After the House and Senate passed different versions of a comprehensive tax reform bill, a conference committee convened and released on Friday a compromise version of comprehensive tax reform, the “Tax Cuts and Jobs Act” (H.R. 1). The House and Senate are expected to vote to approve the conference committee’s version of the bill, and President Trump is expected to sign it by the end of this week. Highlights of the 503-page bill include:
Business Tax Reform
- Replaces the tiered tax rates for corporations with a flat 21% rate. The new rate would be effective for tax years beginning in 2018.
- Repeals the corporate alternative minimum tax (AMT).
- Allows a 100% “full expensing” deduction for the cost of property that otherwise would qualify for bonus depreciation (currently 50% in 2017, 40% in 2018, and 30% in 2019). To qualify for the 100% deduction, property must be acquired and placed in service after September 27, 2017 and before 2023 (or before 2024 for certain longer production period property and certain aircraft). The deduction would be phased down 20% per year (i.e., 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026) for property placed in service after 2022 (or after 2023 for longer production period property and certain aircraft). The bill eliminates the “original use” requirement for qualifying for the expensing deduction.
- Disallows a deduction for interest in excess of the sum of business interest income for the year, plus 30% of adjusted taxable income, and the “floor plan financing interest” on indebtedness used to buy motor vehicles held for sale or lease. In the case of a partnership or S corporation, the disallowance threshold would be determined at the entity level, rather than at the partner or shareholder level. Disallowed amounts would be carried forward indefinitely. The disallowance threshold would not apply to a business with average annual gross receipts of $25 million or less for the prior three years, a regulated public utility, or a qualifying farm or real property trade or business that makes an election.
- Limits the net operating loss (NOL) deduction to 80% of a taxpayer’s taxable income. Disallows the carryback of an NOL to a prior tax year (except in limited circumstances for farms and certain property and casualty insurance companies), and allows NOLs to be carried forward indefinitely.
- Increases the annual cap on the full current deduction (as opposed to capitalization and depreciation over a number of years) for the cost of “Section 179 property” (generally, depreciable tangible property and computer software acquired for use in an active trade or business) from $500,000 to $1,000,000. The bill also increases the phase-out threshold from $2,000,000 of property placed in service during a taxable year to $2,500,000 and expands the definition of Section 179 property to include tangible personal property used to furnish lodging.
- Repeals the 10% credit for rehabilitation of pre-1936 buildings and modifies the 20% credit for qualified rehabilitation expenditures with respect to certified historic structures to require an allocation of the credit over a 60-month period.
- Limits Section 1031 like-kind exchanges to real property.
- Repeals the Section 199 domestic production activities deduction.
- Requires research or experimental expenditures to be capitalized and amortized over a period of five years (or 15 years for research conducted outside the United States).
- Repeals the “technical termination” rule that treats a partnership as terminated if 50% or more of the interests in partnership capital and profits is sold or exchanged within a 12-month period.
- Imposes a three-year holding period requirement with respect to certain profits interests (i.e., “carried interests”) in financial partnerships to obtain the benefit of long-term capital gain treatment, notwithstanding the rules of section 83 or an election under section 83(b).
- Repeals tax-deferred rollover treatment for certain gains from the disposition of publicly traded securities.
- Modifies the $1 million limitation on deductibility of compensation paid by certain public companies under Section 162(m) to apply to previously exempt performance-based compensation and commissions. Expands the definition of publicly held corporations, and includes principal financial officers as covered employees. A transition rule provides that the changes will not apply to compensation paid pursuant to a plan if the right to participate in the plan is part of a written binding contract with the covered employee in effect on November 2, 2017.
Tax Law Reform for Individuals
The individual tax reform provisions described below expire at the end of 2025, except for the repeal of the individual health insurance mandate and rules regarding Section 529 plan distributions, charitable contribution deductions, medical expense deductions, and alimony payments.
