The main focus of the tax world the past year has been the possibility of enactment of significant tax legislation beginning with the Trump Administration’s release of its blueprint for tax reform on April 26th. After months of discussions and meetings among the so-called Big Six – Treasury Secretary Steven Mnuchin, National Economic Director Gary Cohn, House Ways and Means Committee Chairman Kevin Brady (R-TX), House Speaker Paul Ryan (R-WI), Senate Majority Leader Mitch McConnell (R-KY), and Senate Finance Committee Chairman Orrin Hatch (R-UT), the Trump Administration released its framework for tax reform titled “Unified Framework for Fixing Our Broken Tax Code.”
The last few weeks prior to the issuance of this Tax Alert has seen a flurry of Congressional activity with respect to tax reform legislation. On November 2nd, the House GOP leaders unveiled their much anticipated tax reform bill titled the Tax Cuts and Jobs Act (TCJA). The House Ways and Means Committee approved a slightly modified version of the bill on November 9th and the House of Representatives passed the bill on November 16th. Also on November 9th, the staff of the Joint Committee on Taxation released a Description of the Chairman’s Mark of the Tax Cuts and Jobs Act that outlined the various proposals recommended by the Senate GOP. Senate Finance Committee Chairman Orrin Hatch, R-Utah, released changes to the Senate’s version of the TCJA on November 14th and November 16th. The Senate Finance Committee voted to advance the bill to the full Senate on November 16th, and the full Senate passed the bill on December 2nd, with a few modifications, by a 51-49 vote. The two bills now need to be reconciled.
Following is a high level overview of the highlights of the House and Senate tax reform proposals. The information contained herein is as of December 11, provisions related to the Tax Cuts and Jobs Act are expected to change moving forward.
Individual Related Provisions
Tax Brackets and Rates: The House bill consolidates the current seven tax brackets into four while maintaining a top bracket of 39.6%. The Senate bill retains seven tax brackets, although the tax rates and bracket amounts are different than in the current tax code and it lowers the top bracket to 38.5%.
Standard Deduction and Personal Exemption: Both plans nearly double the standard deduction and both plans eliminate the personal exemption.
Alternative Minimum Tax: The House bill eliminates the individual Alternative Minimum Tax while the Senate bill retains it with an increased exemption amount.
Itemized Deductions: Both plans make significant changes to itemized deductions. Changes that have been the subject of heated debate include those related to state and local income taxes, real estate taxes and mortgage interest.
State and Local Income Taxes: The House and Senate plans both eliminate the deduction for state and local income taxes.
Real Estate Taxes: The House and Senate plans continue to allow a real estate tax deduction, but caps it at $10,000.
Mortgage Interest: The House plan allows a mortgage interest deduction related to new loans up to $500,000 (instead of the current $1 million). The mortgage would have to be on the taxpayer’s principal residence, thus it repeals any deduction for mortgage interest related to a second home (generally a vacation home). In addition, it repeals the deduction for new home equity indebtedness that is not acquisition indebtedness (i.e. a second mortgage or a home equity line of credit). The Senate Plan retains from current law both the $1 million deduction limit and the allowance of the deduction for mortgage interest on debt used to acquire a second home. However, it repeals the allowance of a deduction for home equity indebtedness.
Estate & Gift Tax: Both the Senate and House Plans increase the federal estate, generation skipping transfer and gift tax unified credit to $10 million (indexed for inflation) from the currently applicable $5 million (as of 2011) for all decedents dying and generation skipping transfers and gifts made after December 31, 2017.
The House Plan fully repeals the federal estate and generation skipping transfer tax with respect to decedents dying and generation skipping transfers made after 2024. The Senate plan does not provide for a repeal of the estate tax or generation skipping transfer tax. The House plan also reduces the gift tax rate to 35% for gifts made after 2024. The Senate plan does not reduce the gift tax rate.
Sunset Provision: In general, the major provisions in the Senate bill governing the taxation of individuals are set to expire after December 31, 2025. Accordingly, the modified tax rates, increased standard deduction, repealed personal exemptions, increased estate and gift tax exemption, modified/repealed individual deductions, and 23% pass through income deduction are temporary.
Domestic Entity Related Provisions
Corporate Tax Rate: The House Plan cuts the corporate tax rate to 20% for tax years beginning after 2017. The Senate Plan cuts the corporate tax rate to 20% effective for tax years beginning after 2018.
Alternative Minimum Tax: The House plan eliminates the Alternative Minimum Tax and the Senate plan retains it.
Increased Expensing: Both plans allow taxpayers to immediately expense 100% of the cost of qualified property placed in service after September 27, 2017 and before January 1, 2023. The Senate plan allows for a phase out through 2027.
Section 179 Expensing: The House Plan increases the small business expensing limitation under Section 179 for tax years after 2017 and before 2023 from the current limit of $510,000 to $5 million, with the phase-out threshold being increased from the current $2.03 million threshold to $20 million. After 2022, the limit and phase-out would return to the amounts provided under current law.
The Senate Plan increases the small business expensing limitation to $1 million, with the phase-out threshold being increased to $2.5 million. The Senate plan indexes these amounts to inflation and therefore does not expire after five years like the House plan.
Interest Expense Deduction. Both the House and Senate plans contain similar interest expense limitations for tax years beginning after 2017. No deduction is allowed for interest expense in excess of 30% of adjusted taxable income (as defined in the respective plans). Interest disallowed would be carried forward for five taxable years in the House Plan, indefinitely in the Senate Plan. Businesses with average gross receipts of $25 million or less under the House plan and $15 million or less under the Senate plan would be exempt from this limitation.
Carried Interest: Both the House and Senate plans require a three-year holding period in order to obtain long-term capital gain rates with respect to partnership interests received in connection with the performance of services.
Pass-Through Tax Rate. Both the House and Senate plans contain special provisions to lower the tax burden of business owners. However, the two plans create separate frameworks for achieving this goal. An overview of the two plans is contained in the Individual Tax Planning section.
International Tax Related Provisions
Deduction for Foreign Source Portion of Dividends Received by Domestic Corporations.
Both the House and the Senate propose transformational change to the international tax landscape with a move from a worldwide to a territorial taxation system. Currently, US taxpayers pay taxes on their worldwide income (regardless of where it is earned around the globe). Under the reform, US taxpayers would generally pay taxes on income earned in-country but only to the extent such earnings are not treated as Subpart F income, or otherwise taxable in accordance with other key provisions discussed below. To facilitate the move toward a territorial system of taxation both the House and Senate Plans require mandatory repatriation of offshore earnings. In addition, both camps propose full deduction for foreign-source dividends paid by a foreign subsidiary to its US owner(s), changes to the Subpart F regime and Section 956 investment in US property, limitations on loss use and interest deduction, and amendments to the taxation of outbound intangibles. These key provisions and other related items are discussed in greater detail below.
