Effects of the TCJA on the Corporate Tax Regime
The Tax Cut and Jobs Act (“TCJA”) signed into law on December 22, 2017 made many changes impacting U.S. corporate taxes, including the corporate tax rate, the alternative minimum tax, and the utilization of net operating losses. These provisions should improve net after tax earnings and cash flow, and allow for potential tax planning opportunities during transition. Furthermore, these provisions are permanent.
Corporate Tax Rate Cut
One of the major changes enacted in the new legislation is a reduction in the corporate tax rate. Corporations with a tax year beginning after December 31, 2017 will be subject to a flat 21% rate going forward. Fiscal year taxpayers will be required to bifurcate their income and tax income earned on a pro-rata basis. As a result, income earned prior to December 31, 2017 will be taxed at the corporation’s marginal tax rate, and amounts earned after will be taxed at a flat 21%. Notwithstanding other changes in the new legislation, some corporations will see a 14% percentage point reduction (or 40% overall reduction) in tax on income earned after December 31, 2017. No special rate is provided for personal service corporations (PSCs). Therefore, PSCs are also taxed at a flat 21% rate as opposed to the previous 35% flat rate.
Due to the significant reduction in the corporate tax, C corporations should consider any tax planning strategy that could defer income into 2018 or after and accelerate expenses into 2017 to maximize the benefit of the tax rate reduction.
Taxpayers can still take advantage of opportunities that can impact 2017. Therefore, a complete review of all tax accounting methods should be done to confirm no loss in tax benefits results from the tax rate differential. Many method changes are automatic, and can be accomplished with timely submission of the method change request prior to the timely filing of tax returns.
In addition, companies should consider undertaking a complete review of their fixed assets to determine if the proper depreciable lives are being utilized. Where real property acquisitions have occurred within (generally) the last 12 years, a cost segregation study should be considered.
Any of the above may result in an immediate catch up in missed deductions in 2017 and a permanent tax benefit may occur.
Alternative Minimum Tax (AMT) for Corporations
Under the TCJA, the alternative minimum tax (AMT) for corporations is repealed for years beginning after December 31, 2017, with taxpayer friendly modifications for AMT credits resulting from a corporation’s AMT paid in a prior year. Previously, unused AMT credits can be carried forward to offset the corporation’s regular tax liability, limited to the corporation’s AMT in a given tax year.
Under the TCJA, corporations are entitled to receive a refund of unused AMT credits for tax years beginning after December 31, 2017. The refundable portion of the unused AMT credit for tax years beginning in 2018 through 2021 is limited to 50% of the excess minimum tax remaining, over the amount allowable for the year against regular tax liability, with 100% of the AMT credit refundable for tax years beginning in 2021.
This provision can provide additional funds to C corporations in the form of reduced tax liabilities and refundable credits through 2021. In addition, C corporations will no longer be required to track the many AMT-related adjustments required in determining alternative taxable income.
However, there remains some uncertainty around the refundable portion of the AMT credit, where a change in ownership has occurred under IRC Section 382 and potential resulting limitations under IRC Section 383 and how this will interact with the new law.
It is unclear, at this point, if the limitations under IRC Section 383 will limit a corporation’s ability to receive an AMT credit refund where a change in ownership has occurred. While this aspect of the AMT credit rule requires further clarification, the repeal of the AMT and the ability of a corporation to potentially eliminate 100% of its tax liability and generate refundable AMT credits is a win for corporate taxpayers.
Net Operating Losses
Generally, NOLs will be limited to 80% of taxable income for losses arising in tax years beginning after December 31, 2017. It also denies the carryback for NOLs in most cases, while providing for an indefinite carryforward, subject to the percentage limitation.
Under the old rules, NOLs were allowed to be carried back two years and forward 20, with any unutilized NOL lost. The old law also did not limit the use of an NOL to 80% in any one year, as 100% could offset the regular taxable income to the extent NOL carryforwards were available.
As the 80% limitation will only apply to NOLs generated after December 31, 2017, any NOL carryover existing at December 31, 2017 will be carried forward and subject to limitations and expiration under the old rules. NOLs generated after December 31, 2017 will be subject to the new provisions, although the rules under IRC Sections 381 and 382 (change in ownership) will still apply. Lastly, it should be noted that the above changes are not applicable to property and casualty insurers and farming entities.
Tracking NOLs going forward will be extremely important, as completely separate rules apply depending on what year the NOL was generated. For companies that have NOL carryovers, planning ahead will be extremely important, as a company that normally would be able to offset their entire taxable income with an NOL carryforward (old rules) will now be subject to an 80% limitation on post-2017 NOLs, and could be left with taxable income and a resulting tax liability.
