For the first time in decades, clients across the country are saying “I can’t wait to meet with my tax attorney and CPA!” While this is admittedly a stretch, the Tax Cuts and Jobs Act (a.k.a., “tax reform”), signed into law on December 22, 2017, has created a renewed interest in tax law. Tax reform made dozens of changes to the Internal Revenue Code. What do entrepreneurs need to know about these changes? IrishAngels preferred partner Baker Tilly outlines the ten changes that are most relevant to startups.
(1) Patent sales are now taxable at ordinary income rates. Historically, patents and other self-created intellectual property were generally subject to reduced capital gain tax rates upon sale. Tax reform has now eliminated this favorable tax treatment for “a patent, invention, model or design (whether or not patented), or a secret formula or process.” Thus, gain on the sale of these properties will now be taxed at ordinary income rates.
Note that tax reform did not repeal the law that allows individual inventors to obtain favorable tax rates when transferring all substantial rights to a patent. This narrow rule still applies.
(2) Bonus depreciation is available for 100% of eligible assets. Prior to tax reform, companies could immediately deduct the so-called “bonus depreciation” on qualified assets in the year of purchase. Bonus depreciation was equal to 50% of the purchase price of these assets. Under tax reform, the eligible bonus depreciation percentage is increased to 100%.
These new depreciation provisions can produce present value tax savings for businesses with considerable capital expenditures. However, startup companies that are in a loss position should be mindful of the Net Operating Losses limitations described in (3) below before taking bonus depreciation.
(3) There are new ways to use Net Operating Losses. Under tax reform, post-2017 Net Operating Losses (“NOLs”) are subject to two significant restrictions.
First, NOLs can no longer be carried back to prior years, but they can be carried forward indefinitely. Prior to tax reform, NOLs could be carried back two years and carried forward for 20 years.
Second, NOL carryforwards generated after 2017 will only be allowed to offset 80% of taxable income in subsequent years. Prior to tax reform, an NOL carryforward could be used to offset 100% of subsequent year income. Taxpayers can no longer rely upon NOLs to wipe out all income taxes.
(4) State grant funds are now taxable. Tax reform also repealed the rule that exempted state grant funds from a corporation’s income if those funds met certain requirements. These grant funds are now taxable. Note, however, that the increased thresholds discussed in (2) above lighten the blow. That is, grants funds are now taxable, but capital assets purchased with those funds may be immediately expensed under the 100% bonus deprecation threshold.