Republican leaders yesterday released their comprehensive tax reform bill, the “Tax Cuts and Jobs Act.” Although there has been a great deal of high-level discussion over the past few months regarding various tax reform proposals, the bill is the first publicly-released legislative proposal. Highlights of the 429-page bill include:
Business Tax Reform
- Replaces the tiered tax rates for corporations with a flat 20% rate Personal services corporations would be subject to a flat 25% rate. The new rates would be effective for tax years beginning in 2018.
- Repeals the corporate alternative minimum tax (AMT).
- Allows a 100% “full expensing” deduction for the cost of property that otherwise would qualify for bonus depreciation (currently, 50% in 2017, 40% in 2018, and 30% in 2019). To qualify, property must be acquired and placed in service after September 27, 2017 and before January 1, 2023. Property used in a real property trade or business or by a regulated public utility would not be eligible.
- Disallows a deduction for net interest expense in excess of 30% of a business’s adjusted taxable income, regardless of the form of entity. In the case of a partnership or S corporation, the disallowance threshold would be determined at the entity level, rather than at the partner or shareholder level. Amounts disallowed would be carried forward to the succeeding five taxable years. The disallowance threshold would not apply to a business with average gross receipts of $25 million or less, a real property trade or business, or a regulated public utility.
- Limits the net operating loss (“NOL”) deduction to 90% of a taxpayer’s taxable income (which conforms to the current rule under the alternative minimum tax). Disallows the carryback of an NOL to a previous tax year (except in limited circumstances for certain small businesses and farms with casualty and disaster losses), and allows NOLs to be carried forward indefinitely (instead of the current 20-year limitation).
- Increases the annual cap on the full deduction (as opposed to capitalization and depreciation) for the cost of “Section 179 property” (generally, depreciable tangible property and computer software acquired for use in the active conduct of a trade or business) from $500,000 to $5,000,000 and increases the phase-out threshold from $2,000,000 of property placed in service during a taxable year to $20,000,000.
- Repeals the new markets tax credit allowed for developments in economically distressed areas for tax years after 2017.
- Repeals the credit for rehabilitation of certain historic buildings and structures for amounts paid or incurred after 2017.
- Limits Section 1031 like-kind exchanges to real property.
- Repeals the Section 199 domestic production activities deduction.
- Repeals the “technical termination” rule that treats a partnership as terminated if 50% or more of the interests in partnership capital and profits is sold or exchanged within a 12-month period.
- Eliminates favorable long-term capital gain treatment applicable to the sale of a patent before its commercial use.
- Repeals rollover treatment for certain gains from the disposition of publicly traded securities.
- Replaces Section 409A with new Section 409B that includes deferred compensation in income when the payment ceases to be subject to a substantial risk of forfeiture and is not paid within 2 1/2 months after the close of the taxable year. Section 409B applies to non-discounted stock options and stock appreciation rights. Section 409A would continue to apply to deferred compensation for services performed before January 1, 2018, however, any amount not included in income earlier would be included in income in 2025 unless subject to a substantial risk of forfeiture.
- Modifies Section 162(m) to apply the $1 million deduction limitation to previously exempt performance-based compensation and commissions. Expands the definition of publicly held corporations, and includes principal financial officers as covered employees.
Tax Reform for Individuals
- Establishes new income tax brackets for individuals. For married filing jointly (single), the new brackets are:
- 12% for income from $0 to $90,000 ($45,000)
- 25% for income above $90,000 to $260,000 ($45,000 - $200,000)
- 35% for income above $260,000 to $1,000,000 ($200,000 - $500,000)
- 39.6% for income above $1,000,000 ($500,000).
- Phases out the benefit of the 12% bracket for individuals that earn more than $1,200,000 ($1,000,000).
- Increases the standard deduction to $24,400 for married filing jointly, $18,300 for unmarried individuals with at least one qualifying child, and $12,200 for any other case.
- Repeals the personal exemption deduction.
- Repeals the AMT for individuals and provides special rules to allow for refunds of any AMT credit carryforward from prior years.
- Applies a reduced 25% individual tax rate to passive pass-through business income, including income from sole proprietorships. The 25% rate would also apply to 30% of active pass-through business income (0% for certain personal services business income) or a greater percentage based on the amount of capital invested in the business. Corresponding modifications would be made to the calculation of net earnings from self-employment, but self-employment income subject to Social Security and Medicare tax would be expanded to include rental income and pass-through income earned by limited partners and S corporation shareholders.
- Modifies the mortgage interest deduction by limiting the amount of eligible indebtedness to $500,000 and allowing the deduction only for a taxpayer’s principal residence. The new rules would not apply to indebtedness incurred on or before November 2, 2017 (subject to special rules for refinancings) or to indebtedness incurred for certain purchases of a principal residence pursuant to a contract entered into before November 2, 2017.
- Modifies the $250,000 ($500,000 married filing jointly) gain exclusion for sale of a principal residence by increasing the use requirement to 5 of the last 8 years (from 2 of the last 5 years) and phasing out the gain exclusion for taxpayers with average adjusted gross income for the current and preceding two taxable years exceeding $250,000 ($500,000 married filing jointly).
- Repeals the deduction for state and local income or sales taxes and personal property taxes that are not paid or accrued in carrying on a trade or business or producing income. Limits the deduction for state and local real property taxes to $10,000 per year.
