Dear Clients and Friends,
On Friday, December 22, 2017, President Trump signed the Tax
Cuts and Jobs Act (TCJA), the largest tax bill in over 30 years. This tax
reform brings sweeping changes that will affect all taxpayers for 2018 and
future years. The following is a brief
summary of some of the changes that may affect you and your businesses, some of
which may warrant action prior to the close of the current calendar year.
Individual Tax Provisions
New Individual Income Tax Rates. For tax years 2018-2025,
the following tax rates will apply:
Prior Law (2018)
|
|
New Law (2018)
|
Over
|
But not
over:
|
Rate
|
|
Over
|
But
not over:
|
Rate
|
Married Filing Joint or
Qualifying Widow(er)
|
$
|
0
|
$
19,050
|
10%
|
|
$
|
0
|
$
|
19,050
|
10%
|
19,050
|
77,400
|
15%
|
|
19,050
|
77,400
|
12%
|
77,400
|
156,150
|
25%
|
|
77,400
|
165,000
|
22%
|
156,150
|
237,950
|
28%
|
|
165,000
|
315,000
|
24%
|
237,950
|
424,950
|
33%
|
|
315,000
|
400,000
|
32%
|
424,950
|
480,050
|
35%
|
|
400,000
|
600,000
|
35%
|
480,050
|
|
39.6%
|
|
600,000
|
|
37%
|
Single
|
nbsp; 0
|
$
|
9,525
|
10%
|
|
nbsp; 0
|
$
|
9,525
|
10%
|
9,525
|
38,700
|
15%
|
|
9,525
|
38,700
|
12%
|
38,700
|
93,700
|
25%
|
|
38,700
|
82,500
|
22%
|
93,700
|
195,450
|
28%
|
|
82,500
|
157,500
|
24%
|
195,450
|
424,950
|
33%
|
|
157,500
|
200,000
|
32%
|
424,950
|
426,700
|
35%
|
|
200,000
|
500,000
|
35%
|
426,700
|
|
39.6%
|
|
500,000
|
|
37%
|
Head of Household
|
$
|
0
|
$ 13,600
|
10%
|
|
$
|
0
|
$
|
13,600
|
10%
|
13,600
|
51,850
|
15%
|
|
13,600
|
51,800
|
12%
|
51,850
|
133,850
|
25%
|
|
51,800
|
82,500
|
22%
|
133,850
|
216,700
|
28%
|
|
82,500
|
157,500
|
24%
|
216,700
|
424,950
|
33%
|
|
157,500
|
200,000
|
32%
|
424,950
|
453,350
|
35%
|
|
200,000
|
500,000
|
35%
|
453,350
|
|
39.6%
|
|
500,000
|
|
37%
|
Married Filing Separate
|
nbsp; 0
|
nbsp; 9,525
|
10%
|
|
nbsp; 0
|
nbsp; 9,525
|
10%
|
9,525
|
38,700
|
15%
|
|
9,525
|
38,700
|
12%
|
38,700
|
78,075
|
25%
|
|
38,700
|
82,500
|
22%
|
78,075
|
118,975
|
28%
|
|
82,500
|
157,500
|
24%
|
118,975
|
212,475
|
33%
|
|
157,500
|
200,000
|
32%
|
212,475
|
240,025
|
35%
|
|
200,000
|
300,000
|
35%
|
240,025
|
|
39.6%
|
|
300,000
|
|
37%
|
|
|
|
|
|
|
|
|
|
|
|
Simplification of the Kiddie Tax. Under pre-TCJA law,
pursuant to the "kiddie tax" provisions, the net unearned income of a
child was taxed at the parents' tax rates if the parents' tax rates were higher
than the tax rates of the child. The remainder of the child's taxable income (earned
income, plus unearned income up to $2,100 (for 2018), less the child's standard
deduction) was taxed at the child's rates.