- Establishes new income tax brackets for individuals. For married filing jointly (and single), the new brackets are:
- 10% for income from $0 to $19,050 ($9,525)
- 12% for income above $19,050 to $77,400 ($9,525 to $38,700)
- 22% for income above $77,400 to $165,000 ($38,700 to $82,500)
- 24% for income above $165,000 to $315,000 ($82,500 to $157,500)
- 32% for income above $315,000 to $400,000 ($157,500 to $200,000)
- 35% for income above $400,000 to $600,000 ($200,000 to $500,000)
- 37% for income above $600,000 ($500,000).
- Allows a 20% deduction of qualified pass-through business and sole proprietorship income and qualified income from REITS, cooperatives, and publicly traded partnerships. For taxpayers with income greater than a “threshold amount” ($157,500 for an individual or $315,000 for a joint return), the deduction equals the lesser of 20% of qualified business income or the greater of 50% of the W-2 wages with respect to the business or 25% of W-2 wages with respect to the business plus 2.5% of the unadjusted bases of all qualified business property. The limitation is subject to phase-in for taxpayers with income between the threshold amount and the threshold amount plus $50,000 ($100,000 for joints returns).No deduction is allowed for specified service business income if the taxpayer’s income is greater than the threshold amount plus $50,000 ($100,000 for joint returns), subject to certain phase-out provisions.
- Increases the standard deduction to $24,000 for married filing jointly, $18,000 for unmarried individuals with at least one qualifying child, and $12,000 in any other case.
- Suspends the personal exemption deduction.
- Leaves in place the individual AMT, but increases the individual AMT exemption amount to $109,400 for married taxpayers filing a joint return (half this amount for married taxpayers filing a separate return) and $70,300 for other taxpayers. Increases the individual AMT phase-out thresholds to $1,000,000 for married taxpayers filing a joint return and half that amount for all other taxpayers.
- Disallows “excess business losses,” generally defined as the aggregate deductions attributable to trades or businesses of a taxpayer over the sum of aggregate gross income attributable to trades or businesses of the taxpayer plus $500,000 ($250,000 for individuals).Any excess business losses may be carried forward as a net operating loss.
- Modifies the mortgage interest deduction by limiting the amount of eligible indebtedness to $750,000 and disallowing the deduction for interest on home equity indebtedness. The new rules will not apply to indebtedness incurred on or before December 15, 2017 (subject to special rules for refinancings) or to indebtedness incurred for certain purchases of a principal residence pursuant to a contract entered into before December 15, 2017.
- Limits the deduction for non-business state and local taxes (not including foreign real property taxes) to $10,000 per year. A taxpayer may claim the deduction with respect to property tax and either income tax or sales tax.
- Repeals the income-based phase-out of itemized deductions applicable to high income taxpayers.
- Eliminates the individual insurance mandate under the Affordable Care Act that imposes penalties on individuals who fail to maintain minimum essential medical coverage.
- Makes the following modifications:
- Increases the child tax credit to $2,000 per qualifying child and allows a partial $500 credit for certain dependents other than a qualifying child.
- Requires that filer list a social security number for qualifying children to claim the child tax credit.
- Limits distributions from Section 529 plans up to a maximum annual distribution amount of $10,000 per student for elementary or secondary education.
- Excludes from income student debt discharged on account of death or total disability.
- Limits all deductions and losses related to gambling (not just gambling losses) to the amount of gambling winnings.
- Increases the adjusted gross income limit on deductibility of cash contributions to public charities and certain private foundations from 50% to 60%, repeals the charitable contribution deduction for payments made in exchange for college athletic event seating rights, and repeals the donee-reported substantiation exception for a contribution of $250 or more.
- Reduces the medical expense deduction floor from 10% to 7.5% for taxable years beginning after 2016 and ending before 2019.
- Suspends or repeals deductions for:
- All itemized deductions subject to the 2 per cent floor, including tax preparation expenses and employee trade or business expenses.
