As we heard on November 2, the House released the Tax Cuts and Jobs Act. The Act contains provisions that will change the tax landscape for individuals, corporations, businesses with foreign operations, as well as the transfer tax provisions related to gifts and estates. Many commentators have weighed in saying that the changes contained in this bill are the most sweeping reforms since the Tax Reform Act of 1986.
The first thing to remember is that we still have a long way to go. The House bill was just the first step. The Senate hopes to release its bill by November 10, and then the work of committees, negotiations and compromises will begin in earnest with all of the parties focused on having something on the President’s desk before the year ends.
With all of that said, most people are wondering: What does this mean for me? Unfortunately the answer is, it depends.
- The bill does adjust the tax brackets resulting in fewer rate brackets (down to four from the previous six), and higher taxable income prior to reaching the top rate. It does not, however, get rid of the 39.6% bracket which is now triggered for a married couple filing jointly at $1.0 million of taxable income. That said, the bill does include relief for owners of pass-through entities by reducing the tax rate on at least a portion of the income that flows through.
- Itemized deductions are adjusted significantly with the elimination of deductions for state and local taxes, the capping of real estate tax deductions to $10,000, elimination of the deduction for medical expenses, and the elimination of deduction for unreimbursed employee business expenses.
- The deduction related to mortgage interest has been capped to the amount associated with $500,000 of mortgage debt. Under current law the cap is $1.0 million of principal.
- With the new limitations on itemized deductions, the bill also removes the 3% phase out, increases the amount of charitable deduction allowed, and increases the standard deduction for those who don’t itemize.
- There are also significant changes proposed with regard to taxing the gain on the sale of an individual’s principal residence. The changes focus on limiting how often someone can sell their home and qualify for the gain exclusion.
- The long awaited repeal of the Alternative Minimum Tax (AMT) is also included in the bill, an item that is made easier with the elimination of itemized deductions, the very things that often cause taxpayers to fall into the AMT.
- Finally, the popular research and development tax credit has been left unchanged.
- The bill adjusts the Corporate tax rate by imposing a 20% flat tax versus the current graduated rate structure.
- With regard to deductions, there are significant expansions in the ability to deduct qualified property acquisitions, and expansion of the Section 179 expensing elections. However, on the flip side, they have eliminated the Section 199 Domestic Production Deduction and limited the deduction for interest expense.
- In an effort to simplify the tax returns for smaller businesses, they have created exceptions to the application of certain provisions for businesses with gross receipts of less than $25 million. These provisions include Section 263A capitalization, percentage of completion and the limitation mentioned above with regard to the cap on deductible interest expense.
Estate and Generation Skipping provisions:
- The current law includes a lifetime exclusion on transfers of up to $5 million per person. The new bill doubles this to $10 million and provides that this will be indexed for inflation.
- The bill also calls for full repeal of these taxes in 2023, while maintaining the step-up in basis for property transferred after the estate tax is repealed.
- Of particular note is that the Gift Tax, a tax that has always been tied to an overall transfer tax regime, is not repealed with the estate and generation skipping provisions in 2023.
- With a focus on taxing the earnings of US Corporations that have been left offshore, i.e., un-repatriated, the bill calls for the taxation of pre-2018 offshore earnings of foreign subsidiaries of a US shareholder, provided that the US shareholder owns at least 10% of the foreign subsidiaries. The tax rate applied would be 12% of the earnings that are in cash or cash equivalents and 5% for earnings that have been re-invested in the foreign subsidiaries other assets. There are certain elections that can be made, and there are certain provisions that will defer the tax for S Corporations.
- The bill provides for a 100% deduction for foreign-source dividends received by a domestic corporation from a “specified 10%-owned foreign corporation”, not included a passive foreign investment company that is not a Controlled Foreign Corporation (CFC). Because of this new rule, the bill also repeals the indirect foreign tax credit.
- With an effort to provide for anti-base erosions provisions, the bill includes a new category of Subpart F: foreign high return amounts. This requires a US shareholder of any CFC to include in gross income 50% of its “foreign high return amount” determined for the year. While the computations are a bit complicated, this reform effectively establishes a global minimum tax on foreign earnings. If this is passed as written, it will likely have a significant impact for US taxpayers with considerable offshore intangible property.
- The current law limits the deduction for interest payments made to a related party. The new law makes changes to the calculation of that limitation and will likely further limit the deduction for interest paid by a domestic corporation that is a member of an international financial reporting group with average annual global gross receipts of more than $100 million.
As you can tell, depending on your tax situation, you may see a tax savings, or you may not. We will continue to monitor the bills as they make their way through the House and Senate. If you have questions, please feel free to contact us.