For tax years 2018-2025, the taxable income of a child
attributable to earned income is taxed under the rates for single individuals,
and taxable income of a child attributable to net unearned income is taxed
according to the brackets applicable to trusts and estates
Suspension of Personal Exemption Deduction. Under pre-TCJA
law, the deduction for each personal exemption was $4,150 for 2018, subject to
a phaseout for higher earners. For tax years 2018-2025, the deduction for
personal exemptions is temporarily repealed.
Standard Deduction Temporarily Increased. Under pre-TCJA
law, for 2018, the standard deduction amounts were to be: $6,500 for single
individuals and married individuals filing separately, $9,550 for heads of
household, and $13,000 for married individuals filing jointly (including
surviving spouses). Additional standard deductions may be claimed by taxpayers
who are elderly or blind.
For tax years 2018-2025, the standard deduction is increased
to $24,000 for married individuals filing a joint return, $18,000 for head-of-household
filers, and $12,000 for all other taxpayers, adjusted for inflation in tax
years after 2018. No changes were made to the current-law additional standard
deduction for the elderly and blind.
Medical Expense Deduction Threshold Temporarily Reduced. For
tax years 2017-2018, the threshold for medical expense deductions is reduced
from 10% of AGI to 7.5% of AGI for all taxpayers. Additionally, the rule
limiting the medical expense deduction for Alternative Minimum Tax (AMT)
purposes to the excess of such expenses over 10% of AGI doesn't apply to those
tax years.
State and Local Tax Deduction Limited. For tax years
2018-2025, a taxpayer's itemized deduction for state and local taxes is limited
to $10,000 ($5,000 for a married taxpayer filing a separate return) of the
aggregate of (1) state and local property taxes and (2) state and local income,
war profits, and excess profits taxes (or sales taxes in lieu of income taxes)
paid or accrued in the tax year. The law
also provides that an individual may not claim an itemized deduction in 2017 on
a pre-payment of income tax for a future tax year in order to avoid the dollar
limitation applicable for tax years beginning after 2017.
Mortgage and Home Equity Indebtedness Interest Deduction
Limited. Under pre-TCJA law, taxpayers could deduct as an itemized deduction
qualified residence interest, which included interest paid on a mortgage
secured by a principal residence or a second residence. The underlying mortgage
loans could represent acquisition indebtedness of up to $1 million, plus home
equity indebtedness of up to $100,000. For
tax years 2018-2025, the deduction for interest on home equity indebtedness is
eliminated and the deduction for mortgage interest is limited to underlying
indebtedness of up to $750,000 ($375,000 for married taxpayers filing
separately). The new lower limit doesn't
apply to any acquisition indebtedness incurred before 12/15/17.
Charitable Contribution Deduction Limitation Increased. For
contributions made in tax years after 2017, the 50% limitation under IRC Sec.
170(b) for cash contributions to public charities and certain private
foundations is increased to 60%. Contributions
exceeding the 60% limitation are generally allowed to be carried forward and
deducted for up to five years, subject to the later year's ceiling.
Charitable Contribution Deduction for College Athletic
Seating Rights Eliminated. Under pre-TCJA law, a taxpayer could treat 80% of a
payment as a charitable contribution where: (1) the amount was paid to or for
the benefit of an institution of higher education; and (2) such amount would be
allowable as a charitable deduction but for the fact that the taxpayer receives
(directly or indirectly) as a result of the payment the right to purchase
tickets for seating at an athletic event in an athletic stadium of such
institution. For tax years after 2017, no charitable deduction will be allowed
for any payment to an institution of higher education in exchange for the right
to purchase tickets or seating at an athletic event.
Casualty and Theft Loss Deduction Limited. For tax years
2018-2025, the personal casualty and theft loss deduction is eliminated, except
for personal casualty losses incurred in a federally-declared disaster.
However, where a taxpayer has personal casualty gains, the loss suspension
doesn't apply to the extent that such loss doesn't exceed gain. Special rules apply for 2016 and 2017
disasters.
