|
Parker's Explanation of the House Tax Reform Bill (TCJA 2017)
(Parker Tax Publishing November 2017)
On Thursday, November 2, 2017, the House released its long-awaited tax reform package in H.R. 1, Tax Cuts and Jobs Act (TCJA; "the Bill"). Most of the changes in the Bill would go into effect for tax years beginning after 2017. An in-depth explanation of the Bill's key provisions follows.
For individuals, the most notable changes include a reduction in the number of income tax brackets and the lower tax rates that apply to taxable income, the increase in the standard deduction along with the repeal of the personal exemption deduction, the elimination of the alternative minimum tax, the elimination of the state and local income tax deduction, the elimination of the medical expense deduction, a limitation on the amount of mortgage interest that is deductible, a reduction in the amount of gain on the sale of a principal residence that is excludible from income for certain high-income filers, a limitation on the amount of personal real estate taxes that are deductible, and the elimination of numerous other deductions.
Observation: The elimination of a number of federal tax deductions could result in an increase in a taxpayer's state income tax. This is because many states that have an income tax, start the calculation of state taxable income by using federal taxable income.
The Bill also would increase the amount of an individual's estate that is subject to the estate tax and then repeal the estate tax after 2023.
For businesses, the more notable changes include the reduction of the corporate tax rate to 20 percent, increased expensing of qualified property placed in service during the year, a lower tax rate for certain pass-through entity income, the repeal of numerous business credits, such as the work opportunity credit, the repeal of the deduction for income attributable to domestic production activities, and the repeal of the like-kind exchange rules for exchanges of other than real property.
I. Changes Affecting Individuals
Individual Tax Rates and Brackets
Under the Bill, the current seven tax brackets would be consolidated and simplified into four brackets: 12 percent, 25 percent, 35 percent, and 39.6 percent, in addition to an effective fifth bracket at zero percent in the form of the enhanced standard deduction. For married taxpayers filing jointly, the 25-percent bracket threshold would be $90,000, the 35-percent bracket threshold would be $260,000, and the 39.6-percent bracket threshold would be $1 million. For unmarried individuals and married individuals filing separately, the bracket thresholds would be half the thresholds for married taxpayers filing jointly, except that the 35-percent bracket threshold for unmarried individuals would be $200,000. For single parents filing as a head of a household, the bracket thresholds would be the midpoint between the thresholds for unmarried individuals and married taxpayers filing jointly, except that the 39.6-percent bracket threshold for heads of household would be $500,000. These income levels would be indexed for chained CPI instead of CPI, a slightly different measure of inflation, beginning for periods after 2022.
Observation: With the exception of the 28 percent capital gain tax rates on gain from collectibles and the sale of certain small business stock and the 25 percent capital gain rates on Code Sec. 1250 gain, the capital gains tax rate depends on an individual's income tax rate. If an individual's income tax rate is 39.6 percent, the capital gains tax rate is 20 percent. If the individual's income tax rate is lower than 39.6 percent but higher than 15 percent, the capital gains tax rate is 15 percent, and if the individual's tax rate is 15 percent or lower, the capital gains tax rate is 0 percent. While no changes were made to the capital gains rate in the Bill, because the higher income tax rates will generally apply to fewer taxpayers, more taxpayers will qualify for the lower capital gains tax rates.
For high-income taxpayers, the Bill would phase out the tax benefit of the 12-percent bracket, measured as the difference between what the taxpayer pays and what the taxpayer would have paid had the income subject to the 12-percent bracket instead been subject to the 39.6-percent bracket. This tax benefit is phased out at a rate of $6 of tax savings for every $100 of adjusted gross income in excess of $1,000,000 (single filers) or $1,200,000 (joint filers). These thresholds are adjusted for chained CPI in tax years after 2017.
Increase in Standard Deduction and Repeal of Personal Exemptions
Under the Bill, the standard deduction would increase to:
(1) $24,400 in the case of joint return or surviving spouse filing (up from $12,700 in 2017);
(2) $18,300 in the case of an unmarried individual with at least one qualifying child (up from $9,350 for head of household filing status in 2017); and
(3) $12,200 for all other taxpayers (up from $6,350 for single and married filing separately in 2017).
These amounts would be adjusted for inflation based on chained CPI.
However, the personal exemption for individuals, which was $4,050 per person in 2017 before being phased out at higher income levels, is eliminated. The additional personal exemptions for the aged and blind are also eliminated.
Example: Under present law, in 2018 the first $10,650 of income earned by a single taxpayer under age 65 is exempt from income tax ($6,500 standard deduction plus $4,150 personal exemption). Under the Bill, the first $12,200 in income would escape taxation, a $1,550 (or 14.6%) improvement.
Observation: This change will be detrimental to taxpayers who itemize rather than take the standard deduction because they will lose their personal exemptions and receive no benefit from the increased standard deduction. But for some taxpayers, for the next five years, the blow would be softened by a new $300 "family flexibility" tax credit (see below).
Repeal of Dependency Exemptions and Enhancement of Child Tax Credit
Under the Bill, the repeal of the personal exemptions means taxpayers cannot take dependency exemption deductions for their children.
In lieu of dependency exemptions, the Bill creates a new family tax credit. The family tax credit consists of a child tax credit of $1,600 (up from $1,000 in 2017) and a credit of $300 for each taxpayer (both spouses in the case of married taxpayers filing a joint return) and each dependent of the taxpayer who is not a qualifying child under age 17.
The increase in the child tax credit would be effective for tax years beginning after 2017 and would be permanent. The $300 credit would be effective for tax years beginning after 2017, but would expire for tax years beginning after December 31, 2022.
As under current law, the refundable portion of the child tax credit would be limited to $1,000. That $1,000 amount would be indexed for inflation based on chained CPI, and over time would rise to match (but not exceed) the $1,600 base child tax credit. Neither the $300 credit for nonchild dependents nor the $300 credit for other taxpayers would be refundable.
Observation: The main winners of the provision replacing dependency exemptions for children with an expanded child tax credit will be taxpayers in the 12 percent bracket, who would receive a $600 tax benefit from the credit, compared with a $498 tax benefit they would have received for the exemption (12% x $4,150 exemption amount for 2018). Taxpayers in the 25 and 35 percent brackets will reap a smaller tax benefit from the expanded credit than they would have from claiming the exemption.
The math is less friendly for the new $300 credit for dependents who are not qualifying children (which includes children over the age of 16). Trading a $4,150 exemption for a $300 credit would be a losing proposition at every tax rate.
The phase out threshold for the combined child credit, the non-child dependent credit, and the credit for other taxpayers would be increased from $110,000 under current law to $230,000 for joint filers, and from $75,000 to $115,000 for single filers. Credits are phased out at a rate of $50 for each $1,000, or fraction thereof, by which the taxpayer's modified adjusted gross income exceeds the threshold amount.
Observation: The increase in the phaseout thresholds for the child tax credit means that many additional taxpayers can claim the credit. But because the phaseout ranges for the credit would still be much lower than the ones for the exemptions they would be replacing (for example, the phaseout range for exemptions for MFJ taxpayers in 2018 is $320,000 to $442,500), some high-income taxpayers will lose the tax benefits of their dependents altogether.
Changes to Itemized Deductions
Under the Bill, itemized deductions for the following items would be fully repealed for tax years beginning after 2017:
(1) medical expenses;
(2) personal casualty and theft losses;
(3) tax preparation expenses; and
(4) unreimbursed employee expenses.
The repeal of the deduction of personal casualty losses will have no effect on deductions under special disaster relief legislation for Hurricanes Harvey, Irma, and Maria and future disaster relief legislation.
Repeal of State and Local Income Taxes and Limitation on Real Property Tax Deductions. Under the Bill, individuals would not be allowed an itemized deduction for state and local income or sales taxes, but would continue to be entitled to a deduction for state and local income or sales taxes paid or accrued in carrying on a trade or business or producing income. Additionally, individuals would continue to be allowed to claim an itemized deduction for real property taxes paid up to $10,000. This provision would be effective for tax years beginning after December 31, 2017.
