Like it or not, tax reform is here, and its impact is far-reaching. Technology companies in particular should pay close attention as they could be affected more than others. The following is a summary of key provisions in the new law and their implications for tech companies. Additional information on tax law changes – such as R&E expenditures, bonus depreciation, and entertainment expense deductions – can be found in Katz, Sapper & Miller’s tax reform guide for technology companies.

Pass-Through Taxation

New law

Under previous tax law, income from pass-through entities (i.e., sole proprietorships, partnerships, limited liability companies, and S corporations) were taxed as ordinary income to individual owners. Under the new tax law, owners may be permitted to deduct up to 20 percent of their “qualified business income” from pass-through entities on their individual income tax return from the total amount of income that is “passed through” to them.

Under this provision, “qualified business income” is defined as “domestic income from a pass-through entity” but does not include investment income (e.g., dividends, capital gains, and investment interest), reasonable compensation, or guaranteed payments.

In general, the pass-through deduction would be further limited to the greater of:

  • 50 percent of the individual’s share of W-2 wages paid by the pass-through entity for its workforce, or
  • The sum of 25 percent of the individual’s share of W-2 wages paid by the pass-through entity plus 2.5 percent of the unadjusted basis of all qualified property.

As a general rule, income resulting from a “specified service trade or business” does not qualify for the deduction for pass-through income. Examples of specified service trade or businesses include businesses engaged in the performance of services in the fields of health, consulting, law, accounting, and financial services.

However, an individual taxpayer would be exempt from this provision, as well as the W-2 limitation, if their taxable income does not exceed $315,000 for married-filing-jointly filers or $157,500 for single filers.

Business loss limitation

The new tax law disallows excess business losses in a taxable year. However, the excess business losses can be carried forward under the net operating loss provisions discussed below. To determine the “excess business loss” under the new law, a taxpayer would determine the excess of aggregate trade or business deductions over the taxpayer’s aggregate gross income or gain plus the taxpayer’s threshold amount. The taxpayer’s “threshold amount” will be $500,000 for married-filing-jointly filers or $250,000 for single filers (these amounts are indexed for inflation). 

Implication for tech companies

Investors of profitable technology companies could see some benefits in the “pass-through income deduction” dependent upon workforce W-2 wages. On the other hand, investors in technology companies still in development or early stages that generate losses will be affected by limitations to currently deductible of losses under the “business loss limitations.”

We do not yet know how the “specified service business” rule will be applied to technology companies with multiple revenue streams, which contain a service/consulting component. More to come on this specific implication as we receive further clarification.

Corporate Taxation

New law 

Corporate tax rate

Under prior law, C corporations were taxed based on a graduated system with a top rate of 35 percent. The new tax law eliminates the graduated system and replaces it with a flat 21 percent income tax for C corporations. Additionally, the new tax law will not have a special tax rate for personal service corporations.

Corporate alternative minimum tax 

The new tax law repeals the corporate alternative minimum tax. However, corporations with prior year minimum tax credits will continue to be able to carry forward the credit and offset it against the corporation’s regular tax liability.

Implication for tech companies 

The reduction in the corporate income tax rate will generally result in increased cash flow for profitable corporations (less income tax expense). Companies may consider using the excess cash flow to pay down debt (provided the interest deduction is limited; see below).

Exit Implications: The mechanics of an asset sale versus a stock sale are unchanged from prior law. However, more deals may be structured as asset sales as the effect of the “double tax” is less than under prior law.

If an asset sale is in the future, companies should be aware that C corporations will face “double taxation.” The gain on the sale of assets will be assessed corporate level taxes, then the remaining proceeds distributed to the C corporation owners will also be assessed tax on the gain. Even with the new 21 percent C corporation tax, the remaining 79 percent of funds will be taxed to owners when the funds are liquidated at a potential 20 percent individual tax rate for long-term capital gains. This equates to a 37 percent overall tax rate. If a stock sale is possible, the owners will owe a 20 percent long-term capital gain tax on the gain on the sale.