We at Mazars USA will continue to monitor the legislation and report accordingly. The remainder of this guide will address multiple key issues that will assist you in your personal, business and state tax planning, including comments regarding how the above proposals may affect your current strategies.
Individual & Fiduciary Income Tax Rates
The 2017 federal individual and fiduciary income tax rates and brackets are:
|Rate||Single||Married Filing Jointly||Head of Household||Married Filing||Trust and Estates|
|10%||$0 to $9,325||$0 to $18,650||$0 to $13,350||$0 to $9,325||N/A|
|15%||$9,326 to $37,950||$18,651 to $75,900||$13,351 to $50,800||$9,326 to $37,950||$0 to $2,550|
|25%||$37,951 to $91,900||$75,901 to $153,100||$50,801 to $131,200||$37,951 to $76,550||$2,551 to $6,000|
|28%||$91,901 to $191,650||$153,101 to $233,350||$131,201 to $212,500||$76,551 to $116,675||$6,001 to $9,150 5,951 to $9,050|
|33%||$191,651 to $416,700||$233,351 to $416,700||$212,501 to $416,700||$116,676 to $208,350||$9,151 to $12,500 9,051 to $12,400|
|35%||$416,701 to 418,400||$416,701 to $470,700||$416,701 to $444,500
|$208,351 to $235,350||N/A|
|39.6%||Over $418,400||Over $470,700||Over $444,500||Over $235,350||Over $12,500|
The 2018 federal individual and fiduciary income tax rates and brackets are:
|Rate||Single||Married Filing Jointly||Head of Household||Married Filing||Trust and Estates|
|10%||$0 to $9,525||$0 to $19,050||$0 to $13,600||$0 to $9,525||N/A|
|15%||$9,526 to $38,700||$19,051 to $77,400||$13,601 to $51,850||$9,526 to $38,700||$0 to $2,600|
|25%||$38,701 to $93,700||$77,401 to $156,150||$51,851 to $133,850||$38,701 to $78,075||$2,601 to $6,100|
|28%||$93,701 to $195,450||$156,151 to $237,950||$133,851 to $216,700||$78,076 to $118,975||$6,101 to $9,300|
|33%||$195,451 to $424,950||$237,951 to $424,950||$216,701 to $424,950||$118,976 to $212,475||$9,301 to $12,700|
|35%||$424,951 to $426,700||$424,951 to $480,050||$424,951 to $453,350||$212,476 to $240,025||N/A|
|39.6%||Over $426,700||Over $480,050||Over $453,350||Over $240,025||Over $12,700|
Taking into account the phase-out of itemized deductions and the net investment income tax, the top marginal federal individual tax bracket could be as high as 44.6%.
Capital Gains Tax Rates
The long-term capital gains tax rate is 20% (23.8% if the net investment income tax discussed below applies), if taxable income exceeds $470,700 for a married couple filing jointly; $235,350 for a married couple filing separately; $444,500 for heads of household; and $418,400 for single taxpayers. For taxpayers with taxable income below these thresholds, the long term capital gains tax rate remains 15% (18.8% including the net investment income tax). Lower rates may apply to individuals at certain income levels.
Net Investment Income Tax
Taxpayers with qualifying income are liable for the 3.8% net investment income (“NII”) tax on certain items of unearned income. The tax is levied on the lesser of NII or the amount by which modified AGI exceeds certain threshold amounts. The threshold amounts for the NIl tax are:
- $250,000 for a surviving spouse or married filing jointly (“MFJ”) taxpayers;
- $125,000 for married filing separately (“MFS”) taxpayers; and
- $200,000 for single or head of household taxpayers.
Investment income for NIl purposes is (1) gross income from interest, dividends, annuities, royalties, and rents (other than from a trade or business); (2) other gross income from a passive activity or a trade or business of trading in financial instruments; and (3) net gain attributable to the disposition of property other than property attributable to an active trade or business. Some items not included in net investment income include: distributions from certain qualified retirement plans and individual retirement accounts; amounts subject to self-employment tax; and municipal bond interest.
Additional Medicare Surtax
In addition to the NIl tax, the Patient Protection and Affordable Care Act (“PPACA”) instituted an additional .9% Medicare tax effective for the 2013 tax year. The tax is imposed on wages and self-employment income in excess of $250,000 for married filing jointly taxpayers ($200,000 for single taxpayers, and $125,000 for married filing separately).
As one plans for 2017, it is important to keep 2018 in mind. We have included charts below that compare some of the more common tax rates, exemption amounts, and retirement plan contribution limits in 2017 to those that would apply in 2018 (before consideration of potential changes as a result of the TCJA),.
|Maximum income tax rate||39.6%||39.6%|
|Maximum capital gains rate||20%||20%|
|Maximum qualified dividends rate||20%||20%|
|Medicare surtax on NII||3.8%||3.8%|
|Maximum Medicare payroll tax rate/wage base||2.35%*/no limit||2.35%*/no limit|
|Maximum Old-Age, Survivors, and Disability
(Social Security) — rate/wage base Insurance
|Estate tax exemption||$5,490,000||$5,600,000|
|Maximum estate tax rate||40%||40%|
|Gift tax exemption||$5,490,000||$5,600,000|
|Maximum gift tax rate||40%||40%|
|GST tax exemption||$5,490,000||$5,600,000|
|Maximum GST rate||40%||40%|
|Annual gift tax exclusion||$14,000 per donee||$15,000 per donee|
|Annual exclusion gift to non-citizen spouse||$149,000||$152,000|
*This comprises the basic Medicare rate of 1.45%, plus the additional Medicare tax of 0.9% discussed above. The maximum employee portion of Medicare is 2.35%, whereas the maximum employer portion is 1.45%. Employers are responsible for withholding the 0.9% additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year, without regard to filing status.
|401(k)s, 403(b)s, most 457 plans, and the federal government’s Thrift Savings Plan||2017||2018|
|Annual contribution limit||$18,000||$18,500|
|Catch-up contribution if age 50 or older||$6,000||$6,000|
|SIMPLE 401(k)s and SIMPLE IRAs (often used by smaller companies)||2017||2018|
|Annual contribution limit||$12,500||$12,500|
|Catch-up contribution if age 50 or older||$3,000||$3,000|
|SEP IRAs and Solo 401(k)s (often used by the self-employed or small business owners
|Annual Contribution Limit||$54,000||$55,000|
|IRAs (Traditional or Roth)||2017||2018|
|Annual contribution limit||$5,500||$5,500|
|Catch-up contribution if age 50 or older||$1,000||$1,000|
Careful consideration of the income and charitable contribution planning ideas outlined below can help minimize the tax bite.