Limitation on Mortgage Interest Deduction. Currently, taxpayers can claim an itemized deduction for mortgage interest paid with respect to a principal residence and one other residence of the taxpayer. Itemizers may deduct interest payments on up to $1 million in acquisition indebtedness (for acquiring, constructing, or substantially improving a residence), and up to $100,000 in home equity indebtedness. Under the alternative minimum tax (AMT), however, the deduction for home equity indebtedness is disallowed.
The Bill provides that a taxpayer may continue to claim an itemized deduction for interest on acquisition indebtedness. However, for acquisition indebtedness incurred after November 2, 2017, the $1 million limitation would be reduced to $500,000. Interest would be deductible only on a taxpayer's principal residence. Similar to the current-law AMT rule, interest on home equity indebtedness incurred after November 2, 2017, would not be deductible. In the case of refinancings of debt incurred before November 2, 2017, the refinanced debt generally would be treated as incurred on the same date that the original debt was incurred for purposes of determining the limitation amount applicable to the refinanced debt. In the case of a taxpayer who enters into a written binding contract before November 2, 2017, the related debt would be treated as being incurred before November 2, 2017.
Modifications to the Deduction for Charitable Contributions. The Bill makes the following modifications to the deduction for charitable contributions, effective for tax years beginning after 2017:
(1) Increases the AGI limitation for cash contributions to public charities and certain private foundations from 50 percent to 60 percent and retains the 5-year carryover period for contributions exceeding the AGI limit.
(2) Provides that the charitable mileage rate would be adjustable for inflation.
(3) Repeals the special rule that provides a charitable deduction of 80 percent of the amount paid for college athletic event seating rights.
(4) Repeals the substantiation exception in Code Sec. 170(f)(8)(D) that relieves a donee organization from providing a contemporaneous written acknowledgment of contributions of $250 or more when the donee organization files a return with the required information.
Limitation on Gambling Deductions and Expenses. Under the Bill, all deductions for expenses incurred in carrying out gambling transactions (not just gambling losses) would be limited to the extent of wagering winnings, effective for tax years beginning after 2017.
Repeal of Overall Limitation on Itemized Deductions. Under the Bill, the overall limitation on itemized deductions would be repealed, effective for tax years after 2017.
Changes to Exclusions and Above-the-Line Deductions
Under the Bill, the following exclusions and deductions would be fully repealed for tax years beginning after 2017:
(1) deduction for moving expenses;
(2) exclusion for qualified moving expense reimbursement;
(3) deduction for alimony paid (see below for grandfathering rules);
(4) deduction for interest on education loans;
(5) deduction for qualified tuition and related expenses;
(6) exclusion for interest on U.S. savings bonds used to pay qualified higher education expenses;
(7) exclusion for qualified tuition reduction programs;
(8) exclusion for employer-provided education assistance programs;
(9) deduction for contributions to an Archer MSA (existing Archer MSA balances could continue to be rolled over on a tax-free basis to an HSA);
(10) exclusion for employer contributions to an Archer MSA;
(11) exclusion for employee achievement awards;
(12) exclusion for employer-provided dependent care assistance programs; and
(13) exclusion for employer-provided adoption assistance programs.
Modification of Exclusion of Gain from the Sale of a Principal Residence. Under the Bill, a taxpayer would have to own and use a home as the taxpayer's principal residence for five out of the previous eight years (compared with two out of five years under current law) to qualify for the exclusion of gain on the sale of a principal residence. In addition, the taxpayer would be able to use the exclusion only once every five years (as opposed to the two year limit under current law). The exclusion would be phased out by one dollar for every dollar by which a taxpayer's adjusted gross income exceeds $500,000 ($250,000 for single filers). The provision would be effective for sales and exchanges after 2017.
Repeal of Alimony Deduction with Grandfathering. Under the Bill, alimony payments would not be deductible by the payor or includible in the income of the payee. The provision would be effective for any divorce decree or separation agreement executed after 2017. Alimony payments made under a separation agreement executed on or before December 31, 2017, would continue to be deductible, as would payments under a modification of such an agreement unless the modification expressly provides otherwise.
Changes to Rules on the Discharge of Certain Student Loan Debt. Under current law, any debt that is forgiven constitutes income. That includes student loans, even if such loans are forgiven on account of death or disability. Under the Bill, any income resulting from the discharge of student debt on account of death or total disability of the student would be excluded from taxable income. The provision would exclude from income repayment of a taxpayer's loans pursuant to the Indian Health Service Loan Repayment Program. The provision would be effective for discharges of indebtedness received after 2017 and amounts received in taxable years beginning after 2017.
Limitation on the Exclusion for Employer-Provided Housing. Under the Bill, the exclusion from income for housing provided for the convenience of the employer and for employees of educational institutions would be limited to $50,000 ($25,000 for a married individual filing a joint return) and would phase out based on the employee's level of compensation. The exclusion is phased out at a rate of one dollar for every two dollars of adjusted gross income earned above the compensation threshold for highly compensated individuals, which is indexed annually for inflation. The exclusion also would be limited to one residence. The provision would be effective for tax years beginning after 2017.
Repeal of Tax Credits
Under the Bill, the following nonrefundable credits are repealed effective January 1, 2018:
(1) adoption credit;
(2) elderly disabled credit;
(3) credit for certain mortgage credit certificates.
In addition, the plug-in car credit or certain qualified plug-in electric-drive motor vehicles would be repealed effective January 1, 2018.
Consolidation of Education Credits and Saving Rules
Under the Bill, the three existing higher education tax credits - the American Opportunity Tax Credit (AOTC), the Hope Scholarship Credit (HSC), and the Lifetime Learning Credit - would be consolidated into an enhanced AOTC. The new AOTC, like the current AOTC, would provide a 100-percent tax credit for the first $2,000 of certain higher education expenses and a 25-percent tax credit for the next $2,000 of such expenses. Like the current AOTC, expenses covered under the credit include tuition, fees, and course materials. The AOTC would also be available for a fifth year of post-secondary education at half the rate as the first four years, with up to $500 of such credit being refundable. The HSC and LLC would be repealed.
The provisions consolidating education credits would be effective for tax years after 2017.
New contributions to Coverdell education savings accounts after 2017 (except rollover contributions) would be prohibited, but tax-free rollovers from Coverdell accounts into Section 529 plans would be allowed. Elementary and high school expenses of up to $10,000 per year would be qualified expenses for Section 529 plans. Qualified expenses would also be expanded to cover expenses associated with apprenticeship programs. The Bill provides that an unborn child may be treated as a designated beneficiary or an individual under Section 529 plans.
The provisions modifying education savings rules would be effective for contributions and distributions made after 2017.
II. Estate and Gift Tax Changes
Doubling of Unified Credit. The Bill doubles the unified credit exclusion (the threshold above which an estate is subject to the estate tax) to $11.2 million in 2018 (up from $5.6 million under current law). As under current law, the exclusion amount would be indexed for inflation in subsequent years.
Repeal of Estate and Generation-Skipping Transfer Taxes after 2023. For estates of decedents dying and generation-skipping transfers made after December 31, 2023, the Bill repeals the estate tax and the generation-skipping transfer tax. The proposal includes a transition rule for assets placed in a qualified domestic trust by a decedent who died before the effective date of the proposal. Specifically, estate tax will not be imposed on:
(1) distributions before the death of a surviving spouse from the trust more than 10 years after the date of enactment; or
(2) assets remaining in the qualified domestic trust upon the death of the surviving spouse.
The Bill generally retains the present law rules for determining the income tax basis of assets acquired by gift and assets acquired from a decedent. As a result, property received from a donor of a lifetime gift generally will continue to take a carryover basis, and property acquired from a decedent's estate generally will continue to take a stepped-up basis.
Lower Gift Tax Rate. The top marginal gift tax rate is reduced from 40 percent to 35 percent for gifts made after December 31, 2023.
