President Trump Signs Tax Cuts and Jobs Act into Law
The recently passed Tax Cuts and Jobs Act (the Act), which enacts the most comprehensive changes to the US tax system since 1986, has been signed by President Trump and is expected to largely go into effect in 2018. The Act dramatically alters the US taxation of corporations and individuals as well as certain business income, and also brings changes to estate and gift taxation. The Act retains portions of the House and Senate bills, while modifying or excluding others. Highlights of the Act include the following provisions:
Provisions Affecting the Income Taxation of Individuals
Selected provisions affecting individual taxpayers include the following. Note that unless specified otherwise, these provisions are effective as of January 1, 2018 and will expire on December 31, 2025:
- A top marginal rate of 37%, which applies to taxable income above $600k for married filing jointly ($300k for married filing separately, $500k for individuals), and retention of a seven bracket rate structure;
- An increased standard deduction ($24,000 for married filing jointly, $12,000 for single filers generally);
- The repeal of the deduction for miscellaneous itemized deductions, including investment management and tax advisory fees;
- The repeal of the deduction for personal exemptions;
- The repeal of the overall limit on itemized deductions;
- A 20% deduction on certain pass-through business income (excluding, generally, income from services businesses) subject to certain W-2 wage, asset basis, and income limitations. The deduction generally results in an effective tax rate of 29.6% on this income;
- The retention of the alternative minimum tax (AMT), but with increased exemption amounts ($109,400 for married filing jointly, $70,300 for single filers) and phase out thresholds (to $1M for married filing jointly, $500k for single filers);
- The limitation of the deduction for state and local taxes not incurred in a trade or business to $10,000 (state and local income taxes, sales taxes, or property taxes up to an aggregate of $10,000). Note that the Conference Bill contains a provision treating state or local income taxes as paid in the year for which the tax is imposed;
- A limitation on the ability of non-corporate taxpayers to offset non-business income with business losses beyond a threshold amount ($500k for married filing jointly, $250k for other taxpayers), with disallowed losses carried forward as part of the taxpayer’s net operating loss (NOL) (provision to be applied at the partner or S corporation shareholder level);
- The limitation of the mortgage interest deduction to interest on $750k of acquisition indebtedness and the suspension – until 2026 – of any deduction for interest on home equity indebtedness (Note that these limitations apply to indebtedness incurred after December 15, 2017). However, the Conference Agreement suspends the deduction for interest on home equity loans other than home equity financing that qualifies as aquisition indebtedness.
- The increased adjusted gross income limitation (from 50% to 60%) for cash contributions made to public charities in calendar years 2018 through 2025;
- The repeal of the 80% charitable deduction currently available for university athletic seating rights;
- The limitation of personal casualty losses to those incurred as a result of a federally-declared disaster
- The retention of the medical expense deduction, along with a reduced floor (to 7.5% from 10%) for calendar years 2017 and 2018;
- The elimination of the above-the-line deduction for alimony payments made pursuant to agreements entered into after 2018;
- The disallowance of traditional IRA-Roth IRA characterizations, with clarification that recharacterization cannot be used to unwind Roth IRA conversions; and
- A provision for the use of Section 529 accounts for primary and secondary education.
Provisions Affecting Corporate and Non-Corporate Businesses
Selected provisions affecting businesses and corporations include the following. Note that unless specified otherwise, these changes, unlike most of the individual provisions, are permanent:
- A 21% flat corporate tax rate, taking effect in 2018. Like the Senate bill, the Conference Bill does not exclude personal service entities from the new flat rate;
- Reduced dividends received deduction percentages (to 65% from 80%, and to 50% from 70%);
- A limitation on the deductibility of interest expense to 30% of adjusted taxable income, along with modifications to the calculation of adjusted taxable income, including, for calendar years 2018 through 2021, only the add back of depreciation and amortization expense. Exceptions to the limitation are provided for certain real property trades or businesses (but only to the extent the longer life Alternative Depreciation System (ADS) is used) and certain small businesses (generally gross receipts less than $25M);
- The repeal of the corporate alternative minimum tax;
- A temporary provision for full 100% expensing of new, and newly-acquired used, business property acquired and placed in service after September 27, 2017, subject to 20% annual reductions in the bonus depreciation percentage beginning in calendar year 2023 to, ultimately, 20% (for property placed in service during the first tax year after September 27, 2017, taxpayers may elect 50% bonus depreciation rather than 100%);
- Increased section 179 expensing to a maximum of $1M, subject to an increased phase-out threshold of $2.5M and including as eligible property certain additions to real property;
- A carried interest provision limiting, generally, capital gain treatment to assets held for a minimum of three years;
- The limitation of like kind exchanges to exchanges of real property (other than property held primarily for sale);
- Provisions shortening the ADS life for residential rental property from 40 years to 30 years and providing a 15-year recovery period for qualified improvement property;
- For NOLs incurred after 2017, a limitation on the NOL deduction to 80% of taxable income, along with the elimination of the NOL carryback and provision for unlimited carryforwards;
- A modified 20% rehabilitation credit (to be claimed ratably over a five-year period beginning when the structure is put in service and subject to certain transition rules) and subject to transition rules, repeal of the 10% credit for pre-1936 buildings; and
- A provision, from the original House bill, treating gains or losses from certain intellectual property (excluding musical composition and copyrights in musical works) as ordinary rather than capital.
