When the Tax Cuts and Jobs Act (TCJA) was signed into law on Dec. 22, 2017, companies in all industries braced themselves for impending changes. The key takeaway of the TCJA is lower tax rates for both businesses and individuals. However, the impacts of this new tax law are extensive and have left many taxpayers wondering how they will be affected.
For the transportation industry, guidelines are continuing to emerge. In addition to the key provisions that were highlighted in our earlier analysis, Top Three Things to Know About How Tax Reform Impacts Your Trucking Company, the following changes will likely affect most trucking companies.
Meals and Entertainment
The new tax law generally eliminates the deduction for entertainment expenses and in some circumstances further limits the deduction for business meals. Entertainment expenses that are incurred or paid after Dec. 31, 2017 are nondeductible unless they meet certain exceptions. Under the previous tax law, entertainment expenses that were directly related to the taxpayer’s trade or business were able to be deducted at 50 percent. Business meals that are provided for the convenience of the employer are now limited to a 50 percent deduction and are set to be fully nondeductible after 2025. Under the previous tax law, these were fully deductible.
There are many specific guidelines, but some of the most common questions focus on the following topics:
|Client business meals where business is conducted, the taxpayer is present, and the expense is not lavish or extravagant.||Still 50 percent deductible.|
|Office holiday party, company outings, and picnics.||Still 100 percent deductible (falls under Section 274(e) exception).|
|Meals during business travel or at a conference.||Still 50 percent deductible.|
|Meals provided for the convenience of the employer or overtime employee meals.||Now 50 percent deductible, will be nondeductible after 2025.|
|Entertainment at sporting events, golf course, or similar events.||Now nondeductible.|
There is uncertainty regarding meals that occur in connection with entertainment events. Under the new law, meals that are related to operating a trade or business are 50 percent deductible; however, the law is silent with respect to meals that are provided in connection with an entertainment event. We believe that the expense of these particular meals fall under the definition of operating a trade or business and would be entitled to a 50 percent deduction. However, until further guidance is available from the IRS, the tax treatment is uncertain.
Our recommendation is to create separate general ledger accounts for meals expense and entertainment expense. Typically, these are grouped in a single account, as both expenses were 50 percent deductible. Going forward, it is advisable to separate these expense items in order to determine the deductible amount.
In general, under the previous tax law, taxpayers were entitled to fully deduct business interest expense. The new tax law may limit a taxpayer’s business interest expense deduction. The new limitation is effective for tax years beginning after Dec. 31, 2017. There are a few exceptions to the limitation, most notably for taxpayers with gross receipts that do not exceed $25 million.
The deduction of business interest expense is limited to the sum of:
- Business interest income
- 30 percent of the business’s Adjusted Taxable Income (ATI) for the tax year
- Interest from floor plan financing (generally impacts automobile dealerships)
ATI is equal to the business’s taxable income, but excludes:
- Any income, gain, deduction, or loss which is not related to the business
- Business interest income and expense
- Any net operating losses, if applicable
- Qualified Business Income (QBI) deduction, which is part of the new tax law
- Depreciation, amortization, or depletion
In other words, ATI is equal to taxable earnings before interest, taxes, depreciation, and amortization. It is important to note that depreciation, amortization, and depletion will be included in ATI starting with tax years beginning after 2021, thus reducing ATI. The reduction in ATI will further limit the interest deduction. This will have a significant impact on capital intensive businesses. Any disallowed business interest expense can be carried forward indefinitely.
The limitation is determined at the entity level, on an entity-by-entity basis, but deductibility is determined at the shareholder/partner level. For S corporations, any disallowed interest carries over at the entity level until the S corporation has enough income to free up the previously disallowed interest expense. Partnerships treat any excess interest expense differently. The excess interest is allocated to the partners and carried over at the partner level until the partner is allocated enough taxable income from that partnership to free up the previously disallowed interest expense.
This new business interest expense limitation is complex and will likely have a big impact on carriers. It is important to understand the implications when tax planning for 2019 and beyond.
For further information on these topics or other ways the new tax law could affect the transportation industry, please contact a KSM advisor. Additional information regarding tax reform, long-term planning strategies, and more can be found here.