Gambling Loss Limitation Clarified. For tax years 2018-2025,
the limitation on wagering losses under IRC Sec. 165(d) is clarified to provide
that all deductions for expenses incurred in carrying out wagering
transactions, and not just gambling losses, are limited to the extent of
gambling winnings.
Miscellaneous Itemized Deductions Suspended. For tax years
2018-2025, the deduction for miscellaneous itemized deductions that are subject
to the 2% floor is eliminated.
Overall Limitation on Itemized Deductions Eliminated. Under
pre-TCJA law, higher-income taxpayers who itemized their deductions were
subject to a limitation on these deductions. For tax years 2018-2025, the overall
limitation on itemized deductions is eliminated.
Income and Losses
New Deduction for Pass-through Business Income. For tax
years 2018-2025, an individual generally may deduct 20% of qualified business
income from a partnership, S corporation, or sole proprietorship, as well as
20% of aggregate qualified Real Estate Investment Trust (REIT) dividends,
qualified cooperative dividends, and qualified publicly traded partnership
income. Special rules apply to specified agricultural or horticultural
cooperatives. The 20% deduction is not allowed in computing Adjusted Gross
Income (AGI), but rather is allowed as a deduction reducing taxable income.
A limitation based on W-2 wages paid is phased in for married
filing joint taxpayers with taxable income of $315,000 or more ($157,500 for
other individuals). A disallowance of the deduction with respect to specified
service trades or businesses also is phased in above these threshold amounts of
taxable income. A specified service trade or business means any trade or
business involving the performance of services in the fields of health, law,
consulting, athletics, financial services, brokerage services, or 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 owners, or which involves the
performance of services that consist of investing and investment management
trading, or dealing in securities, partnership interests, or commodities.
Treatment of Carried Interest. Under pre-TCJA law, carried
interests were taxed in the hands of the taxpayer at favorable capital gain
rates instead of as ordinary income. For tax years beginning after 2017, the
TCJA imposes a three-year holding period requirement in order for certain
partnership interests received in connection with the performance of services
to be taxed as long-term capital gain rather than ordinary income.
New Limitations on "Excess Business Loss." An
excess business loss for the tax year is the excess of aggregate deductions of
the taxpayer attributable to the taxpayer's trades and businesses over the sum
of aggregate gross income or gain of the taxpayer plus a threshold amount. The
threshold amount for a tax year is $500,000 for married individuals filing
jointly and $250,000 for other individuals, with both amounts indexed for
inflation. In the case of a partnership or S corporation, the provision applies
at the partner or shareholder level.
Self-created Property Not Treated as Capital Asset. Under
pre-TCJA law, property held by a taxpayer
is generally considered a capital asset. However, certain assets are
specifically excluded from the definition of a capital asset, including
inventory property, depreciable property, and certain self-created intangibles
(e.g., copyrights and musical compositions).
Effective for dispositions after 2017, the TCJA amends IRC
Sec. 1221(a)(3) , resulting in the exclusion of patents, inventions, models or
designs (whether or not patented), and secret formulas or processes, which are
held either by the taxpayer who created the property or by a taxpayer with a
substituted or transferred basis from the taxpayer who created the property (or
for whom the property was created), from the definition of a "capital asset."
Alimony Deduction by Payor and Income Inclusion by Payee
Repealed. For any divorce or separation agreement executed after 2018, or
executed before that date but modified after it (if the modification expressly
provides that the new amendments apply), alimony and separate maintenance
payments are not deductible by the payor spouse and are not included in the
income of the payee spouse.
Moving Expense Deduction and Reimbursements Suspended. For tax years 2018-2025, the deduction for
moving expenses and the income exclusion for qualified moving expense
reimbursements is eliminated, except for members of the Armed Forces on active
duty (and their spouses and dependents) who move pursuant to a military order
and incident to a permanent change of station.
