On Friday, December 15, the House-Senate Conference Committee on tax reform agreed to a tax reform bill to be voted on by Congress this week. The stage appears to be set for the most sweeping tax reform legislation since 1986.

This alert highlights some of most significant portions of the bill affecting business and wealth and succession planning.

Conference Committee – Tax Cuts and Jobs Act

Corporate Tax Rates & AMT

  • Eliminates graduated rate structure and instead taxes corporate taxable income at 21% effective for taxable years beginning after December 31, 2017
  • Repeals corporate AMT for taxable years beginning after December 31, 2017

Corporate Dividends Received Deduction

  • Reduces 70% dividends received deduction to 50%; reduces 80% dividends received deduction to 65%.

Net Operating Losses

  • Limits the NOL deduction to 80% of taxable income effective for taxable years beginning after December 31, 2017; present law will continue to apply to NOLs of property and casualty insurance companies
  • Indefinite carryforward; carryback generally repealed
  • Two-year carryback for certain losses incurred by farms
  • Two-year carryback and 20-year carryforward for NOLs of a property and casualty insurance company

Cost Recovery / Full Expensing

  • 100% expensing for qualified property placed in service after September 27, 2017 and before January 1, 2023; for a taxpayer’s first taxable year ending after September 27, 2017, the taxpayer may elect to apply a 50% allowance instead of the 100% allowance
  • Excludes property used by a regulated public utility and, with limited exceptions, property used in a trade or business that has had floor plan financing indebtedness
  • Eliminates the requirement that original use begin with the taxpayer; property is eligible for full expensing as long as it is taxpayer’s first use

Section 179 Expensing

  • Increases section 179 small business expensing limitations to $1,000,000, and increases the phase-out threshold to $2,500,000 (indexed for inflation), effective for property placed in service in taxable years beginning after 2017 (with no end date)
  • Expands the definition of qualified real property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging as well as several types of improvements to nonresidential real property placed in service after the date the property was first placed in service

Recovery Period for Real Property

  • Eliminates the separate definitions of qualified leasehold improvements, qualified restaurant and qualified retail improvement property and provides a general 15-year recovery period for all qualified improvement property

Cash Method of Accounting

  • Increases the $5,000,000 average gross receipts threshold for corporations and partnerships with corporate partners to $25,000,000 (indexed for inflation) and businesses would not have to meet this requirement for all prior taxable years
  • Businesses with average gross receipts of $25,000,000 or less would be able to use the cash method even if the business has inventories
  • Businesses with average gross receipts of $25,000,000 or less would be fully exempt from the uniform capitalization rules
  • $10,000,000 average gross receipts exception to requirement for use of percentage-of-completion accounting method for long-term contracts would be increased to $25,000,000

Interest Expense Deduction

  • Eliminates the deduction for net interest expenses in excess of 30% of adjusted taxable income
  • For taxable years beginning after December 31, 2017 and before January 1, 2022, adjusted taxable income would be defined as a business’s taxable income computed without regard to business interest expense, business interest income, NOLS, depreciation, amortization or depletion. Beginning January 1, 2022, taxable income would be defined as a business’s taxable income computed without regard to business interest expense, business interest income, and NOLS.
  • Businesses with average gross receipts of $25,000,000 or less for the three-taxable- year period ending with the prior taxable year would be exempt from this interest limitation
  • This limitation would not be applicable to certain regulated public utilities. At taxpayer’s election, the limitation would not apply to a real property trade or business – however if the taxpayer makes this election, the taxpayer is required to use ADS to depreciate any of its nonresidential real property, residential real property, and qualified improvement property (e.g., full expensing of qualified improvement property would be disallowed)
  • Disallowed interest could be carried forward indefinitely

Pass-Through Taxation

  • For taxable years beginning after December 31, 2017 and before January 1, 2026, an individual taxpayer generally may deduct 20% of qualified business income from a partnership, S corporation, or sole proprietorship, as well as 20% of aggregate qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income.
  • For each qualified trade or business, the deduction is limited to the greater of (a) 50% of the W-2 wages paid with respect to the qualified trade or business or (b) the sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property. This limitation does not apply to a taxpayer with taxable income not exceeding $315,000 (for married individuals filing jointly) or $157,500 (for other individuals ) , but the application of this limit would be phased in for individuals with taxable income exceeding those amounts
  • A qualified trade or business means any trade or business other than a specified service trade or business and other than the trade or business of being an employee. However, the deduction would apply to specified service businesses for those taxpayers whose taxable income does not exceed $315,000 (for married individuals filing jointly) or $157,500 (for other individuals). The benefit of the deduction for service businesses is phased out for individuals with taxable income exceeding those amounts
  • Trusts and estates are eligible for the 20% deduction under the provision.

Limitation on Deduction of Excess Business Losses

  • For taxable years beginning after December 31, 2017 and before January 1, 2026, “excess business losses” of a taxpayer other than a corporation are not allowed for the taxable year. These losses are carried forward and treated as part of the taxpayer’s net operating loss (NOL) carryforward in subsequent taxable years.
  • An “excess business loss” is defined as the excess of aggregate deductions of the taxpayer attributable to trades or businesses over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount (which is initially $500,000 (for married individuals filing jointly) or $250,000 (for other individuals).