III. Maximum Rate on Business Income of Individuals; Changes to Calculating Net Earnings for Self-Employment Tax
Under the Bill, qualified business income of an individual from a partnership, S corporation, or sole proprietorship is subject to federal income tax at a rate no higher than 25 percent. Qualified business income means, generally, all net business income from a passive business activity plus the capital percentage of net business income from an active business activity, reduced by carryover business losses and by certain net business losses from the current year.
Observation: The 25-percent rate is the maximum rate. To the extent a taxpayer's qualified business income is less than the maximum dollar amount for the 25-percent rate bracket applicable to the taxpayer, such income is subject to tax at the lower rate brackets applicable to the taxpayer. However, taxable income (reduced by capital gain) that exceeds the maximum dollar amount for the 25-percent rate bracket applicable to the taxpayer, and that exceeds qualified business income, is subject to tax in the next higher rate brackets.
The Bill provides that a 25-percent tax rate applies generally to dividends received from a real estate investment trust (other than any portion that is a capital gain dividend or a qualified dividend), and applies generally to dividends that are includable in gross income from certain cooperatives.
As discussed below, the Bill also makes significant changes to the calculation of net earnings subject to self-employment tax.
Calculating Qualified Business Income
The Bill defines the term "qualified business income" as -
(1) the sum of (i) 100 percent of any net business income derived from any passive business activity plus (ii) the capital percentage of net business income derived from any active business activity, MINUS
(2) the sum of (i) 100 percent of any net business loss derived from any passive business activity, (ii) 30 percent (except as otherwise provided in the case of specified service activities or in the case of a taxpayer election to prove out a different percentage) of any net business loss derived from any active business activity, and (iii) any carryover business loss determined for the preceding tax year.
Qualified business income does not include income from a business activity that exceeds these percentages.
Passive Business Activity and Active Business Activity. Under the Bill, a business activity means an activity that involves the conduct of any trade or business. A taxpayer's activities include those conducted through partnerships, S corporations, and sole proprietorships. An activity has the same meaning as under the present-law passive loss rules in Code Sec. 469. As provided in regulations under those rules, a taxpayer may use any reasonable method of applying the relevant facts and circumstances in grouping activities together or as separate activities (through rental activities generally may not be grouped with other activities unless together they constitute an appropriate economic unit, and grouping real property rentals with personal property rentals is not permitted). It is intended that the activity grouping the taxpayer has selected under the passive loss rules is required to be used for purposes of the passthrough rate rules.
Example: Bill has an interest in a bakery and a movie theater in Baltimore, and a bakery and a movie theatre in Philadelphia. For purposes of the passive loss rules, Bill has grouped them as two activities, a bakery activity and a movie theatre activity. Bill must group them the same way (i.e., as two activities - a bakery activity and a movie theatre activity) for purposes of the passthrough rate rules.
Under the Bill, the term "passive business activity" generally has the same meaning as a passive activity under the present-law passive loss rules. However, for this purpose, a passive business activity is not defined to exclude a working interest in any oil or gas property that the taxpayer holds directly or through an entity that does not limit the taxpayer's liability. Rather, whether the taxpayer materially participates in the activity is relevant. Further, for this purpose, a passive business activity does not include an activity in connection with a trade or business or in connection with the production of income.
The Bill defines an "active business activity" as an activity that involves the conduct of any trade or business and that is not a passive activity.
Example: Megan has a partnership interest in a manufacturing business and materially participates in the manufacturing business. Megan's partnership interest is considered an active business activity.
Determining Net Business Income or Loss. Under the Bill, the determination of qualified business income requires a calculation of net business income or loss from each of an individual's passive business activities and active business activities. Net business income or loss is determined separately for each business activity.
Net business income is determined by appropriately netting items of income, gain, deduction and loss with respect to the business activity. The determination takes into account these amounts only to the extent the amount affects the determination of taxable income for the year.
Example: In 2018, Paul's sole proprietorship has $300,000 of ordinary income from inventory sales, and makes an expenditure of $50,000 that is required to be capitalized and amortized over five years under applicable tax rules. In this case, Paul's net business income is $300,000 minus $10,000 (current-year ordinary amortization deduction), or $290,000. The net business income is not reduced by the entire amount of the capital expenditure. It is only reduced by the amount deductible in determining taxable income for the year.
Net business income or loss also includes any amounts received by the individual taxpayer as wages, director's fees, guaranteed payments and amounts received from a partnership other than in the individual's capacity as a partner, that are properly attributable to a business activity.
Example: Sam is a shareholder in ABC, an S corporation engaged in a business activity. Sam is paid $150,000 in wages by ABC. In addition, his share of ABC's ordinary income for the year is $200,000. Sam's net business income is $350,000 (Sam's share of current year ordinary income plus $150,000 in wages).
Net business income or loss does not include specified investment-related income, deductions, or loss. Specifically, net business income does not include:
(1) any item taken into account in determining net long-term capital gain or net long-term capital loss;
(2) dividends, income equivalent to a dividend, or payments in lieu of dividends;
(3) interest income other than that which is properly allocable to a trade or business;
(4) the excess of gain over loss from commodities transactions, other than those entered into in the normal course of the trade or business or with respect to stock in trade or property held primarily for sale to customers in the ordinary course of the trade or business, property used in the trade or business, or supplies regularly used or consumed in the trade or business;
(5) the excess of foreign currency gains over foreign currency losses from Code Sec. 988 transactions, other than transactions directly related to the business needs of the business activity;
(6) net income from notional principal contracts, other than clearly identified hedging transactions that are treated as ordinary (i.e., not treated as capital assets); and
(7) any amount received from an annuity that is not used in the trade or business of the business activity.
Net business income does not include any item of deduction or loss properly allocable to such income.
Carryover Business Loss. Solely for purposes of determining qualified business income eligible for a maximum rate of 25 percent, a carryover business loss from the preceding tax year reduces qualified business income in the current tax year.
The carryover business loss is the excess of (1) the sum of 100 percent of any net business loss derived from any passive business activity, 30 percent (except as otherwise provided under rules for determining the capital percentage, which is discussed below) of any net business loss derived from any active business activity, and any carryover business loss determined for the preceding tax year, over (2) the sum of 100 percent of any net business income derived from any passive business activity plus the capital percentage of net business income derived from any active business activity. There is no time limit on the carryover business losses.
Example: Mary has two business activities that give rise to a net business loss of $30,000 and $40,000, respectively, in 2018. This gives rise to a carryover business loss of $70,000 to 2019. In 2019, the two business activities each give rise to net business income of $20,000, for total business income of $40,000. In this case, Mary carries over a business loss of $30,000 to 2020.
Observation: The determination of carryover business loss, for purposes of determining the amount of qualified business income eligible for a maximum rate of 25 percent under the Bill, does not affect the extent to which items of income, gain, deduction, and loss are included in taxable income. For example, the carryforward of net operating losses and the treatment of passive activity losses continue to affect the determination of taxable income as provided in Code Sec. 172 and Code Sec. 469, respectively.
Determining a Taxpayer's Capital Percentage. For purposes of determining qualified business income, the Bill provides that the capital percentage used in the calculation is the percentage of net business income from an active business activity that is included in qualified business income.
In general, the capital percentage is 30 percent, except as provided in the case of the application of any of three special rules discussed below: (1) a specially calculated percentage for capital-intensive business activities, (2) zero percentage in the case of specified service activities, and (3) a specially calculated percentage for capital-intensive specified service activities.
Also, the capital percentage is reduced if the portion of net business income represented by the sum of wages, guaranteed payments, amounts received from a partnership other than in the individual's capacity as a partner, and director's fees, that are properly attributable to a business activity exceeds the difference between 100 percent and the capital percentage.
