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On December 20, Congress completed passage of the largest federal tax reform law in more than 30 years. Commonly called the “Tax Cuts and Jobs Act” (TCJA), the new law means substantial changes for individual taxpayers.
The following is a brief overview of some of the most significant provisions. Except where noted, these changes are effective for tax years beginning after December 31, 2017, and before January 1, 2026.
- Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37%. While most taxpayers will pay less, some taxpayers will pay slightly more under the new law. Every situation is unique but taxpayers most likely to be impacted with slightly higher taxes are upper-middle class individuals with a marginal tax rate of 35%, up from 33%.
- Near doubling of the standard deduction to $24,000 (married couples filing jointly), $18,000 (heads of households), and $12,000 (singles and married couples filing separately)
- Elimination of personal exemptions
- Doubling of the child tax credit to $2,000 and other modifications intended to help more taxpayers benefit from the credit, such as the ability to claim a new $500 nonrefundable credit for dependents who do not qualify for the child tax credit (for children who are too old for the child tax credit, as well as other non-child dependents).
- Elimination of the individual mandate under the Affordable Care Act requiring taxpayers not covered by a qualifying health plan to pay a penalty — effective for months beginning after December 31, 2018, and permanent
- Reduction of the adjusted gross income (AGI) threshold for the medical expense deduction to 7.5% for regular and AMT purposes — for 2017 and 2018. In 2019, the threshold will increase to 10%.
- New $10,000 limit on the deduction for state and local taxes (on a combined basis for property and income taxes; $5,000 for separate filers)
- Reduction of the mortgage debt limit for the home mortgage interest deduction to $750,000 ($375,000 for separate filers) for new mortgages taken out after December 14, 2017. Taxpayers with a mortgage taken out before December 15, 2017 can continue to claim home mortgage interest on up to $1 million ($500,000 if MFS) going forward. The $1 million limit continues to apply to a refinanced mortgage incurred before December 15, 2017.
- Elimination of the deduction for interest on home equity debt
- Elimination of the personal casualty and theft loss deduction (with an exception for federally declared disasters)
- Elimination of miscellaneous itemized deductions subject to the 2% floor (such as certain investment expenses, professional fees and unreimbursed employee business expenses)
- The deduction for charitable contributions is expanded so that taxpayers may contribute up to 60% of adjusted gross income, rather than 50%.
- Elimination of the AGI-based reduction of certain itemized deductions
- Most of the changes to itemized deductions remain in place until 2025 and then itemized deductions will generally follow the rules in place before the TCJA.
- Elimination of the moving expense deduction (with an exception for members of the military in certain circumstances)
- Alimony payments made under court orders executed after December 31, 2018 will no longer be deductible. Alimony income under similar orders will not be includable in income. Payments made under existing orders are grandfathered and should be reported using the pre-TCJA rules.
- Self-employed taxpayers may be able to deduct up to 20% of qualified business income from a sole proprietorship, partnership or S corporation. Limitations apply to the deductions.
- Expansion of tax-free Section 529 plan distributions to include those used to pay qualifying elementary and secondary school expenses, up to $10,000 per student per tax year — permanent
- AMT exemption increase, to $109,400 for joint filers, $70,300 for singles and heads of households, and $54,700 for separate filers
- Doubling of the gift and estate tax exemptions, to $10 million (expected to be $11.2 million for 2018 with inflation indexing)
Be aware that additional rules and limits apply. Also, there are many more changes in the TCJA that will impact individuals. If you have questions or would like to discuss how you might be affected, please contact us.
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The recently passed tax reform bill, commonly referred to as the “Tax Cuts and Jobs Act” (TCJA), is the most expansive federal tax legislation since 1986. It includes a multitude of provisions that will have a major impact on businesses. Here’s a look at some of the most significant changes. They generally apply to tax years beginning after December 31, 2017, except where noted.
- Replacement of graduated corporate tax rates ranging from 15% to 35% with a flat corporate rate of 21%
- Repeal of the 20% corporate alternative minimum tax (AMT)
- New 20% qualified business income deduction for owners of flow-through entities (such as partnerships, limited liability companies and S corporations) and sole proprietorships — through 2025. Limitations apply at the individual level based on taxable income and type of qualified business income.
- Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets — effective for assets acquired and placed in service after September 27, 2017, and before January 1, 2023
- Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phase-out threshold to $2.5 million
- Other enhancements to depreciation-related deductions
- New disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
- New limits on net operating loss (NOL) deductions. They can no longer be carried back to the prior two years. NOLs carried forward may be deducted against up to 80% of taxable income.
- Elimination of the Section 199 deduction, also commonly referred to as the domestic production activities deduction or manufacturers’ deduction — effective for tax years beginning after December 31, 2017, for noncorporate taxpayers and for tax years beginning after December 31, 2018, for C corporation taxpayers
- New rule limiting like-kind exchanges to real property that is not held primarily for sale
- New tax credit for employer-paid family and medical leave — through 2019
- New limitations on excessive employee compensation
- New limitations on deductions for employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation. The TCJA eliminates the deduction for business entertainment expenses, except for meals. Starting in 2026 the deduction for meals provided to employees for the convenience of the employer is eliminated. The deduction for payment of employee parking, mass transit or commuting expenses is eliminated.
Keep in mind that additional rules and limits apply to what we’ve covered here, and there are other TCJA provisions that may affect your business. Contact us for more details and to discuss what your business needs to do in light of these changes.
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On December 22, the largest change to U.S. tax policy in decades was signed into law. With most of the provisions set to go into effect in the new year, it’s important that the manufacturing industry review the changes to understand the impact to their companies. To help, we’ve summarized top considerations and implications below.
Click here to see the changes!
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On Friday, December 15, a joint conference committee comprised of House and Senate members released an agreed-upon version of the Tax Cuts and Jobs Act (the “Act”). The Act provides the most comprehensive update to the tax code since 1986 and includes a number of provisions of particular interest to our private clients.
The Act now goes before the full House and Senate for a vote the week of December 18, 2017, but is widely expected to pass as a result of some last-minute negotiations to secure a projected unanimous GOP vote in the Senate.
As was previously proposed in the earlier Senate bill, individual tax reform is temporary. Unless noted, the provisions discussed below would go into effect on January 1, 2018, and expire on December 31, 2025.
Ordinary Income Tax Rates
The conference agreement replaces the existing tax rate structure, choosing the seven-rate structure previously proposed by the Senate. However, the agreement changed the Senate’s breakpoints for the higher marginal rates and lowered the top marginal tax rate to 37 percent. Further, the agreement does not adopt the House’s proposal to phase out the 12-percent bracket for high income taxpayers.
|Tax Rate||Married Filing Jointly and Surviving Spouses||Single||Head of Household||Married Filing Separately||Estates & Trusts|
|10%||$0 – $19,050||$0 – $9,525||$0 – $13,600||$0 – $9,525||$0 – $2,550|
|12%||$19,050 – $77,400||$9,525 – $38,700||$13,600 – $51,800||$9,525 – $38,700||N/A|
|22%||$77,400 – $165,000||$38,700 – $82,500||$51,800 – $82,500||$38,700 – $82,500||N/A|
|24%||$165,000 – $315,000||$82,500 – $157,500||$82,500 – $157,500||$82,500 – $157,500||$2,550 – $9,150|
|32%||$315,000 – $400,000||$157,500 – $200,000||$157,500 – $200,000||$157,500 – $200,000||N/A|
|35%||$400,000 – $600,000||$200,000 – $500,000||$200,000 – $500,000||$200,000 – $300,000||$9,150 – $12,500|
|37%||Over $600,000||Over $500,000||Over $500,000||Over $300,000||Over $12,500|
Long-term Capital Gains and Qualified Dividends
Long-term capital gains and qualified dividends tax rates remain largely unchanged from present law and apply the following rates based on the taxpayer’s taxable income:
|Tax Rate||Married Filing Jointly and Surviving Spouses||Single||Head of Household||Married Filing Separately||Estates & Trusts|
|0%||$0 – $77,200||$0 – $38,600||$0 – $51,700||$0 – $38,600||$0 – $2,600|
|15%||$77,200 – $479,000||$38,600 – $425,800||$51,700 – $452,400||$38,600 – $239,500||$2,600 – $12,700|
|20%||Over $479,000||Over $425,800||Over $452,400||Over $239,500||Over $12,700|
The conference agreement calls for a child’s earned income to be taxed at the rates applied to single filers and a child’s net unearned income to generally be taxed at ordinary income and preferential (i.e. capital gains) rates applied to estates and trusts. Accordingly, a child’s income would no longer be taxed at the parents’ rate.
