This blog post was originally published on February 7, 2018. It was updated on November 7, 2018.
Investment funds have opportunities to benefit, but don’t delay
The Tax Cuts and Jobs Act, seen to be very “business friendly,” includes a number of provisions affecting the private equity and investment fund industry. Without the proper planning before year-end, you could miss out on benefits.
Most urgent: Maximize the new deduction for qualified business income (QBI).
Many investment companies are structured as pass-through entities, such as subchapter S corporations, partnerships and limited liability companies. The new tax law includes a QBI deduction break for owners of certain pass-through entities that may reduce your maximum effective tax rate for 2018.
Owners of some pass-through entities will now receive a 20% deduction on qualified business income, effectively reducing their maximum effective tax rate from 39.6% in 2017 to 29.6% in 2018. The deduction may be limited to 50% of the W-2 wages paid, or the sum of 25% of the wages plus 2.5% of depreciable basis. There’s another plus for pass-throughs: they keep the deduction on entity-level state and local taxes.
The QBI deduction limitations and restrictions are set at the owner level. Planning for year-end 2018 should include discussion of salaries, timing and distribution of income.
Prepare to capture expanded bonus depreciation.
The rules have changed for bonus depreciation, a method of accelerated depreciation that allows you to take an additional deduction the first year you own qualified property. Previously, bonus depreciation was calculated at 50% of the basis of qualified property, and only brand new property qualified. For property acquired after September 27, 2017, and through the end of 2022, 100% of the basis can be depreciated, and the property only has to be “new to the taxpayer,” meaning used property can qualify.
Year-end planning should include assessing any property purchased during the year. You may also want accelerate purchases to this year, if it’s advisable.
You may want to revisit your capital strategy.
Interest expense deductibility is limited immediately, and it will get worse. For net interest expense that exceeds 30% of adjusted taxable income (ATI), deductibility has been limited. Through 2021, ATI is computed without accounting for depreciation, amortization or depletion, but beginning in 2022 those items are included. This could decrease your ATI, and thus limit your interest expense deductibility further.
Highly leveraged portfolio companies should take note and address this issue strategically. A capital strategy relying on more equity and less debt may be advisable.
Opportunity zones could present a strategic opportunity for investment funds.
The new opportunity zone program gives investors in certain economically distressed communities the opportunity to defer tax capital gains. You can create funds to seed new business, provide capital in order to expand existing businesses or invest in real estate development. The longer you hold the property, the greater the benefit. If you defer your gains on opportunity zone investments for 10 years, you’ll pay no tax on the appreciation of your investment.
There are 67 opportunity zones in Miami-Dade county alone, and 427 in the State of Florida. For your investors seeking tax advantages, an opportunity zone fund may be the ideal offering.
In addition to fulfilling the promise of providing investment dollars to distressed communities, creating tax-advantaged opportunity zone funds may be beneficial for your clients and your firm.
For 2018, the Tax Cuts and Jobs Act increases the urgency of consulting your tax advisor before year-end, as some of these strategies require action before the end of the tax year. Contact your Kaufman Rossin tax professional for planning advice and assistance.