Individual Income Tax Planning
- Capital gains and losses.
a. Netting of capital gains and losses: Taxpayers are allowed to deduct up to $3,000 of net capital losses against ordinary income. Excess capital losses are carried over to future tax years. Review your capital loss carryovers to determine if any appreciated positions could be sold without incurring additional income tax.
b. Harvest tax losses: If you have overall net capital gains, consider selling loss positions. Securities sold at a loss could be repurchased subject to the wash sale rule. This rule prohibits you from recognizing losses if you purchase substantially identical securities within 30 days before or after the sale. Consider purchasing Exchange Traded Funds tied to the original securities industry or sector to avoid waiting the 30 days.
c.Qualified small business stock (“QSBS”): QSBS is defined as stock of a C corporation with gross assets of less than $50 million at all times from August 10, 1993 through the date of issuance of the stock. The corporation must meet the active business requirement and the stock must be acquired in exchange for money, property or as pay for services at its original issue or in a tax free transaction. Those who acquire the stock from another person generally do not qualify for the preferred tax treatment. Taxpayers who acquire stock that is qualified small business stock, and hold the stock for five years, may exclude up to 100% of the gain from income upon the sale of the stock. The exclusion is generally 50%, but was increased to 75% for QSBS acquired after February 17, 2009, and before September 28, 2010, and to 100% for QSBS acquired after September 27, 2010. QSBS gain is generally treated as a preference item for AMT purposes, except that QSBS gain which qualifies for the 100% exclusion is not treated as an AMT preference item.
- Alternative minimum tax (“AMT”). AMT is a parallel tax system that was originally intended to cause wealthy taxpayers to pay their fair share of tax. Over the years, more and more individuals (many of whom would not consider themselves wealthy) have become subject to this tax. The AMT system disallows or limits many common income tax deductions including the deduction for state and local income taxes, real estate taxes, interest on home equity loans not used to build or improve your residence, and miscellaneous itemized deductions, such as investment advisory fees. AMT brackets and exemptions are indexed annually for inflation. When timing income and deductions, taxpayers must carefully analyze their AMT situation. The House version of the TCJA contains a provision eliminating the AMT beginning with the 2018 tax year, while the Senate version proposes to retain the AMT, but raise the exemption amount and index it for inflation.
a. If, under current law, you project that you will be subject to AMT in 2017, you should consider deferring certain deductions, such as state income tax payments and real estate taxes, until 2018 if you do not expect to be subject to AMT in 2018.
b. If you project that you will be subject to AMT in 2017, you should consider accelerating ordinary income into 2017. You will pay your tax sooner, but the income may be taxed at 28% (the highest AMT rate) as opposed to 39.6% (the highest ordinary income tax rate). However, consideration should also be given to the potential tax rates and brackets that may become law under the TCJA.
c. If you are not projected to be subject to AMT in 2017, you should consider paying your fourth-quarter state estimated tax payments prior to December 31, 2017, rather than waiting until its actual due date of January 15, 2018. Consideration should also be given to prepaying additional state income taxes in 2017 if this can be done without triggering AMT provided one believes that the deduction for state income taxes will be eliminated in 2018.
d. If you are not projected to be subject to AMT in 2017, also consider exercising Incentive Stock Options (“ISOs”).
- Retirement Planning. In terms of retirement planning, there has been very little change from the prior year. There are minor changes to contribution limits and phase-out amounts coming into effect in 2018 that should be planned for prior to year-end. Taxpayers should recall a Revenue Procedure issued in 2016 that provided relief for missed rollovers. Revenue Procedure 2016-47, effective August 24, 2016, relates to distributions from retirement plans or IRAs. These types of distributions are normally taxable, unless the distribution is rolled over into another retirement plan or IRA. This rollover must occur with 60 days of receiving the distribution. In the past, a taxpayer who did not make the qualified rollover within the 60 days would be subject to the complicated and onerous procedure of requesting a private letter ruling from the IRS. This process was both very expensive and time consuming. Revenue Procedure 2016-47 helps to relieve those burdens. If the 60-day period is exceeded, the taxpayer can follow a self-certification procedure, whereby the plan administrator, or IRA trustee or custodian, may rely on the certification, and qualify the rollover as being done within the 60-day window, thus making the distribution nontaxable.
a. SEP-IRAs: Self-employed individuals can take advantage of contributions to retirement plans to improve their tax standing. An individual with a SEP-IRA may be eligible to make a contribution of up to the lower of $54,000 ($55,000 in 2018), or 20% of net self-employment income. This can offset the ordinary income earned during the year, which will lower the overall tax bite. Self-employed individuals can also establish other types of plans, such as a Keogh Plan and defined benefit plans.
b. ROTH IRA Conversion: A Roth IRA allows tax-free growth of assets, tax-free distributions, and does not require minimum distributions each year upon reaching age 70-1/2. Consider converting a traditional IRA to a Roth IRA. Converting to a Roth IRA results in the converted amount of the traditional IRA being taxed as ordinary income in the conversion year. The converted amount is also considered part of your modified adjusted gross income when determining if you are subject to the net investment income tax. If the current proposed tax reform becomes law, consideration should be given to potentially lower tax rates in 2018.
c. ROTH IRA Re-Characterization: If you convert to a Roth IRA in 2017, you can re-characterize it back to a traditional IRA until October 15, 2018. This gives you time to monitor market conditions, and make a decision to undo the Roth conversion if the account value decreases significantly from the time of conversion, thereby avoiding the recognition of income tax based on the higher value of the account on the date the conversion was made. This flexibility can be enhanced further by segregating the Roth IRA into separate accounts invested in diversified portfolios of varying asset classes. If the current proposed tax reform becomes law, this opportunity will no longer be available for the 2018 tax year.
d. Establishment of Retirement Plan: Qualified retirement plans need to be established by December 31, 2017, although they can be funded in 2018. IRAs can be established and funded by April 15, 2018. Many people wait until the last minute to fund IRAs, usually around April 15th of the following year when tax returns are filed. Consider funding IRAs in January of each year so that the earnings will gain an extra 15 months or so of tax deferred earnings.
e. Required minimum distributions: A taxpayer must take their required minimum distribution by April 1st of the year after they turn age 70 ½. The taxpayer could take the first distribution in the year they turn age 70 ½ in order to avoid having to take two distributions in the same year. Consideration should be given to the tax rates and brackets that may become law as part of the proposed tax reform.
