payable will welcome the opportunity.

In addition, the bill will allow all businesses to use the cash method when average gross receipts are less than $25 million, even when inventory is present.

Take: Elimination of Deductions for Entertainment Expense 

If you're the kind of MAN'S MAN whose idea of a kick-ass client meeting is a round of golf followed by a visit to the strip club, there are changes afoot for your business. The House bill would deny all deductions for entertainment, amusement, or recreation activities. As a result, from this point on, when I choose to spend my lunch hour at the Diamond Cabaret, instead of calling it "entertainment," I'll characterize it as "research into employee versus independent contractor issues."

The denied deductions would also include any membership dues, fringe benefits provided to employees in the form of an on-premises gym, and other athletic facilities. This could cause a huge decline in golf club memberships by big corporations. AND YOU SAID THIS TAX BILL WAS NOTHING BUT A WAY TO LINE THE PRESIDENT'S POCKETS, SNOWFLAKE.

Give: Narrower Application of Section 263A 

If you've ever been asked to delve into the depths of Section 263A, you know that it represents the very worst of what the Internal Revenue Code has to offer. Terms of art. Exceptions and allocations. Complicated formulas using incomprehensible ratios. It's a burden on tax preparers, because we feel an obligation to get it right, even though we know full well that clients would never pay us for the time it would take to actually get it right.

Basically, it works like this. In 1986, Congress decided that for businesses that purchase or produce inventory, too many of their expenses were being deducted currently. A portion of the company's general and administrative expenses -- the theory went -- were allocable to the production or purchase of that inventory, and should only be deducted when the inventory is sold. As a result, Section 263A was born, requiring all taxpayers who produce inventory -- and all resellers with more than $10 million in average gross receipts -- to endure the painstaking task of allocating a portion of most G&A expenses to inventory.

The House bill would alleviate that burden in many cases, allowing all businesses with average gross receipts of less than $25 million to avoid the Section 263A rules. They will not be missed.

See that, big corporation? Yesterday's tax bill wasn't just a giveaway to big business packaged as a middle class tax cut. Sure, you got your $1.4 trillion tax cut, and your immediate expensing, and your greater access to the cash method, but you also LOSE A PIECE OF YOUR INTEREST EXPENSE AND 10% OF YOUR NOLS.

Not so smug now, are you?

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Hey, you. Yes, you. Big corporation that just HAD to have a huge tax cut. Well, you got your way: of the $1.5 trillion in tax breaks in the House bill, nearly $1 trillion of it winds up right in your already-plump pockets.

But you might want to wipe that smug look off your face. Sure, the corporate rate will plummet from 35% to 20% if the bill becomes law, but the House's proposal wasn't ALL good news for big business. Like any tax bill, there was some give and take.

Let's take a look:

Take: Borrowing Got More Expensive 

Businesses borrow money; probably more than they should. What makes it palatable, however, is that a deduction is currently allowed for the interest expense, reducing the after-tax cost of borrowing.

The House bill would end that gravy train, however, by disallowing a businesses' net interest expense (interest expense in excess of income) in excess of 30% of the company's EBITDA. That's right, you heard me...EBITDA is now factoring into tax calculations. Please give me more of that sweet, sweet simplicity.

Businesses with average gross receipts of less than $25 million will be exempted from these rules. And any excess interest disallowed under the rules of this section would be carried forward for five years.

The GOP has long discussed limiting interest expense, for three reasons:

1. It helps pay for the rate cuts by raising $170 billion in revenue over the next ten years,
2. It (hopefully) reduces the current corporate dependency on debt, and shifts it towards equity, and
3. Adds simplicity to the law by eliminating the need for complicated rules designed to prevent earnings strippings, whereby a U.S. corporation borrows money from a low-tax foreign affiliate and "strips" earnings out of the U.S. in the form of interest payments.

So kiss your interest expense goodbye. At least, that is, until the Wall Street lobbyists show up in D.C. and the GOP folds faster than Yu Darvish.

Give: Full Expensing is Here (At least for a While) 

Purchase an asset, and you'll spend almost as much coin paying your tax preparer to figure out how to depreciate the thing as you did to buy it in the first place. First, you've got to figure out if you can use the $5,000 (or $2,500) safe harbor deduction under Reg. 1.263(a)-1(f). If you can't, you gotta' check out Section 179. Failing that, you'll be kicking the tires on bonus depreciation. All of those steps are predicated, of course, on you first being able to figure out the proper useful life, which is no small task.

For the next five years, the House bill will allow businesses to immediately expense the full cost of most assets; really, anything with a life of 20 years or less. This should allow for the expansion of capital investment, and most economists are confident that the move will do as much to boost the economy as any single change in the proposal.

