December 21, 2017
The Tax Cuts and Jobs Act of 2017
Congress has passed and the President is expected to sign the Tax Cuts and Jobs Act of 2017, the Republican tax reform bill. This alert summarizes some of the key business, international, and individual provisions of the Act that may impact you and your business. Please contact your primary Ulmer relationship attorney or one of the lawyers listed in this alert to discuss these provisions.
RATES, DEDUCTIONS, AND ACCOUNTING
Corporate Tax Rate
- The Act changes the corporate tax rate to a flat 21% for tax years beginning after December 31, 2017.
- The Act reduces the 80% dividends received deduction to 65% and the 70% dividends received deduction to 50%.
Corporate Alternative Minimum Tax
- The Act repeals the corporate AMT for tax years after December 31, 2017.
Temporary 100% Expensing for Certain Business Assets
- The Act permits full expensing for qualified depreciable assets placed in service after September 27, 2017.
- Expensing for property placed into service following January 1, 2023 is phased down by 20% per year starting in 2023.
- The Act removes the original-use requirement.
Expansion of Code Section 179 Expensing
- The Act increases the maximum amount that a taxpayer is permitted to expense under Code Section 179 to $1,000,000, and increases the phase-out threshold to $2,500,000.
- The Act expands the definition of Code Section 179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging.
- The Act also expands the definition of qualified real property eligible for Section 179 expensing to include any of the following improvements to nonresidential real property placed into service after the date that such property was first placed into service: roofs, heating, ventilation, air conditioning, fire protection and alarm systems, and security systems.
Limit on Business Interest Expense Deduction
- The Act limits the deduction for net interest expenses incurred by a business to the sum of business interest income, 30% of the business’s adjusted taxable income (without regard to deductions allowable for depreciation, amortization or depletion), and floor plan financing interest.
- Businesses with average annual gross receipts of $25 million or less are exempt from the limit.
- Taxpayers involved in certain real estate activities may choose to be exempt from this limitation (any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management leasing, or brokerage trade or business).
- Disallowed interest can be carried forward indefinitely.
Real Property Recovery Periods
- The Act affects depreciation deductions for property placed into service after December 31, 2017.
- The Act provides a 15-year recovery period for qualified improvement property which is any improvement to an interior portion of a building that is nonresidential property if such improvement is placed in service after the date that such building was first placed in service.
- For property placed into after December 31, 2017, the ADS recovery period for residential rental property is shortened from 40 years to 30 years.
Net Operating Loss Deduction
- The Act limits the net operating loss (NOL) deduction to 80% of taxable income and provides that amounts that are carried and applied against other years must be adjusted to account for the limitation on losses arising in tax years beginning after December 31, 2017.
- The Act eliminates carrybacks (except for farming NOLs, which have a special two-year carryback) and allows unused NOLs to be carried forward indefinitely for losses arising in taxable years beginning after December 31, 2017.
Section 1031 Like-Kind Exchanges of Real Property
- The Act limits the like-kind exchange non-recognition of gain to real property that is not held primarily for sale.
- This limitation generally applies to exchanges completed after December 31, 2017; however, there is an exception for any exchange if either the property being exchanged or the property received is exchanged or received before December 31, 2017.
- The Act provides that no deduction is permitted for (1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or (3) a facility or portion of a facility used in connection with (1) or (2).
- The Act disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, subject to certain exceptions.
- The Act creates a 3-year holding period for long-term capital gain treatment for certain carried interests in certain investment or real estate funds.
Denial of Deductibility of Fines and Penalties for Federal Income Tax Purposes
- The Act precludes a taxpayer from deducting amounts paid in relation to violation of a law or investigation of a law, if a government (or similar entity) is a complainant or investigator with respect to the violation or potential violation, subject to certain exceptions.
Denial of Deduction for Settlements Subject to Nondisclosure Agreements Paid in Connection with Sexual Harassment or Sexual Abuse
- The Act provides that no deduction is allowed for any settlement, payout, or attorney’s fees related to sexual harassment if the payments are subject to a nondisclosure agreement.
Substantial Built-in Loss for a Partnership
- The Act provides that, in addition to the present-law definition, a substantial built-in loss also exists if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all the partnership’s assets in a fully taxable transaction for cash equal to the assets’ fair market value, immediately after the transfer of the partnership interest.