f. AGI Limitations for Deductible IRA and Roth IRA Contributions: Contributions to an IRA are deductible provided the taxpayer’s adjusted gross income is below a certain amount. For single and head of household taxpayers who are active participants in a workplace retirement plan, the contribution is fully deductible if the adjusted gross income is $62,000 or less ($63,000 in 2018). It then begins to be phased out and is not deductible at all once the taxpayer’s adjusted gross income is $72,000 or more ($73,000 in 2018). For married filing jointly taxpayers, the range is $99,000 – $119,000 ($101,000 – $121,000 in 2018). For taxpayers who are not active participants in a workplace retirement plan, but their spouse is, the phase-out range is $186,000-$196,000 ($189,000 – $199,000 in 2018). Taxpayers whose adjusted gross income exceeds these ranges can still make a contribution to a non-deductible IRA.The phase-out range for single and head of household taxpayers to be eligible to make a Roth IRA contribution is $118,000 – $133,000 ($120,000-$135,000 in 2018) and for married filing jointly taxpayers the range is $186,000 – $196,000 ($189,000-$199,000 in 2018)
- Passive Activities. Taxpayers may take deductions for business and rental activities that they do not materially participate in, but nonetheless derive income from (i.e., passive activities). The passive activity rules stipulate that a taxpayer is allowed to deduct losses stemming from passive activities to the extent of one’s passive income or if it is the final year of the investment. When passive losses exceed passive income, unused passive losses are carried forward to offset future passive income. Review your passive activities to determine if some can be grouped together. You may meet the material participation test for a group of activities even though you may not meet the material participation test for each individual activity. Certain tax elections must be made in order to group activities.
a. Consider the real estate professional rules if you spend the majority of your time in real estate related activities. A real estate professional is not subject to the passive activity rules.
b. Converting a passive activity to a non-passive activity, i.e., one in which you materially participate, would reduce your net investment income tax.
c. Rental Income Exclusion. If you rent out all, or a portion, of your principal residence or second home for less than 15 days, the income is tax free, but expenses directly associated with the rental won’t be deductible.
- Miscellaneous Items.
a. The Internal Revenue Service (“IRS”) has released relief provisions that are available to Hurricane Harvey and Hurricane Irma victims. The provisions include a listing of counties, islands and municipalities that fall within the covered disaster area, which will receive relief without submitting a request or notifying the IRS. The listing can be provided upon request or found on the disaster relief page on IRS.gov.Individuals who live, and businesses whose principal place of business is located, in the covered disaster area will have an extended period of time to file most tax returns that have either an original or extended due date occurring on or after August 23, 2017 for Hurricane Harvey victims or on or after September 5, 2017 for Hurricane Irma victims. Tax returns due during these periods will now be due January 31, 2018. The due date for estimated income tax payments falling within this period will be extended to January 31, 2018 as well.Taxpayers affected by either hurricane who reside, or have a business located, outside the covered disaster area must call the IRS disaster hotline to request this relief. Additional information can be found in IRS News Release TX-2017-9 in relation to Hurricane Harvey and IRS News Release IR-2017-150 in relation to Hurricane Irma.The IRS has also announced relaxed rules for qualified plans making hardship distributions to families that have been affected by Hurricane Harvey. Some of the relief provisions include exemption from verification procedures of hardship, removal of prohibitions on post contributions after a hardship distribution and the ability to make the distributions prior to amendment of the plans. To take advantage of this relief, the distributions must be made by January 31, 2018. More details can be found in IRS Announcement 2017-11 in relation to Hurricane Harvey and IRS Announcement 2017-13 in relation to Hurricane Irma.
Additionally, the Disaster Tax Relief and Airport and Airway Extension Act of 2017 provides further relief. This law waives the 10% additional tax on early distributions from retirement plans for up to $100,000 in distributions made on or after August 23, 2017 and before January 1, 2019. The distribution must be made to an individual whose principal place of abode on specified dates was in a hurricane disaster area and who sustained economic loss by way of hurricane. A taxpayer who has received such a distribution may repay the distribution by making additional contributions to a retirement account within three years and include the distribution in income over a three year period. This section also permits individuals to recontribute funds to a retirement plan if they were distributed for a home purchase in a hurricane disaster area that was cancelled on account of a hurricane. The limit on a retirement plan loan has been increased and the deadline to repay the loan has been extended as well.
This law also allows for an employee retention tax credit for employers affected by the hurricanes, the credit is equal to 40% of the qualified wages (up to $6,000 per employee) paid to an employee whose principal place of employment on specified dates was in a hurricane disaster zone.
The bill temporarily suspends limitations on charitable contributions made prior to Decemeber 31, 2017 for relief efforts, as well as eliminates the requirement for casualty losses to exceed 10% of adjusted gross income to qualify for deduction and the requirement that the taxpayer must itemize to claim a casualty loss.
b. You can elect to amortize certain bond premiums, thus creating a current year tax deduction. If amortizing is elected, the premium is considered a basis adjustment that is factored into the gain or loss calculation on disposition.
c. Consider accelerating or deferring income, such as salaries or bonuses, to take advantage of income tax brackets.
d. Medical expenses are deductible only if they exceed 10% of your AGI. The threshold is 7.5% of AGI for any tax year beginning before January 1, 2017 for taxpayers who have attained age 65 before the close of such year. If the current House tax reform proposal becomes law, the medical expense deduction will be repealed in 2018. Consequently, taxpayers should consider paying medical expenses prior to the end of 2017 to utilize this deduction if the floor is exceeded. The current Senate tax reform proposal would not repeal medical expense deduction and the threshold would be 7.5% of AGI for any taxpayer for the 2017 and 2018 tax year.
e. Careful consideration of deferring income and accelerating deductions should occur if one believes that income tax rates and brackets will change as President Trump and the GOP have proposed.
f. You should review your income tax withholdings and estimated tax payments already made to determine if you already have paid enough to avoid the underpayment of estimated tax penalty. If not, request that your employer take out additional withholdings and/or make a fourth-quarter estimated tax payment. Income tax withholdings are considered withheld pro rata throughout the year, so if there is a shortfall during one of the previous quarters, additional withholdings at this time can help avoid or minimize the underpayment of estimated tax penalty. When determining your estimated tax liability for 2017, remember to include the additional .9% Medicare tax as well as the 3.8% net investment income tax.
g. If the current House proposed tax reform becomes law it would limit the deductibility of mortgage interest to that which is paid on the first $500,000 of principal, it will also require the $500,000 all be in relation to the taxpayer’s primary property. The current Senate version of the reform bill continues to allow mortgage interest on qualified debt of up to $1,000,000 on primary and secondary residences. Both versions would eliminate the deduction for interest on home equity indebtedness. If the current proposed tax reform becomes law, consideration should be given to accelerating the payment of the following expenses into 2017 to receive the tax deduction while it is still allowable; tax preparation fees, moving expenses and employee expenses related to a trade or business.
