2017 Tax Legislation Highlights
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (referred to as “the Act”), which is the most significant overhaul of U.S. taxes in over 30 years. In our 2017 Tax Legislation Highlights, we touch on some of the more widely applicable provisions that should have the most impact on the business community as well as some changes that may affect the individual. If you have any questions about these updates, please feel free to contact our tax team for a consultation.
TAX REFORM: TAX CUTS AND JOBS ACT
Corporate Tax Provisions
The Act replaces the current corporate tax rate schedule with a flat rate of 21%, effective for tax years beginning after December 31, 2017. Fiscal-year corporations will need to use a blended rate calculated using present-law Section 15, which is based on the number of days in their tax year that occur before and after the effective date of January 1, 2018.
The Act also reduces the dividends received deduction (DRD) rates, with the 70% DRD being reduced to 50%, and the 80% DRD being reduced to 65%.
The Corporate Alternative Minimum Tax (AMT) is repealed for tax years beginning after December 31, 2017. Any unused minimum tax credit of a corporation may be used to offset regular tax liability for any tax year.
The Act provides a 20% deduction for qualified pass-through business income at the individual level. The deduction is limited to the greater of either 50% of the owner’s allocable share of W-2 wages paid by the business, or 25% of that W-2 wage share plus 2.5% of the original cost basis of qualified property.
In general, qualified business income is the net amount of qualified items of income, gain, loss, and deduction with respect to any qualified trade or business of the taxpayer. Qualified items generally are items of income, gain, loss, and deduction effectively connected with the conduct of a qualified trade or business in the United States. Qualified business income does not include investment-type income (e.g., capital gains, dividends and non-business interest) or reasonable compensation and guaranteed payments.
Pass-through business owners will be required to aggregate trade or business income and loss, and any net business losses in excess of $250,000 (single) or $500,000 (joint) would not be deductible. Such losses would be carried forward and treated as part of the taxpayer’s net operating loss (NOL) carryforward in subsequent taxable years. This limitation would apply after the application of the passive loss rules. Business losses covered by this provision would include pass-through losses as well as sole proprietor and farm losses. In the case of partnership and S corporation losses, the limitation is applied at the partner or shareholder level.
The Act provides certain relief to taxpayers converting to C corporation status, effective on enactment. First, any Section 481(a) amount required to be taken into account by any eligible terminated S corporation would be taken into account ratably over the six-year period beginning with the year of change. An eligible terminated S corporation is any C corporation that (1) was an S corporation on the date of enactment, (2) revoked its S corp election on or after the date of enactment (but no more than two years after the date of enactment), and (3) had the same shareholders in identical ownership percentages on the date of enactment and on the date of revocation.
The Act also expands the ability of these former S corporations to make tax-free distributions from the accumulated adjustments account (AAA). Under current law, an S corporation that converts to a C corporation can only make tax-free distributions during the one-year post termination transition period (PTP). The Act provides that after the PTP, a converted C corporation would still be able to treat a portion of the distributions as tax-free according to the ratio of AAA to accumulated earnings and profits.
For partnership tax years beginning after 2017, a partnership would be treated as continuing to exist (i.e., there would be no ‘technical termination’) even if more than 50% of the total capital and profits interests of such partnership were sold or exchanged.
Other Business Provisions
NOL deductions are limited to 80% of taxable income for tax years beginning after December 31, 2017. NOL carry-backs are also eliminated, but NOLs can be carried forward indefinitely.
The Act limits the net business interest deduction in excess of interest income to 30% of adjusted taxable income for tax years beginning after December 31, 2017. Adjusted taxable income is defined as taxable income before interest expense, interest income, NOL deductions and the 20% deduction for certain qualified business income under Section 199A. For tax years before January 1, 2022, adjusted taxable income also includes depreciation, amortization and depletion.
The gross receipts requirement to use the cash method of accounting has been increased from $5 million to $25 million for corporations and partnerships with corporate partners. The increased threshold of $25 million also applies to the Section 263A uniform capitalization (UNICAP) exemption and the percentage of completion method for long-term construction contracts.
The Section 199 Domestic Production Activities Deduction (DPAD) is repealed for tax years beginning after December 31, 2017
The 50% deduction for entertainment, amusement or recreation expenses is repealed for payments after December 31, 2017.
For property placed in service between September 27, 2017 and January 1, 2023, the Act provides 100% bonus depreciation, allowing for immediate full expensing of qualified assets. For qualified property placed in service in calendar years 2023, 2024, 2025 and 2026, the applicable bonus depreciation percentage is reduced to 80%, 60%, 40% and 20%, respectively. The Act removes the requirement that the original use of qualified property commence with the taxpayer. Therefore, bonus depreciation is allowed for new and used property.