Example: Mary has an active business that she conducts through her wholly owned S corporation, ABC. If ABC has net business income of $100,000, including $75,000 of wages that ABC pays Mary, the otherwise applicable capital percentage is reduced from 30 percent to 25 percent (100 percent - 75 percent (the percentage of net business income represented by wages)). If net business income is the same but ABC instead pays $80,000 of wages to Mary, the capital percentage would be reduced to 20 percent (because now wages are 80 percent of net business income; 100 percent - 80 percent = 20 percent).
Observation: In determining the capital percentage, the Bill generally disregards the proportion of wages and ordinary business income that make up net business income. But it makes an exception when wages, etc. make up a high percentage of net business income.
Specially Calculated Percentage for Capital-Intensive Business Activities. A taxpayer may elect the application of an increased percentage with respect to any active business activity other than a specified service activity (described below). The election applies for the tax year it is made and each of the next four tax years. The election must be made no later than the due date (including extensions) of the return for the tax year made, and is irrevocable. The percentage under the election is the applicable percentage (described below) for the five tax years of the election.
The applicable percentage is the percentage applied in lieu of the capital percentage in the case of an election with respect to capital-intensive business activities, or with respect to capital-intensive specified service activities (discussed below). Once an election is made, the applicable percentage (not the capital percentage) determines the portion of the net business income or loss from the activity for the taxable year that is taken into account in determining qualified business income subject to federal income tax at a rate no higher than 25 percent.
The applicable percentage is determined by dividing -
(1) the specified return on capital for the activity for the taxable year; by
(2) the taxpayer's net business income derived from that activity for that taxable year.
The specified return on capital for any active business activity is determined by multiplying a deemed rate of return times the asset balance for the activity for the taxable year, and reducing the product by interest expense deducted by the activity for the taxable year. The deemed rate of return for this purpose is the short-term AFR plus seven percentage points. The asset balance for this purpose is the adjusted basis of property used in connection with the activity as of the end of the taxable year, determined without taking into account basis adjustments for bonus depreciation under Code Sec. 168(k) or expensing under Code Sec. 179.
In the case of an active business activity conducted through a partnership or S corporation, the taxpayer takes into account his distributive share of the asset balance of the partnership's or S corporation's adjusted basis of property used in connection with the activity. Property used in connection with an activity is property described in Code Sec. 1221(a)(2), which includes property of a character which is subject to the allowance for depreciation provided in Code Sec. 167 and real property used in the trade or business.
Example: At the end of the tax year, Paul's active business activity has on hand machinery with an adjusted basis of $100,000 (determined without taking into account basis adjustments for bonus depreciation or Code Sec. 179 expensing) and cash of $50,000. In this case, the asset balance for the activity is $100,000.
Observation: IRS guidance is to be provided to ensure that in determining asset balance, no amount is taken into account for more than one activity.
Specified Service Activities. Under the Bill, special rules apply for specified service activities. In the case of an active business activity that is a specified service activity, generally the capital percentage is zero and the percentage of any net business loss from the specified service activity that is taken into account as qualified business income is zero percent. Regulatory authority will be provided to treat all specified services activities of an individual as a single business activity to the extent the activities would be treated as a single employer for purposes of aggregation rules.
The term "specified service activity" means any trade or business activity involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, or investing, trading, or dealing in securities, partnership interests, or commodities. For this purpose, a security and a commodity have the meanings provided in the rules for the mark-to-market accounting method for dealers in securities (i.e., Code Sec. 475(c)(2) and Code Sec. 475(e)(2), respectively).
Capital-Intensive Specified Service Activities. A taxpayer may annually elect the application of an increased percentage with respect to any active business activity that is specified service activity, provided the applicable percentage for the taxable year is at least 10 percent.
Calculating Net Earnings for Self-Employment Tax
The Bill provides that only the labor percentage of gross income less deductions from a trade or business carried on by an individual, including an individual who is a partner or S corporation shareholder in a trade or business carried on by a partnership or S corporation, are taken into account in determining net earnings from self-employment. The labor percentage is the excess (expressed as a percentage) of one minus the capital percentage (or applicable percentage, as the case may be).
Thus, the Bill provides that net earnings from self-employment generally include the individual's pro rata share of nonseparately computed income or loss from any trade or business of an S corporation in which the individual is a stockholder. Proper adjustment is made for wages paid in a trade or business carried on by an S corporation to a taxpayer who is a shareholder.
Example: Bill, an S corporation shareholder, is paid wages of $20,000 with respect to the trade or business conducted by the S corporation. After the deduction for wages, Bill has a pro rata share of income from the S corporation of $100,000. Assume the labor percentage is 70 percent. In determining net earnings from self-employment, Bill's $20,000 of wages is added to his $100,000 pro rata share of the S corporation's income before applying the labor percentage of 70 percent ($120,000 x .7 = $84,000). The resulting $84,000 amount is then reduced by the wages of $20,000 yielding net earnings from self-employment of $64,000. Present-law rules imposing FICA tax on the wages of $20,000 are not changed by the provision.
The Bill repeals the present-law exclusion for a limited partner's distributive share of partnership income or loss in determining net earnings from self-employment (including repeal of the exception for partnership guaranteed payments in the nature of remuneration for services). Thus, under the proposal, limited partners are treated the same as other partners for purposes of determining net earnings from self-employment.
The Bill modifies the exceptions that apply in determining net earnings from self-employment by providing that rentals from real estate and personal property leased with the real estate are not among the exceptions. The Bill retains the present-law exceptions for dividends and interest, and gains or loss from the sale or exchange of a capital asset, or gains or losses from other property that is neither inventory nor held primarily for sale to customers.
Effective Date
The changes related to the maximum rate for business income and the calculation of net earnings from self-employment in the Bill are effective for tax years beginning after December 31, 2017. A transition rule provides that for fiscal year taxpayers whose tax year includes December 31, 2017, a proportional benefit of the reduced rate under the provision is allowed for the period beginning January 1, 2018, and ending on the day before the beginning of the taxable year beginning after December 31, 2017.
IV. Business-Related Changes
Reduction in Corporate Tax Rate
The Bill provides that, instead of the current graduated corporate tax rates, corporations would be subject to a flat 20-percent tax rate for tax years beginning after 2017. Personal service corporations would be subject to a flat 25-percent corporate tax rate, also for tax years beginning after 2017.
Enhanced Expensing
100 Percent Bonus Depreciation. Under the Bill, taxpayers would be able to fully and immediately expense 100 percent of the cost of qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (with an additional year for certain qualified property with a longer production period) under Code Sec. 168(k)(1)(A). This provision replaces the current law allowance of additional first-year depreciation for certain "qualified property" placed in service during the year. The provision would expand the property that is eligible for this immediate expensing by repealing the requirement that the original use of the property begin with the taxpayer. Instead, the property would be eligible for immediate expensing if it is the taxpayer's first use. Under the Bill, qualified property would not include any property used by a regulated public utility company or any property used in a real property trade or business.
Under current law, the limitation under Code Sec. 280F on the amount of depreciation deductions allowed with respect to certain passenger automobiles is increased in the first year by $8,000 for automobiles that qualify (and for which the taxpayer does not elect out of the additional first-year deduction). The $8,000 amount is phased down from $8,000 by $1,600 per calendar year beginning in 2018. Thus, the Code Sec. 280F increase amount for property placed in service during 2018 is $6,400, and during 2019 is $4,800. Under the Bill, the $8,000 increase amount in the limitation on the depreciation deductions allowed with respect to certain passenger automobiles is increased from $8,000 to $16,000 for passenger automobiles acquired and placed in service after September 27, 2017, and before January 1, 2023.
The current law provision allowing taxpayers to elect to accelerate the use of their AMT credits in lieu of additional depreciation would be repealed. The repeal of this election would be effective for tax years beginning after 2017.
Expansion of Code Section 179 Expensing. Under the Bill, the small business expensing limitation under Code Sec. 179 would be increased to $5 million and the phase-out amount would be increased to $20 million. The provision would modify the expensing limitation by indexing both the $5 million and $20 million limits for inflation. The provision would modify the definition of Code Sec. 179 property to include qualified energy efficient heating and air-conditioning property.