6.Pass Through Business Income. Both the House and Senate tax reform plans contain special provisions to lower the tax burden of business owners. However, the two plans create separate frameworks for achieving this goal.
House Plan: Stakeholders in pass-through entities (sole proprietorships, partnerships, limited liability companies, and S corporations) that conduct an active trade or business would be eligible for a 25% rate on the portion of the income that is deemed “business income.” The TCJA provides a 70/30 safe-harbor formula whereby 70% of the income will be subject to the individual’s ordinary income tax rates with 30% of the income taxed at the lower of the preferential 25% rate or the taxpayer’s marginal tax rate.
Specifically excluded from the safe harbor are pass-throughs that generate income from professional services, i.e.; fields of health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting, etc. thus taxing this income at the individual’s ordinary income tax rates. Net income derived from passive activities would be eligible for the 25% rate in its entirety.
In addition, the House plan introduces a 9% ‘small pass-through’ tax rate applicable to the first $75,000 ($37,500 for unmarried individuals) of net business income earned by an active stakeholder in a pass-through business where the owner earns less than $150,000 ($75,000 for unmarried individuals) from the pass-through entity. This benefit is fully phased out once the owner earns $225,000, and would be implemented over a 5 year period.
Senate Plan: Provides an individual deduction of 23% of “domestic qualified business income” earned from a pass-through entity.
Qualified business income does not include certain investment related income or income earned from pass throughs engaged in professional services, i.e.; fields of health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting, etc. However, the deduction is still available from such professional services firms to the extent a taxpayer’s income does not exceed $500,000 ($250,000 for other individuals), subject to a phase out rule.
The Plan contains a second limitation for taxpayers eligible for the small pass through rate. The limitation is the lessor of 23% of domestic business income or 50 percent of W-2 wages allocable to qualified business income.
The potential changes to the taxation of pass through income should be considered for future planning.
Estate and Gift Tax Planning
The Tax Cuts and Jobs Act passed by the House states that effective as of December 31, 2017, Section 2010(c)(3) of the Internal Revenue Code would be amended to double the basic exclusion amount of $5,000,000 to $10,000,000 (indexed for inflation). This amount applies to the lifetime gift tax exemption, the estate tax exemption and the generation-skipping transfer tax exemption. In addition, both the estate tax and the generation-skipping transfer tax have been set to be repealed, effective for decedents dying after December 31, 2024.
The Senate’s version of the bill would similarly increase the basic exclusion amount to $10,000,000 (indexed for inflation), effective as of December 31, 2017. However, it would not repeal the estate tax or the generation-skipping transfer tax. In fact, on top of excluding the repeal of the estate and generation-skipping transfer tax, it goes further by providing an expiration date for the increase in the basic exclusion amount. After December 31, 2025, the basic exclusion amount would revert back to the amount provided prior to January 1, 2018 ($5 million – indexed for inflation).
The TCJA passed by the House of Representatives will retain the previous “stepped-up basis” regime even after repeal of the estate tax. Consequently, not only will a taxpayer forgo paying tax on assets in the estate, but he/she will pass on property to beneficiaries whose basis will be equal to the fair market value as of the date of death. Future beneficiaries will inherit appreciated assets that will avoid both potentially large capital gains taxes and estate taxes. As far as gift tax is concerned, effective for gifts made after December 31, 2024, the TCJA passed by the House will lower the gift tax rate to 35%, as opposed to the current rate of 40%. In contrast, the Senate bill retains a gift tax rate of 40% and does not reduce the rate for gifts made after December 31, 2024.
In light of the contrasting bills, it is difficult to say whether or not the estate and generation-skipping transfer taxes will be repealed. It is also challenging to predict both the amount and timing of future exclusion amounts and gift tax rates. In terms of planning, a delayed repeal of the estate tax and/or a temporary increase of the basic exclusion amount could create difficulty and uncertainty. Estate planning will have to encompass strategies for an atmosphere with and without the estate tax. Additionally, a variety of planning situations may require immediate use of any additional estate or generation-skipping transfer tax exemption in anticipation of a future change by legislators.
Another significant development in the trust and estate area during 2017 was the withdrawal of proposed regulations issued under Internal Revenue Code Section 2704. The proposed regulations under Section 2704 were originally designed to limit the ability to apply artificial valuation discounts to intra-family transfers of interests in entities through the use of lack of control and lack of marketability. In agreement with comments and critiques, the Secretary of the Treasury decided that complying with the proposed regulations would be impractical and exceedingly difficult. According to the Secretary, the proposed regulations would have added an unreasonable burden on taxpayers and their advisers. The Treasury and the IRS now believe that the proposed regulations’ approach to the problem of artificial valuation discounts was ineffective.
On October 4, 2017, in response to Executive Order 13789, issued by President Donald Trump, the Secretary of the Treasury recommended full withdrawal of these proposed regulations. On October 20, 2017, Notice of Proposed Rulemaking, Fed. Reg. Vol. 82, No. 202 officially withdrew the proposed regulations under Section 2704.
Major changes to the estate and generation-skipping transfer tax at the federal level could lead to a host of changes at the state level. Consequently, even if federal estate taxes are repealed, there could be significant planning opportunities at the state level, and there will continue to be numerous important non-tax reasons for estate planning.
Consider this additional year-end planning:
- Maximize annual exclusion gifts. In 2017, each person may make total annual gifts that are free of gift tax of up to $14,000 ($28,000 for a married couple) to an unlimited number of donees. The annual exclusion will increase to $15,000 for tax year 2018. To qualify for the “annual exclusion,” the gift must be a present interest — meaning that the donee must have immediate right and access to the gifted property. An annual exclusion gift also does not reduce one’s lifetime exemption.
- Special attention should be paid if annual exclusion gifts are made to life insurance trusts in order to pay for premiums. Such gifts should be documented, and trustees should ensure that the trust beneficiaries receive notice of withdrawal rights, also known as Crummey letters.
a. It is important that gifts are made towards the beginning of the tax year to utilize the annual exclusion before the potential passing of a taxpayer. This will ensure that the assets are removed from the estate in the most prudent manner. Failure to timely utilize the annual exclusion can be costly for a taxpayer who makes gifts to multiple donees in a single year.