The breakpoints for the ordinary income, long-term capital gains, and qualified dividends tax brackets would be adjusted in future years for inflation. However, inflation would be measured using the Chained Consumer Price Index (C-CPI), which generally provides a slower inflationary adjustment than the current Consumer Price Index (CPI) measurement. This measurement of inflation is applied for all individual tax inflation adjustments permitted in the Act and would be permanent, not expiring in 2025 with the other individual provisions.
Standard Deduction and Personal Exemptions
The conference agreement increases the standard deduction beginning in 2018 to $24,000 for joint filers, $18,000 head-of-household filers, and $12,000 for all other individual filers. The deduction would be indexed for inflation in future years. The additional standard deduction for the elderly and the blind was retained; the House had previously proposed to repeal the additional deduction.
Further, the conference agreement suspends the deduction for personal exemptions through 2025. The conference agreement, however, retains the $100 and $300 exemptions for complex and simple trusts, respectively, and a $4,150 exemption for qualified disability trusts which is to be adjusted for inflation in future years. The House had previously proposed to repeal the exemption for qualified disability trusts.
Child Tax Credit
The Child Tax Credit would be increased to $2,000 per qualifying child, with up to $1,400 being fully refundable. A qualifying child is a dependent child who is under age 17. The Credit would begin to phase out for joint filers with adjusted gross income exceeding $400,000 and other filers with adjusted gross income exceeding $200,000.
An additional $500 non-refundable credit may be available for other dependents, provided however, that such additional credit is only available to non-citizen dependents if they are a resident of the United States.
Currently, the Child Tax Credit is $1,000 per qualifying child and is nonrefundable. The Child Tax Credit currently phases out for joint filers with adjusted gross income exceeding $110,000.
Adjustments to Income (“Above-the-Line” Deductions)
The conference agreement suspends through 2025, the deduction for moving expenses except in the case of a member of the U.S. military who moves pursuant to a military order. Currently, individuals may take an above-the-line deduction for certain unreimbursed moving expenses incurred by reason of relocating for work.
For any divorce or separation agreements entered into after December 31, 2018, the deduction for alimony or separate maintenance payments is repealed. Recipients of alimony or separate maintenance payments will no longer be required to include the alimony payments in their gross income. Under the new provisions, alimony or separate maintenance payments will be treated similar to child support, in that they are not accounted for in the tax system (no deduction and no inclusion). Existing alimony and separate maintenance agreements are grandfathered in as are any modifications to existing agreements unless, however, the parties to a modification expressly provide that the new rules should apply to the modified agreement.
Prenuptial agreements are not grandfathered in and taxpayers may wish to revisit those agreements in light of these new provisions.
The medical expense deduction threshold would be temporarily lowered to permit a deduction against both the regular tax and alternative minimum tax (AMT) for medical expenses in excess of 7.5-percent of adjusted gross income for all taxpayers itemizing deductions in 2017 and 2018. Currently, the 7.5-percent adjusted gross income threshold is only available for taxpayers over age 65 (younger taxpayers have a 10-percent adjusted gross income threshold) and all taxpayers have a 10-percent of adjusted gross income threshold for AMT purposes.
The sum of the itemized deductions for state and local real property taxes, state and local personal property taxes, and state and local income or sales taxes may not exceed $10,000 ($5,000 for married individuals filing separate returns). The deduction for foreign real property taxes is suspended through 2025. The $10,000 limitation does not apply to foreign income taxes paid or taxes paid or accrued in carrying on a trade or business.
Further, the agreement provides an anti-abuse provision to prevent a deduction in 2017 on the prepayment of state and local income taxes attributable to future years.
Home Mortgage Interest
The itemized deduction for mortgage interest has been reduced to only permit the deduction of interest on acquisition indebtedness not exceeding $750,000 ($375,000 for married filing separate taxpayers) on the taxpayer’s primary or second home. The interest deduction for home equity indebtedness is suspended.
Currently, taxpayers can take a combined acquisition and home equity indebtedness interest expense deduction on $1,100,000 of debt. Debt incurred on or before December 15, 2017, is grandfathered in and subject to the current limitations. Further, taxpayers who entered into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and who purchases such residence before April 1, 2018, are also eligible for the current higher limitations.
The conference agreement makes three modifications to current charitable contribution rules. First, the agreement increases the percentage limitation for cash contributions to public charities from 50-percent of adjusted gross income to 60-percent of adjusted gross income.
Second, the agreement denies a charitable deduction for payments made in exchange for college athletic event seating rights. Currently, taxpayers may deduct 80 percent of amounts paid to an eligible college despite receiving tickets to a collegiate athletic event provided a charitable deduction would have otherwise been allowed had the taxpayer not received event tickets in return.
Finally, the agreement repeals the substantiation exception for certain contributions reported by the charitable organization. Currently, taxpayers are not required to obtain a contemporaneous written acknowledgement of contributions in excess of $250 if the donee organization reports the donation on their return.
The conference agreement failed to adopt the House proposal that the charitable standard mileage rate be adjusted for inflation.
The deduction for personal casualty losses is suspended through 2025 except in the case of losses attributable to a Federally declared disaster; provided, however, that taxpayers with a personal casualty loss gain for any taxable year during the suspension period may continue to deduct personal casualty losses not attributable to a Federally declared disaster in an amount equal to no more than the personal casualty loss gain.
Further, the conference agreement contains special casualty loss relief for taxpayers who suffered losses in certain 2016 disasters. Primarily, taxpayers affected by such disasters may be able to take up to a $100,000 disaster distribution from their retirement plan. In addition, casualty losses resulting from such disasters would be deductible if they exceed $500, without application of the 10 percent of adjusted gross income threshold. Such losses may be claimed even by taxpayers who elect the standard deduction.
Miscellaneous Itemized Deductions Subject to the 2 percent Floor
All miscellaneous itemized deductions subject to the 2% adjusted gross income floor have been suspended. This includes the miscellaneous itemized deductions for investment fees and expenses, tax preparation fees, and unreimbursed employee business expenses among others.
Overall Limitation on Itemized Deductions
The overall limitation on itemized deductions enacted in 1990, often called the “Pease limitation” (named after former Congressman Donald Pease) has been repealed through 2025.
The conference agreement expands the definition of qualified higher education expenses that may be paid from a 529 account to include up to $10,000 of expenses for tuition at an elementary or secondary public, private, or religious school, and certain expenses in connection with a homeschool.
The shared responsibility payment for individuals failing to maintain minimum essential health insurance coverage has been reduced to $0 beginning after December 31, 2018.
Beginning after December 31, 2017, nonrecognition of gain from like-kind exchanges would be limited to real property not held primarily for sale. Transitional relief is provided for exchanges where property was either disposed of or received in an exchange on or before December 31, 2017.
Electing Small Business Trusts (ESBTs)
ESBTs are eligible S corporation shareholders and are currently permitted to only have as beneficiaries, individuals or entities that would otherwise be eligible to own S corporation stock directly. A nonresident alien individual is currently an impermissible S corporation shareholder and as such, an impermissible current beneficiary of an ESBT. The conference agreement permits nonresident alien individuals to be a potential current beneficiary of an ESBT.
