The Tax Cuts and Jobs Act, H.R. 1 (TJCA) was passed in December bringing with it the most substantial changes to the Federal tax code in decades. Click here for prior articles about these changes. Missouri has made several state tax code revisions as well.
The TJCA has made modifications to the rules for depreciation of fixed assets. Since the state of Missouri conforms to the Federal rules for depreciation and section 179 expensing, these additional deductions on the Federal return will result in lower taxable income on your Missouri return as well.
Bonus depreciation of 100% is available to certain property put in service after September 27, 2017. Additionally, the Section 179 deduction has increased to $1 million in 2018 and the phaseout threshold begins when costs exceed $2.5 million. Beginning in the year 2023 the bonus percentage will decrease and will ultimately be eliminated by 2026.
Missouri business taxable income is prepared using your Federal taxable income. This means when a limitation on certain business deductions is applied at the Federal level, this restriction is then also passed on to your state tax return. These new Federal adjustments on the following business expenses may potentially increase your state income as well.
Business Interest Limitation
Corporations and pass-through entities with average gross receipts of more than $25 million for the prior three years are subject to a limitation on business interest. In general, this limitation would reduce the amount of deductible interest to any business interest income plus 30% of your adjusted taxable income.
Net Operating Losses
Per the TJCA, starting in 2018 any net operating loss can only be carried-forward. While we can no longer carry losses back (except for farming which still has a two-year carryback), the carryforward period has been extended from 20 years to indefinitely. Finally, NOLs can now only offset 80% of a taxpayer or entity’s taxable income instead of reducing it to zero.
Federal Corporate Tax Rate
Starting in 2018, the Federal corporate tax rate is permanently reduced from 35% to 21% and Federal individual rates are reduced as well with the top bracket going from 39.6% to 37%. Missouri allows corporations to deduct one-half of their Federal income tax from their state taxable income. Missouri individuals are also allowed a deduction for Federal taxes, subject to limitations and a phase out as income increases. The amount of this state tax deduction may be reduced under the new Federal tax rates.
Entertainment expenses are no longer deductible on the Federal return and expenses for meals are more limited than in the past. These changes will also impact Missouri.
20% Business Deduction for Flow-through Entities vs. Domestic Production Activities Deduction
This Federal deduction will grant the individual owners of pass-through businesses (LLCs, partnerships and S-Corporations) up to a 20% deduction of their qualified business income on their individual Federal tax returns (subject to limitations based on income and industry).
The state of Missouri bases individual taxable income on your Federal adjusted gross income which is calculated before utilizing the 20% business deduction. While this is one of the biggest pieces of the TJCA, this deduction will only take place on your individual Federal income tax return. Missouri has a similar deduction for business income which will phase in starting at 5% per year and maxing out at 20%. However, the deduction will not go into effect unless the net general revenue of the State meets targets established by law.
This qualified business income deduction replaces and expands the Federal Domestic Production Activities Deduction (DPAD) which was available to industries “producing” products in the United States. The DPAD was applicable to Corporations and pass-through businesses and also reduced Missouri taxable income. A taxpayer who received the DPAD in the past will experience an increase in Missouri taxable income due to the repeal of DPAD.
The recently signed S.B. 884 will reduce the state corporate income tax rate from 6.25% to 4.0% beginning in the year 2020. Another recent bill, H.B. 2540, reduced individual rates starting in 2019. The 2019 top rate is reduced to 5.4% with potential future deductions dependent on the State meeting revenue targets.
Mandatory Single-Receipts Factor Apportionment
The most dynamic change from S.B. 884 for Missouri corporations will be the requirement to use a single-sales factor method of apportioning income to Missouri. Apportionment requires a company to use “factors” to determine what percentage of their income belongs to each state in which they do business. Currently, Missouri corporations are permitted to use a variety of approaches including the traditional equally-weighted three-factor (property, payroll and sales) or a modified single sales factor apportionment. Starting in 2020, property and payroll will be ignored in Missouri and instead business income will be apportioned to Missouri based solely on the fraction of sales in Missouri over total sales. In general, sales of tangible personal property will be considered Missouri sales if the final destination point is in the state. Services and intangibles will be sourced to Missouri if the market for the sale is in the state.
Since the ability to choose your apportionment method will be removed, this change will likely increase the taxable income of multi-state corporations doing business in Missouri if they didn’t already choose to use the single sales factor.
We encourage you to contact your WK advisor for a thorough review of the Federal and state impacts to your business.