AMT
AMT Retained with Increased Exemption Amounts. The TCJA
retains the individual AMT but with the following increased exemption amounts
and phase-out thresholds for years 2018-2025:
|
Prior Law (2018)
|
New Law (2018)
|
AMT Exemption:
|
|
|
Married filing joint or qualifying widow(er)
|
nbsp;
86,200
|
nbsp;
109,400
|
Single or head of household
|
55,400
|
70,300
|
Married filing separate
|
43,100
|
54,700
|
Exemption Reduced by
25% of AMTI over:
|
|
|
Married filing joint or qualifying widow(er)
|
nbsp;
164,100
|
$1,000,000
|
Single or head of household
|
123,100
|
500,000
|
Married filing separate
|
82,050
|
500,000
|
Qualified Tuition Programs (Section 529 accounts) Expanded.
Under pre-TCJA law, the earnings on funds in a QTP could be withdrawn tax-free
only if used for qualified higher education expenses at eligible schools.
Eligible schools included colleges, universities, vocational schools, or other
postsecondary schools eligible to participate in a student aid program of the
Department of Education. For
distributions after 2017, "qualified higher education expenses" is
expanded to include tuition at an elementary or secondary public, private, or
religious school, up to a $10,000 limit per tax year.
Other Significant Items
Child Tax Credit Increased. For tax years 2018-2025, the
child tax credit is increased from $1,000 to $2,000 per qualifying child under
the age of 17, and other changes are made to phase-outs and refundability.
Under pre-TCJA law, the credit phased out by $50 for each
$1,000 of modified AGI over $75,000 for single or head of household filers,
$110,000 for married joint filers, and $55,000 for married individuals filing
separately. Under the TCJA, the income level at which the credit phases out is
increased to $400,000 for married taxpayers filing jointly ($200,000 for all
other taxpayers) (not indexed for inflation).
Nonchild Dependents. A $500 nonrefundable credit is provided
for certain nonchild dependents.
Refundability. The amount that is refundable is increased to
$1,400 per qualifying child, and this amount is indexed for inflation, up to
the $2,000 base credit amount. The earned income threshold for the refundable
portion of the credit is decreased from $3,000 to $2,500.
Affordable Care Act Individual Mandate Repealed. Under
pre-TCJA law, the Affordable Care Act required individuals, who were not
covered by a health plan that provided at least minimum essential coverage, to
pay a "shared responsibility payment" with their federal tax return.
Unless an exception applied, the tax was imposed for any month that an individual
did not have minimum essential coverage.
For months beginning after 2018, the amount of the individual shared
responsibility payment is permanently reduced to zero.
Recharacterization of Roth Conversions Eliminated. For tax
years beginning after December 31, 2017, the special rule that allows a
contribution to one type of IRA to be recharacterized as a contribution to the
other type of IRA does not apply to a conversion contribution to a Roth IRA.
Thus, recharacterization cannot be used to unwind a Roth IRA conversion.
Estate and Gift Tax Exemption Doubled. Under pre-TCJA law,
the first $5 million (as adjusted for inflation in years after 2011) of
transferred property was exempt from estate and gift tax. For estates of
decedents dying and gifts made in 2018, this "basic exclusion amount"
was $5.6 million ($11.2 million for a married couple). For estates of decedents dying and gifts made
after 2017 and before 2026, the TCJA doubles the base estate and gift tax
exemption amount from $5 million to $10 million.
Entity-specific Tax Provisions
Under the TCJA, C corporations, S corporations,
partnerships, and nonprofit organizations will see significant changes. Here
are some highlights.
C Corporations
Tax Rates. Currently, C corporations are used to graduated
tax rates, with a top rate of 35% if taxable income exceeds $10 million. In
addition, personal service corporations are taxed at a flat rate of 35%. For
tax years beginning after 12/31/17, the TCJA lowers the corporate tax rate to a
flat 21%. This applies to personal service corporations as well.
