The Tax Cuts and Jobs Act is Finally Here, No More Do Overs
This week, Republicans agreed on a final version of the tax reform bill and filed a conference agreement on December 15, 2017. The agreement reconciled the House and Senate versions of the bill. After some technicalities and re-approval by both the House and Senate, the Tax Cuts and Jobs Act is on its way to being signed by President Trump. The new law will enact comprehensive changes to both individual and business taxation including reductions in tax rates.
The final version of the act, which was previously approved separately by the House and Senate, adheres more closely to the Senate version. The final legislation will exceed 1,000 pages and includes some very complex provisions intended to focus on economic growth.
Highlights of key provisions include the following:
- The act’s final version retains the seven overall tax brackets, but tax cuts are achieved by cutting the rates themselves. The final version cuts the top rate to 37% as follows:
|Rates||Single||Married Joint||Married Separate||Head of Household|
|10%||Up to $9,525||Up to $19,050||Up to $9,525||Up to $13,600|
|12%||$9,525 to |
|$19,050 to |
|$9,525 to |
|$13,600 to |
|22%||$38,700 to |
|$77,400 to |
|$38,700 to |
|$51,800 to |
|24%||$82,500 to |
|$165,000 to |
|$82,500 to |
|$82,500 to |
|32%||$157,500 to |
|$315,000 to |
|$157,500 to |
|$157,500 to |
|35%||$200,000 to |
|$400,000 to |
|$200,000 to |
|$200,000 to |
|37%||Over $500,000||Over $600,000||Over $300,000||Over $500,000|
- The standard deduction is increased to $24,000 for married taxpayers filing jointly; $18,000 for single filers with at least one qualifying child (Head of Household filers); and $12,000 for single filers and includes enhancements for the elderly and the blind.
- Personal exemptions are repealed and merged in with the higher standard deduction.
- The Child/Dependent Tax Credit will be $2,000 with $1,400 refundable. Modified income limits will make the credit available to more families and a $500 credit will be available for a non-child dependent.
- The Kiddie tax is simplified by applying the trust and estate rates (reflected below) to the unearned income of a child.
- The capital gain and dividend rates are maintained at 20%, plus the 3.8% surtax, where applicable.
- The act retains a modified Individual Alternative Minimum Tax (AMT) as of 2018 and provides for increased exemptions and higher phase out limitations. The limits are indexed for inflation. The new law will change the impact of AMT and should reduce the number of affected taxpayers.
- There are significant changes to itemized deductions. The “Pease” limitation, which previously limited up to 80% of most itemized deductions, has been repealed. Instead, most itemized deductions are either eliminated or modified, such as:
- The deduction for non-business state and local income, sales and property taxes will be limited to $10,000 in aggregate ($5,000 for married taxpayers filing separately). This provision potentially harms taxpayers living in high income and property tax states. (As disclosed in our recent Tax Flash on December 18, a specific provision was added to the law to disallow a deduction for the prepayment of 2018 income taxes before the end of 2017.)
- The deduction for medical expenses has been retained and will be enhanced. The act lowers the threshold for the deduction to 7.5% from 10% of adjusted gross income for tax years 2017 and 2018.
- The act repeals all miscellaneous itemized deductions that were previously subject to the 2% floor. Miscellaneous deductions included investment fees, tax preparation expenses and unreimbursed employee business expenses. However, the deduction for investment interest expense remains unchanged.
- The deduction for personal casualty and theft losses is repealed, except for losses resulting from federally declared disasters.
- The adjusted gross income limit on cash contributions is increased from 50% to 60%.
- 529 Savings Plans can be withdrawn tax-free if used for higher education expenses. The act now allows up to $10,000 per year to be used for elementary and high school tuition and funds to be used for private and religious schools.
- The deduction for mortgage interest is subject to the following rules:
- Interest on acquisition debt currently in existence can be deducted under current rules.
- The $1 million debt limit is reduced to $750,000 for debt incurred after December 15, 2017, and will only include mortgage interest deduction on a principal residence and second residence.
- Home equity interest will be nondeductible.
- The final act includes a repeal of the Shared Responsibility Payment (Individual Mandate) under the Affordable Care Act after 2018.
- While the above-the-line educator costs is not repealed, the act eliminates many tax credits and income exclusions, including:
- Moving expenses other than those in Armed Forces.