Potential purchasers of tech companies will have an impact on how the sale is structured as well; thus, the correct decision on structure will depend greatly on the vision and timing of liquidation as well as the negotiations between the two parties.

Corporations who issue GAAP financial statements need to assess accruals for income taxes under ASC 740 as a result of the tax reform provisions. For calendar-year taxpayers, the impact of the law changes will need to be reflected in the Dec. 31, 2017, GAAP financial statements. Deferred tax assets and liabilities are valued at the anticipated tax rate in which the temporary differences are expected to reverse. With the corporate tax rate reduction to 21 percent, companies will need to remeasure their deferred tax assets and liabilities using the new, lower rate. The impact of the rate change will be reflected in the company’s income statement in continuing operations.

Choice of Business Entity

New law

The change in the tax rates for C corporations has raised the question about whether C corporations should now be the entity of choice over pass-through entities.

Implication for tech companies

Technology companies are generally either structured as an LLC or C corporation. Most technology companies begin with capital funding from founders, family, friends, and angel investors. An LLC structure provides investors the additional benefit of passing start-up losses through to the owners as ordinary losses, which may be deductible. When the companies begin accessing capital from more institutional investors or venture capital firms, many entities convert to C corporations. The new legislation could have an impact on entity choice for technology companies. A driver of this decision is likely the anticipated exit strategy of the company (see the implications discussed previously) and whether or not the company will be profitable and intends to distribute cash flow to owners.

Sale of Patents and Self-Created Property 

New law

Under the new tax law, gain from the sale of a self-created patent, invention, model or design, or secret formula will result in ordinary income for the taxpayer who created the property or the taxpayer with a substituted or transferred basis from the creator.

Implication for tech companies

For technology companies, significant value is attributable to intangible assets, such as goodwill, customer lists, know-how, patents, process, etc. Because the C corporation tax regime does not differentiate between ordinary and capital gain income, the sale of these particular assets will not be treated differently under a C corporation structure. LLCs, in contrast, were entitled to preferential capital gain rates in most circumstances. However, under the new law this preferential treatment is eliminated. In pass-through disposition transactions it will be critical to allocate income away from self-created intangibles to the extent possible because self-created intangibles will now be subject to ordinary income rates instead of capital gain rates.

Interest Expense Deduction

New law

Deductions for business interest expenses will be limited to the sum of:

  • Business interest income,
  • 30 percent of the business’s adjusted taxable income, and
  • Interest from floor plan financing

Businesses with average annual gross receipts of $25 million or less will be exempt from this limitation and would be able to deduct interest expense in full. For this provision, adjusted taxable income is determined without regard to depreciation, amortization, or depletion deductions – effectively, EBITDA (earnings before interest, taxes, depreciation, and amortization). The interest limitation is further restricted after 2021 to 30% of EBIT. There is no grandfathering provision for existing debt; therefore, current structures will be affected immediately.

Implication for tech companies

Because technology companies may utilize significant debt in its capital structure, the impact of this provision may be particularly meaningful. Limits on the deductibility of interest will make debt more expensive (on an after-tax basis), and will influence the mix of debt and equity employed in leveraged transactions.

You can read more about the tax reform’s implications from Katz, Sapper & Miller’s tax reform guide for technology companies.


About the Authors
Erin Eberly, CPA, is a partner in Katz, Sapper & Miller’s Business Advisory Group and is co-chair of the Life Sciences and Technology Industry Services Groups. Erin helps clients maximize tax savings opportunities, with a specialization in planning and structuring for partnerships and LLCs.


Tim DuVall, CPA, is a partner in Katz, Sapper & Miller’s Business Advisory Group and is co-chair of the Life Sciences and Technology Industry Services Groups. Tim assists clients in a variety of industries with business, tax, and accounting strategies that help grow their bottom line.