The provision to modify the definition of Code Sec. 179 property to include qualified energy efficient heating and air-conditioning property would be effective for property acquired and placed in service after November 2, 2017. The provision to increase the dollar limitations would be effective for tax years beginning after 2017 through tax years beginning before 2023.
Accounting Methods
Expanded Use of the Cash Method of Accounting. Under the Bill, the $5 million gross receipts threshold that limits which corporations and partnerships with a corporate partner can use the cash method of accounting would be increased to $25 million and the requirement that such businesses satisfy the requirement for all prior years would be repealed. The increased $25 million threshold would be extended to farm corporations and farm partnerships with a corporate partner, as well as family farm corporations. Also, under the Bill, the average gross receipts test would be indexed to inflation. The provision would be effective for tax years beginning after 2017.
Accounting for Inventories. The Bill provides that businesses with average gross receipts of $25 million or less would be permitted to use the cash method of accounting even if the business has inventories. Under the cash method of accounting, a business may account for inventory as non-incidental materials and supplies. Under the Bill, a business with inventories that qualifies for and uses the cash method of accounting would be able to account for its inventories using its method of accounting reflected on its financial statements or its books and records. The provision would be effective for tax years beginning after 2017.
Exemption from UNICAP Rules Expanded. Under the Bill, businesses with average gross receipts of $25 million or less would be fully exempt from the uniform capitalization (UNICAP) rules. This exemption would apply to real and personal property acquired or manufactured by such business. The provision would be effective for tax years beginning after 2017.
Increased Flexibility in Accounting for Long-term Contracts. Under the Bill, the $10 million average gross receipts exception to using the percentage-of-completion method would be increased to $25 million. Businesses that meet the increased average gross receipts test would be permitted to use the completed-contract method (or any other permissible exempt contract method). The provision would be effective for tax years beginning after 2017.
Compensation and Benefits
Non-Qualified Deferred Compensation. Under the Bill, an employee would be taxed on compensation as soon as there is no substantial risk of forfeiture with regard to that compensation (i.e., receipt of the compensation is not subject to future performance of substantial services). A condition will not be treated as constituting a substantial risk of forfeiture solely because it consists of a covenant not to compete or because the condition relates (nominally or otherwise) to a purpose of the compensation other than the future performance of services - regardless of whether such condition is intended to advance a purpose of the compensation or is solely intended to defer taxation of the compensation.
The provision would be effective for amounts attributable to services performed after 2017. The current-law rules would continue to apply to existing non-qualified deferred compensation arrangements until the last tax year beginning before 2026, when such arrangements would become subject to the provision.
Modification of Limitation on Excessive Employee Remuneration. Under the Bill, the exceptions to the $1 million deduction limitation for commissions and performance-based compensation for a covered employee of a publicly traded corporation would be repealed. The provision also would revise the definition of "covered employee" to include the CEO, the chief financial officer, and the three other highest paid employees, realigning the definition with current SEC disclosure rules. Under the modified definition, once an employee qualifies as a covered person, the deduction limitation would apply for federal tax purposes to that person so long as the corporation pays remuneration to such person (or to any beneficiaries). The provision would be effective for tax years beginning after 2017.
Excise Tax on Excess Tax-Exempt Organization Executive Compensation. Under the Bill, a tax-exempt organization would be subject to a 20-percent excise tax on compensation in excess of $1 million paid to any of its five highest paid employees for the tax year. The excise tax would apply to all remuneration paid to a covered person for services, including cash and the cash value of all remuneration (including benefits) paid in a medium other than cash, except for payments to a tax-qualified retirement plan, and amounts that are excludable from the executive's gross income.
Once an employee qualifies as a covered person, the excise tax would apply to compensation in excess of $1 million paid to that person so long as the organization pays him remuneration. The excise tax also would apply to excess parachute payments paid by the organization to such individuals. Under the provision, an excess parachute payment generally would be a payment contingent on the employee's separation from employment with an aggregate present value of three times the employee's base compensation or more.
The provision would be effective for tax years beginning after 2017.
Changes to Interest Deduction Rules
Under the Bill, every business, regardless of its form, would be subject to a disallowance of a deduction for net interest expense in excess of 30 percent of the business's adjusted taxable income. The net interest expense disallowance would be determined at the tax filer level - for example, at the partnership level instead of the partner level. Adjusted taxable income is a business's taxable income computed without regard to business interest expense, business interest income, net operating losses, and depreciation, amortization, and depletion.
Any interest amounts disallowed under the provision would be carried forward to the succeeding five tax years and would be an attribute of the business (as opposed to its owners). Special rules would apply to allow a pass-through entity's unused interest limitation for the taxable year to be used by the pass-through entity's owners and to ensure that net income from pass-through entities would not be double counted at the partner level.
The Bill provides an exemption from these rules for small businesses, which are described as businesses with average gross receipts of $25 million or less. Additionally, the provision would not apply to certain regulated public utilities and real property trades or businesses.
The provision would also repeal Code Sec. 163(j), which limits the ability of a corporation to deduct disqualified interest (generally, interest paid or accrued to a related party when no federal income tax is imposed with respect to the interest) paid or accrued in a taxable year if certain threshold tests.
The provision would be effective for tax years beginning after 2017.
Property Transactions
Like-Kind Exchange Rules Would Only Apply to Real Property. Under the Bill, the special rule in Code Sec. 1031 allowing deferral of gain on like-kind exchanges would be modified to allow for like-kind exchanges only with respect to real property.
The provision would be effective for transfers after 2017. However, the provision would provide a transition rule to allow like-kind exchanges of personal property to be completed if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before December 31, 2017.
Repeal of Rollover of Publicly Traded Securities Gain into Specialized Small Business Investment Companies. The Bill would repeal a special rule in Code Sec. 1202 that permits an individual or corporation to roll over without recognition of income any capital gain realized on the sale of publicly traded securities when the proceeds are used to purchase common stock or a partnership interest in a specialized small business investment corporation (SSBIC) within 60 days of the sale of the securities. The provision would be effective for sales after 2017.
Certain Self-Created Property Would Not Be Treated as a Capital Asset. Under the Bill, gain or loss from the disposition of a self-created patent, invention, model or design (whether or not patented), or secret formula or process would be ordinary in character, making such treatment consistent with the treatment of copyrights under current law. In addition, the election to treat musical compositions and copyrights in musical works as a capital asset would be repealed. The provision would be effective for dispositions of such property after 2017.
Repeal of Special Rule for Sale or Exchange of Patents. Under the Bill, the special rule treating the transfer of a patent before its commercial exploitation as long-term capital gain would be repealed. The provision would be effective for dispositions after 2017.
Deductions
Repeal of Domestic Activities Production Deduction. Under the Bill, the deduction in Code Sec. 199 for domestic production activities would be repealed. The repeal would be effective for tax years beginning after 2017.
Repeal of Deduction for Local Lobbying Expenses. Under the Bill, deductions for lobbying expenses with respect to legislation before local government bodies (including Indian tribal governments) would be disallowed. The provision would be effective for amounts paid or incurred after 2017.
Expenses Relating to Entertainment, Recreation Activities, and Certain Facilities. Under the Bill, no deduction would be allowed for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes. In addition, no deduction would be allowed for transportation fringe benefits, benefits in the form of on-premises gyms and other athletic facilities, or for amenities provided to an employee that are primarily personal in nature and that involve property or services not directly related to the employer's trade or business, except to the extent that such benefits are treated as taxable compensation to an employee (or includible in gross income of a recipient who is not an employee).
The 50-percent deduction limitation under current law also would apply only to expenses for food or beverages and to qualifying business meals, with no deduction allowed for other entertainment expenses. Furthermore, no deduction would be allowed for reimbursed entertainment expenses paid as part of a reimbursement arrangement that involves a tax-indifferent party such as a foreign person or an entity exempt from tax.
The provision would be effective for amounts paid or incurred after 2017.