Take: Limited Utilization of Net Operating Loss Carrybacks and Carryforwards

If there's one bright side to losing a ton of money as a corporation, it's that if you're patient, those losses will eventually come around and do their part. That's because a corporate loss -- or net operating loss, in tax parlance -- may be carried forward to offset income for twenty years.

In addition, net operating losses can be carried back two years to offset income recognized in the past and generate a refund of previously paid taxes.

The NOL rules would be altered under the House plan. Carrybacks of net operating losses incurred in 2018 and beyond would no longer be permitted. And in addition, the carryforward of any 2018 or later NOL would only be allowed to be used against 90% of a corporation's taxable income. Yes, that means that a corporation could have $900,000 of income in 2019, a $1 million net operating loss from 2018 available to offset that income, and still end up paying tax on $90,000 of income on its 2019 tax return.

Give: Wider Availability of the Cash Method 

If you're a business, you'd generally prefer to be on the cash method. The cash method works the way it sounds -- you recognize income when cash is received and take deductions when cash is paid. It's nice and simple. The other alternative -- the accrual method -- is not so nice and simple. It requires you to generally recognize income on the earlier of the date the income is 1. earned, 2. due, or 3. received. Expenses are only deductible when 1. the fact of the liability is fixed, 2. the amount of the liability can be determined with reasonable accuracy, and 3. economic performance has occurred. If you just read those previous two sentences and found yourself thinking: "I know all of those words individually, but the way you put them together makes no sense," well, you're not alone. Hence, the desire for the cash method.

Unfortunately, Section 448 prohibits the use of the cash methods by 1. C corporations, and 2. partnerships with a C corporation partner, when the C corporation in either scenario has average annual gross receipts for the previous three years in excess of $5 million.

In addition, businesses of all vintages must use the accrual method when they are required to account for inventories. Thus, an S corporation or partnership with $5 million of receipts, which normally would be free to use the cash method, will find itself forced to use the accrual method to account for purchases and sales of inventory. There are some narrow exceptions to this rule -- namely, Revenue Procedures 2001-10 and 2002-28 -- which allow for small businesses to use the cash method even when inventory is present, but those exceptions don't apply once average receipts exceed $10 million.

The House bill would greatly expand the applicability of the cash method by allowing C corporations and partnerships with a C corporation partner to use the cash method until average gross receipts exceed $25 million, as opposed to the current $5 million. Any corporation whose accounts receivables routinely exceed its accounts payable will welcome the opportunity.

In addition, the bill will allow all businesses to use the cash method when average gross receipts are less than $25 million, even when inventory is present.

Take: Elimination of Deductions for Entertainment Expense 

If you're the kind of MAN'S MAN whose idea of a kick-ass client meeting is a round of golf followed by a visit to the strip club, there are changes afoot for your business. The House bill would deny all deductions for entertainment, amusement, or recreation activities. As a result, from this point on, when I choose to spend my lunch hour at the Diamond Cabaret, instead of calling it "entertainment," I'll characterize it as "research into employee versus independent contractor issues."

The denied deductions would also include any membership dues, fringe benefits provided to employees in the form of an on-premises gym, and other athletic facilities. This could cause a huge decline in golf club memberships by big corporations. AND YOU SAID THIS TAX BILL WAS NOTHING BUT A WAY TO LINE THE PRESIDENT'S POCKETS, SNOWFLAKE.

Give: Narrower Application of Section 263A 

If you've ever been asked to delve into the depths of Section 263A, you know that it represents the very worst of what the Internal Revenue Code has to offer. Terms of art. Exceptions and allocations. Complicated formulas using incomprehensible ratios. It's a burden on tax preparers, because we feel an obligation to get it right, even though we know full well that clients would never pay us for the time it would take to actually get it right.

Basically, it works like this. In 1986, Congress decided that for businesses that purchase or produce inventory, too many of their expenses were being deducted currently. A portion of the company's general and administrative expenses -- the theory went -- were allocable to the production or purchase of that inventory, and should only be deducted when the inventory is sold. As a result, Section 263A was born, requiring all taxpayers who produce inventory -- and all resellers with more than $10 million in average gross receipts -- to endure the painstaking task of allocating a portion of most G&A expenses to inventory.

The House bill would alleviate that burden in many cases, allowing all businesses with average gross receipts of less than $25 million to avoid the Section 263A rules. They will not be missed.

See that, big corporation? Yesterday's tax bill wasn't just a giveaway to big business packaged as a middle class tax cut. Sure, you got your $1.4 trillion tax cut, and your immediate expensing, and your greater access to the cash method, but you also LOSE A PIECE OF YOUR INTEREST EXPENSE AND 10% OF YOUR NOLS.

Not so smug now, are you?

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