Provisions Affecting the Income Taxation of Trusts and Estates and Estate/Gift Taxation
Selected income tax provisions relating to trusts and estates include:
- Eligibility of trusts and estates for the 20% pass-through deduction described above;
- Lowering fiduciary income tax bracket rates to a top marginal rate of 37%; and
- Allowing a nonresident alien individual to be a potential current beneficiary of an electing small business trust (“ESBT”).
Selected estate and gift tax provisions include:
- A temporarily increased unified credit basic exclusion amount of $10M (for 2018, $11.2M adjusted for inflation) applicable to calendar years 2018 through 2025; and
- A temporarily increased estate, gift, and generation skipping transfer tax (“GST”) exemption amount to $11.2M applicable for calendar years 2018 through 2025, adjusted for inflation.
Selected international provisions include:
- The adoption of “territorial”/participation exemption principles through a 100% deduction for the foreign-source portion of dividends received by US corporations from certain specified ten percent owned foreign corporations (subject to a one year holding period), along with the repeal of the indirect foreign tax credit;
- A mandatory tax on certain previously untaxed post-1986 accumulated foreign earnings and profits of 15.5% (for foreign earnings held in cash or cash equivalents) or 8% (for foreign earnings held in illiquid assets). The tax is payable, at the taxpayer’s election, over eight years;
- The repeal of the active trade or business exception with respect to foreign reorganizations, thus requiring recognition of gain on property transfers to a foreign corporation even to the extent the property is used in an active trade or business;
- The imposition of a 10% withholding obligation on purchasers of partnership interests from non-US partners to the extent any portion of the gain on sale is characterized as effectively connected income (ECI) (effective for transfers after December 31, 2017). Note that if the buyer fails to withhold, the partnership must withhold distributions otherwise payable to the buyer;
- A look-through provision characterizing gain on the sale of a partnership interest as ECI to the extent a sale of the underlying assets by the partnership would be ECI, effective November 27, 2017;
- The elimination of the requirement that a controlled foreign corporation (CFC) be owned for a continuous 30-day period by a “United States shareholder” as a condition for subpart F inclusions; and
- The modification of the definition of “United States shareholder” to include US persons owning 10% or more of the value of a foreign corporation’s outstanding shares (previously limited to 10% of combined voting power) and modifications to certain attribution rules.
Other Provisions of Note
- The repeal of the partnership technical termination provision;
- The modification of section 118 (contributions to corporate capital), definition of “contributions to capital” to exclude – and therefore include in gross income - certain contributions from customers (or potential customers) or contributions from government entities or civic groups;
- The repeal of Code Section 199’s deduction for income attributable to domestic production activities (with an exception for activities in Puerto Rico for tax years beginning prior to January 1, 2018);
- The disallowance of any deduction for entertainment, amusement or recreation even if directly related to the active conduct of a trade or business;
- Special provisions with respect to certain S corporations revoking their S elections within two years of the final enactment date of the legislation, including treatment of distributions from the terminated S corporation as paid from accumulated adjusted earnings and earnings and profits.
Changes in House and Senate Bill not included in Conference Report
Note that certain provisions included in the House and/or Senate bills, were NOT included in the Conference Report, including (selectively):
- The requirement of FIFO for certain securities basis calculations;
- The elimination of private activity bonds (repealed in the House bill);
- The inclusion of capital contributions to a partnership in the partnership’s gross income unless the contribution is made in exchange for a partnership interest;
- The phase-out of the investment tax credit relating to certain energy-related investments, including solar energy, fiber-optic solar energy, qualified fuel cell and qualified small wind energy property (subject to phase out in the House bill);
- Any modification to the low income housing credit, thus preserving it in its current form (the Senate bill had proposed various modifications);
- Repeal of the Work Opportunity Tax Credit (WOTC) and New Markets Tax Credit (NMTC), thus preserving each in its current form (the House bill repealed both the WOTC and NMTC);
- A provision phasing out the exclusion of gain on the sale of a personal residence (the House bill would have limited the amount of the exclusion, and both the House and Senate bills would have imposed modified holding period requirements); and
- Any provision affecting the deductibility of student loan interest (the House bill would have repealed the deduction).
The Act is the most significant change to US tax law in decades. Many of the provisions are very complex. Please consult your Berdon tax advisor to determine how these new laws will affect you or your business.
If you have any questions about this Alert, or the tax reform bill or process, please contact:
Michael Eagan 212.331.8831 | email@example.com
Marc Ausfresser 212.331.7639| firstname.lastname@example.org
Or contact your Berdon advisor
Berdon LLP New York Accountants