Under the new rule where only post 2017 NOLs are utilized up to the 80% limit, the tax rate will be 4.2% on taxable income after NOL utilization. NOLs will be utilized on a first in, first out basis, according to the years they were generated.
Additional provisions that could impact the corporate tax regime include changes to the like kind exchange rules, elimination of the Domestic Production Activity Deduction and modification of the dividends received deduction percentages. Other provisions in the TCJA that could impact corporations, such as modifications to the depreciation rules and interest deductibility rules have been the subject of previous Mazars USA Tax Alerts.
Under prior law, no gain or loss is recognized for property held for investment or productive use in a trade or business that is exchanged for property of like-kind that is held for investment or productive use in a trade or business. In a qualifying like-kind exchange, the basis in the replacement property equals the taxpayer’s adjusted basis in the exchanged property, plus any cash tendered to complete the exchange, thus deferring any gain inherent in the exchanged property.
Effective for exchanges completed after December 31, 2017, the TCJA limits the applicability of gain deferral to only like-kind exchange of real property. A transition rule allows for like-kind exchanges of qualifying personal property if the taxpayer either disposed of the relinquished property or acquired replacement property on or before December 31, 2017.
Section 199 Domestic Production Activity Deduction
Under prior law, a taxpayer could claim a 9% deduction under Internal Revenue Code Section 199 for qualified production activities performed in whole or in part within the United States, subject to a W-2 wage limitation.
The TCJA repeals Section 199 for tax years beginning after 2017.
Taxpayers will no longer be able to claim the Section 199 deduction to reduce their income. This law was extremely complicated and difficult to both comply with and administer. Its repeal is likely due to the overall reduction in the corporate tax rate to 21% for tax years beginning after December 31, 2017.
The Section 199 deduction can be claimed for any open tax year beginning before January 1, 2018. Therefore, taxpayers with qualifying production activity income within the scope of Section 199 that have never taken this deduction should consider claiming the Section 199 deduction for 2017 tax years and consider amending returns for open tax years prior to 2017.
Dividends Received Deduction (DRD)
The TCJA reduces some of the dividends received deduction (“DRD”) percentages for dividends received in tax years beginning after December 31, 2017.
The DRD is a federal deduction applicable to C corporations that receive dividend income. The purpose of this deduction is to alleviate the potential consequences of triple taxation. Triple taxation occurs when a company paying the dividend does so with after-tax money. The corporation receiving the dividend is then taxed on the dividend. Finally, if the receiving corporation pays out the dividend to its shareholders, the shareholders are then taxed.
The actual amount of the DRD depends on the percentage of ownership held in the corporation making the dividend. Not all dividends qualify for a DRD. For example, dividends received from foreign corporations are generally ineligible.
The following table presents the three DRD deduction rates under the old and new rules:
Deduction % Old Rules
Deduction % New Rules
|Less than 20%||70%||50%|
|20% up to 80%||80%||65%|
|80% or more||100%||100%|
So for example, Corporation A owns 25% of Corporation D. Corporation D pays a $10,000 dividend to Corporation A in 2017. Corporation A takes a $8,000 DRD ($10,000 x 80%) in 2017. Further assume that Corporation A uses a 35% federal corporate tax rate. Corporation A pays $700 in federal taxes ($2,000 taxable dividend income, net of DRD x 35% tax rate).
The effective tax rate on the $10,000 dividend is 7%. Now consider the same dividend is paid in 2018. Corporation A may only claim a $6,500 DRD ($10,000 x 65%). However, under the new tax law, Corporation A is subject to the new lower 21% tax rate. Corporation A’s tax on the dividend is $735 ($3,500 taxable dividend income, net of DRD, x 21% tax rate). The effective tax rate on the 2018 dividend is now 7.35%, .35% more than under the old rules.
The downward adjustments to the DRD percentages are intended to generally preserve the current effective rates on dividends eligible for a DRD. As illustrated above, the effective rate on the dividend income has increased slightly. For corporations owning less than 20% of the dividend paying corporation, the effective tax rate is 10.5% under both the old and the new rules.
Only C Corporations may claim a DRD. S Corporations, partnerships (including LLCs), and individuals are not entitled to a DRD. If a partnership with dividend income has C Corporation partners, they should inform those corporate partners if dividends received are eligible for a DRD.
Please contact your Mazars USA LLP professional for additional information.