Cash Method of Accounting
- The Act increases small business eligibility from $5 million to $25 million (indexed for inflation).
PASS-THROUGH ENTITY DEDUCTION
- After 2017, the Act allows a new deduction of 20% of domestic “qualified business income” (“QBI”) from a partnership, S corporation, or sole proprietorship.
- The Act defines QBI as the net amount of qualified items of income, gain, deduction, and loss for any qualified trade or business of the taxpayer, but specifically excludes any qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income.
- For a taxpayer with taxable income of more than $315,000 (for a joint return) or $157,500 (for a single filer), the Act imposes a limit on the deduction based on wages paid or on wages paid plus a capital element.
- The limit is the greater of the taxpayer’s allocable share of (a) 50% of the W-2 wages paid with respect to the trade or business, or (b) the sum of 25% of the W-2 wages with respect to the trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property (tangible property subject to depreciation held by the qualified trade or business at the close of the tax year, and which is used in the production of qualified business income, and for which the depreciable period has not ended prior to the end of the taxable year).
- The Act imposes an additional limit for taxpayers engaged in specified service businesses whose taxable income exceeds $315,000 (for a joint return) or $157,500 (for a single return filer) (the “Threshold Limit”).
- For specified service business owners, the deduction phases out for taxable income above the Threshold Limits.
- The amount of the deduction permitted under the Act is reduced by the ratio of the taxpayer’s taxable income in excess of the Threshold Amount divided by $100,000 (for a joint filer) or $50,000 (for a single filer).
- Thus, the deduction is fully phased-out for a specified service business owner with taxable income of at least $415,000 (for a joint filer) or $207,500 (for a single filer).
- The Act provides that the definition of a specified service trade or business in the Code would be modified to exclude engineering and architecture services.
- Trust and estate owners of pass-through entities are eligible for the 20% deduction.
EXECUTIVE COMPENSATION AND BENEFITS
Modification of Limitation on Excessive Employee Remuneration
- The Act modifies the $1,000,000 yearly limit on the deduction for compensation with respect to a covered employee of a publicly traded corporation.
- The Act expands the scope of application of Section 162(m) to include corporations with publicly traded debt and foreign companies publicly traded through American depository receipts.
- The Act eliminates the exceptions when compensation is commission-based or performance-based.
- The Act imposes a rule where if an individual is a covered employee at any time on or after January 1, 2017, that individual’s compensation from the same company remains subject to the 162(m) limit in the future, including payments made after that individual resigns, dies, etc.
- The Act includes a company’s principal financial officer as a covered employee.
- The Act provides a transition rule exception from this provision for remuneration provided pursuant to a written binding contract in effect on November 2, 2017 as long as the contract has not been materially modified.
Excise Tax on Excess Tax-Exempt Organization Executive Compensation
- The Act imposes a 21% excise tax on compensation in excess of $1 million paid to an applicable tax-exempt organization’s five highest-paid employees for the tax year (or any person who qualified as such an employee for any preceding tax year after December 31, 2016).
- The Act also applies the excise tax to any parachute payment (solely separation pay) exceeding the portion of the base amount (the average annual annualized compensation includible in the covered employee’s gross income for the five taxable years ending before the date of the employee’s separation from employment) subject to exceptions.
- Employer-paid compensation paid to employees who are not highly compensated employees (under Code Section 414(q)) is excluded from the definition of parachute payments, and compensation attributable to medical services of qualified medical professionals is exempt from the parachute payment rules.
- Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to such remuneration.
Qualified Equity Grants
- The Act creates a new election to defer recognition of gain for up to five years after vesting for employees of nonpublic companies who are granted stock options or restricted stock units (RSUs).
- These new elections apply only to employee’s employer stock, and the options or RSUs must be granted in connection with performance of services by the employee.
- A written plan must provide that at least 80% of the employees of the company would be granted stock options or RSUs with the same rights and privileges, and only if affected employees (new hires or existing employees) are either granted stock options or restricted stock units for that year, and not a combination of both.
- Certain employees would be excluded from the election such as 1% owners, the CEO, and CFO.
- RSUs would not be eligible for a Section 83(b) election, and the receipt of qualified stock would not be treated as nonqualified deferred compensation for purposes of Section 409A.
- Subject to transition rules, these provisions would apply to stock attributable to options exercised, or RSUs settled, after December 31, 2017.