- Utilization of lifetime exemption. Each person can gift a total amount up to their lifetime exemption ($5,490,000 in 2017 and $5,600,000 in 2018) without incurring gift tax. You may want to use a portion or all of your gift tax exemption to make substantial lifetime gifts. Gifts that use the gift tax exemption can remove the value of the gifted asset, plus any future appreciation, from your taxable estate.
- Gifts to Non-Citizen Spouse. In 2017, the annual exclusion for gifts to a spouse who is not a citizen of the United States is $148,000. In 2018, the annual exclusion for gifts to a spouse who is not a citizen of the United States will increase to $152,000, a steady rise from 2017. Careful attention should be paid to situations involving gifts to a non-citizen spouse as these gifts do not qualify for the marital deduction.
- Front Loading Section 529 Plans. A section 529 plan is a plan established to put aside funds for college. A transfer to a section 529 plan is considered a gift, and qualifies for the annual exclusion discussed above. Five years’ worth of gifts can be made at one time, thereby allowing a married couple to gift up to $140,000 to a 529 plan in 2017. Beginning in 2018, this amount will increase to $150,000. This gift would not generate a tax or use any exemption amounts. Instead, the gift is treated as having been made over five years. For instance, if you gave $70,000 to a section 529 plan before the end of 2017, you would be deemed to have given a $14,000 annual exclusion gift that year and for the following four years.
- Grantor Retained Annuity Trusts (GRATs). GRATs can be used to transfer future appreciation of an asset to beneficiaries. These trusts generally work best with assets that are likely to appreciate quickly and during a time (such as now) when interest rates are low.
- Portability. Portability allows the surviving spouse to use the deceased spouse’s unused lifetime gift and estate tax exemption (“DSUE”) amount during the surviving spouse’s lifetime, or have the amount applied upon death. Therefore, if one spouse dies with an estate tax exemption amount remaining, the surviving spouse’s remaining exemption will be increased by the deceased spouse’s unused amount. Portability gives individuals another opportunity to maximize the use of both spouses’ exemption amounts, especially if a lifetime plan has not been put in place or fully implemented. Portability does not apply to the GST tax exemption. Portability must be elected.
- QTIP Election. The portability election, when used together with certain electing trusts qualifying for the estate tax marital deduction (the qualified terminable interest property trust aka “QTIP” Trust), allowed an estate to provide for the most beneficial use of the DSUE, providing for post-mortem estate tax planning. However, in prior issued guidance, there was a procedure by which the IRS would disregard a QTIP election if the election was not necessary to reduce the estate tax to zero. It was not clear to practitioners whether a QTIP election made on a tax return filed to elect portability was valid or may be disregarded. Guidance issued by the IRS in 2016 indicates that a QTIP election will not be disregarded when an estate has elected portability, regardless of whether the election was necessary to reduce the estate tax to zero. This guidance allows for the maximization of the DSUE.
- Other estate planning tools exist and can be discussed with your advisors, such as the use of Sales to Intentionally Defective Grantor Trusts, Qualified Personal Residence Trusts, and the use of Family Limited Partnerships.
Nine states have ushered in changes to their transfer tax system in 2017. In New Jersey, the estate tax was previously repealed (in 2016) for decedents dying on or after January 1, 2018. In addition to the complete repeal in 2018, the law increased the exemption amount for decedents dying in 2017 to $2 million from, up from $675,000. The New Jersey inheritance tax remains in place so bequests to non-lineal beneficiaries will still be subject to a tax.
Most of the other states’ changes to their estate taxes were statutory or inflation-adjusted changes to exemption amounts. For instance, New York’s exemption was increased to $5.25 million effective April 1, 2017. The New York exemption amount is scheduled to catch up to the Federal exemption amount on January 1, 2019. Maryland and Minnesota also increased their exemptions to $3 million and $2.1 million, respectively, effective January 1, 2017. Maryland’s exemption will continue to climb to $4 million in 2018 and match the Federal exemption amount by the beginning of 2019. Minnesota’s exemption will climb to $2.4 million in 2018, $2.7 million in 2019, and $3 million in 2020. The balance of the state changes related to inflation adjustments to the exemption amount (Delaware, Hawaii, Maine, Rhode Island, and Washington). Delaware repealed its estate tax for decedents dying after December 31, 2017.
Domestic Business Planning
This year has not seen the passage of significant tax legislation thus far. However, the TCJA is currently working its way through the House and Senate and expected to be on the President’s desk for signature prior to year-end. The PATH Act of 2015 extended many tax provisions for businesses, but certain proposals in the TCJA will modify or eliminate some of these provisions. While most of the TCJA proposals are slated to go into effect for tax years beginning in 2018, taxpayers will still need to consider post-2017 changes in their 2017 tax planning.
Businesses seeking to maximize tax benefits through 2017 year-end may want to consider two general strategies: (1) use of traditional timing techniques for income and deductions, such as income deferral and deduction acceleration, and (2) tax incentives such as accelerated asset expensing and numerous other credits and incentives available for the 2017 tax year.
Whether a taxpayer should defer/accelerate income or expense is a facts and circumstances determination. However, taxpayers should consider:
- Costs related to tangible property may provide significant tax planning opportunities. Acquisitions of certain items of property under $5,000 can be deducted under a de minimus safe-harbor provision, if the taxpayer issues audited financial statements. In the event that audited financial statements are not issued, the limit is decreased to $2,500. Taxpayers are required to have a written capitalization policy to qualify. While there are other accelerated asset expensing provisions, it should be noted that most, if not all, states follow the de minimus provision which could reduce/eliminate state modifications (add-backs) resulting from the other federal accelerated expensing provisions outlined below.
- The IRS has provided qualified retail and restaurant businesses with a safe-harbor method for determining whether expenses paid or incurred to remodel or refresh a qualified building are deductible, or capitalized as improvements. If the safe harbor applies, 25% of qualifying remodel-refresh costs are capitalized, and the remaining costs are currently deductible.
- Bonus depreciation can be deducted for up to 50% of the cost of qualified property in 2017 (the 50% threshold decreases thereafter, phasing out after 2019). Although a final decision on taking the bonus depreciation deduction is not necessary until a return is filed, taxpayers should consider the impact of this deduction for 2017, especially in planning asset acquisitions prior to year end.
The TCJA contains proposals to significantly expand the expensing percentage and definition of qualified property. Most notably, the expensing limit would increase to 100% and the purchased new requirement is replaced with a taxpayer’s ‘first use’ in the House plan. Should this proposal be signed into law, it would apply to assets placed in service after September 27, 2017.