Further, ESBTs are currently permitted to take a charitable contribution deduction in accordance with the contribution deduction rules of trusts. Unlike individuals, trusts do not have a limitation on their contribution deduction and are prohibited from carrying forward excess contributions. The conference agreement calls for ESBTs to determine their charitable deduction going forward in accordance with the rules applicable to individuals. Accordingly, ESBTs would be subject to the charitable deduction percentage limitations and carryforward provisions that individuals are.
Individual Alternative Minimum Tax (AMT)
The individual alternative minimum tax (AMT) has been retained. However, the exemption amounts have been temporarily increased to $109,400 for joint filers and $70,300 for single filers. The current exemptions are $83,800 and $53,900 for joint and single filers, respectively. The House bill had originally proposed the repeal of the individual AMT. The exemption phase-out thresholds would also be increased to $1,000,000 for joint filers and $500,000 for single filers. The phase-out threshold for estates and trusts would be unchanged. The exemptions and phase-out thresholds are indexed for inflation after 2018.
Estate and Gift Taxes
The lifetime exemption for estate and gift taxes is increased to $10,000,000 as of 2011 (and adjusted forward from there for inflation). As a result, taxpayers making gifts, and the estates of decedents dying in 2018 would have a roughly $11,000,000 basic exclusion amount. The estate, gift, and generation-skipping transfer taxes are not repealed; the House bill would have repealed estate and generation-skipping transfer taxes.
Deduction for Qualified Business Income of Pass-Thru Entities
The conference agreement permits an individual taxpayer, whether they choose to take the standard deduction or to itemize, to deduct 20-percent of their “combined qualified business income” from a partnership, S corporation, or sole proprietorship, subject to a wage limitation that is phased in for joint taxpayers with taxable income exceeding $315,000 and other taxpayers with taxable income exceeding $157,500.
“Combined qualified business income” includes the taxpayer’s qualified trade or business income, qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.
Specified service trades and businesses are generally not eligible for the deduction. However, there are exceptions to permit the deduction for engineering and architecture businesses, and small specified service trades and business. Small specified service trades and business begin to phase out of the deduction for joint taxpayers with taxable income exceeding $315,000 and other taxpayers with taxable income exceeding $157,500; joint taxpayers completely phase out of the deduction with $415,000 of taxable income, other taxpayers completely phase out at $207,500 of taxable income.
Estates and trusts are eligible for the 20-percent deduction. The previous Senate proposal would have excluded estates and trusts from eligibility.
Business Losses and Net Operating Losses
Business losses would only be permitted in the current year to the extent they don’t exceed the sum of taxpayer’s gross income and, for joint filers, $500,000 ($250,000 for all other taxpayers). Excess business losses would be disallowed and instead added to the taxpayer’s net operating loss (NOL) carryforward. Currently, suspended passive activity losses are allowed in full upon the taxable disposition of the passive activity.
The conference agreement amends the non-corporate NOL rules to limit deducible NOL carryforwards to the lesser of the carryforward amount or 90-percent (80-percent beginning in 2023) of taxable income determined without regard to the NOL deduction. Taxpayers would no longer be permitted to carryback their net operating losses to the previous two taxable years.
Senate budget reconciliation rules resulted in the expiration of most of the individual provisions, including the pass-thru deduction, after 2025 in order to ensure that the new 21-percent corporate rate could be made permanent.
The change to the C-CPI as the measure of inflation is a permanent change that will ultimately result in a tax increase once the individual provisions of the Tax Cuts and Jobs Act expire.
The pass-thru deduction attempts to make the tax rates of pass-thru entities not unusually disparate to the new lower corporate rate. As a result, businesses likely won’t rush to reorganize as corporations in the short-term. However, the anti-abuse provisions in the pass-thru deduction computation and the permanence of the lower corporate rate may prove to make corporations a more attractive form of entity long-term.
Notably, the conference agreement did not include the Senate proposal to require the basis of specified securities be determined on a first-in, first-out basis is not included in the conference report. The Senate had sought to prevent taxpayers from specifically identifying the lot sold in the sale of specified securities. Further, the compromise did not include any amendments to the current residence gain exclusion provisions. Both the House and Senate had proposed changing the use and ownership test to five of the previous eight years and the House had further proposed a phase out of the exclusion for high income taxpayers.
The increase in the estate and gift exemption ensures that fewer taxpayers will be subject to the estate tax. Moreover, the failure of the committee to agree to a repeal of the estate and GST taxes ensures that our traditional estate and gift planning techniques remain relevant for high-net-worth families.
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On Friday evening, December 15, 2017, the conference report to H.R. 1, “Tax Cuts and Jobs Act” (the “Act”) was released. The conference report was agreed to by the House and Senate conferees last week and reflects the resolved differences between the House bill and the Senate amendment. While the final compromise looks more like the Senate bill, it reflects many compromises, some additions, deletions, and other modifications that are in step with Congressional priorities. This Alert discusses the major provisions contained in the conference report. It is important to note that most provisions in the bill expire after December 31, 2025, to comply with Senate budget reconciliation rules. The exception is the reduction in corporate income tax rate; the new 21-percent rate will be permanent.
The House and Senate are expected to vote on the conference report this week. The President is expected to sign the bill before end of the year.
Key provisions of the report affecting individual taxpayers include lower tax rates in modified brackets, higher standard deductions, and limitations on certain itemized deductions such as state and local taxes. For corporations, the tax rate is reduced to a flat 21 percent and the alternative minimum tax is repealed. Certain partners and shareholders will be eligible to deduct 20 percent of their income from pass-through entities. Foreign taxation shifts to a territorial system, and the deemed repatriation tax rate is 15.5 percent for earnings held in cash or cash equivalents, and 8 percent on all other earnings. The report also includes increases in certain property expensing and depreciation limits, and changes to accounting methods, as detailed below.
The conference report includes a reduction of individual rates, which are generally effective January 1, 2018, and expire December 31, 2025. For individuals:
- The top individual rate will be 37 percent for joint filers with more than $600,000 of taxable income and single filers with more than $500,000 of taxable income. The current top rate is 39.6 percent for joint filers with taxable income over $466,951 and single filers with taxable income over $415,051.
- The standard deduction will be increased to $24,000 for joint filers and $12,000 for single filers. The personal exemption is repealed through 2025. Currently, the standard exemption is $12,600 for joint filers and $6,300 for single filers.
- The Child Tax Credit is increased to $2,000 per qualifying child, with up to $1,400 being fully refundable. An additional $500 credit may be available for other dependents. The Credit begins to phase out for joint filers with adjusted gross income exceeding $400,000 and single filers with adjusted gross income exceeding $200,000. Currently, the Child Tax Credit is $1,000 per qualifying child and is nonrefundable. The Child Tax Credit currently phases out for joint filers with adjusted gross income exceeding $110,000.
- The adjusted gross income limitation for cash contributions to certain charitable organizations is increased to 60 percent. Currently, the adjusted gross income limitation for cash contributions to public charities is 50 percent.
- The itemized deduction for medical expenses is made more available for taxpayers under age 65 by reducing the adjusted gross income floor for 2017 and 2018 to 7.5 percent for all taxpayers. Currently, the adjusted gross income floor is 10 percent for taxpayers under age 65 and 7.5 percent for taxpayers over age 65.
- The itemized deduction for state and local taxes has been limited to $10,000 for the aggregate sum of real property taxes, personal property taxes, and either (i) state or local income taxes or (ii) state and local sales tax. Currently, each of those state and local taxes is a separate itemized deduction with no limitation. Further, the bill prohibits a deduction in excess of the $10,000 limitation for 2018 state and local taxes actually paid in 2017.