Modification of Net Operating Loss Deduction. Under the Bill, taxpayers would be able to deduct a net operating loss (NOL) carryover or carryback only to the extent of 90 percent of the taxpayer's taxable income (determined without regard to the NOL deduction). The Bill also would generally repeal all carrybacks but provide a special one-year carryback for small businesses and farms in the case of certain casualty and disaster losses.
The provision generally would be effective for losses arising in tax years beginning after 2017. In the case of any net operating loss, specified liability loss, excess interest loss or eligible loss, carrybacks would be permitted in a taxable year beginning in 2017, as long as the NOL is not attributable to the increased expensing allowance. Additionally, the provision would allow NOLs arising in tax years beginning after 2017 and that are carried forward to be increased by an interest factor to preserve its value.
Unrelated Business Taxable Income Increased by Certain Fringe Expenses. Under the Bill, tax-exempt entities would be taxed on the values of providing their employees with transportation fringe benefits, and on-premises gyms and other athletic facilities, by treating the funds used to pay for such benefits as unrelated business taxable income, thus subjecting the values of those employee benefits to a tax equal to the corporate tax rate. The provision would be effective for amounts paid or incurred after 2017.
Limitation on Deduction for FDIC Premiums. Under the Bill, a percentage of assessments by the Federal Deposit Insurance Corporation (FDIC) to support the Deposit Insurance Fund (DIF) would be non-deductible for institutions with total consolidated assets in excess of $10 billion. The percentage of nondeductible assessments would be equal to the ratio that total consolidated assets in excess of $10 billion bears to $40 billion, so that assessments would be completely non-deductible for institutions with total consolidated assets in excess of $50 billion. The provision would be effective for tax years beginning after 2017.
Tax Credits
Under the Bill, the following tax credits are repealed for tax years beginning after 2017:
(1) credit for clinical testing expenses for certain drugs for rare diseases or conditions;
(2) employer-provided child care credit;
(3) work opportunity tax credit;
(4) credit for expenditures to provide access to disabled individuals;
(5) enhanced oil recovery credit; and
(6) credit for producing oil and gas from marginal wells.
Repeal of Rehabilitation Credit. Under the Bill, the rehabilitation credit would be repealed.
Under a transition rule, the credit would continue to apply to expenditures incurred through the end of a 24-month period of qualified expenditures, which would have to begin within 180 days after January 1, 2018.
Repeal of Deduction for Certain Unused Business Credits. Under the Bill, the deduction for unused business credits would be repealed. The provision would be effective for tax years beginning after 2017.
Termination of New Markets Tax Credit. Under the Bill, no additional new markets tax credits would be allocated after 2017; however, credits that would have already been allocated may be used over the course of up to seven years as contemplated by the credit's multi-year timeline.
Modification of Credit for Portion of Employer Social Security Taxes Paid with Respect to Employee Tips. Under the Bill, the credit an employer can claim for a portion of social security taxes paid with respect to employee tips would be modified to reflect the current minimum wage so that it is available with regard to tips reported only above the current minimum wage rather than tips above $5.15 per hour. Additionally, all restaurants claiming the credit would be required to report to the IRS tip allocations among tipped employees (allocations at no less than 10 percent of gross receipts per tipped employee rather than 8 percent), which is a currently a reporting requirement only for restaurants with at least ten employees.
This provision would be effective for tips received for services performed after 2017.
Changes to Energy Credits. The Bill would make the following changes to energy-related credits:
(1) modify the credit for electricity produced from certain renewable resources;
(2) modify the energy investment credit;
(3) extend and phaseout the residential energy efficient property credit; and
(4) modify the credit for production from advanced nuclear power facilities.
Other Changes Affecting Businesses
Corporate Gross Income Would Include Certain Capital Contributions. Under the Bill, the gross income of a corporation would include contributions to its capital, to the extent the amount of money and fair market value of property contributed to the corporation exceeds the fair market value of any stock that is issued in exchange for such money or property. Similar rules would apply to contributions to the capital of any noncorporate entity, such as a partnership. The provision would be effective for contributions made, and transactions entered into, after the date of enactment.
Repeal of Rules for Technical Termination of Partnerships. Under the Bill, the technical termination rule in Code Sec. 708(b)(1)(B) applicable to partnerships would be repealed. Thus, the partnership would be treated as continuing even if more than 50 percent of the total capital and profits interests of the partnership are sold or exchanged, and new elections would not be required or permitted. The provision would be effective for tax years beginning after 2017.
V. Foreign-Related Changes
Deduction for Foreign-source Portion of Dividends Received by Domestic Corporations from Specified 10-Percent Owned Foreign Corporation. Under the Bill, the current-law system of taxing U.S. corporations on the foreign earnings of their foreign subsidiaries when these earnings are distributed would be replaced with a dividend-exemption system. Under the exemption system, 100 percent of the foreign-source portion of dividends paid by a foreign corporation to a U.S. corporate shareholder that owns 10 percent or more of the foreign corporation would be exempt from U.S. taxation. No foreign tax credit or deduction would be allowed for any foreign taxes (including withholding taxes) paid or accrued with respect to any exempt dividend, and no deductions for expenses properly allocable to an exempt dividend (or stock that gives rise to exempt dividends) would be taken into account for purposes of determining the U.S. corporate shareholder's foreign-source income.
The provision would be effective for distributions made after 2017.
Application of Participation Exemption to Investments in United States Property. Under the Bill, the imposition of current U.S. tax on U.S. corporate shareholders with respect to untaxed foreign subsidiary earnings reinvested in United States property would be repealed.
The provision would be effective for tax years of foreign corporations beginning after 2017.
Limitation on Losses with Respect to Specified 10-Percent Owned Foreign Corporations. Under the Bill, a U.S. parent company would reduce the basis of its stock in a foreign subsidiary by the amount of any exempt dividends received by the U.S. parent from its foreign subsidiary - but only for purposes of determining the amount of a loss (but not the amount of any gain) on any sale or exchange of the foreign subsidiary stock by its U.S. parent. The provision would be effective for distributions made after 2017.
In addition, if a U.S. corporation transfers substantially all of the assets of a foreign branch to a foreign subsidiary, the U.S. corporation would be required to include in income the amount of any post-2017 losses that were incurred by the branch.
The provision would be effective for transfers after 2017.
Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation. Under the Bill, U.S. shareholders owning at least 10 percent of a foreign subsidiary, generally, would include in income for the subsidiary's last tax year beginning before 2018 the shareholder's pro rata share of the net post-1986 historical earnings and profits (E&P) of the foreign subsidiary to the extent such E&P has not been previously subject to U.S. tax, determined as of November 2, 2017, or December 31, 2017 (whichever is higher). The net E&P would be determined by taking into account the U.S. shareholder's proportionate share of any E&P deficits of foreign subsidiaries of the U.S. shareholder or members of the U.S. shareholder's affiliated group.
The E&P would be classified as either E&P that has been retained in the form of cash or cash equivalents, or E&P that has been reinvested in the foreign subsidiary's business (e.g. property, plant, and equipment). The portion of the E&P comprising cash or cash equivalents would be taxed at a reduced rate of 12 percent, while any remaining E&P would be taxed at a reduced rate of 5 percent. Foreign tax credit carryforwards would be fully available, and foreign tax credits triggered by the deemed repatriation would be partially available, to offset the U.S. tax.
At the election of the U.S. shareholder, the tax liability would be payable over a period of up to eight years, in equal annual installments of 12.5 percent of the total tax liability due.
If the U.S. shareholder is an S corporation, the provision would not apply until the S corporation ceases to be an S corporation, substantially all of the assets of the S corporation are sold or liquidated, the S corporation ceases to exist or conduct business, or stock in the S corporation is transferred.