Dividends Received Deduction. Corporations are generally
permitted a special deduction for dividends received. If the corporation owns
at least 20% of another corporation, an 80% dividends received deduction is
permitted. Otherwise, the deduction is limited to 70%. If the payor and
recipient corporations are members of the same affiliated group, a 100%
dividends received deduction is allowed. Under the TCJA, the 80% dividends
received deduction is reduced to 65%, and the 70% deduction is reduced to 50%.
This applies to tax years beginning after 12/31/17.
AMT. The TCJA repeals the corporate AMT for tax years
beginning after 12/31/17. For tax years beginning after 2017 and before 2022,
the AMT credit is refundable and can offset regular tax liability in an amount
equal to 50% (100% for tax years beginning in 2021) of the excess of the
minimum tax credit for the year over the amount of the credit allowable for the
year against regular tax liability. This means the full amount of the minimum
tax credit will be allowed in tax years beginning before 2022.
Contributions to Capital. Generally capital contributions
are excluded from a corporation's gross income. The TCJA provides that the term
contributions to capital does not include (1) any contribution in aid of
construction or any other contribution as a customer or potential customer and
(2) any contribution by any governmental entity or civic group (other than a
contribution made by a shareholder as such).
S Corporations
Electing Small Business Trusts. Electing Small Business
Trusts (ESBTs) are allowed to own stock in an S corporation. Effective 1/1/18,
the TCJA permits a nonresident alien individual to be a potential current
beneficiary of an ESBT.
Partnerships
Technical Terminations. A partnership is considered to
terminate for tax purposes if, within a 12-month period, there is a sale or
exchange of 50% or more of the partnership's capital and profits interests.
This rule is repealed under the TCJA for partnership tax years beginning after
12/31/17. As such, new elections are not required or permitted following
technical termination under prior law.
Substantial Built-in Loss Rule. In general, a partnership
must adjust the basis of its property following the transfer of a partnership
interest if it has a substantial built-in loss. A substantial built-in loss
exists if the partnership's adjusted basis in the property exceeds its fair
market value by more than $250,000. Under the TCJA, a substantial built-in loss
also exists if the recipient of the interest would be allocated a net loss in
excess of $250,000 upon a hypothetical disposition of all partnership assets in
a fully taxable transaction for cash equal to the assets' fair market value
immediately after the transfer of the interest. The provision applies to
transfers of partnership interests after 12/31/17.
Charitable Contributions and Foreign Taxes. For partnership
tax years beginning after 12/31/17, a partner's distributive share of the
partnership's charitable contributions and foreign taxes is taken into account
in determining the amount of his or her loss. However, in the case of a
charitable contribution of property with a fair market value that exceeds its
adjusted basis, the partner's distributive share of the excess is not taken
into account.
Nonprofit Organizations
New Excise Tax on Excess Executive Compensation. The TCJA
imposes a new 21% excise tax on tax-exempt organizations that pay excessive
compensation to their top executives, effective for tax years beginning after
12/31/17. The tax applies to the sum of (1) compensation in excess of $1
million paid to a covered employee and (2) any excess parachute payment made to
a covered employee. A covered employee is one of the five highest compensated
employees of the tax-exempt organization for the tax year or was a covered
employee of the organization (or a predecessor) for any preceding tax year
beginning after 12/31/16. Special rules apply to compensation paid to licensed
medical professionals.
New Excise Tax on Private Colleges and Universities. For tax
years beginning after 12/31/17, the TCJA imposes a new 1.4% excise tax on the
net investment income of certain private colleges and universities. The college
or university must have at least 500 students, more than 50% of which are
located in the U.S. In addition, the college or university must have assets
(other than those used directly in carrying out the institution's exempt
purpose) of at least $500,000 per student.
Calculation of Unrelated Business Taxable Income. For tax
years beginning after 12/31/17 (but subject to a transition rule for NOLs
arising in a tax year beginning before 1/1/18), losses from one unrelated trade
or business may not be used to offset income derived from another unrelated
trade or business. Therefore, the TCJA requires nonprofit organizations to
separately calculate and apply their unrelated business gains and losses.