- The itemized deduction for mortgage interest has been reduced to only permit the deduction of interest on acquisition indebtedness not exceeding $750,000. The additional interest deduction for home equity indebtedness is repealed through 2025. Currently, taxpayers can take a combined acquisition and home equity indebtedness interest expense deduction on $1,100,000 of debt. Debt incurred on or before December 15, 2017, is grandfathered in to the current limitations. Further, taxpayers who entered into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and who purchase such residence before April 1, 2018, are also eligible for the current higher limitations.
- All miscellaneous itemized deductions subject to the two percent adjusted gross income floor have been repealed through 2025. This includes the miscellaneous itemized deductions for investment fees and expenses, tax preparation fees, and unreimbursed employee business expenses among others.
- The overall limitation on itemized deductions enacted in 1990, often called the “Pease limitation” (named after former Congressman Donald Pease) has been repealed through 2025.
- For any divorce or separation agreements entered into after December 31, 2018, the deduction for alimony or separate maintenance payments is repealed. Similarly, the exclusion from gross income for alimony or separate maintenance payments is repealed, thus requiring recipients to include those payments in their gross income. Existing alimony and separate maintenance agreements are grandfathered in as are any modifications to existing agreements unless, however, the parties to a modification expressly provide that the new rules should apply to the modified agreement.
- The lifetime exemption for estate and gift taxes is increased to $10,000,000 as of 2011 (and adjusted forward from there for inflation). As a result, taxpayers making gifts, and the estates of decedents dying, in 2018 would have a roughly $11,000,000 basic exclusion amount. (Estate, gift, and generation-skipping transfer taxes are not repealed; the House bill would have repealed estate and generation-skipping transfer taxes.)
- The shared responsibility payment for individuals failing to maintain minimum essential health insurance coverage has been reduced to $0 beginning after December 31, 2018.
- The individual alternative minimum tax (AMT) has been retained. However, the exemption amounts have been increased to $109,400 for joint filers and $70,300 for single filers. The current exemptions are $83,800 and $53,900 for joint and single filers, respectively. (The House bill would have repealed the individual AMT.)
- The earlier Senate proposal to require the basis of specified securities be determined on a first-in, first-out basis is not included in the conference report. The Senate had sought to prevent taxpayers from specifically identifying the lot sold in the sale of specified securities.
- The corporate tax rate has been reduced by forty percent—from thirty-five to twenty-one percent. The corporate AMT has been repealed. The net interest deduction limit has been kept at 30 percent of adjusted taxable income with an indefinite carryforward period. Small businesses with less than $25 million in annual gross receipts over a three-year period are exempted from the interest limitation. While the conference agreement does repeal the section 199 domestic production deduction, the effective date of the repeal is not until December 31, 2018.
- Net operating losses (NOLs) are limited to 80 percent of taxable income and may only be carried forward, indefinitely. NOLs are likely to increase based on expanded expensing of capital investments in certain property – including property that had previously been used by, and provided benefit to, another taxpayer. The property must be placed in service between September 27, 2017, and January 1, 2023, to be fully deducted. The 100-percent allowance is phased down by 20 percent per year beginning in 2023.
- Certain capital contributions from state and local governments will no longer be excluded from income under section 118. Section 108(e)(6), however, will not be altered for computations of cancellation of debt income. And the meaningless gesture doctrine will continue to apply to section 351 exchanges of wholly-owned corporations in which no shares are issued. Like-kind exchanges under section 1031 will be limited to real property. The 70 and 80 percent dividend received deduction amounts for corporations have been reduced to 50 and 65 percent, respectively.
- Under the conference report, shareholders of S corporations may obtain a deduction equal to the lesser of 20 percent of qualified business income, which requires a complex computation, with respect to such trade or business, or 50 percent of the W-2 wages with respect to such business. Further, a nonresident alien individual may now be in indirect shareholder of an S corporation as a potential current beneficiary of an electing small business trust.
TAXATION OF PARTNERSHIPS AND PASS THROUGH ENTITIES
- For tax years beginning after December 31, 2017, partners and shareholders of S corporations and LLCs may deduct up to 20 percent of their qualified business income from the partnership or S Corporation. For taxpayers in a service business (e.g., law or accounting), no deduction is permitted unless their taxable income is less than $157,500 ($315,000 if married filing a joint return).
- Under the conference agreement, application of Section 1031 is limited to transactions involving the exchange of real property that is not held primarily for sale. The like-kind exchange rules will no longer apply to any other property, including personal property that is associated with real property. This provision will be effective for exchanges completed after December 31, 2017. However, if the taxpayer has started a forward or reverse deferred exchange prior to December 31, 2017, section 1031 may still be applied to the transaction even though completed after December 31, 2017.
- The technical termination rules under section 708(b)(1)(B) are repealed for tax years beginning after 2017. No changes are made to the actual termination rules under section 708(b)(1)(A).
- Under general rules, gain recognized by a partnership upon disposition of a capital asset held for at least one year is characterized as long-term capital gain. Further, the sale of a partnership interest held for at least one year will generate long-term capital gain, except to the extent section 751(a) applies. Under the conference agreement, long-term capital gain will only be available with respect to “applicable partnership interests” to the extent the capital asset giving rise to the gain has been held for at least three years.
The conference report contains provisions relating to the establishment of a participation exemption for the taxation of foreign income. These new rules include:
- A dividend exemption system, which generally provides for a 100 percent dividend received deduction for the foreign-sourced portion of dividends received by a domestic C corporation (other than a RIC or REIT) from specified 10-percent owned foreign corporations with respect to which the domestic corporation is a U.S. shareholder when certain conditions are satisfied;
- Sales or transfers involving specified 10-percent owned foreign corporations (including rules relating to (a) limiting losses on certain sales or exchanges of such foreign corporations in situations involving a domestic corporation eligible for the dividends received deduction; (b) treating as a dividend for purposes of applying the participation exemption any amount received by a domestic corporation which is treated as a dividend for purposes of section 1248 in the case of the sale or exchange by a domestic corporation of stock in a foreign corporation held for one year or more; (c) the interaction of section 964(e), the subpart F rules and the participation exemption in the case of certain sales by a CFC of a lower-tier CFC; (d) requiring branch loss recapture in certain cases when substantially all of the assets of a foreign branch are transferred by a domestic corporation to specified 10-percent owned foreign corporations with respect to which the domestic corporation is a U.S. shareholder subject to certain limitations; and (e) the repeal of the foreign active trade or business exception under section 367(a));
- An election to increase percentage of domestic taxable income offset by overall domestic loss treated as foreign source (modifies section 904(g)); and
- A transition tax generally requiring U.S. shareholders of “specified foreign corporations” (as specifically defined in section 965) to include as subpart F income their pro rata shares of deferred foreign income of such foreign corporations. The total deduction from the amount of the section 951 inclusion is the amount necessary to result in a 15.5-percent rate of tax on accumulated post-1986 foreign earnings held in the form of cash or cash equivalents, and eight percent rate of tax on all other earnings. The calculation is based on the highest rate of tax applicable to corporations in the taxable year of inclusion, even if the U.S. shareholder is an individual. There are numerous rules relating to the application of the transition tax (e.g., rules for allowing a reduction of the amount included in income of a U.S. shareholder when there are specified foreign corporations with deficits in earnings and profits). There is an election to pay the liability relating to the inclusion in eight installments at certain specified percentages along with a special election for S corporation shareholders to defer the payment of the liability until certain events. Additionally, the IRS has regulatory authority to carry out the intent of the provision, including the ability to prescribe rules or guidance in order to deter tax avoidance through use of entity classification elections and accounting method changes, or otherwise.
- There are provisions in the conference report that provide for a deduction for domestic C corporations (that are not RICs or REITs) for certain specified percentages of foreign-derived intangible income of the domestic corporation and global intangible low-taxed income which is included in income of such domestic corporation subject to certain limitations (this provision generally follows the Senate amendment with certain clarifications and modifications).
