Tax Reform Legislation Signed Into Effect: What Businesses Need to Know for 2018 Planning
On December 22, 2017, President Trump signed tax reform legislation that represents the most significant changes to the Internal Code since 1986. The tax reform bill affects both individual and business taxpayers; below please find a summary of the provisions we expect to most directly affect the majority of our business clients. Please note that the legislation is quite complex and that the following summary is merely bullets points of what we feel are the most relevant provisions. Unless otherwise noted, these provisions are effective for tax years beginning after December 31, 2017 (i.e. the 2018 calendar tax year).
SUMMARY OF CHANGES FOR CORPORATIONS
For all tax years beginning after December 31, 2017 the corporate tax rate is a flat 21%. Prior to 2018 the corporate tax rate was applied on a graduated basis with a maximum rate of 35%.
Alternative Minimum Tax (“AMT”)
The corporate AMT is repealed. Prior year minimum tax credits are still allowed.
Dividends Received Deduction (“DRD”)
The 80% DRD available to corporations on dividends received from 20% or more owned corporations and the 70% DRD on dividends from less than 20% owned corporations will be reduced to a 65% and 50% DRD, respectively.
Corporate Net Operating Losses (“NOL”)
– For NOL’s arising after December 31, 2017, NOL’s may only be utilized to offset 80% of taxable income.
– The NOL carryback is eliminated. NOL’s may carry forward indefinitely.
– Under the current law, for publicly traded companies there is a $1 million limit on the deductibility of executive compensation for certain covered employees. There is an exception to this limit for performance based compensation. Under the new law, the exception for performance based compensation is eliminated for taxable years beginning after December 31, 2017.
– Covered employees of a publicly traded company subject to the limit would include the CEO, CFO, and the three highest paid employees.
– Once a person becomes a covered employee they are always a covered employee.
OTHER BUSINESS PROVISIONS
– Taxpayers with average gross receipts of less than $25 million may account for inventories as materials and supplies that are not incidental.
– Taxpayers with average gross receipts under $25 million are exempt for the Uniform Capitalization rules (“UNICAP”) regarding inventory.
Cash Method of Accounting
– The threshold for the allowance of the cash (as opposed to accrual) method of accounting has been increased to $25 million of average gross receipts.
– Taxpayers may take 100% bonus depreciation on property placed in service between September 27, 2017 and January 1, 2023.
- Unlike the law currently in effect, bonus depreciation may be taken on used property under the new law as long as the other conditions for taking bonus depreciation are met (such as placed in service in the US).
- After 2022, bonus depreciation begins to be phased down.
Section 179 Expensing
– The amount a taxpayer may expense under Section 179 after December 31, 2017 is increased to $1,000,000 and the phase out threshold is increased to $2,500,000.
– Like-Kind Exchanges will be limited to Real Property.
– Interest expense deducted by a business is limited to 30% of adjusted taxable income.
- Adjusted taxable income is defined as taxable income computed without regard to: non-business income or deductions, business interest or business interest income, NOL’s, Section 199A qualified business income, and for tax years before January 1, 2022 depreciation, amortization or depletion.
- Business with average annual gross receipts of $25 million or less are exempt for the limit.
- Interest expense disallowed shall be treated as paid in the following year.
- For partnerships, the limitation will be applied at the partnership level.
Domestic Production Activities Deduction (“DPAD”)
– The DPAD is repealed for tax year beginning after December 31, 2017.
Meals & Entertainment
– The deduction for entertainment expenses (which was previously subject to a 50% limitation) is eliminated.
– 50% of food and beverages associated with operating a business may still be deducted in certain circumstances.
– The deduction for employee transportation fringe benefits is disallowed.
Research and Development (“R&D”)
– The R&D credit is retained.
– Specified R&D expenditures must be capitalized and amortized over a 5 year period.
– R&D expenses incurred outside the US after December 31, 2021 would have to be capitalized and expensed over a 15 year period.