- Deduction or alimony payments effective for any divorce decree or separation agreement executed or modified after 2018.
- Exclusion for employee achievement awards.
- Elimination of the Deduction for Domestic Production Activities.
- Credit for clinical testing expenses for certain drugs for rare diseases or conditions is reduced to 25%.
- Rehabilitation credit is not completely repealed, but limited to 20% for certified historic structures and repealed for pre-1936 non-historic structures.
- Disabled Access Credit.
- Retain and simplified the Earned Income Tax Credit to improve efficiency.
All of the individual tax changes under the new law are generally effective beginning in 2018 and are temporary and expire after 2025. If Congress does not act at that time to extend these provisions, starting in 2026, the new provisions will lapse and the current rules will return.
Due to the changes described above, many taxpayers will no longer opt to itemize deductions. The beneficial tax rates on long-term capital gains and qualified dividends continue to apply.
High wage earners in high tax states will likely see higher tax bills. Conversely, a similar taxpayer residing in a low tax state will likely see a tax savings due to the lower top rate and the expanded 35% tax bracket.
Charitable gifts could be worth more in 2017 instead of 2018 due to the change in the rates.
Estate and Trust Provisions
Tax Rate Structure
|Rates||Estate and Trusts|
|10%||Up to $2,550|
|24%||$2,550 to $9,150|
|35%||$9,150 to $12,500|
- Doubles the basic exclusion amount for gift and estate tax purposes from the current exclusion of $5.49 million in 2017 to $11.2 million, which will be indexed for inflation.
- The increased exclusion amount applies to estates of decedents dying and gifts made after December 31, 2017 and before January 1, 2026.
- The increased exclusion amount also applies to the generation-skipping transfer (GST) tax.
The new high exemption amount will allow married couples to exempt $22.4 million in 2018 from any gift or estate tax.
On January 1, 2026, the basic exclusion amount will revert to $5 million, as indexed for inflation from 2010.
The step-up in basis at death would continue to be in effect.
- Lower the top corporate tax rate from 35% to a flat 21% (the same flat rate applies to personal service corporations).
- Eliminates the corporate alternative minimum tax.
- The dividend received deductions will be reduced to 50% from the current 70% and 65% from the current 80%. This change is to account for the reduced corporate rate.
- Allows immediate expensing of 100% of the cost of new investments in depreciable assets acquired after September 27, 2017, and before January 1, 2023. (The placed-in-service date will be extended for one year for property with a longer production period).
- Unlike the present bonus depreciation rules, the asset does not have to be new property; however, it must be the business taxpayer’s first use of such property.
- Qualified property does not include any property used in a real property trade or business.
- Section 179 expensing is increased to $1 million for years 2018 to 2022. A phase-out of the Section 179 benefit will begin when the purchases exceed $2.5 million. (Qualified energy efficient heating and air conditioning property will be included as Section 179 property).
- The Senate proposal to reduce the cost recovery periods of residential and non-residential property to 25 years was not adopted. These remain at 27.5 and 39 years, respectively. However the recovery period for qualified improvement property is set at 15 years. The separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property are eliminated.
- Caps will be placed on write offs of business use vehicles. The new caps will be $10,000 for the first year a vehicle is placed into service, (presently, $3,160).
- Every business, regardless of form, would be subject to disallowance of a deduction for net interest expense in excess of 30% of the business’ adjusted taxable income. Net interest expense is determined at the tax filer level (e.g., the partnership versus the partner). Adjusted taxable income is business taxable income without regard to business interest expense, business interest income, net operating losses, depreciation, amortization and depletion. Disallowed interest under this rule becomes an indefinite carryover as an attribute of the business (not its owners). Businesses with average gross receipts of $25 million or less would be exempt from the interest limitation rules. (There is also an election for real estate trade or businesses to elect out of this limitation, but the cost is that use of the Alternative Depreciation System is required).
- Eliminate the deduction under Internal Revenue Code § 199 for domestic production (DPAD).
- Net Operating Losses (NOLs) would generally not be eligible for a carryback. However, any carryover can be used only to the extent of 80% of taxable income. This rule will apply to losses arising in tax years beginning after December 31, 2017. Additionally, the carryforward period will be indefinite.