The conference report also modifies the foreign tax credit system in several ways, including:
- Repealing the section 902 indirect foreign tax credit and providing for the determination of the section 960 credit on a current year basis (the conference report generally follows the House bill with certain modifications);
- Sourcing income from the sales of inventory solely on the basis of production activities; and
- Providing a separate foreign tax credit limitation basket for foreign branch income.
Additionally, the conference report includes a number of significant modifications to the CFC subpart F rules including:
- The repeal of an inclusion based on the withdrawal of previously excluded subpart F income from qualified investment;
- The elimination of an inclusion of foreign base company oil-related income;
- The modification of the stock attribution rules for determining status of a foreign corporation as a CFC (this modification would make it more likely for a foreign corporation to be treated as a CFC as a result of stock of certain related foreign persons being attributed downward to a U.S. person);
- The modification of the definition of U.S. shareholder by incorporating a 10 percent value test in determining who is a U.S. shareholder (thus, making it more likely for a person to be a U.S. shareholder and a foreign corporation to be a CFC);
- The elimination of the requirement that a corporation be a CFC for 30 days before subpart F inclusions apply; and
- A provision providing that a U.S. shareholder of any CFC must include in gross income for a taxable year its “global intangible low-taxed income” in a manner generally similar to inclusions of subpart F income (complex calculation). The Conference Report generally adopts the Senate amendment with clarifications and modifications).
Moreover, the conference report includes a number of provisions designed to address base erosion, including rules relating to:
- Providing for a base erosion minimum tax, which requires certain corporations to pay additional corporate tax in situations where such corporations have certain “base erosion payments” and certain threshold conditions are satisfied (the conference report follows the Senate amendment with certain modifications);
- Limiting income shifting through intangible property transfers (including treating goodwill and going concern value and workforce in place as section 936(h)(3)(B) intangibles and, with respect to aggregate basis valuation, requiring the use of that method of valuation in the case of transfers of multiple intangible properties in one or more related transactions if the Secretary determines that an aggregate basis achieves a more reliable result than an asset-by-asset approach.);
- Disallowing a deduction for certain related party interest or royalty payments paid or accrued in certain hybrid transactions or with certain hybrid entities under certain circumstances. The conference report generally follows the Senate amendment, but provides that the Secretary shall issue regulations or other guidance as may be necessary or appropriate to carry out the purposes of the provision for branches (domestic or foreign) and domestic entities, even if such branches or entities do not meet the statutory definition of a hybrid entity; and
- Not permitting shareholders of surrogate foreign corporations to be eligible for reduced rates on dividends under section 1(h). The conference report follows the Senate amendment with a modification providing that the provision applies to dividends received from foreign corporations that first become surrogate foreign corporations after date of enactment.
The conference report also contains rules relating to:
- Restricting the insurance business exception to the PFIC rules;
- Repealing the fair market value method of interest expense apportionment; and
- Codifying Rev. Rul. 91-32 and providing withholding rules relating to a foreign person’s sale of a partnership interest where the partnership engages in a U.S. trade or business.
Some notable provisions that were included in the House bill, Senate amendment, or both, that were not included in the conference report include (but are not limited to) the following provisions relating to:
- Excepting domestic corporations that are U.S. shareholders in CFCs from the application of section 956;
- Generally permitting transfers of intangible property from controlled foreign corporations to United States shareholders in a tax efficient manner;
- Accelerating the election to allocate interest, etc., on a worldwide basis;
- An inflation adjustment of de minimis exception for foreign base company income;
- Making permanent the controlled foreign corporation look-thru rule of section 954(c)(6);
- Current year inclusion of foreign high return amounts by United States shareholders of controlled foreign corporations (but see provision relating to “global intangible low-taxed income” provision discussed above),
- Limiting deductions of interest by domestic corporations which are members of an international financial reporting group (House Bill) or worldwide affiliated group (Senate amendment),
- Imposing an excise tax on certain amounts paid by certain U.S. payors to certain related foreign recipients to the extent the amounts are deductible by the U.S. payor (but see provision above relating to the base erosion minimum tax), and
- Possessions of the United States.
COST RECOVERY PROVISIONS
- Property defined under section 168(k) and placed in service after 2007 and before 2020 is currently allowed a 50 percent deduction for the taxable year in which the property is placed in service. The conference report would allow full expensing for the property placed in service after September 27, 2017, for a five-year period. There would be a phase down of the full expensing by 20 percent per year for property placed in service after January 1, 2023 (January 1, 2024 for longer production period property). Bonus property previously had only been allowed for new property. The conference report expands bonus property to include used property.
- Annual depreciation limitations for luxury automobiles under section 280F is currently $3,160 in the first year, $5,100 in the second year, $3,050 in the third year, and $1,876 in the fourth and later years. The conference report was significantly increased under the conference report to $10,000 in the first year, $16,000 in the second year, $9,600 in the third year, and $5,740 in the fourth and later years.
- Computer or peripheral equipment is removed from the definition of listed property and no longer subject to the heightened substantiation requirements currently required.
- Depreciable property used in a farming business currently has special recovery periods, such as seven years for certain machinery and equipment, grain bins, and fences, as well as cotton ginning assets. The life was reduced to a five-year recovery period for property placed in service after 2008 and before 2010. The conference report renews the five-year recovery period. Also, the required use of 150 percent declining balance method currently required for property other than real property and trees or vines bearing fruits or nuts would be repealed for property with lives of 10 years or less.
- Under the conference report, the MACRS recovery periods maintains the present law general recovery MACRS recovery periods of 39 years for nonresidential real property and 27.5 years for residential rental property. The Senate amendment had lowered the life to a 25-year recovery period for all real property.
- Definition of qualified improvement property eliminates the separate definitions for “qualified leasehold improvement”, “qualified restaurant property”, and “qualified retail improvement property”. The 15-year recovery period remains unchanged.
- Generally, under section 179, business taxpayers may elect to deduct the cost of qualifying property with an annual limit of $500,000 through 2015, after which the amount was adjusted for inflation. The $500,000 limitation is reduced by the amount of which the cost of the property placed in service during the taxable year exceeds $2 million. The conference report increases the expensing limitation from $500,000 to $1 million. Further, the phase out under the conference report would begin when the amount of the property exceeds $2.5 million, up from the $2 million dollar amount.
- The section 179 definition of qualified real property under the conference report is expanded to include improvements to nonresidential real property including roofs, heating, ventilation, air conditioning, fire protection, alarm systems, and security systems.
TAX ACCOUNTING METHOD PROVISIONS
- Under section 448, C corporations, a partnership with a C corporation partner, or a tax shelter generally may not use the cash method of accounting. There are exceptions, one of which is for C corporations or partnerships with a C corporation partner with average annual gross receipts of not more than $5 million dollars over the prior three years. The conference report increases the three-year average gross receipts threshold from $5 million to $25 million.
- Section 447 generally requires that corporations or partnerships with a corporate partner engaged in farming must use the accrual method of accounting. The conference report permits farms that meet the $25 million average three-year gross receipts threshold to use the cash method, even if it is a corporation or partnership with a corporate partner.
- Taxpayers subject to the UNICAP provisions under section 263A are required to capitalize all direct costs and an allocable portion of most indirect costs that are associated with production or resale activities. Under the conference report, businesses which meet the $25 million average annual gross receipts test would be exempt from the UNICAP requirements.
- Under section 471, inventory accounting is normally required to clearly reflect income. Under the conference report, businesses that meet the $25 million average annual gross receipts test would be exempt from inventory reporting. Taxpayers would be permitted to use a method of accounting that either treats inventories as non-incidental materials and supplies or conforms to the taxpayer’s financial accounting.
- Section 460 generally requires percentage-of-completion accounting for long-term contracts. One exception is for construction contracts that are expected to be completed within a two year period and have annual average gross receipts over the preceding three years of $10 million or less. Under the conference report, the exception would increase the $10 million annual average gross receipts over the prior three years to $25 million.