Rollovers of Plan Loan Offsets
- The Act provides that an employee who has taken a plan loan from a qualified retirement plan has until the due date for the filing of the employee’s tax return for that year (including extensions) to contribute the loan balance to an IRA (instead of the current 60 days) to avoid having the loan amount treated as a taxable distribution.
- This provision applies to employees whose plans terminate or who separate from service while having a plan loan outstanding for tax years beginning after December 31, 2017.
Nonqualified Deferred Compensation
- The Act maintains the current treatment of nonqualified deferred compensation under 409A.
BUSINESS TAX CREDITS
Historic Tax Credit
- The Act repeals the 10% credit for pre-1936 buildings.
- The Act provides a 20% credit (to be claimed ratably over a five-year period beginning in the tax year when the structure is placed into service) for a certified historic structure subject to a modification.
- The Act has a transition rule that applies to qualified rehabilitation expenditures (for either a historic structure or pre-1936 building), for any building owned or leased by the taxpayer at all times on or after January 1, 2018, through the 24-month period selected by the taxpayer (or the 60-month period selected by the taxpayer under the rule for phased rehabilitation) that is to begin not later than the end of the 180-day period beginning on the date of the enactment of the Act.
Low-Income Housing Credit
- The Act preserves the Low-Income Housing Credit.
New Markets Tax Credit
- The Act preserves the current status of the New Markets Tax Credit.
Research and Development Credit
- The Act preserves the Research and Development Credit.
Employer Credit for Paid Family Medical Leave
- The Act allows eligible employers (those who allow all qualifying full-time employees at least two weeks annual paid family and medical leave and allow part-time employees a commensurate amount of leave on a pro rata basis) to claim a business credit for 12.5% of the wages paid to qualifying employees during any period where such employee is on family and medical leave if the payment rate under the program is 50% of the wages normally paid to an employee.
- The Credit would be increased by .25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%.
- The Credit would not apply to wages paid in tax years beginning after December 31, 2019.
Move to territorial (rather than worldwide) system of corporate taxation.
- Under current law, foreign income earned by a foreign subsidiary of a U.S. corporation is subject to U.S. tax when the income is distributed as a dividend to the U.S. corporation.
- The Act exempts from U.S. taxation 100% of the foreign-source portion of dividends paid by a 10%-owned foreign subsidiary to its U.S. corporate shareholder.
- No foreign tax credit or deduction allowed for foreign taxes paid/accrued with respect to exempt dividends.
- Effective for distributions made after 2017.
Deemed repatriation of untaxed foreign earnings.
- The Act requires a U.S. corporate shareholder of a foreign subsidiary to include in income the subsidiary’s earnings and profits (E&P) to the extent the E&P has not been previously subject to U.S. tax.
- Untaxed foreign E&P determined as of November 2, 2017 or December 31, 2017, whichever is higher.
- 5% tax rate for foreign E&P retained as cash or cash equivalents.
- 8% tax rate for foreign E&P that was reinvested in the foreign subsidiary’s business (e.g., property, plant and equipment).
- S. corporate shareholder can elect to pay the tax over 8 years.
Minimum U.S. tax on foreign subsidiary intangible income.
- To prevent base erosion and profit shifting, the Act subjects to U.S. taxation 50% of a U.S. parent corporation’s “global intangible low-taxed income” (GILTI) for its foreign subsidiaries, with a deduction of 37.5% for foreign-derived intangible income.
- In effect a minimum tax on foreign subsidiary intangible income.
- Effective for tax years beginning after 2017.
Base erosion tax on payments from U.S. corporations to foreign affiliates.
- Also to prevent base erosion and profit shifting, the Act imposes a base erosion tax on payments made by U.S. corporations to foreign related corporations if the payments are deductible or includible in the basis of a depreciable/amortizable asset. Payments for cost of goods sold do not count as base erosion payments.
- The provision applies to U.S. corporations with 3-year average annual gross receipts of at least $500 million and who meet certain other requirements.
- Applicable to base erosion payments paid or accrued in tax years beginning after 2017.
- The Act imposes brackets of 0%, 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
- The top rate of 37% begins at $500,000 for single taxpayers and $600,000 for married filing jointly.
- Single filers – $12,000.
- Joint filers – $24,000.
- Unmarried individual with at least one qualifying child – $18,000.
- The increased standard deduction amounts expire after December 31, 2025.