Participation Exemption System
– Effective for tax year beginning after December 31, 2017, domestic C-Corporations owning 10% or more of a foreign corporation can take a 100% dividend received deduction (“DRD”) on foreign source dividends from such 10% or more owned foreign corporation.
- Domestic corporations can look through partnerships to determine if they are eligible for the DRD.
- No foreign tax credit may be claimed against dividends eligible for the DRD.
- A domestic corporation must have held the shares of the foreign corporation for a full year to be eligible for the DRD.
- Foreign taxes may no longer be grossed up and credited on actual dividends from foreign corporations (previous Section 902 deemed paid credit).
– The provisions under Subpart F which require a deemed dividend inclusion by US shareholders of Controlled Foreign Corporations on certain types of overseas earnings are still in place.
– There are provisions to prevent taxpayers from transferring certain US operations or foreign branches into foreign corporations in a tax-free manner.
– Note that this is not necessarily a territorial tax system, but simply a 100% deduction on dividends received by US Corporations who own 10% or more of a foreign corporation.
– Prior to the Participation Exemption System going into effect, taxpayers will have to include in income in the last tax year beginning before January 1, 2018 (i.e. the 2017 tax year for most taxpayers) their share of the post-1986 undistributed earnings and profits (E&P) of foreign corporations.
- This applies to all 10% US shareholders, not just US corporate shareholders.
- Post-1986 E&P is determined as the greater of the amount at either November 2, 2017 or December 31, 2017, not reduced by distributions during 2017.
– The tax rate on the mandatory inclusion is 15.5% on the aggregate E&P attributable to cash and cash equivalents, and 8% in all other cases.
– A reduced foreign tax credit may be taken against the mandatory inclusion.
– There is an election to pay the tax on the mandatory inclusion in installments over 8 years.
– A US shareholder who expatriates within 10 years following the enactment of the bill is taxed at much higher rates on the mandatory inclusion.
– There is a new income inclusion for US shareholders of controlled foreign corporations, similar to Subpart F, called GILTI (Global Intangible Low Taxed Income).
- GILTI is computed as the excess of a CFC’s income over a threshold amount
- Corporations can deduct 50% of GILTI (limited to 37.5% beginning in 2026), therefore lowering the effective tax rate on GILTI to 10.5%.
- Corporations can also take a partial foreign tax credit against GILTI.
– There is a new deduction for Foreign Derived Intangible Income (“FDII”) earned by US Corporations on foreign sales.
- FDII is computed as a US Corporation’s deemed income attributed to sales to foreign persons over a threshold amount.
- US Corporations with FDII can claim a 37.5% deduction (lowered to 21.875% beginning in 2026) against their income.
– There is a new Base Erosion and Anti-Abuse Tax (“BEAT”)
- Applies to a domestic corporations not taxed on a flow-through basis, which are part of a group with at least $500 million of annual domestic gross receipts, and which have a “base erosion percentage” of 3% or higher.
- Targets payments to a foreign related party for which deductions are allowed.
- BEAT tax will equal 10% (5% in 2018) of modified taxable income over the regular tax liability, reduced by certain credits.
Other International Provisions
– Foreign branches of a US company will be in a separate foreign tax credit limitation basket.
– Income from inventory produced will be sourced to the country in which the inventory was produced.
– For purposes of allocating interest expense for the foreign tax credit, it must be done based upon the adjusted basis of assets beginning in 2018.
– The CFC look-through rules remain as-is, the bill does not mention them.
FOR MORE INFORMATION
Please be aware that this is simply an overview of the provisions of the tax reform legislation we feel are of direct concern to our clients, and it should not be referenced as a full guide to the upcoming changes. We encourage you to contact us with any questions or concerns you may have related to these changes and how they might affect you individually. For such inquiries, or for information about our services, please contact us at firstname.lastname@example.org or (212) 245-5900.