- Under a special rule for income inclusion, an accrual basis taxpayer is now required to recognize an item into income no later than the year in which the item is taken into account on the applicable financial statement. Thus, an accrual method taxpayer with an applicable financial statement would include an item in income under section 451 upon the earlier of when the all events test is met or when the taxpayer includes such item in revenue in an applicable financial statement. An exception would apply for any item of income for which a special method of accounting is used. If a contract has multiple performance obligations, taxpayers may allocate the transaction price in accordance with the allocation made in the taxpayer’s applicable financial statement. Also, the conference report codifies the current deferral method of accounting for advance payments for goods, services, and other specified items under Rev. Proc. 2004-34.
- Under section 199, a deduction of nine percent of the lesser of qualified production activities income or taxable income is generally permitted. The deduction for section 199 – domestic production activities deduction – has been repealed.
- Taxpayers may elect to currently deduct the amount of certain reasonable research or experimental expenditures paid or incurred in connection with a trade or business under section 174, or elect to capitalize and amortize such expenditures over not less than 60 months Alternatively, a taxpayer may elect to amortize research or experimental expenditures over ten years. Under the conference report, specified research or experimental expenditures, including software development, would be required to be capitalized and amortized over a five-year period (15 years if expenditures are attributable to research conducted outside of the United States) and no longer currently deductible. Land acquisition and improvement costs, and mine (including oil and gas) exploration costs would be exempt from this rule. Upon retirement, abandonment or disposition of the property, any remaining basis would continue to be amortized over the remaining amortization period. The provision would apply for expenditures paid or incurred in tax years beginning after December 31, 2022.
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By David Yasukochi
On Dec. 2, the Senate passed its version of proposed tax reform legislation, the “Tax Cuts and Jobs Act,” on a vote of 51-49. The House had previously passed its own tax bill on Nov. 16, 2017. Currently, both bills reside with a conference committee for reconciliation. This sets the stage for a possible enactment of a final bill before the New Year.
With each bill proposing slightly different provisions, it’s important that tech companies familiarize themselves with the proposals to understand how they may be impacted in the future. Should legislation pass, most provisions of both bills will be effective starting in 2018.
What’s at Stake for U.S. Tech?
The key highlights of the House and Senate tax bills, as well as their potential impact on tech companies, are summarized below.
|Provision||Implication for Tech Companies|
|Reduce the Corporate Tax Rate (House & Senate): |
Both the House and Senate bills propose to reduce the corporate tax rate from 35 to 20 percent. The Senate bill, however, would delay this implementation until 2019.
|A reduction in the corporate tax rate would be a boon to tech companies overall, as they have often protested that the current U.S. corporate tax rate is among the highest of all the developed nations.
While all tech companies are looking forward to the change, smaller tech companies that operate domestically are especially excited: This is because many still face high effective tax rates when compared to their global tech peers, like Google or Apple, who are often able to enjoy lower effective rates due to sophisticated tax planning, including base shifting and other measures. Because smaller companies often have more limited bandwidth, resources, and footprint, they may be unable to implement as effective a global tax structure as their global tech counterparts. Thus, the corporate tax reduction would be a huge win.
|Eliminate Ability to Carryback Net Operating Losses |
(House & Senate):
Both the House and Senate proposals will generally eliminate taxpayers’ abilities to carryback net operating losses (NOL), and will limit the use of NOLs to 90 percent of taxable income (it is down to 80 percent after 2022 in the Senate bill). NOLs will no longer have an expiration period.
|In situations where tech company earnings are volatile, the restrictions on the carryback and use of NOLs could present a significant cash flow obstacle.|
|Repeal the Domestic Activities Deduction (DPAD) |
(House & Senate):
The House and Senate bills both propose to repeal the Domestic Activities Deduction (DPAD), which was originally enacted to encourage manufacturing within the U.S. For C corporations, repeal is effective one year later (years beginning after 2018) in the Senate version.
|While the impact of this repeal is somewhat muted, since a good portion of hardware manufacturing activities are done offshore, many software developers were able to take advantage of the DPAD.|
|Create a Territorial Tax System (House & Senate): |
Both bills propose the creation of a territorial tax system, which would tax U.S. companies only on their domestic income vs. their worldwide income.
|The creation of a territorial tax system is a provision that has long been on the tax wish list for U.S. tech companies, who have long complained that the current tax framework has made them uncompetitive with their global peers. Most businesses would agree that a territorial tax system could lead to significant tax savings. Nevertheless, accompanying international tax provisions (including those covered below) may mute some of the enthusiasm.|
|Tax Existing Overseas Profits: |
House: The House bill imposes a one-time tax rate of 14 percent on companies’ existing foreign profits held in cash offshore and 7 percent on their offshore noncash assets. Companies would have up to eight years to pay what they owe.
Senate: The Senate bill’s proposed one-time tax rates on companies’ existing foreign profits are slightly higher: 14.49 percent on cash assets and 7.49 percent on non-cash assets held offshore.
|This measure is designed to raise tax revenue from income that has not previously been subject to U.S. tax. Under current law, companies pay U.S. tax only when they bring the money home. But it’s also meant to entice companies to invest some of their foreign profits stateside.
While tech companies are widely viewed as key beneficiaries of the shift to the territorial tax system because of the large amount of earnings maintained overseas by some of the more prominent members, the toll charge may also disproportionately impact them as well.
Both the House and Senate bills feature an assessment of tax on a “deemed” distribution of existing profits, whether or not the amounts are actually distributed. The toll charge is significantly higher than that assessed under Section 965 (which featured an effective tax rate of 5.25 percent), a one-year tax holiday created by the American Jobs Creation Act of 2004. The toll charge is payable over eight years under both bills, with some differences in annual amounts due.
|Taxation of Low-Taxed Income and Intangibles:|
House: The House bill requires shareholders to include in their income 50 percent of the “Foreign High Return Amount” (FHRA) of their foreign subsidiaries. The FHRA is income earned by controlled foreign corporations (CFC) in excess of a specified routine return on tangible assets. A foreign tax credit equal to 80 percent of the amount attributable to this excess is permitted.
Senate: The Senate bill requires inclusion by shareholders of Global Intangible Low-Taxed Income (GILTI), which is similar in concept to the FHRA above. However, there are differences in the way in which the excess is computed, and rather than being imposed on 50 percent of the excess, the bill introduces a deduction equal to 50 percent that decreases down to 37.5 percent after 2025. The bill also permits a deduction for foreign-derived intangible income (below).
|Tech companies with foreign subsidiaries in low-tax jurisdictions appear to be prime targets for this legislation. While the territorial income provision is the carrot, these provisions are the stick to get U.S. companies to domesticate their high value activities, or at least to permit the U.S. to monetize some of those activities located in low-tax jurisdictions.|
|Offer a Deduction for Foreign-Derived Intangible Income (Senate): |
The Senate bill permits an additional deduction against profits of a U.S. shareholder derived from foreign-derived intangible income, as an offset to GILTI. The deduction is initially 37.5 percent of the foreign derived intangible income, which is the U.S. shareholder’s excess return associated with export sales of property or services.
|This provision effectively taxes such income at a 12.5 percent tax rate. Some commentators have described this as being similar to a “patent box,” which is featured in the tax framework of some European countries to encourage the formation of intellectual property within those respective countries, and provides a preferential tax rate on certain income.|
|Change Taxation of Foreign-Related Party Transactions:|
House: The House bill imposes a 20 percent excise tax on payments to related foreign parties that are part of the same international financial reporting group. It also applies to partnerships and branches. Specified amounts include amounts allowable by the payor as a deduction, or includible in the cost of goods sold (COGS) or inventory, or in the basis of a depreciable or amortizable asset. The related party can opt out by electing to treat the income as Effectively Connected Income (ECI).