Repeal of Code Section 902 Indirect Foreign Tax Credits; Determination of Code Section 960 Credit on Current Year Basis. Under the Bill, no foreign tax credit or deduction would be allowed for any taxes (including withholding taxes) paid or accrued with respect to any dividend to which the dividend exemption under section 4001 of the bill would apply. A foreign tax credit would be allowed for any subpart F income that is included in the income of the U.S. shareholder on a current year basis, without regard to pools of foreign earnings kept abroad. The provision would be effective for tax years of foreign corporations beginning after 2017 and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
Source of Income from Sales of Inventory Determined Solely on Basis of Production Activities. Under the Bill, income from the sale of inventory property produced within and sold outside the United States (or vice versa) would be allocated and apportioned between sources within and outside the United States solely on the basis of the production activities with respect to the inventory.
The provision would be effective for tax years beginning after 2017.
Repeal of Inclusion Based on Withdrawal of Previously Excluded Subpart F Income from Qualified Investment. Under the Bill, the imposition of current U.S. tax on previously excluded foreign shipping income of a foreign subsidiary if there is a net decrease in qualified shipping investments would be repealed.
The provision would be effective for tax years of foreign corporations beginning after 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
Repeal of Treatment of Foreign Base Company Oil Related Income as Subpart F Income. Under the Bill, the imposition of current U.S. tax on foreign base company oil related income would be repealed.
The provision would be effective for tax years of foreign corporations beginning after 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
Inflation Adjustment of De Minimis Exception for Foreign Base Company Income. Under the Bill, the $1 million gross income threshold for taxing a U.S. parent's foreign subsidiary's gross income would be adjusted for inflation.
The provision would be effective for tax years of foreign corporations beginning after 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
Look-thru Rule for Related Controlled Foreign Corporations Made Permanent. Under the Bill, a special "look-through" rule which provides that passive income received by one foreign subsidiary from a related foreign subsidiary generally is not includible in the taxable income of the U.S. parent, provided such income was not subject to current U.S. tax or effectively connected with a U.S. trade or business, would be made permanent. It had been scheduled to expire for tax years beginning after 2020.
The provision would be effective for tax years of foreign corporations beginning after 2019, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
Modification of Stock Attribution Rules for Determining Status as a Controlled Foreign Corporation. Under the Bill, a U.S. corporation would be treated as constructively owning stock held by its foreign shareholder.
The provision would be effective for tax years of foreign corporations beginning after 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
Elimination of Requirement that Corporation Must Be Controlled for 30 Days Before Subpart F Inclusions Apply. Under the Bill, a U.S. parent would be subject to current U.S. tax on the CFC's subpart F income even if the U.S. parent does not own stock in the CFC for an uninterrupted period of 30 days or more during the year.
The provision would be effective for tax years of foreign corporations beginning after 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
Current Year Inclusion by U.S. Shareholders with Foreign High Returns. Under the Bill, a U.S. parent of one or more foreign subsidiaries would be subject to current U.S. tax on fifty percent of the U.S. parent's foreign high returns. Foreign high returns would be measured as the excess of the U.S. parent's foreign subsidiaries' aggregate net income over a routine return (7 percent plus the Federal short-term rate) on the foreign subsidiaries' aggregate adjusted bases in depreciable tangible property, adjusted downward for interest expense. Foreign high returns would not include income effectively connected with a U.S. trade or business, subpart F income, insurance and financing income that meets the requirements for the active finance exemption (AFE) from subpart F income under current law, income from the disposition of commodities produced or extracted by the taxpayer, or certain related-party payments. Like subpart F income, the U.S. parent would be taxed on foreign high returns each year, regardless of whether it left those earnings offshore or repatriated the earnings to the United States.
Foreign high returns would be treated similarly to currently-taxed subpart F income for certain purposes of the Code, including for purposes of allowing a foreign tax credit. The foreign tax credits allowed for foreign taxes paid with respect to foreign high returns would be limited to 80 percent of the foreign taxes paid, would not be allowed against U.S. tax imposed on other foreign-source income (i.e., such foreign tax credits would only be allowed to offset U.S. tax on foreign high return inclusions), and would not be allowed to be carried back or forward to other tax years.
The provision would be effective for tax years of foreign corporations beginning after 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
Limitation on Deduction of Interest by Domestic Corporations Which Are Members of an International Financial Reporting Group. Under the Bill, the deductible net interest expense of a U.S. corporation that is a member of an international financial reporting group would be limited to the extent the U.S. corporation's share of the group's global net interest expense exceeds 110 percent of the U.S. corporation's share of the group's global earnings before interest, taxes, depreciation, and amortization (EBITDA). This limitation would apply in addition to the general rules for disallowance of certain interest expense under section 3301 of the bill. Taxpayers would be disallowed interest deductions pursuant to whichever provision denies a greater amount of interest deductions. Any disallowed interest expense would be carried forward for up to five tax years, with carryforwards exhausted on a first in, first out basis. For this purpose, an international financial reporting group is a group of entities that includes at least one foreign corporation engaged in a trade or business in the United States or at least one domestic corporation and one foreign corporation, prepares consolidated financial statements, and has annual global gross receipts of more than $100 million.
The provision would be effective for tax years beginning after 2017.
Excise Tax on Certain Payments from Domestic Corporations to Related Foreign Corporations; Election to Treat Such Payments as Effectively Connected Income. Under the Bill, payments (other than interest) made by a U.S. corporation to a related foreign corporation that are deductible, includible in costs of goods sold, or includible in the basis of a depreciable or amortizable asset would be subject to a 20 percent excise tax, unless the related foreign corporation elected to treat the payments as income effectively connected with the conduct of a U.S. trade or business. Consequently, the foreign corporation's net profits (or gross receipts if no election is made) with respect to those payments would be subject to full U.S. tax, eliminating the potential U.S. tax benefit otherwise achieved. Exceptions would apply for intercompany services which a U.S. company elects to pay for at cost (i.e., no markup) and certain commodities transactions. To determine the net taxable income that is to be deemed effectively connected income (ECI), the foreign corporation's deductions attributable to these payments would be determined by reference to the profit margins reported on the group's consolidated financial statements for the relevant product line. No credit would be allowed for foreign taxes paid with respect to the profits subject to U.S. tax. Further, in the event no election is made, no deduction would be allowed for the U.S. corporation's excise tax liability.
The provision would apply only to international financial reporting groups with payments from U.S. corporations to their foreign affiliates totaling at least $100 million annually. The provision would be effective for tax years beginning after 2018.
Extension of Deduction Allowable with Respect to Income Attributable to Domestic Production Activities in Puerto Rico. Under the Bill, eligibility of domestic gross receipts from Puerto Rico for the domestic production deduction would apply retroactively to tax years beginning after December 31, 2016, and before January 1, 2018.
Extension of Temporary Increase in Limit on Cover Over of Rum Excise Taxes to Puerto Rico and the Virgin Islands. Under the Bill, the $13.25 per proof gallon excise tax cover-over amount paid to the treasuries of Puerto Rico and the U.S. Virgin Islands would apply retroactively to include imports after December 31, 2016, and be extended to rum imported into the United States before January 1, 2023.
Extension of American Samoa Economic Development Credit. Under the Bill, the American Samoa economic development credit for taxpayers currently operating in American Samoa would retroactively apply to tax years beginning after December 31, 2016, and be extended to tax years beginning before January 1, 2023.
Restriction on Insurance Business Exception to Passive Foreign Investment Company Rules. Under the provision, the PFIC exception for insurance companies would be amended to apply only if the foreign corporation would be taxed as an insurance company were it a U.S. corporation and if loss and loss adjustment expenses, unearned premiums, and certain reserves constitute more than 25 percent of the foreign corporation's total assets (or 10 percent if the corporation is predominantly engaged in an insurance business and the reason for the percentage falling below 25 is solely due to temporary circumstances).
The provision would be effective for tax years beginning after 2017.
Limitation on Treaty Benefits for Certain Deductible Payments. Under the Bill, if a payment of a fixed or determinable, annual or periodical (FDAP) income is deductible in the United States and the payment is made by an entity that is controlled by a foreign parent to another entity in a tax treaty jurisdiction that is controlled by the same foreign parent, then the statutory 30-percent withholding tax on such income would not be reduced by any treaty unless the withholding tax would be reduced by a treaty if the payment were made directly to the foreign parent.