- Repeals the income-based phase-out of itemized deductions applicable to high income taxpayers.
- Makes the following modifications:
- Increases the child tax credit to $1,600 and creates a new $300 credit for a taxpayer and non-child dependents
- Extends the American opportunity tax credit to the fifth year of qualified education expenses, subject to a 50% reduction.
- Prohibits new contributions to Coverdell education savings accounts and allows a tax-free rollover of Coverdell education savings account into Section 529 plan
- Allows Section 529 plans to be used to pay elementary or secondary education tuition and expenses associated with apprenticeship programs.
- Excludes from income student debt discharged on account of death or total disability.
- Requires a social security number to claim the refundable portion of the child tax credit and the American opportunity tax credit.
- Prevents individuals prohibited from engaging in employment in the United States from claiming the earned income tax credit.
- Limits all deductions and losses related to gambling (not just gambling losses) to the amount of gambling winnings.
- Increases the limit on deductibility of cash contributions to public charities and certain private foundations from 50% to 60% and requires substantiation of all contributions of $250 or more.
- Repeals credits for:
- Elderly and disabled persons.
- Adoption expenses.
- Interest on certain home mortgages.
- New qualified plug-in electric drive motor vehicles.
- Lifetime Learning Credit and Hope Scholarship Credit.
- Repeals deductions for:
- Medical expenses.
- Alimony payments, but excludes the payments from income of the recipients.
- Personal casualty losses.
- Tax preparation expenses.
- Moving expenses.
- Contributions to Archer medical savings accounts.
- Employee trade or business expenses.
- Interest on education loans, qualified tuition expenses, and other education related deductions.
- Repeals the exclusion from compensation for:
- Employer-provided dependent care assistance programs.
- Qualified moving expense reimbursements.
- Employer-provided housing.
- Contributions to Archer medical savings accounts.
Gift and Estate Tax Reform
- Doubles the per-individual estate and gift tax exemption from $5 million to $10 million (adjusted for inflation from 2011).
- Repeals the estate and generation-skipping taxes beginning after 2023.
- Reduces the gift tax highest marginal rate to 35% after 2023.
Taxation of Foreign Income and Foreign Persons
- Requires a one-time income inclusion for U.S. persons that own 10% or more of the voting power in certain foreign corporations. Reduces the applicable tax rate to 12% for the cash and cash equivalents held by the foreign corporation, and 5% for the remaining income inclusion amount. A taxpayer can elect to pay the tax over 8 years.
- Generally exempts from tax foreign-source dividends paid by a foreign corporation to a U.S. corporation that owns stock representing 10% or more of the voting power in the foreign corporation.
- Excludes U.S. corporations from the requirement to include in income untaxed earnings and profits of a controlled foreign corporation (“CFC”) that are invested in United States property.
- Requires a U.S. person that owns stock representing 10% or more of the voting power in a CFC to include in income 50% of the U.S. person’s share of the CFC’s otherwise deferred “foreign high return amount,” the aggregate of certain net income over a “routine return” (7% plus the federal short-term rate).
- Makes various other changes to the anti-deferral rules applicable to CFCs.
- Imposes a 20% excise tax on a U.S. corporation for certain payments to a foreign corporation which is a member of the same “international financial reporting group” that are deductible, included in costs of goods sold, or included in the basis of depreciable or amortizable assets.
- Limits the deductibility of the interest expense of a U.S. corporation that is a member of an “international financial reporting group” (defined differently from when used for the 20% excise tax described above) based on the U.S. corporation’s share of the group’s global interest expense and global EBITDA.
- Reduces a U.S. corporation’s basis in its stock of a foreign corporation by the amount of exempt dividends received from the foreign corporation for purposes of calculating loss (but not gain) from the sale of the stock.
- Repeals the indirect foreign tax credit and modifies the foreign tax credit for subpart F income.
- Disallows reduced treaty withholding tax rates for deductible payments of fixed, determinable annual or periodic income made by a U.S. entity controlled by a foreign corporation to a related foreign corporation in another foreign jurisdiction.
Energy Tax Reform
The bill contains a number of energy-related tax provisions, including modifications of the production tax credit and investment tax credit for renewable energy projects. For a more complete discussion of the energy-related provisions, see Tax Reform Bill Limits Renewable Energy Credits.
Tax Exempt Organizations
- Modifies the unrelated business income tax rules to clarify that all entities exempt from tax under Section 501(a) are subject to the rules, and limits the exclusion of research income from unrelated business taxable income only to publicly available research.
- Changes the excise tax on private foundation investment income to a flat rate of 1.4%.
- Subjects certain private colleges and universities that have at least 500 students to a 1.4% excise tax on net investment income.
- Permits churches to make statements relating to political campaigns in ordinary course of religious services and activities.
- Adds certain reporting requirements for donor-advised funds.
- Imposes on certain tax-exempt organizations and related entities a 20% excise tax on compensation paid to any of the five highest compensated employees of the tax-exempt entity in excess of $1 million for the year and on severance pay that exceeds three times the employee’s average income over the five previous years.
- Repeals Section 457(b) for non-governmental tax exempt employers for services performed after December 31, 2017.
Tax Exempt Bonds
- Makes substantial changes to the rules for tax-exempt bond provisions, including the repeal of the exclusion for interest paid on newly issued private activity bonds.