- Alimony payments, but excludes the payments from income of the recipients, for divorce or separation instruments executed after December 31, 2018.
- Personal casualty losses, except for losses attributable to a federally declared disaster.
- Moving expenses, except for members of the Armed Forces.
- Suspends the exclusion from compensation for qualified moving expense reimbursements and qualified bicycle commuting reimbursements
Gift and Estate Tax Reform
- Doubles the per-individual estate and gift tax exemption from $5 million to $10 million (adjusted for inflation from 2011) for tax years beginning after 2017 and before 2026. In 2026 the exemption amount returns to $5 million (adjusted for inflation).
Taxation of Foreign Income and Foreign Persons
- Requires a one-time income inclusion for U.S. persons that own 10% or more of the voting power in certain foreign corporations. Allows a deduction so that the tax rate applicable to the inclusion is 15.5% for the cash and cash equivalents held by the foreign corporation, and 8% for the remaining income inclusion amount, with a corresponding reduction in any allowed indirect foreign tax credit. A taxpayer can elect to pay the tax over 8 years.
- Generally exempts from tax foreign-source dividends paid by a foreign corporation to a U.S. corporation that owns stock representing 10% or more of the voting power in the foreign corporation.
- Imposes a “base erosion and anti-abuse tax” (i.e., “BEAT tax”), which generally equals the excess of 10% (5% in 2018, 12.5% after 2025 and 1% point higher for certain banks and securities dealers) of a taxpayer’s modified taxable income over the taxpayer’s regular tax liability, with a reduction for certain credits. The new tax applies to any C corporation that is not a RIC or a REIT, has average gross receipts of at least $500 million for the prior 3 years, and has a base erosion percentage of 3% (2% for certain taxpayers) or more. All persons treated as a single employer pursuant to IRC § 52(a) generally are treated as one person for purposes of the new tax.
- Requires a U.S. person that owns stock representing 10% or more of the voting power in a controlled foreign corporation (CFC) to include in income the U.S. person’s share of the CFC’s “global intangible low-taxed income” (GILTI).GILTI is the aggregate of certain income over the “net deemed intangible return” (generally, 10% of qualified business asset investments, less certain interest expenses of the CFC).
- Generally allows a deduction for 50% (37.5% after 2025) of GILTI, as defined and discussed above, and 37.5% (21.875% after 2025) of foreign-derived intangible income, which is a portion of intangible income determined by formula.
- Makes various other changes to the anti-deferral rules applicable to CFCs.
- Modifies transfer pricing and other anti-abuse rules to tighten limitations on the ability to use intangible property to shift income.
- Disallows the deduction for interest or royalties paid in a “hybrid transaction” (the interest or royalties are not included in the recipient’s home country) or to a “hybrid entity” (the recipient is treated as a fiscally transparent entity for the purposes of the tax law of one country but not the other).
- Reduces a U.S. corporation’s basis in its stock of a foreign corporation by the amount of exempt dividends received from the foreign corporation for purposes of calculating loss (but not gain) from the sale of the stock.
- Repeals the indirect foreign tax credit and modifies the foreign tax credit for subpart F income.
- Provides that dividends paid by certain expatriated entities subject to anti-inversion rules are not qualified dividends eligible for the lower tax rate.
Tax Exempt Organizations
- Requires that tax-exempt organizations compute unrelated business taxable income separately with respect to each trade or business and allows NOL deductions only with respect to a trade or business from which the loss arose.
- Subjects certain private colleges and universities that have at least 500 tuition-paying students to a 1.4% excise tax on net investment income.
- Imposes on certain tax-exempt organizations and related entities a 21% excise tax on compensation paid to any of the five highest compensated employees of the tax-exempt entity in excess of $1 million for the year and on severance pay to highly compensated employees that exceeds three times the employee’s average income over the five previous years, with certain exceptions for medical professionals.