General Business Tax Provisions
Expensing and Depreciating Property
Section 179
Deduction. Under pre-TCJA law, the maximum Section 179 deduction was scheduled
to be $520,000 for 2018. In addition, the qualifying property phase-out
threshold was scheduled to be $2,070,000. The TCJA increases the maximum
Section 179 deduction and phase-out threshold to $1 million and $2.5 million,
respectively, for property placed in service in tax years beginning after
12/31/17. For tax years beginning after 2018, these amounts will be indexed for
inflation. The TCJA also expands the definition of Section 179 property to
include certain tangible personal property used predominantly to furnish
lodging and certain improvements to nonresidential real property (roofs, HVAC,
fire protection and alarm systems, and security systems).
Immediate Expensing of Qualifying Business Assets. The TCJA
establishes a 100% first-year deduction for qualified property acquired and
placed in service after 9/27/17 and before 1/1/23. This applies to new and used
property. In later years, this first-year deduction phases down as follows:
• 80% for
property placed in service in 2023.
• 60% for property placed in
service in 2024.
• 40% for property placed in
service in 2025.
• 20% for property placed in
service in 2026.
For qualifying property placed in service after 9/27/17,
business owners can take advantage of this provision on their 2017 tax returns.
Or, under a first-year transition rule, they can use prior law and claim 50%
bonus depreciation.
Increased Luxury Automobile Depreciation Limits. For
passenger autos placed in service after 12/31/17 for which bonus depreciation
is not claimed, the maximum amount of allowable depreciation is increased to
$10,000 for the placed-in-service year, $16,000 for the second year, $9,600 for
the third year, and $5,760 for the fourth and later years. These amounts will
be indexed for inflation for autos placed in service after 2018. For passenger
autos eligible for bonus first-year depreciation, the increase to the
first-year depreciation limit remains $8,000.
Shortened Recovery Period for Real Property. For property
placed in service after 12/31/17, the separate definitions of qualified
leasehold improvement, qualified restaurant, and qualified retail improvement
property are eliminated. The TCJA imposes a general 15-year recovery period and
straight-line method for qualified improvement property.
General Deductions, Exclusions, and Credits
Interest Expense. Regardless of its form, every business
will be subject to a net interest expense disallowance. For tax years beginning
after 12/31/17, net interest expense in excess of 30% of the company's adjusted
taxable income will be disallowed. Adjusted taxable income is generally defined
as taxable income computed without regard to deductions for depreciation,
amortization, or depletion. However, taxpayers (other than tax shelters) with
average annual gross receipts for the prior three years of $25 million or less
are exempt from this limitation.
NOLs. The TCJA generally repeals the two-year carryback rule
for NOLs. For losses arising in tax years beginning after 12/31/17, the NOL
deduction is limited to 80% of taxable income. With the exception of property
and casualty insurance companies, NOLs can be carried forward indefinitely.
Property and casualty insurance companies can carry their NOLs back two years
and forward 20 years to offset 100% of taxable income.
Domestic Production Activities Deduction Repealed. Business
were allowed a deduction equal to a percentage of the income earned from
certain manufacturing and other production activities conducted within the U.S.
For tax years beginning after 12/31/17, the domestic production activities deduction
is repealed.
Like-kind Exchanges. The TCJA limits the like-kind exchange
rules so they apply only to real property that is not held primarily for sale.
However, under a special transition rule, the like-kind exchange rules continue
to apply to exchanges of personal property if the taxpayer has either disposed
of the relinquished property or acquired the replacement property on or before
12/31/17.
Research and Experimental Expenses. Pre-TCJA law allowed
taxpayers to currently deduct Research and Experimental (R&E) expenses paid
or incurred in connection with a trade or business. Alternatively, taxpayers
could capitalize their R&E expenditures and amortize them ratably over the
useful life of the research (not to exceed 60 months) or a period of 10 years.