- The amount permitted to be expensed under IRC §179 for new and used eligible business property purchased during 2017 is $510,000, with an investment limit of $2,030,000 before phase-out. The TCJA contains proposals to significantly expand the IRC §179 expensing limit. Should this proposal be signed into law, it would apply to assets placed in service in tax years beginning after December 31, 2017.
- The Work Opportunity Tax Credit should be considered where a company hires employees from targeted groups. This credit is often overlooked and can offset the corporate tax liability or personal tax liability of owners of pass through entities. The House plan repeals this credit for tax years beginning after December 31, 2017.
- The research and development credit may be claimed for increases in business-related qualified research expenditures, and for payments to universities and other qualified organizations for basic research. Eligible small business owners should consider electing to use this credit against the FICA component of payroll tax or against the alternative minimum tax liability. This credit has broad application and taxpayers are encouraged to speak with their tax advisor. The TCJA proposals preserve this credit.
- The five-year period for recognizing built-in gains tax for S corporations is now permanent. Taxpayers anticipating a reduced corporate tax may wish to plan accordingly for dispositions of property subject to the built-in gains tax. The TCJA calls for a 20% corporate tax rate in either 2018 or 2019, allowing some planning for property dispositions.
- For asset sales, consider electing the installment sale method to defer or reduce tax in certain circumstances.
- Domestic manufacturing and certain other production activities may qualify for a tax deduction under IRC §199, which allows taxpayers to deduct 9% of the lesser of qualified production activity income or taxable income for the year, limited to 50% of qualifying wages. Taxpayers should look to take advantage of the deduction as it applies to their particular situation. This deduction is allowed in 2017. However, the TCJA proposes to repeal this provision in either 2018 or 2019.
- Cash basis taxpayers should analyze whether they can prepay expenses and accelerate deductions. Credit card charges through December 31, 2017 paid in January 2018 can be deducted in 2017.
- Accrual basis taxpayers should review their accounts receivable for possible bad debt deductions, payroll and expense accruals and payment timing, and dispose of unsalable inventory.
- NOL and credit utilization should be considered in determining whether to accelerate income and/or deduction recognition. If such attributes are expiring, acceleration of income may be an appropriate course of action, despite the anticipation of reduced corporate income tax rates.
- The TCJA proposes to limit NOL utilization to 90% of taxable income and eliminate carry back claims with very limited exceptions for tax years beginning after December 31, 2017. The Senate proposal calls for an 80% NOL limitation for tax years beginning after December 31, 2022. Therefore, taxpayers should determine whether NOLs have more value in carrying back or forward.
- The TCJA proposes a narrowed definition for property qualifying for like-kind exchange treatment to include only real property. Careful attention must be given to exchanges under consideration or in process for other types of property and whether the TCJA will grandfather open transactions at December 31, 2017.
- Taxpayers owning pass-through entity interests should review their tax basis so losses are not suspended into future years. With proposed changes in tax rates on the horizon, careful analysis should be given to this issue.
- Effective for tax years beginning after December 31, 2017, adjustments made in an IRS examination of a partnership may be assessed against the partnership itself in the year of examination. This shifts the burden of examination adjustments from the partners during the tax year under examination to the partners in the year the examination ends. Taxpayers should review for eligibility of electing out of these provisions. However, planning should be done to implement these provisions early and/or adjust partnership agreements to mitigate the impact of complying with these rules or inadvertently falling into these provisions.
As we move to year end, business tax planning will be very challenging in light of a number of proposals contained in the TCJA, even though many are slated to take effect after 2017. The issue of accelerating or deferring income and expenses will have even greater significance in light of proposed tax rate changes.
Significant proposals related to the repeal of numerous tax credits and utilization of unused credits, S corporation conversions and post conversion distributions, narrowing of the like-kind exchange rules, and the corporate dividend received deduction all require taxpayers to consider these potential changes and make decisions accordingly prior to 2018. Therefore, it would be very helpful from a planning standpoint to have closure with respect to the TCJA before year end.
International Tax Planning
Tax year 2017 brought a few changes in the international tax arena, particularly with respect to certain international tax disclosure requirements. We highlight the most prominent ones below as well as the proposed House TCJA international tax provisions, along with those in the Senate version of the bill. The bill is not yet current law, but it is relevant as it represents a substantial shift in the core principles of the current US corporate international taxation. It introduces a new territorial taxation approach combined with a dividend exemption reminiscent of the European participation exemption.
- Launch of Country-by-Country (“CbC”) Reporting Requirement for certain large Multinationals (“MNEs”). CbC reporting emerged from the Base Erosion and Profit Shifting (“BEPS”) Initiative of the Organization for Economic Cooperation and Development (OECD). The goal of reporting is to collect information on the interactions between entities in a related group of companies, with particular focus on identifying transactions that fall under the transfer pricing rules and regulations. This reporting requirement will not only be implemented in the US, but globally by many countries that are members of the OECD, as well as by some other non-member countries.
Parent entities of US MNEs with $850 million or more of revenue in a previous annual reporting period will be required to file Form 8975, Country-by-Country Report. The Form 8975 is used to report a US MNE group’s income, taxes paid, and other indicators of economic activity on a country-by-country basis starting with a tax year that begins on or after June 30, 2016. In some cases, the report can be filed before the first reporting periods (if necessary to align with other countries). Once collected, the information will be shared, often times automatically, between the countries pursuant to bilateral Competent Authority Arrangements (“CAAs”), Tax Information Exchange Agreements (“TIEAs”), or the Convention on Mutual Administrative Assistance in Tax Matters. Due to the significant income threshold, this requirement will affect only the biggest taxpayers, but must not be overlooked as noncompliance may expose the MNE to substantial transfer price adjustment penalties.
- Regulations under IRC section 367 on outbound transfers to foreign corporations. In December 2016, the Treasury issued regulations under section 367 (TD 9803) affecting 2017 reporting and tax treatment of certain outbound transfers. In particular, the regulations did away with favorable treatment of some outbound transfers of foreign goodwill and going concern value (“FGGCV”). This was accomplished by limiting the application of the active trade or business (“ATB”) exception. ATB previously applied more broadly to exempt such FGGCV transfers from income recognition. In addition to this limitation, the regulations require the identification of all intangible property that is subject to the rules. The regulations under section 367 also impacted the information disclosure known as the “6038B statement.” This statement is required in case of certain contributions into a foreign corporation. Under the new rules, the statement will have to specify the types of property transferred according to a specific designated category (e.g., active business property, stock, depreciated property, certain intangible property, installment obligations, etc.).
This newly required level of detail arguably makes it easier for the IRS to monitor the implementation of the rules. Thus, careful planning is required where outbound transfers involve intangibles, and especially FGGCV.