- Research and Development (R&D) costs are subject to potential change. While the R&D credit is retained; for tax years 2022 and later, R&D expenses will not be subject to immediate write-off, but will be subject to mandatory five year amortization (15 years for research outside of the US). On retirement, abandonment or disposition of property, the unamortized basis will continue to be written off over the balance of the amortization period.
- After 2017, like-kind exchanges will apply only to real property, not held for sale, subject to a transition rule allowing for an exchange for personal property if there is a disposition of relinquished property or acquisition of replacement property by December 31, 2017.
- No deduction will be allowed for entertainment, amusement or recreation activities facilities, or membership dues relating to such activities or other social purposes. However the current deduction for business meals (subject to the 50% limitation) will be retained.
- Section 162(m) related to limitations on deductions for compensation to executives has been modified. The exception to the $1 million compensation limit for executives of publicly traded companies for commission and performance-based compensation, will be repealed effective for years beginning after December 31, 2017.
- Corporations and partnerships with corporate partners with average gross receipts of up to $25 million (indexed for inflation) are allowed to use the cash method of accounting. Existing corporation that meet this gross receipts threshold can automatically change their accounting method.
A key element of tax reform was to change the corporate tax rate so as to make U.S. corporations more competitive with those in foreign jurisdictions. This is accomplished by setting a flat 21% rate for regular corporations for tax years beginning after 2017. The law provides no special rate for personal service corporations, which will now be subject to the same 21% corporate rate.
The corporate AMT is repealed. Corporations will be allowed to use certain tax benefits to effectively pay below the new 21% rate.
Based on the above summary, many current business benefits will face repeal, but the framework specifically retains the R&D Credit, the Work Opportunity Tax Credit, the New Markets Tax credit, a revised Rehabilitation Tax Credit and the Low Income Housing Tax Credit.
Pass Through Entity Taxes
- An individual taxpayer may deduct 20% of domestic qualified business income from partnership, S corporation or sole proprietorship.
- The amount of the deduction will be limited to the greater of:
- 50% of W-2 wages paid by the business or;
- The sum of 25% of W-2 wages paid by the business and 2.5% of business capital.
- The wage limitation does not apply if taxable income is less than $157,500 (single) or $315,000 (joint) and applies fully if taxable income exceeds $207,000 (single) or $415,000 (joint).
- Trusts and estates will qualify for this deduction.
- The deduction is a post adjusted gross income item.
- The deduction is not affected by whether the owner is passive or active.
- For specific service businesses, such as those in accounting, law, consulting, and investing, but not engineering or architecture, the 20% deduction will apply only if the taxpayer’s taxable income is less than $157,500 (single) or $315,000 (joint). No deduction will be allowed if the taxable income exceeds $207,000 (single) or $415,000 (joint).
- The act changes the long-term capital gains holding period for certain assets held in partnerships engaged in investment and real estate activities (carried interest). After 2017, a three year holding period is created for long-term capital gain treatment of gains for a carried interest (instead of the typical one year requirement).
The final bill generally follows the Senate’s approach to the taxation of pass-through entities (S corporations, partnerships or sole proprietorships) and creates a rather complicated deduction for “qualified business income” for tax years 2018 through 2025. The final bill clarifies that the deduction will not be taken in reaching adjusted gross income, though it is available to both itemizers and non-itemizers. In a positive change, the final bill permits this deduction to be used by owners of pass-through entities which are trusts or estates.
The act creates preferential treatment for certain pass through entities by basically permitting a non-itemized deduction of 20%. The reduced amount would then be subject to the new marginal rates. Owners of larger, more profitable, service businesses will likely not be eligible for this deduction.
International Tax Provisions
- The new law adopts a participation exemption system that provides a 100% deduction for the foreign-source portion of dividends received from specified 10% owned foreign corporations by domestic corporations that are United States shareholders of those foreign corporations. No foreign tax credit or deduction is allowed for any taxes paid or accrued with respect to a dividend that qualifies for the 100% deduction.
- The new law preserves the deemed dividend treatment for investment in U.S. property by controlled foreign corporations, including corporate shareholders that will be entitled to the 100% dividends received deduction.