The Act increases the Section 179 dollar limitation to $1 million from $500,000, while increasing the cost of property subject to the phase-out to $2.5 million from $2 million for property placed in service in tax years beginning after 2017. The new dollar limitations would be indexed for inflation for tax years beginning after 2018.
For Research & Development (R&D) costs paid or incurred after December 31, 2021, the Act repeals the ability of taxpayers to expense them or defer them over a period of 60 or more months. Instead, R&D costs are required to be capitalized and amortized over five years beginning with the midpoint of the year in which they are incurred.
International Tax Provisions
The Act will enact new Section 245A, which would provide a 100-percent dividends received deduction (DRD) for the foreign-source portion of dividends received by a U.S. corporation from foreign corporations with respect to which it is a U.S. corporate shareholder. The foreign-source portion of dividends from such ‘specified 10-percent owned foreign corporations’ would include only the portion of undistributed E&P that is not attributable to effectively connected income (ECI) or dividends from an 80-percent owned domestic corporation, determined on a pooling basis.
As part of a move to a territorial system, the Act amends Section 965 to impose a toll charge on a U.S. shareholder’s pro rata share of certain foreign subsidiaries’ previously untaxed foreign earnings (determined as of November 2, 2017 or December 31, 2017, whichever is higher). The one-time transition tax rate is 15.5% for cash and cash equivalents and 8% for other assets. The provision would permit a U.S. shareholder to elect to spread the payments of the tax liability over eight years.
The Act will enact new Section 951A, which would require a U.S. shareholder to include in income the global intangible low-taxed income (GILTI) of its controlled foreign corporations (CFCs) in a manner similar to subpart F income inclusions. The GILTI amount is determined by calculating the aggregate net CFC tested income of the U.S. shareholder’s CFCs reduced by the U.S. shareholder’s net deemed tangible income return in order to arrive at the GILTI amount.
The Act also introduces a new Section 250 relating to deductions for foreign derived intangible income (FDII) and GILTI. Section 250 would allow as a deduction an amount equal to 37.5% of a domestic corporation’s FDII plus 50% of the GILTI amount included in gross income of the domestic corporation under new Section 951A. FDII is the portion of the net income of a domestic corporation, after taking into account allocable deductions and a reduction for a routine return on qualified business asset investment (QBAI), that is derived from sales or services provided, either directly or indirectly, to foreign unrelated persons located outside of the United States.
The Act includes a base erosion anti-avoidance tax (BEAT) provision. It targets base erosion by imposing an additional corporate tax liability on corporations (other than a RIC, REIT, or S corporation) with average annual gross receipts for the three-year period ending with the preceding taxable year of at least $500 million and that make certain base-eroding payments to related foreign persons for the taxable year of three percent or more of all their deductible expenses, with certain exceptions.
Individual Tax Provisions
The Act preserves the seven tax brackets for individuals but cuts each rate:
- 10% retained
- 15% lowered to 12%
- 25% lowered to 22%
- 28% lowered to 24%
- 33% lowered to 32%
- 35% retained
- 39.6% lowered to 37%
The standard deduction for 2018 would be increased to $24,000 for joint filers, $12,000 for individual filers, and $18,000 for single filers with at least one qualifying child. Amounts would be adjusted for inflation for tax years beginning after 2018. Personal exemptions ($4,150 in 2018 with phaseout starting at $320,000 of joint income) would be repealed after 2017.
—The mortgage interest deduction is limited to $750,000 in principal value for debt incurred after December 15, 2017. Taxpayers with a binding written contract in place before December 15, 2017 who purchase a home before April 1, 2018, can continue to deduct interest up to $1 million in acquisition debt.
—The Act allows individual taxpayers to deduct for tax years beginning after 2017 up to $10,000 for any combination of state and local income taxes, property taxes and sales taxes. Otherwise, an individual could deduct such taxes only if incurred in a trade or business or Section 212 activity.
—The Act preserves the itemized deduction for charitable contributions, with certain modifications. The Agreement would increase from 50% to 60% the income limit for charitable contributions of cash to public charities; deny a charitable deduction for payments made in exchange for college athletic event seating rights; and repeal the substantiation exception for certain contributions reported by the donee organization.
—The AGI threshold for deducting medical expenses is reduced from 10% to 7.5% in 2017 and 2018.
—The Act also eliminates the ‘Pease’ limitation on overall individual itemized deductions.
Additionally, the Act retains the individual AMT, but beginning in 2018, the exemption amounts are increased to $109,400 for joint filers and $70,300 for all other taxpayers. The phaseout thresholds rise to $1 million for joint filers and $500,000 for all other taxpayers.
If you have questions about how these law changes may affect your business, or whether any changes were enacted that may impact your particular industry or entity structure, please contact our tax partner, Jon Rausch, at 512.610.7215 or firstname.lastname@example.org.