Senate: The Senate bill requires payment of 10 percent of a company’s modified taxable income over its regular tax liability. The tax rate increases to 12.5 percent for taxable years after 2025. This is applicable to a C corporation with gross receipts of $500 million or more, and a “base erosion percentage” of 4 percent or more for that taxable year. Base erosion payments are those that are amounts paid or accrued to a foreign related party, but importantly, does not include amounts includible in COGS. The base erosion percentage represents the base erosion payments as a percentage of total deductions.
|The House provision could have a significant impact on technology companies that depend on overseas related parties as a key part of their supply chain, and could force companies to evaluate ways to restructure their operations and flows to mitigate the proposed taxes. The election to treat income as ECI could be a widely considered option.|
|Limitations on Interest Deductibility:|
House: Revises Section 163(j) and expands its applicability to every business, including partnerships. Generally limits deduction of interest expense to interest income plus 30 percent of adjusted taxable income (an EBITDA-like measure). Disallowed interest may be carried over for five years. Contains a small business exception.
Senate: Similar to the House provision with the notable differences that adjusted taxable income is essentially an EBIT measurement, and disallowed interest is carried forward indefinitely.
|Interest expense ceiling could be problematic to many tech companies, especially with the relatively short five year carryforward period in the House version. The impact of the two proposals will also be dramatically different for some tech companies due to the differences in the definition of adjusted taxable income.|
|Limitation on Interest Deductions of International Financial Reporting Groups:|
House: Would impose a ceiling on U.S. corporations which are members of large (>$100 million average annual gross receipts over a three year period) international financial reporting groups. The proposal would limit U.S. members from deducting more than a proportionate share of worldwide interest expense, based on worldwide EBITDA, multiplied by 110 percent. Interest expense limitation is the lower of this or that computed under 163(j) (above).
Senate: Similar to the House proposal. Applied to members of worldwide affiliated groups, but proportionate share is based on a debt-to-equity differential percentage of the worldwide affiliated group, and multiplied by 130 percent (reduced down to 110 percent in years 2022 and forward).
|See comment above. These provisions could also impact tech companies in dramatically different ways because of the use of EBITDA in the House version, and a debt-to-equity ratio concept used in the Senate bill.|
|Require Amortization of Research & Experimental Expenditures (House & Senate): |
Both bills will require research and experimental (R&E) expenditures to be capitalized and amortized over a five-year period. The inclusion of software development costs in this category is codified. This is effective for tax years beginning after 2022 under the House bill and after 2025 under the Senate bill.
|While much fanfare was given to the fact that the R&E credit would be preserved under both versions of the tax legislation, little was said about this provision, perhaps due to the delayed effective date.|
|Change Taxation for Employee Fringe Benefits:|
House: Among items no longer excludable from employee wages include: moving expense reimbursements, employer-provided dependent care assistance, and employer-provided educational assistance. The House bill also limits exclusion for employer-provided lodging to $50,000.
Items no longer deductible, unless includible in W-2, include: certain moving expense deductions, employer-paid parking, mass transit, van pooling and other qualified transportation benefits, entertainment expenses, amounts in excess of imputed income for cafeterias, and dependent care facilities.
Senate: The Senate bill includes similar non-deductibility provisions as the House proposal. In addition, it disallows deduction for meals provided for the convenience of the employer on the employer’s business premises (effective after 2025).
|Tech companies have been at the forefront of offering employees “friendly” working environments and amenities. Elimination of non-taxable fringe benefits and the denial of the deduction for such items will make companies face the decision of ceasing to offer those benefits or to absorb the imputed tax cost of continuing.|
|Add $1 Million Deduction Limitation on Executive Compensation (House & Senate): |
Both the House and Senate bills add the CFO to the definition of “covered employees.” The proposals eliminate the exception for commissions and performance-based compensation, including stock options. These amounts are currently not subject to the limitation.
|For many public tech companies, the exclusion applicable to performance-based compensation provides significant tax relief from the impact of Section 162(m).|
|Qualified Equity Grants (House): |
The House bill permits an election to be made by a recipient of qualified stock that is not publicly tradeable to be deferred until the earlier of:
• The stock is transferable;
• The employee becomes an excluded employee;
• The first date the stock becomes readily tradable on an established securities market;
• Five years after the employee’s right to the stock is substantially vested; or
• The date on which the employee revokes his or her election.
“Qualified stock” is stock received by virtue of the exercise of an option or settlement of a restricted stock unit (RSU). This does not apply to stock appreciation rights (SAR) or restricted stock.
This provision is not included in the Senate bill.
|If passed, this may come as welcome relief to private tech companies—particularly, startup companies—that otherwise restrict the transferability of their stock. Recipients of equity grants have historically had to remit cash to their employer upon exercise of, e.g., stock options to cover the withholding taxes due upon exercise, even though the underlying stock lacked liquidity.
The ability to defer taxation of a stock award until it becomes transferable helps to mitigate some of the risk on the part of the recipient.
Many changes are still expected over the next several weeks, as the House and Senate bills undergo reconciliation by the conference committee. Based on the magnitude of the changes proposed thus far, if a final bill is signed before the end of the calendar year as targeted by President Trump, the changes will require significant reassessments of tax positions for financial reporting purposes to be reported in the quarter. U.S. tech companies would be wise to keep abreast of the latest developments to avoid the risk of being unprepared.
This article originally appeared in BDO USA, LLP’s “BDO Knows Alert” (December 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com
David Yasukochi is a Tax Office managing partner and co-leader of BDO’s Technology practice. He can be reached via phone at 714-913-2597 or email at firstname.lastname@example.org.
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House and Senate Reach Tax Reform Compromise
On December 13, 2017, House and Senate Republicans reached a compromise on tax reform legislation, the “Tax Cuts and Jobs Act.” The compromise bill reportedly includes agreements on corporate and individual tax rates, the treatment of pass-through income, the estate tax, and itemized deductions such as those for mortgage interest and state and local taxes, among other areas. The text of the bill is expected to be released on Friday, with votes in the full House and Senate next week.
These are among the changes reportedly included in the compromise legislation… While bill language is not yet available, these agreed-to provisions are the first provisions reportedly out of the Conference Committee. The corporate tax rate would be set at 21% for tax years beginning in 2018, as opposed to the current rate of 35% and the previously proposed cut to 20%.
- The highest individual tax rate would be reduced from 39.6% to 37%. The Senate legislation originally called for a 38.5% top rate.
- Individuals receiving pass-through income from entities such as partnerships and S corporations would be able to deduct 20% of this income from their taxable income, a lower rate than the 23% proposed in the Senate plan. The House bill would have capped the rate at which this income was taxed at 25%. This deduction would be subject to various limitations and applicable to only certain income sources.
- The estate tax would remain in place; however the lifetime exemption is expected to increase to roughly $11 million in 2018 (and be indexed for inflation). Both the House and Senate had proposed an increased exemption amount. The House had further proposed the future repeal of the estate tax.
- The alternative minimum tax for corporations would be repealed, matching the House bill. The individual AMT would remain, but the threshold amounts would increase.
- Mortgage interest would be deductible based on indebtedness up to $750,000, which is the midpoint between the House proposal of $500,000 and the Senate’s plan to keep the existing $1 million cap.
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Senate Passes it’s Version of Tax Reform, Setting Stage for Conference Committee Action and Possible Enactment Before the New Year
In the very early hours of Saturday morning December 2, 2017, the Senate passed its version of proposed tax reform legislation, the “Tax Cuts and Jobs Act” 51-49, with Senator Bob Corker (Tenn.) as the only Republican voting against the bill. The House previously passed its own tax bill on November 16, 2017. With Saturday’s Senate action, the House will meet Monday, December 4, 2017, and vote whether to send both bills to a conference committee for reconciliation or to move forward with the Senate’s version of the bill. This sets the stage for a possible enactment of a final bill before the New Year.