- The Act repeals the deduction for personal exemptions effective for tax years beginning after December 31, 2017.
Alternative Minimum Tax (AMT)
- The Act temporarily increases the exemption amount to $109,400 for married filing jointly and $70,300 for single filers.
- Effective for tax years following December 31, 2017, and before January 1, 2026, the Act increases the phase-out of the AMT exemption amounts to the following: $1,000,000 for married taxpayers filing jointly or for surviving spouses; and $500,000 for single taxpayers.
Limitation on Itemized Deductions
- The Act eliminates the overall limit on itemized deductions for tax years beginning after December 31, 2017, and before January 1, 2026.
Mortgage Interest Deduction
- The Act reduces the mortgage interest deduction for home acquisition indebtedness to interest on $750,000 for mortgage debt for a principal residence and a second home incurred after December 15, 2017.
- The $1 million limit remains for debt incurred on or before December 15, 2017.
- The Act eliminates the deduction for interest on home equity indebtedness.
State and Local Tax Deduction
- The Act limits the itemized deduction for sales, state and local income, and property tax up to a combined total of $10,000 ($5,000 for married individuals filing separately) for tax years beginning after December 31, 2017 and ending before January 1, 2026.
- For amounts paid in tax years prior to January 1, 2018 for state or local income taxes, beginning after December 31, 2017, the taxpayer’s payment is treated as if it was paid on the last day of the tax year for which the state or local income tax is imposed for purposes of the applying the $10,000 limit.
- The Act increases adjusted gross income limitation on cash contributions from 50% to 60%.
- The Act repeals the current 80% deduction for contributions made for university athletic seating rights.
- The Act repeals the exception to the contemporaneous written acknowledgment requirement for contributions of $250 or more when the donee organization files the required return.
- The Act allows Code Section 529 accounts to be used to pay up to $10,000 per year for qualified expenses for qualified tuition programs, which now include elementary and secondary schools (but not home-schooling expenses).
Affordable Care Act Individual Mandate
- The Act reduces the individual responsibility payment to $0 for months beginning after December 31, 2018.
Medical Expense Deduction
- For tax years beginning after December 31, 2016, and ending before January 1, 2019, the Act reduces the medical expense deduction floor to 7.5% of adjusted gross income from the current floor of 10%.
- For these years, the threshold applies for purposes of the AMT and regular tax.
Alimony Payments Deduction
- The Act eliminates the above-the-line deduction for alimony payments effective for any divorce or separation instrument executed after December 31, 2018, or for any divorce or separation instrument before December 31, 2018, and modified after that date, if the modification expressly provides that the amendments to the Code made by the Act apply to the modification.
- Alimony payments received by the payee spouse will become nontaxable.
Moving Expense Deduction
- The Act eliminates the deduction for a taxpayer who incurs moving expenses when starting a new job in a new location at least 50 miles away from the taxpayer’s former residence.
- The Act maintains the deduction for moving expenses (and reimbursements for these expenses) for members of the U.S. Armed Forces under certain circumstances.
Exclusion for Qualified Moving Expense Reimbursements
- The Act suspends the exclusion from gross income for qualified moving expense reimbursements for tax years beginning after December 31, 2017, and before January 1, 2026.
- The Act maintains the exclusion for active duty members of the Armed Forces who move pursuant to a military order and incident to a permanent change of station.
Expenses Attributable to the Trade or Business of Being an Employee
- For tax years beginning after December 31, 2017, and before January 1, 2026, the Act suspends the deduction for expenses attributable to the trade or business of performing services as an employee.
Enhancement of the Child Tax Credit
- The Act increases the Child Tax Credit to $2,000.
- The phase-out amount for the Credit begins at $400,000 for married filing jointly.
Estate and Gift Taxes
- The Act doubles the estate and gift tax exemption for estates of individuals dying and for gifts made after December 31, 2017, and before January 1, 2026.
- The exclusion amount is increased from $5 million to $10 million provided in Code Section 2010(c)(3) and indexed for inflation.
- The Act does not repeal the estate tax.
- The Act increases the generation-skipping tax exemption amount to $10 million (with inflation adjustments), effective for generation-skipping transfers made after 2017 and before 2026.
- The Act does not repeal the generation-skipping transfer tax.
Recharacterization of Certain IRA and Roth IRA Contributions
- The Act provides that a recharacterization cannot be used to unwind Roth IRA conversions.