By: Amanda Wilson
This morning, Congress passed the Republican’s tax reform bill, the Tax Cuts and Jobs Act (the “Act”). President Trump is expected to sign the Act into law almost immediately. The Act will drastically change the Internal Revenue Code, with most of the changes going into effect January 1st. The following is a brief list of some of the key changes.
Individual Income Tax Changes
- Maintains the same number of tax brackets, but reduces the tax rate for the top bracket from 39.6% to 37%. In addition, the Act adjusts the taxable income ranges for the tax brackets in a manner that reduces the effective tax rate for most taxpayers.
- Provides a 20% deduction for qualified business income, which is generally income from a partnership, sole proprietorship, S corporation, as well as certain non-capital gain REIT dividends or publicly traded partnership income. The deduction is limited to the greater of (i) 50 percent of the W-2 wages paid by the qualified trade or business, or (ii) the sum of 25% of the W-2 wages plus 2.5% of the unadjusted basis of the qualified trade or business assets. Business that provide services in certain fields such as health, law, consulting, financial services and brokerage services are excluded from this preferential treatment.
- Approximately doubles the standard deduction (for those that do not itemize deductions).
- Suspends personal exemption deductions (currently, $4,050 each for taxpayer, spouse, and any dependents).
- Increases the child care credit to $2000 (refundable up to $1400), and provides for a $500 nonrefundable credit for the care of qualifying dependents other than children (for example, parents).
- Suspends the limitation on itemized deductions (the so-called Pease limitation that can limit itemized deductions to 80% for high earners).
- Limits the mortgage interest deduction to indebtedness up to $750,000 (as compared to $1 million currently) for loans incurred after December 31, 2017, and suspends the deduction for mortgages on second homes and home equity loans.
- Suspends itemized deductions for state and local taxes (except for $10,000 in state and local income or property tax).
- Suspends deductions for personal casualty losses (from fires, storms, theft), although this does not apply where there is special disaster relief legislation.
- Suspends deductions for tax preparation expenses, medical expenses, employee expenses, and most moving expenses.
- Increases the individual alternative minimum tax exemption amount and phase-out thresholds.
- Repeals deductions for alimony payments, and provides for income inclusion on the part of the recipient. This change applies to agreements executed or modified after December 31, 2018.
- Increases the charitable contribution limitation from 50% to 60% of adjusted gross income for cash contributions to public charities and certain private foundations.
- Provides that excess business losses must be carried forward to future tax years. Excess business losses for a business are the amount that the aggregate deductions attributable to trades or businesses exceed the sum of (i) the aggregate gross income or gains plus (ii) $250,000. Excess business losses are determined after the application of the passive activity loss rules.
With the exception of the changes discussed in the last three bullet points (alimony, charitable contributions and excess business losses), the changes discussed above are all temporary and will expire December 31, 2025.
Estate and Generation-Skipping Transfer Tax Changes
- Doubles the existing basic exclusion amount for estate and gift tax from $5 million to $10 million (adjusted for inflation). The change is temporary and expires after December 31, 2025.
Business Tax Changes
- Reduces the corporate tax rate to a flat 21%.
- Repeals the corporate alternative minimum tax.
- Allows corporations to expense fully and immediately 100% of the cost of qualified property acquired and placed in service after September 2017 and before January 1, 2023.
- Increases the Section 179 expense amount from $500,000 to $1 million and the phase-out amount from $2 million to $2.5 million.
- Disallows deduction for net interest expense in excess of 30% of the business’s adjusted taxable income (a comparable rule would apply to partnerships). Disallowed losses are carried forward.
- Provides that tax-free like-kind exchanges will only be available for real property.
- Repeals the deduction for local lobbying expenses.
- Repeals the deduction for income attributable to domestic production activities. The repeal is effective for C corporations for taxable years beginning after December 31, 2018.
- Expands the Section 162(m) $1 million limitation on deductible compensation by eliminating the exception for performance-based compensation.
- Creates a 21% excise tax for tax-exempt organizations on the payment of compensation in excess of $1 million (as well as certain parachute payments) if paid to one of the five highest paid employees.
- Repeals the deduction for entertainment expenses.
- Taxes gain or loss from the disposition of a self-created patent, invention, model, or secret formula as ordinary in character (currently capital in nature).
- Repeals the rule triggering a technical termination of partnerships where there is an exchange of 50% or more of the partnership interests within a 12 month period.
- Imposes a special three-year holding period for long term capital gain treatment on dispositions of partnership interests received by a taxpayer in exchange for certain services (i.e., taxes such gain at ordinary income rates if three-year holding period is not satisfied). This three-year holding period applies even where the taxpayer made a Section 83(b) election.
- Modifies the rehabilitation credit.
- Repeals tax credit bond rules.
International Tax Reform
- Provides for a 100% exemption on foreign source portion of dividends paid by a foreign corporation to U.S. corporate shareholders that own at least 10% or more of the foreign corporation. This means that U.S. corporations can generally bring future foreign earnings back into the U.S. tax-free.
- Repeals the tax imposed when untaxed foreign subsidiary earnings are reinvested in U.S. property.
- Provides for a one-time tax on earnings currently held offshore as a deemed-repatriation. The tax rate is effectively 15.5% for any portion of earnings and profits that are cash or cash equivalents, and 8% for all other amounts.
- Repeals the availability of certain foreign credits, including the Section 902 indirect foreign tax credit.
- Provides a deduction for C corporations that results in an effective tax rate on foreign-derived intangible income of 21.875% (2018), 12.5% (2019-2025) or 15.625% (2026 on) and an effective tax rate on global intangible low-taxed income of 17.5% (2018), 10% (2019-2025) or 12.5% (2026 on).
- Modifies Subpart F income in generally tax-favorable ways.
- Introduces a new tax regime on U.S. shareholders with foreign high returns.
- Imposes a tax on payments made by U.S. corporations to related foreign corporations if the payments are deductible.
It should be noted that the Bill does not change the tax rates for capital gains and dividends nor does it impact the Affordable Care Act's 3.8% net investment income tax imposed on high earners. It does, however, repeal the Affordable Care Act’s individual mandate.