- The new law requires that for the last taxable year beginning before January 1, 2018, any U.S. shareholder of a foreign corporation that has at least one U.S. 10% shareholder must include in income its pro rata share of post-1986 accumulated earnings. The 10% U.S. shareholders must determine their deferred foreign income based on the greater of the aggregate post-1986 accumulated foreign earnings and profits as of November 9, 2017, or December 31, 2017, not reduced by distributions during the taxable year ending with or including the measurement date, unless such distributions were made to another specified foreign corporation.
- The effective tax rates for the deemed repatriation of foreign earnings upon transition to the new participation exemption system are established at 15.5% (for cash and cash equivalents) and 8% (for other earnings).
- U.S. shareholders subject to the repatriation tax may elect to pay the net tax liability in eight installments (8% in each of the first 5 years, 15% in year six, 20% in year 7, and 25% in year 8.
- A special rule is provided for S corporations, allowing continued deferral of the transition tax liability, unless a specified “triggering event” occurs (e.g., loss of S status, liquidation, or transfer of shares).
- The new law imposes a minimum tax on foreign earnings considered to be above a “routine” amount, termed global intangible low-tax income or “GILTI”. The tax is imposed on a current basis, at a full 21% rate, subject to a 50% deduction; additionally, the tax can be offset by a reduced (80%) foreign tax credit. As a result, an overall foreign effective tax rate of at least 13.125% generally will prevent the imposition of residual U.S. tax. The 50% GILTI deduction is reduced after 2025 from 50% to 37.5%.
- The new law provides a deduction for certain foreign derived intangible income, a variation of the “innovation box” benefit provided by other countries, allowing a 37.5% deduction for income earned directly by U.S. taxpayers from serving foreign markets (foreign derived intangible income). The deduction will result in a 13.125% effective tax rate on foreign derived intangible income. The deduction is reduced after 2025 from 37.5 percent to 21.875%.
- The new law does not include a permanent extension of the CFC look-through rule of section 954(c)(6). Thus, the look-through rule will remain a “tax extender” that will need to be renewed in order to prevent its expiration after 2019.
- The new law adopts the Senate’s base erosion and anti-abuse tax (BEAT) approach by imposing a new minimum tax at a rate of 10%. The BEAT is applicable to a more limited subset of multinational groups and, generally is not applicable to cross-border purchases of inventory includible in cost of goods sold. In adopting the BEAT, the Congress rejected the controversial House proposal for an excise tax on certain payments to related foreign parties that would have required multinational groups subject to the provision to choose between the gross-basis excise tax and an election by the recipient of the payment to treat the amount as “effectively connected income” subject to US tax.
- The new law provides an anti-hybrid rule denying deductions for interest and royalties paid to related foreign persons, where the payments either are not includible or are deductible in the hands of the recipient in its residence country.
- The new law provides for the denial of a dividends received deduction for hybrid dividends received from a CFC, and treats hybrid dividends as Subpart F income if received by a CFC.
- The new law provides changes to the definition of intangible property and expansions of the Internal Revenue Service’s ability to apply aggregation and “realistic alternatives” theories in connection with taxing the transfer of intangible property by a domestic corporation to a foreign corporation, and repeals the active trade or business exception for the outbound transfer of other assets to a foreign corporation.
The international provisions of the final bill move the United States towards a territorial system of taxation. The existing worldwide system is not entirely abandoned, as the new law provides for certain carryover provisions that allow the United States to tax certain categories of foreign earnings of U.S. companies. Specifically, the GILTI tax provisions and the minimum tax on intangible income continue to provide the U.S. with the ability to tax foreign earnings of U.S. companies.
The participation exemption provisions of the new law provide for the long overdue movement of the U.S. to align itself with the rest of the world in terms of allowing the tax-free repatriation of foreign earnings of domestic corporate subsidiaries. The participation exemption applies only to corporate shareholders of foreign corporations and as such, individual and pass-through shareholders of foreign corporations will continue to need to plan for the potential deferral of foreign earnings. Further, the transition tax on the mandatory, deemed repatriation of accumulated post-1986 earnings and profits will require analysis of pre-2018 reporting of foreign earnings. Taxpayers will also need to assess the short-term cash impact of the deemed repatriation provisions, as taxable income inclusions may result with respect to pre-2018 tax years.
The new law is likely to contain many technical glitches and will probably require technical corrections, fixes and adjustments to policies. Your Marcum Tax Advisor will keep you posted on any such revisions.