How Will the New Tax Legislation Affect Your Business: A Guest Spot PerspectiveBy Richard Stern | Mark R. Baran | January 24, 2018
In this installment of The Guest Spot, Richard Stern and Mark Baran of Marks Paneth LLP discuss the tax overhaul passed by congress and signed into law by President Donald Trump in late 2017 and the implications of the new legislation for your business.
While the commercial production industry waited for the final version of the Tax Cuts and Jobs Act (H.R. 1) to be unveiled late last year, there was much speculation and uncertainty about how the industry would be impacted. Depending on a production company’s business and financial structure, the new tax law had the potential to provide significant benefits, unfavorable results, or both.
Now that the President has signed H.R. 1 into law, we can clearly identify what sections of the bill will have the greatest impact on the industry. The three primary areas of reform that will most directly affect the commercial production industry are:
- a revised, though complex, way to tax pass-through income,
- individual and corporate tax changes, and
- temporary 100% expensing for certain business assets.
Taxation of Pass-Through Income
H.R. 1 has created a new method of computing income for pass-through entities. The new law allows owners of a qualified trade or business to take a deduction of up to 20% of the qualified business income. Subject to certain income thresholds, qualified trades or businesses (partnerships, S corporations, and sole proprietorships that are not service trades or businesses) will be allowed a deduction for the lessor of (a) 20% of the qualified business income with respect to such trade or business, or (b) the greater of 50% of the W-2 wages paid with respect to the qualified trade or business OR the sum of 25% percent of the W-2 wages plus 2.5% of the unadjusted basis (determined immediately after acquisition) of all qualified property.
Specified Service Trade or Business
Businesses that are unable to take this new deduction include specified service trades or businesses. According to the text of H.R. 1, “a specified service trade or business is any trade or business activity involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, any trade or business where the principal asset of which is the reputation or skill of one or more of its owners or employees (excluding engineering and architecture), or any business that involves the performance of services that consist of investment and investment managing, trading or dealing in securities, partnership interest, or commodities.”
Although guidance will be needed in the weeks and months ahead, H.R. 1 attempts to clarify the scope of this “specified service trade or business” definition. While “performing arts” services fall under the definition of a disqualified service trade or business, commercial film production partnerships will likely qualify for the 20% deduction.
How the 20% Deduction Works
The 20% deduction is available with respect to qualified business income if the taxpayer’s taxable income does not exceed $315,000 for married individuals filing jointly (or $157,500 for other individuals). These amounts are phased out over the next $100,000 for married individuals ($50,000 for individuals). By way of example on how this 20% deduction would work, assume a taxpayer is fully phased-out (taxable income above the $415,000), not a service trade or business, and has a 10% interest in a production limited liability company, partnership or S corporation that pays wages of $500,000. The taxpayer would be limited to a deduction of $25,000 ($500,000 x 10% allocated share x 50% limitation). This basic example reflects how the 50% wage limitations are calculated, and assumes that 20% of the taxpayer’s share of qualified business income is greater than $25,000.
Where Do We Go From Here?
More guidance will be needed to determine how this change affects tiered partnerships or single member partnerships, such as when an investment partnership invests in a production partnership.
We also anticipate that there will be delays in the design and release of the various 2017 pass-through entity tax returns and K-1s, to allow time for the additional information to be included.
Individual and Corporate Tax Changes
There are numerous changes affecting the owners of pass-through businesses – both individuals and C corporations. For C corporations, rates have changed, most notably a reduction in the top corporate marginal rate from 35% to 21%. Since the majority of production companies are pass-through entities, it is unclear at this time whether these new tax laws (especially the lower corporate rate) will create an incentive to convert to a corporate form.
Other changes impact corporations, including repeal of the corporate alternative minimum tax, limitations on losses, net interest deductions, and greater availability of favorable accounting methods. For businesses other than C corporations, excess business losses will be disallowed. Excess business losses are the aggregate deductions over gross income or gain plus a threshold amount of $250,000 (or $500,000 for joint filers).
For individuals, H.R. 1 repeals or limits certain deductions and preference items, while doubling the commercial standard deduction. One major change in regard to itemized deductions is the capping of state and local tax deductions (both property and income taxes) at $10,000 which adversely impacts individuals in high state tax jurisdictions such as New York, Illinois and California. Several other itemized tax deductions have been eliminated including certain fringe, employee business, and entertainment expenses.
Temporary 100% Expensing for Certain Business Assets
H.R. 1 increases the maximum amount a taxpayer may expense under Section 179 to $1,000,000 (from $500,000), and increases the phase-out threshold amount to $2,500,000 (up from $2,000,000). H.R. 1 also allows full expensing of property placed in service after September 27, 2017, and before January 1, 2023 (bonus depreciation). Post production and editorial equipment would also be eligible to claim as an expense. It is important to note that qualified property eligible for the additional first-year depreciation allowance now includes qualified film, television and live theatrical productions placed in service after September 27, 2017, and before January 1, 2023, for which a deduction otherwise would have been allowable under Section 181.
As with most major legislation, there are some ups and downs with the tax rules and technical areas that will require clarification. Companies should begin discussions with their tax advisors and assess the impact of these laws on their specific business operations.
This article was originally published in the January 2018 issue of "Spotted: The AICP Newsletter."
About Richard Stern
Richard Stern, CPA, is a Partner in the Theater, Media and Entertainment Group at Marks Paneth LLP. While he serves clients in a broad range of industries, he concentrates heavily on theater, media and entertainment with a particular focus on serving the commercial, film and television industry including film equipment rental companies, directors, editors and music producers, as well as creative services. Mr. Stern also deals with production tax credits available for the film, television and... READ MORE +
About Mark R. Baran
Mark Baran, JD LL.M., is a Principal in the Tax Department at Marks Paneth LLP. He has more than 25 years of specialized tax, transactional and legal experience advising publicly-traded and private companies, regulated financial institutions, investors, high net worth individuals, and government agencies. Mr. Baran provides specialized tax consulting and transactional services to a broad spectrum of clients and industries including the public sector. He routinely provides tax opinions on the tax implications of... READ MORE +