Like-Kind Exchanges

  • The rule allowing deferral of gain on like-kind exchanges is modified to allow for like-kind exchanges only with respect to real property.
  • There would be a transition rule that allows like-kind exchanges of personal property to be completed if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before December 31, 2017

Carried Interests

  • Imposes a 3-year holding period requirement for qualification as long-term capital gain with respect to certain partnership interests received in connection with the performance of services

Partnerships – Technical Termination

  • Repeals the technical termination rule

Partnerships – Basis Limitation on Partner Losses

  • Modifies the basis limitation on partner losses; that limitation will apply to a partner’s distributive share of charitable contributions and foreign taxes; in the case of a charitable contribution of appreciated property by a partnership, the basis limitation does not apply to the extent of the partner’s distributive share of the excess of FMV over basis

Partnerships – Substantial Built-in Loss

  • Modifies the substantial built-in loss rules for purposes of the basis adjustment upon a transfer of a partnership interest; in addition to the present-law definition, a substantial built-in loss would also exist if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all 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 – in other words, substantial built-in loss would be tested at both the partnership and the partner level

Partnerships – Source of Gain or Loss on Sale of Interest

  • Gain or loss from the sale or exchange of a partnership interest is considered effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at FMV as of the date of the sale or exchange
  • The transferee of a partnership interest would be required to withhold 10% of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation. If the transferee fails to withhold the correct amount, the partnership would be required to deduct and withhold from distributions to the transferee partner an amount equal to the amount the transferee failed to withhold

Business Credits

  • Reduces credit for clinical testing expenses for certain drugs for rare diseases or conditions (“orphan drug” credit) from 50% to 25%
  • Repeals the 10% credit for pre-1936 buildings; retains the 20% credit for qualified rehabilitation expenditures which can be claimed ratably over a 5-year period beginning in the taxable year in which a qualified rehabilitated structure is placed in service
  • Adds new general business credit equal to a percentage of wages paid to qualifying employees while on family and medical leave

Bond Reforms

  • Repeals exclusion from gross income for interest on a bond issued to advance refund another bond
  • Repeals authority to issue tax-credit and direct-pay bonds (prospectively)

Local Lobbying Expenses

  • Disallows deductions for lobbying expenses with respect to legislation before local government bodies (including Indian tribal governments)

Domestic Production Activities

  • Repeals the domestic production activities deduction

International Tax Regime

  • Modified territorial tax system for U.S. corporations
  • 100% foreign dividend exemption for dividends paid by non-inverted foreign corporations to U.S. corporations

Repatriation “Toll Tax”

100% U.S. corporate shareholders taxed on share of CFC’s previously untaxed foreign E&P:

  • - 15.5% rate for cash and cash-equivalents
  • - 8% rate for non-cash assets
  • - Payable over 8 years on back-loaded basis

Proportional reduction in foreign tax credits attributable to previously untaxed foreign earnings

Controlled Foreign Corporations

  • U.S. shareholders of CFCs will be subject to 10.5% (13.125% after 2025) tax on global intangible low-taxed income (GILTI), which is equal to (a) the shareholder's pro rata share of certain foreign profits of the CFC over (b) a deemed return of 10% of the shareholder’s pro rata share of the CFC's total basis in tangible property used to produce such profits
    • - An 80% foreign tax credit is permitted so that, in effect, the minimum tax will not apply to taxpayers if, on an aggregate basis, their effective foreign tax rate is 13.125% (16.406% after 2025) or higher
  • Stock attribution rules for determining “CFC” status would be revised such that a U.S. corporation would be treated as constructively owning stock held by its foreign shareholder and a requirement that a corporation must be controlled for an uninterrupted period of 30-days before it can be subject to U.S. tax on the CFC’s Subpart F income would be eliminated

Foreign Derived Intangible Income

  • U.S. corporations will be entitled to a 37.5% (21.875% after 2025) deduction for their “foreign derived intangible income” (FDII) – income from the deemed intangible return portion of income from sales of goods and services for foreign use or consumption – resulting in a maximum tax of 13.125% (16.406% after 2025) on such income. Income from sales of property to related foreign persons would be FDII only if resold to unrelated foreign persons for foreign use. Income from services provided to a related party would be FDII only if such service is not substantially similar to services that such related party provides within the U.S.

Anti-Base Erosion Provisions

  • 10% (5% in 2018, 12.5% after 2025) tax on U.S. corporations’ deductible/depreciable payments not subject to U.S. withholding tax to 25% related foreign persons to the extent that 10% of the taxpayers taxable income, as increased by such deductible/depreciable payments, exceeds taxpayers’ regular tax liability without regard to any tax credits other than §41(a) R&D credit
  • Applies to U.S. corporations (other than RICs, REITS and S corporations) with average annual gross receipts of at least $500 million and least 3% of whose deductions are derived from payments to related foreign persons

Estate, Gift and Generation-Skipping Transfer Taxes

  • Federal estate, gift and GST exemption doubled to $10,000,000 adjusted for inflation (i.e., $11,200,000 in 2018) for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026

Net Investment Tax on Private Colleges and University Endowments

  • 1.4% tax imposed on net investment income of private colleges and universities with at least 500 tuition-paying students during the preceding taxable year and an aggregate fair-market value of assets equaling or exceeding $500,000 per student; this provision only applies to institutions with more than 50% of the tuition paying students located in the United States

Buchanan’s tax team and Government Relations specialists are committed to closely monitoring the legislative process and providing you with information regarding the most recent developments. When and if Congress passes a tax reform bill, we will be poised to help you understand what has changed and plan for the impact of those changes.

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