For amounts paid or incurred in tax years beginning after 12/31/21, the TCJA
requires specified R&E expenses to be capitalized and amortized ratably
over five years (15 years if R&E is conducted outside of the U.S.).
Deduction for Fringe Benefits. The TCJA makes the following
adjustments to the fringe benefit rules (for amounts paid or incurred after
12/31/17):
• Disallows
deductions for entertainment expenses.
• Expands
the current 50% limit on the deductibility of business meals to those provided
in an in-house cafeteria or otherwise on the employer's premises.
• Denies a
deduction for employee transportation fringe benefits. However, the TCJA retains
the exclusion from income for such benefits received by an employee.
• Eliminates
a deduction for transportation expenses that are the equivalent of commuting
for employees, except as provided for the safety of the employee.
For amounts paid or incurred after 12/31/25, the TCJA
disallows an employer's deduction for expenses associated with meals provided
for the convenience of the employer on its business premises, or provided on or
near the employer's business premises through an employer-operated facility
that meets certain requirements.
Excessive Employee Compensation. An employer's compensation
deduction may be limited by IRC Sec. 162(m), which generally provides a
deduction limit of $1 million for compensation paid by a publicly-held
corporation during any tax year to a covered employee. However, there are
exceptions for commissions, performance-based compensation (including stock
options), payments to a tax-qualified retirement plan, and amounts that are
excludable from the executive's gross income. For tax years beginning after
12/31/17, the exceptions for commissions and performance-based compensation are
repealed. These changes do not apply to written binding contracts that were in
effect on 11/2/17 (unless the contract is materially modified).
New Credit for Employer-paid Family and Medical Leave. For
tax years beginning after 12/31/17 and before 1/1/20, the TCJA allows
businesses to claim a general business credit equal to 12.5% of the amount of
wages paid to qualifying employees during any period in which such employees
are on family and medical leave if the rate of payment is 50% of the wages
normally paid to an employee. The credit is increased by 0.25 percentage points
(but not above 25%) for each percentage point by which the rate of payment
exceeds 50%. All qualifying full-time employees have to be given at least two
weeks of annual paid family and medical leave.
Accounting Method Changes
Inclusion Year. For tax years beginning after 12/31/17, an
accrual-method taxpayer is generally required to recognize income no later than
the tax year in which such income is taken into account on an Applicable
Financial Statement (AFS) or other financial statement under rules specified by
the IRS. If an accounting method change is needed to conform to this new rule,
such change will be treated as initiated by the taxpayer and made with the
IRS's consent.
Expansion of Cash Method of Accounting. For tax years
beginning after 12/31/17, the cash method may be used by taxpayers (other than
tax shelters) that satisfy a $25 million gross receipts test, regardless of
whether the purchase, production, or sale of merchandise is an income-producing
factor. In addition, such taxpayers are not required to account for
inventories. Instead, they may treat inventories as nonincidental materials and
supplies or conform to their financial accounting treatment of inventories.
Long-term Contracts. Generally, construction companies with
average annual gross receipts of $10 million or less in the prior three years
are exempt from the Percentage of Completion Method (PCM). The TCJA expands
this exemption to contracts for the construction or improvement of real
property if the contract (1) is expected to be completed within two years and
(2) is performed by a taxpayer that meets the $25 million gross receipts test
discussed earlier. This change is effective for contracts entered into after
12/31/17.
International Tax Provisions
Pre-TCJA law taxed the worldwide income of domestic
corporations. This created a potential for double taxation if the country in
which the corporation operated also imposed an income tax. The foreign tax
credit helped alleviate this burden. The TCJA changes from a worldwide system
of taxation to a territorial system. Several TCJA provisions help with the
transition.
Deduction for Foreign-source Portion of Dividends. The TCJA
essentially provides an exemption for certain foreign income. This is
accomplished through a 100% deduction for the foreign-source portion of
dividends received from 10% owned 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 deduction. The deduction is available only to C
corporations and does not apply to Regulated Investment Companies (RICs) or
REITs. The provision applies to distributions made after 12/31/17.
