Lasting Impact of the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act of 2017 (TCJA), which was signed into law on December 22, 2017, brought significant changes and tax reform, amending the Internal Revenue Code. Six years later, both corporations and individuals are still experiencing the ramifications of this legislation.
One of the most significant changes imposed by the TCJA was the increase in the availability of the overall cash method of accounting for business taxpayers. Under the pre-TCJA rules, there were several limitations to utilizing the cash method of accounting. These limitations included but were not limited to gross receipts requirements, limitations due to inventories, and ineligibility due to specific trade or business activities.
Under the pre-TCJA tax rules, certain industries were not able to use the cash method of accounting due to the nature of their business. Specifically, manufacturers, retailers, wholesalers and other similar businesses that have inventories were extremely limited in their accounting method choices. Due to the presence of inventories, these taxpayers were required to follow complex accounting rules pursuant to Internal Revenue Code Sections 471 and 263A, which govern the capitalization of overhead costs and certain selling, general and administrative expenses.
The TCJA amended the Internal Revenue Code, which provides taxpayers more latitude to the use of the overall cash method of accounting. Now, taxpayers whose average gross receipts (average of the prior three tax years) do not exceed $25 million can use the overall cash method of accounting, where they may have been limited before. The TCJA also implemented an annual inflation adjustment to the gross receipts test, which has reached $29 million for 2023.
In addition to the gross receipts exemption, the TCJA also amended Internal Revenue Code Sections 471 and 263A, which govern the treatment of inventory costs. These changes provide a small business exemption where the complex rules would no longer apply to taxpayers meeting the gross receipts test. As a result of the new exemptions, the TCJA allows manufacturers, retailers, wholesalers and other taxpayers who do not exceed the gross receipts test to use the overall cash method of accounting. Additionally, this expanded group of taxpayers now using the gross receipts test, may also receive an exemption from the uniform capitalization requirements established under 263A.
A third impact of the TCJA was the reintroduction of Internal Revenue Code Section 163(j), which established criteria under which certain taxpayers would be limited on the amount of deductible business interest. Under 163(j), commonly controlled businesses are required to aggregate gross receipts for purposes of the gross receipts test. Businesses that exceed the small business exemption ($29 million in 2023) are subject to the business interest limitation.
For these taxpayers, the business interest deduction for the applicable year is limited to the sum of interest income, 30% of adjusted taxable income (ATI), and floor plan financing interest expense. ATI represents the taxpayer’s taxable income excluding business interest expense, business interest income, net operating loss deductions, qualified business income deductions, and items of income, gain, deduction, or loss not allocable to a trade or business. For tax years beginning before January 1, 2022, any deduction for depreciation, amortization, or depletion was also excluded from the computation of ATI. This last adjustment is noteworthy because, before 2022, depreciation, amortization, and depletion were included in the computation ATI, which typically resulted in a higher ATI, increasing the total amount of business interest expense. For tax years ending after December 31, 2021, taxpayers may find that their business interest deduction is reduced compared to previous years.
A final provision of the TCJA worth noting was the introduction of the qualified business income deduction under Internal Revenue Code Section 199A. The provision created a deduction equal to 20% of qualified business income for any trade or business, excluding C corporations, the trade or business of performing services as an employee, and specific threshold limitations for those defined as a specified trade or business. A specified trade or business is one involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading or dealing in certain assets or any trade or business where the principal asset is the skill of one or more of its employees or owners. Although the credit computation has several factors involved, the overall tax benefit available to manufacturers under 199A is of great significance.
While taxpayers are continuing to benefit from these lasting provisions, it is important to note that the qualified business income deduction is set to expire as of December 31, 2025. If you have questions regarding the provisions discussed above and your business or personal income tax situation, we encourage to you discuss these matters with your tax advisor, or feel free to reach out to us at Dannible and McKee, LLP.
Contributing author: Kaitlyn L. Mariano, CPA, is a senior tax manager at Dannible & McKee, LLP. Kaitlyn has over 11 years of experience overseeing tax engagements for a variety of the firm’s clientele, focusing on manufacturers, contractors, multi-state taxation and high-net-worth individuals. For more information on this topic, contact Kaitlyn at firstname.lastname@example.org or (315) 472-9127.