The provision would be effective for payments made after the date of enactment.
VI. Retirement Plan-Related Changes
Repeal of Special Rule Permitting Recharacterization of Traditional IRA Contributions as Roth IRA Contributions and Vice Versa. Currently, an individual may re-characterize a contribution to a traditional IRA as a contribution to a Roth IRA (and vice versa). An individual may also recharacterize a conversion of a traditional IRA to a Roth IRA. The deadline for recharacterization generally is October 15 of the year following the conversion. When a recharacterization occurs, the individual is treated for tax purposes as not having made the conversion. The recharacterization must include any net earnings related to the conversion.
The Bill would repeal this rule, effective for tax years beginning after 2017.
Modification of Rules Relating to Hardship Distributions. Under current law, defined contribution plans are generally not permitted to allow in-service distributions (distributions while an employee is still working for the employer) attributable to elective deferrals if the employee is less than 59 1/2 years old. One exception is for hardship distributions, which plans may offer participants only if the plan follows guidelines such as requiring an immediate and heavy financial need of the employee for any distribution to be made. Regulations require that plans not allow employees taking hardship distributions to make contributions to the plan for six months after the distribution. Under the Bill, the IRS would be required within one year of the date of enactment to change its guidance to allow employees taking hardship distributions to continue making contributions to the plan.
The revised regulations under this provision would be effective for plan years beginning after 2017.
Modification of Rules Relating to Hardship Withdrawals from Cash or Deferred Arrangements. Defined contribution plans are generally not permitted to allow in-service distributions (distributions while an employee is still working for the employer) attributable to elective deferrals if the employee is less than 59 1/2 years old. One exception is for hardship distributions, which plans have the option of offering to participants. Hardship distributions may be allowed only for amounts actually contributed by the employee and may not include account earnings or amounts contributed by the employer. Under the Bill, employers may choose to allow hardship distributions to also include account earnings and employer contributions. The provision would be effective for plan years beginning after 2017.
Extended Rollover Period Allowed for the Rollover of Plan Loan Offset Amounts. Under current law, defined contribution plans are permitted (but not required) to allow plan loans. If the employee fails to abide by the applicable rules, the loan is treated as a taxable distribution that may also be subject to the 10-percent penalty for early withdrawals. If a plan terminates or an employee's employment terminates while a plan loan is outstanding, the employee has 60 days to contribute the loan balance to an individual retirement account (IRA), or the loan is treated as a distribution.
Under the Bill, employees whose plan terminates or who separate from employment while they have plan loans outstanding would have until the due date for filing their tax return for that year to contribute the loan balance to an IRA in order to avoid the loan being taxed as a distribution. The provision would apply to tax years beginning after 2017.
Modification of Nondiscrimination Rules to Protect Older, Longer Service Participants. Under current law, employer-sponsored retirement plans must meet a variety of requirements in order to be tax-qualified, including nondiscrimination rules designed to ensure that the group of employees covered by a plan and the contribution or benefits provided to employees must not discriminate in favor of highly compensated employees. In general, employers may choose to stop allowing employees to accrue new benefits in a plan or only allow existing employees to accrue new benefits while closing the plan to new employees. For employers sponsoring both a defined contribution plan and a defined benefit plan, the nondiscrimination rules allow limited cross-testing between the two plans. However, some employers who allow current workers to continue to accrue benefits but have closed their defined benefit plan to new employees violate the nondiscrimination rules.
Under the Bill, expanded cross-testing between an employer's defined benefit and defined contributions would be allowed for purposes of the nondiscrimination rules. The provision would generally take effect on the date of enactment.
VII. Other Changes
Bond Reforms
The Bill would make the following bond-related changes:
(1) terminate private activity bonds;
(2) repeal advance refunding bonds;
(3) repeal tax credit bonds; and
(4) tax interest on bonds issued to finance the construction of, or capital expenditures for, a professional sports stadium.
Insurance Reforms
The Bill would make the following insurance company-related changes:
(1) change the carryback and carryforward period for losses of a life insurance company;
(2) repeal the small life insurance company deduction;
(3) change the calculation of life insurance reserves;
(4) repeal the special 10-year period for adjustments to taxable income in computing reserves by life insurance companies;
(5) modify the rules for life insurance proration for purposes of determining the dividends received deduction;
(6) repeal the special rule for distributions to shareholders from pre-1984 policyholders surplus account;
(7) modify the proration rules for property and casualty insurance companies;
(8) modify the discounting rules for property and casualty insurance companies;
(9) repeal the special estimated tax payment rules; and
(10) require the capitalization of certain policy acquisition expenses.
Exempt Organization Reforms
Clarification of Unrelated Business Income Tax Treatment of Entities Treated as Exempt from Taxation under Code Section 501(a). Under the Bill, all entities exempt from tax under Code Sec. 501(a), notwithstanding the entity's exemption under any other provision of the Code, would be subject to the UBIT rules.
The provision would be effective for tax years beginning after 2017.
Exclusion of Research Income Limited to Publicly Available Research. Under the Bill, the organization may exclude from UBTI only income from such fundamental research the results of which are freely made available to the public.
The provision would be effective for tax years beginning after 2017.
Simplification of Excise Tax on Private Foundation Investment Income. Under the Bill, the excise tax rate on net investment income of a private foundation would be streamlined to a single rate of 1.4 percent. Additionally, the rules providing for a reduction in the excise tax rate from 2 percent to 1 percent would be repealed.
The provision would be effective for tax years beginning after 2017.
Private Operating Foundation Requirements Relating to Operation of Art Museum. Under the Bill, an art museum claiming the status of a private operating foundation would not be recognized as such unless it is open to the public for at least 1,000 hours per year.
The provision would be effective for tax years beginning after 2017.
Excise Tax Based on Investment Income of Private Colleges and Universities. Under the Bill, certain private colleges and universities would be subject to a 1.4 percent excise tax on net investment income. The provision would only apply to private colleges and universities that have at least 500 students and assets (other than those used directly in carrying out the institution's educational purposes) valued at the close of the preceding tax year of at least $100,000 per full-time student. State colleges and universities would not be subject to the provision.
The provision would be effective for tax years beginning after 2017.
Exception from Private Foundation Excess Business Holding Tax for Independently-Operated Philanthropic Business Holdings. Under the Bill, private foundations would be exempt from this excess business-holdings tax if they own a for-profit business under these conditions: (1) the foundation owns all of the for-profit business' voting stock, (2) the private foundation acquired all of its interests in the for-profit business other than by purchasing it, (3) the for-profit business distributes all of its net operating income for any given tax year to the private foundation within 120 days of the close of that tax year, and (4) the for-profit business' directors and executives are not substantial contributors to the private foundation nor make up a majority of the private foundation's board of directors.
This provision would be effective for tax years beginning after 2017.
Churches Are Permitted to Make Statements Relating to Political Campaign in Ordinary Course of Religious Services and Activities. Under the Bill, the provision known as the "Johnson Amendment," is qualified so that entities described under Code Sec. 508(c)(1)(A) would not fail to be treated as organized and operated exclusively for a religious purpose, assuming the speech is in the ordinary course of the organization's business and its expenses are de minimus. Under the "Johnson Amendment," an entity exempt from tax under Code Sec. 501(c)(3) is prohibited from "participating in, or intervening in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office."
This provision would be effective for tax years ending after date of enactment.
Additional Reporting Requirements for Donor Advised Fund Sponsoring Organizations. Under the Bill, donor advised funds would be required to disclose annually their policies on inactive donor advised funds as well as the average amount of grants made from their donor advised funds.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com
We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.
Try Our Easy, Powerful Search Engine
A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play
Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.
Dear Tax Professional,
My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.
Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.
To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.
Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.
Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!
Sincerely,
James Levey
Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com
|