The Senate bill is similar to that passed by the House; however, there are some significant differences that must be reconciled between the two houses. The Senate bill, for example, provides seven individual rate brackets with the highest at 38.5 percent, while the House bill provides for four rates with the top rate at 39.6. Both bills raise the standard deduction, with the House doubling the deduction to $24,400 and the Senate raising the deduction to $24,000 for married couples filing a joint return, and both bills eliminate personal exemptions. Regarding state and local taxes, both bills would repeal the individual state and local income tax deduction, while allowing individuals to deduct up to $10,000 of U.S. property taxes. The Senate bill increases the child credit to $2,000; the House bill increases the credit to $1,600. Mortgage interest would be deductible for debt up to $1 million in the Senate bill; the House would cap debt at $500,000 and only for indebtedness on taxpayers’ principal residence. The House bill repeals the individual alternative minimum tax (“AMT”), while the Senate bill retains the AMT but raises the exemption amount. The Senate bill also repeals the individual health insurance mandate. Estate and generation-skipping transfer (“GST”) taxes would be repealed after 2024 under the House bill. Prior to repeal, the House proposes to double the lifetime exemption amounts. The Senate would similarly double the exemption amounts, but would not repeal the estate and GST taxes. Both bills would reduce the corporate tax rate to 20 percent, with the Senate bill delaying that reduction for one year (2019). The Senate bill provides a 23-percent deduction for income from pass through entities – the House would tax such income at a 25-percent rate. The Senate version would permit certain small service businesses to take advantage of the pass through deduction; the House version does not permit service businesses from applying their proposed lower pass through rate. Further, the Senate pass through deduction would not apply to trusts and estates, the House version permits trusts and estates to take advantage of the lower pass through rate. While the House bill repeals the corporate AMT, the Senate bill retains the corporate AMT. With the new 20-percent rate on corporations, retention of the corporate AMT may reduce or eliminate many of the remaining deductions for corporations. Some of the key international tax provisions contained in the Senate bill relating to the establishment of
a participation exemption for taxation of foreign income include rules relating to (i) a dividend exemption system which generally provides for a 100 percent dividend received deduction for the foreign-sourced portion of dividends received by a domestic corporation from specified 10-percent owned foreign corporations with respect to which the domestic corporation is a U.S. shareholder when certain conditions are satisfied, (ii) certain sales or transfers involving specified 10-percent owned foreign corporations (including rules designed to limit losses on certain sales or exchanges of such foreign corporations in situations involving a domestic corporation eligible for the dividends received deduction), (iii) requiring branch loss recapture when substantially all of the assets of a foreign branch are transferred by a domestic corporation to specified 10-percent owned foreign corporations with respect to which the domestic corporation is a U.S. shareholder, and (iv) a transition tax requiring U.S. shareholders of certain foreign corporations to include as subpart F income their deferred foreign income of such foreign corporations (the tax rates for such inclusion have changed in the final Senate bill—for instance, a U.S. corporation with the mandatory inclusion would be taxed at a 14.5 percent rate with respect to E&P represented by cash or cash equivalents and a 7.5 percent rate with respect to illiquid assets). There are also provisions in the Senate bill addressing passive and mobile income, including rules relating to (i) taxing U.S. shareholders of CFCs on their portion of amounts treated as “global intangible low taxed income” through a complex calculation, (ii) permitting a deduction for domestic corporations for certain specified percentages of foreign-derived intangible income of the domestic corporation and global intangible low-taxed income, which is included in income of such domestic corporation (subject to limitations), and (iii) permitting transfers of certain intangible property from CFCs to U.S. shareholders in a tax efficient manner for a three-year period of time. Additionally, the Senate bill includes a number of significant modifications to the CFC subpart F rules, including (i) the elimination of an inclusion of foreign base company oil-related income, (ii) an inflation adjustment of the de minimis exception for foreign base company income, (iii) the repeal of an inclusion based on the withdrawal of previously excluded subpart F income from qualified investment, (iv) the modification of the stock attribution rules for determining status of a foreign corporation as a CFC (this modification would make it more likely for a foreign corporation to be treated as a CFC as a result of stock of certain related foreign persons being attributed downward to a U.S. person), (v) the modification of the definition of U.S. shareholder by incorporating a 10-percent value test in determining who is a U.S. shareholder (thus, making it more likely for a person to be a U.S. shareholder and a foreign corporation to be a CFC), (vi) the elimination of the requirement that a corporation be a CFC for 30 days before subpart F inclusions apply, (vii) making the CFC look-thru rule of section 954(c)(6) permanent, and (viii) the modification of section 956 (which deals with investments in U.S. property) to provide that corporations that are eligible for a deduction for dividends from CFCs will be exempt from a subpart F inclusion for investments in U.S. property. Moreover, the Senate bill includes a number of provisions designed to address base erosion, including rules relating to (i) limiting the deduction for interest expense of domestic corporations that are members of a worldwide affiliated group with excess domestic indebtedness when certain conditions apply, (ii) limiting income shifting through intangible property transfers (including treating goodwill and going concern value and workforce in place as section 936(h)(3)(B) intangibles), (iii) disallowing a
deduction for certain related party interest or royalty payments paid or accrued in certain hybrid transactions or with certain hybrid entities under certain circumstances, (iv) not permitting shareholders of surrogate foreign corporations to be eligible for reduced rates on dividends under section 1(h), and (v) providing for a base erosion and anti-abuse tax which requires a corporation to pay additional corporate tax in situations where the corporation has certain “base erosion payments” and certain conditions are satisfied (a complex formula is used for determining this tax). Very generally, these rules can apply to corporations (other than a RIC, REIT or S corporation) where the average annual gross receipts of which for a three tax year testing period are at least $500 million and the “base erosion percentage” for the tax year is four percent or higher. Base erosion payments generally are certain deductible payments to related foreign persons and certain amounts paid or accrued to related foreign persons in connection with the acquisition of depreciable or amortizable property, as well as certain payments to expatriated entities. There are several definitions, special rules and exceptions in applying this provision. The Senate bill also modifies the foreign tax credit system in several ways, including (i) repealing the section 902 indirect foreign tax credit and providing for the determination of the section 960 credit on a current year basis, (ii) providing a separate foreign tax credit limitation basket for foreign branch income, (iii) accelerating the election to allocate interest on a worldwide basis, (iv) sourcing income from the sales of inventory solely on the basis of production activities, and (v) modifying section 904(g) by providing an election to increase the percentage of domestic taxable income offset by overall domestic loss treated as foreign source. Finally, the Senate bill also contains rules relating to (i) restricting the insurance business exception to the PFIC rules, (ii) repealing the fair market value method of interest expense apportionment, (iii) modifying the source rules involving possessions, and (iv) codifying Rev. Rul. 91-32 relating to a foreign person’s sale of a partnership interest where the partnership engages in a U.S. trade or business.
The Senate’s passage of its tax reform bill paves the way for the House to choose to either move forward with the Senate version of tax reform or request a conference committee to reconcile the House’s and Senate’s bill. If the House moves forward with the Senate version or a reconciled bill can garner the support of a majority of the Senate, it may receive quick passage by both the House and Senate, leading to enactment before the end of the year.
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What happens next with tax reform? On Dec. 2, the U.S. Senate passed the Tax Cuts and Jobs Act in a 51-49 vote. Many changes were made to the bill in order to win over the Senators who opposed parts of it, including a provision to keep the current individual alternative minimum tax (AMT), but with a higher exemption threshold. (The corporate AMT would also be retained.) An earlier version of the b ill repealed the AMT. The Senate and the House must now “reconcile” the bill by agreeing to the same version before it can go to the President to sign into law.
Stay tuned here and on our social media sites for more information as it is released.
Click here for more recent news from Anderson ZurMuehlen
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