By: Deborah G. Kosnett, CPA
It is well-known that the Tax Cuts and Jobs Act (TCJA) reduced the Federal income tax rate for corporations, from a top rate of 35% to a flat rate of 21%. The rate change is officially effective for tax years beginning after December 31, 2017. What isn’t as well-known, though, is the fact that for fiscal-year corporations, the rate change is effective now – i.e., for those corporations whose current fiscal year began in 2017 – despite TCJA language stating otherwise. This odd state of affairs is courtesy of Internal Revenue Code section 15, an obscure code section mandating that actual statutory changes in tax rates (as opposed to changes for inflation, etc.) are to be prorated between years for fiscal year entities.
Internal Revenue Code, § 15. Effect Of Changes
(a) General Rule — If any rate of tax imposed by this chapter changes, and if the taxable year includes the effective date of the change (unless that date is the first day of the taxable year), then—
(1) — tentative taxes shall be computed by applying the rate for the period before the effective date of the change, and the rate for the period on and after such date, to the taxable income for the entire taxable year; and
(2) — the tax for such taxable year shall be the sum of that proportion of each tentative tax which the number of days in each period bears to the number of days in the entire taxable year.
The reason section 15 is so obscure is twofold: first, there is no direct reference to it anywhere else in the Internal Revenue Code; second, section 15 has not been triggered for more than two decades, so there are tax advisers currently in practice who have never had to work with section 15, nor had even heard of it until now. Nevertheless, it is clear that section 15 does indeed apply to the change in corporate rate. This will result in both favorable and unfavorable changes for fiscal year organizations for that portion of their tax year that falls in 2018, depending on whether they previously were paying Federal tax at the higher graduated corporate rates, or at the lower 15% rate.
So, what does all of this mean for exempt organizations with unrelated business income and/or taxable subsidiaries?
- For a calendar year organization, no proration will be needed. The calendar 2018 tax year begins on the effective date of the rate change, so the 21% corporate tax rate will apply for the entire year.
- For fiscal year organizations with fiscal years beginning prior to 1/1/18, the corporate rates for both years will apply, prorated for the number of days pre-rate change and post-rate change.
- Section 15 applies only to the corporate tax rate itself. Other changes resulting from the TCJA will not apply to fiscal year organizations whose fiscal year began before 1/1/18; changes in deductions and credits, if applicable, will apply beginning with the organization’s fiscal year beginning after 12/31/17.
- Fiscal year organizations making estimated payments generally should take into account the change in rates for quarterly due dates that fall in 2018. Note that at present, it appears that small organizations with prior year tax liabilities may continue to rely on the 100%-of-prior-year safe harbor (as section 6655(d)(1)(B)(ii), governing underpayment of estimated taxes, was not changed by the TCJA) in estimating their overall annual Federal tax liability for tax form years 2017 and 2018 (transitional years). Forms 1120-W and 990-W for 2018 have of course not yet been issued, and there presently are no revisions to these forms for 2017.
Deborah G. Kosnett, CPA is a tax principal with Tate & Tryon, CPAs, and may be reached at [email protected].