- Regulations Requiring Domestic Disregarded Entities (DREs) to report transaction with foreign parents. The reporting requirement previously applied only to “regarded” entities. DREs, that include LLCs and other entities disregarded as separate from its owner, are subject to this requirement in tax years starting as of January 1, 2017 (i.e. with respect to 2018 compliance year). It is noteworthy that there are no de minimis thresholds for such reporting and exceptions only involve situations where the information was already reported on another required disclosure form (e.g., 5471 or 1120-FSC). Taxpayers with DREs subject to this requirement must have an EIN, even if it is not otherwise required.
- Notable Case Law Developments.
- Amazon.com, Inc. v. Commissioner: In this case, the court examined certain buy-in payments, intangible transfers, and intangible development cost allocations that occurred in 2004 pursuant to a restructuring by Amazon in the US and its Luxembourg subsidiary. Even though the Court’s analysis is limited to the previous version of the applicable regulations, it is nonetheless very impactful as it showcases the principles for the arm’s length valuation of intangibles that the court deems applicable to such transfers. Indeed, the court sided with Amazon on many issues, i.e., by finding that IRS buy-in valuation methods were arbitrary, capricious and unreasonable and that the development costs were not fully allocable to the cost sharing pools (as IRS attempted to argue), but rather may be allocated to non-cost sharing activities of Amazon cost centers. Note that this victory may not be long lasting as the Senate bill purports to reverse the outcome of the case by introducing a new intangibles taxation regime as well as by granting broader powers to the IRS to determine an applicable valuation method.
- Grecian Magnesite Mining, Industrial & Shipping Co., SA vs. Commissioner: In a major victory for the taxpayers, the US Tax Court reversed Revenue Ruling 91-32 stating that non-US persons disposing of a partnership interest are not treated as having effectively connected income (“ECI”) associated with a US trade or business. The non-ECI characterization of gain allows non-US residents to take advantage of the capital gains, which are not taxed to foreign persons. In its analysis, the Court denied application of the aggregate partnership theory (where the partners are seen as transferring their proportionate share of partnership property) and sided with the taxpayer by maintaining the entity theory principle (where the partners are seen as transferring their partnership interest only, without looking through to its underlying ECI property). Note that the Senate bill, if passed, would reverse the outcome of the case by deeming the gains to be effectively connected with the US trade or business and introducing a mandatory 10% withholding tax on such dispositions.
- Crestek, Inc. v. Commissioner: In this case, Crestek is a parent of a group of companies that included several controlled foreign corporations (“CFCs”) and a domestic subsidiary. The CFCs and the domestic subsidiary engaged in intercompany transactions that included loans, guarantees and intercompany receivables. The court agreed with the position of the IRS and concluded that Crestek CFCs had substantial investments in US property under IRC section 956, resulting in additional income pickup. Section 956 income from investment in US property by CFCs continues to be one of the most sophisticated and scrutinized issue for the IRS. Thus, whenever loan or guarantee arrangements are present between the CFC and US companies of the group, review of the transactions is warranted to assure proper 965 income pickup.
- Potential Elimination of Certain Regulations Announced.
- On April 21, 2017 President Trump signed an executive order directing the US Treasury to identify tax regulations that “impose an undue financial burden on United States taxpayers, add undue complexity to the federal tax laws, or exceed the statutory authority of the Internal Revenue Service” issued on or after January 1, 2016. Following this executive order, the Treasury has identified several “international tax” regulations that may pose an undue burden, including: regulations under section 385 (treatment of certain interests in corporations as stock or indebtedness); section 987 (income and currency gain or loss); and IRC §367 (treatment of certain transfers of property to foreign corporations). Furthermore, the IRS announced a one year delay to the implementation of section 385 documentation requirements.
- Tax Cuts and Jobs Acts Proposals. While the exact elements of the tax reform has not yet crystallized and does not constitute current law, the unveiled bill provides a good indication of what the tax landscape will look like in the coming years. International tax provisions of particular importance include:
- Territorial Tax System and Dividend Deduction. The bill suggests complete tax exemption for dividends received by US companies from their foreign subsidiaries, provided there is a minimum 10% participation. Additionally, a holding period of either six months or one year must be satisfied, under the House and the Senate bills, respectively. Previously accumulated foreign profits will be deemed repatriated and taxed at different rates according to the type of assets: a 14% tax will apply to cash and other liquid assets (14.49% under the Senate Plan), and a 7% (7.49% under the Senate Plan) rate will apply to all other (illiquid) assets. The payment of repatriation tax may be spread over eight years in installments of 12.5%.
- Controlled Foreign Corporation (“CFC”) Rule Modification. The CFC regime imposes taxation on certain passive income and related party income of foreign subsidiaries, even in the absence of dividend distributions. The reform, among other changes, repeals the long-standing 30-day rule requiring that CFC legislation only applies where a corporation is controlled for at least 30 days during a year. Another important revision under the Senate bill concerns the definition of the US shareholder for CFC purposes: the definition was expanded to include any US person who owns 10% or more of the total value of shares of all classes of stock (irrespective of voting power).
- Anti-Base Erosion and Profits Shifting Provisions.
i. The House bill suggests modifications to interest deduction limitation provisions of the code to strengthen anti-avoidance mechanisms. More specifically, a US corporation’s net interest expense will be limited based on its share of EBITDA of the “international financial reporting group” it belongs to. The Senate bill would limit deductible net interest expense of a US corporation based on the US corporation’s net interest expense as well as the debt-to-equity differential percentage of the “worldwide affiliated group.”
ii. A 20% excise tax may apply to certain outbound related party payments, unless an election is made to treat such income as effectively connected to US trade or business (i.e. subject to US taxation on a net basis).
iii. Taxation of low-taxed intangible income. Additionally, the Senate bill proposes a new regime for taxation of intangibles under a global intangible low-taxed income (“GILTI”) regime. U.S shareholders will be taxed on GILTI currently, with a 37.5% deduction (reduced to 21.875% for tax years after 2025) for foreign-derived intangible income. Furthermore, circumventing the case law of Amazon.com, Inc. v. Commissioner the IRS would gain authority to specify the method used to determine the value of intangible property.
iv. Under the Senate bill, a “base erosion minimum tax” will be imposed on “base erosion payments” made to a foreign related party. The tax is imposed on the difference between the 10% (12.5% for tax years after 2025) of the modified taxable income over an amount equal to the regular tax liability.
Careful and well executed planning requires special attention across a wide range of areas. Your planning should be analyzed in light of the current legislative environment and keeping your individual goals in mind.
To refine your approach, learn more about any of the strategies mentioned or to discuss your individual circumstances, please contact your Mazars USA LLP tax professional for more information.