If a domestic corporate shareholder sells foreign
corporation stock held for one year or more, any amount that is treated as a
dividend for purposes of IRC Sec. 1248 is treated as a dividend for purposes of
the special dividends received deduction. In addition, if a domestic corporate
shareholder benefits from the foreign dividends received deduction, it must
reduce its adjusted basis in the stock of the 10%-owned foreign corporation by
the amount of the deduction. This is done only for the purpose of determining
losses on future sales or exchanges of the stock.
Deemed Repatriation Tax. To transition to a new territorial
system, the TCJA imposes a deemed repatriation tax. This requires U.S.
shareholders owning at least 10% of a foreign subsidiary to include in income
their prorata share of the subsidiary's post-1986 earnings and profits. The
portion of earnings and profits made up of cash or cash equivalents is taxed at
15.5%, while noncash assets are taxed at 8%.
The U.S. shareholder may elect to pay the deemed
repatriation tax over eight years. The payment for each of the first five years
equals 8% of the net tax liability. The sixth installment equals 15% of the net
tax liability. The seventh installment increases to 20% of the net tax
liability, while the remaining balance of 25% is due in the eighth year.
The TCJA provides a special rule for S corporations. S
corporation shareholders are allowed to elect to maintain deferral on such
foreign income until the S corporation (1) changes its status, (2) sells
substantially all of its assets, or (3) ceases to conduct business. Deferral
also may be maintained until the electing shareholder transfers its S
corporation stock.
Foreign Intangible Income. The TCJA provides C corporations
with a reduced tax rate on Foreign-derived Intangible Income (FDII) and Global
Intangible Low-taxed Income (GILTI). FDII is generally intangible income that
is derived from serving foreign markets. GILTI is the domestic corporation's
portion of foreign earnings that exceed an amount equal to a standard rate of
return on the foreign company's assets. GILTI does not include effectively
connected income, subpart F income, foreign oil and gas income, or certain
related party payments. The effective tax rate on FDII is 13.125% in tax years
beginning after 2017 and before 2026 and 16.406% after 2025. The effective tax
rate on GILTI is 10.5% in tax years beginning after 2017 and before 2026 and
13.125% after 2025.
Base Erosion Anti-abuse Tax (BEAT). A base erosion payment
is generally any deductible amount paid or accrued by a taxpayer to a related
foreign person. Under the TCJA, certain corporations with average annual gross
receipts of at least $500 million are required to pay a BEAT with respect to
base erosion payments paid or accrued in tax years beginning after 12/31/17.
The tax is generally 10% (12.5% for tax years beginning after 12/31/25) of the
modified taxable income of the taxpayer over an amount equal to the regular tax
liability of the taxpayer for the year. Members of affiliated groups that
include a bank or securities dealer will be taxed at 11%, increasing to 13.5%
after 2025. Amounts paid or incurred for services are excluded from the BEAT if
those services meet the requirements for the services cost method under the
transfer pricing rules.
Related Party Payments. Under the TCJA, deductions for
certain related-party payments are denied. These include interest or royalty
payments to a related party if (1) the related party does not report the
payments as income under the laws of the resident country, or (2) the related
party is allowed a deduction with respect to the payments. These are generally
known as hybrid transactions. For tax years that begin after 12/31/17, amounts
paid or accrued pursuant to a hybrid transaction are disallowed.
Conclusion
The TCJA is bringing sweeping changes to individual and
business taxpayers. Although most of the changes do not commence until 2018,
some may warrant action in the final days of 2017 in order to preserve
deductions or delay the recognition of income to take advantage of lower rates.
Your tax professionals at HPG can help you understand and navigate these tax
law changes. As each person's tax situation is unique, please contact a member
of the HPG team to discuss how best to approach these widespread changes to
suit your specific tax profile.
Very truly yours,
Hughes Pittman & Gupton, LLP