This summary describes some of the more significant changes made to U.S. federal tax laws by H.R. 1, the bill signed into law by President Trump on December 22, 2017. Except where otherwise noted, the changes take effect in 2018, or in the first taxable year that begins in 2018. For budgetary reasons, some of the provisions are modified after eight or 10 years. Those far-off changes are not addressed in this summary.
Individual Income Tax
The top marginal tax rate for ordinary income is reduced to 37%.
The top rate for long-term capital gains and qualified dividends remains at 20%. The 0% rate for QSBS and the 3.8% tax on net investment income remain unchanged. However, gain on the sale of a carried interest in an investment partnership is taxed as short-term capital gain unless the interest is held for more than three years.
The debt limit for the home mortgage interest deduction is generally $750,000 for debt incurred on or after December 15, 2017, and $1 million for debt incurred before that date.
The itemized deduction for state and local income taxes, sales taxes, and property taxes is limited to $10,000 combined. Prepayments of state and local income taxes made in 2017 for a later tax year are treated as paid in the later year in applying the $10,000 limit.
The percentage limit on certain cash charitable contributions is increased from 50% to 60%.
For divorce or separation instruments executed in 2019 or thereafter, alimony is not deductible by the payor and is not includible in gross income by the recipient.
Several other deductions are eliminated or modified.
The individual AMT exemption amounts and phase-out thresholds are increased, such that the AMT will apply to fewer low- and middle-income individuals.
Estate and Gift Tax
The estate and gift tax are retained, but the exemption amount is doubled from $5 million to $10 million, indexed for inflation based on 2011 dollars.
Business Income Tax
Corporate Income Tax
The corporate tax rate is reduced to 21%.
The corporate AMT is repealed.
The following contributions to a corporation’s capital are taxable: (i) any contribution in aid of construction or any other contribution as a customer or potential customer, or (ii) any contribution by any governmental entity or civic group, other than a contribution made by a shareholder as such.
Individuals’ Business Income
Subject to certain wage and capital limitations, an individual is allowed a deduction equal to 20% of his qualified business income, resulting in a top tax rate of 29.6%. Qualified business income must be “effectively connected” with a U.S. trade or business, such that it would be taxable to a foreign person. Certain investment income is excluded. In the case of a partnership or S corporation, the deduction applies at the partner or shareholder level. Service businesses in the fields of health, law, consulting, financial services, brokerage services and certain others do not qualify for the deduction. The wage/capital limitation and the disqualification of service businesses do not apply if taxable income is less than $157,500 ($315,000 for joint returns).
Business losses of individuals are not allowed to the extent they exceed other gross income plus $250,000 ($500,000 for joint returns), indexed for inflation. Disallowed losses carry forward as NOLs.
Provisions Applicable to All Businesses
The § 199 domestic manufacturing deduction is repealed.
Bonus depreciation of 100% is generally available for depreciable property acquired and placed in service after September 27, 2017, and before January 1, 2023.
The deduction for business interest expense is limited to the sum of (i) business interest income, (ii) 30% of adjusted taxable income and (iii) floor plan financing interest. Disallowed deductions carry forward indefinitely. Adjusted taxable income generally means EBITDA for 2018 - 2021, and EBIT thereafter. Floor plan financing interest means interest on debt used to finance the acquisition of motor vehicles held for sale to retail customers and secured by the inventory so acquired. A small business, an electing real property businesses, an electing farming business and certain regulated utilities are not subject to the limit.
NOLs arising in taxable years beginning after December 31, 2017 can only be deducted to the extent of 80% of taxable income (before NOL deduction). Additionally, NOLs arising in taxable years ending after December 31, 2017, are not carried back, and are carried forward indefinitely.
Like-kind exchanges only apply to real property.
Several deductions relating to meals, entertainment expenses, membership dues and employee fringe benefits are repealed or limited.
Employee Compensation
The exceptions to § 162(m) for performance-based compensation and commissions are repealed, subject to a transition rule. Thus, compensation paid to covered employees is subject to the $1 million limit without regard to whether it is performance-based or commission-based. Once an employee is a covered employee for 2017 or any subsequent year, he or she remains a covered employee thereafter. The definition of the term “covered employee” is modified to be consistent with current U.S. Securities and Exchange Commission rules.
Certain employees exercising stock options or receiving stock in settlement of RSUs can elect to defer their income tax for up to five years if the stock they receive is qualified stock. The corporation transferring the qualified stock must provide a notice to the employee certifying that the stock is qualified stock, that the employee may make the deferral election and the consequences of making the election. Substantial penalties can apply if the notice is not provided as required. If an election is made, deferral applies only to income tax; FICA and FUTA taxes cannot be deferred.
International Tax
Mandatory Repatriation
The accumulated foreign earnings and profits of any CFC and any other foreign corporation owned 10% or more by a U.S. corporation are deemed repatriated. U.S. 10% shareholders are taxed on the deemed repatriated earnings at reduced rates: 15.5% for earnings held in cash or cash equivalents, and 8% for other earnings. The earnings can be actually repatriated without further U.S. tax, subject to foreign exchange gain or loss.
Foreign tax credits can be used to reduce a corporate U.S. shareholder’s U.S. tax liability, but credits are only allowed for foreign taxes on the taxable portion of the deemed repatriated earnings, based on the reduced rates. Individual U.S. shareholders can elect to be taxed as corporations to obtain the benefit of foreign tax credits.
The deemed repatriation is mandatory. It takes effect for the foreign corporation’s last taxable year that begins before January 1, 2018. Thus, for calendar‑year U.S. taxpayers owning calendar-year foreign corporations, the deemed repatriated income arises in 2017. U.S. taxpayers can elect to pay the tax in installments, over eight years.
GILTI
Any 10% U.S. shareholder of a CFC is subject to a new anti-deferral regime starting with the CFC’s first tax year beginning in 2018. The U.S. shareholder must include in gross income its “global intangible low-taxed income” or “GILTI.” GILTI means all net income of all CFCs, with limited exceptions for certain types of income, over and above a deemed fixed return on all CFCs’ tangible assets.
U.S. corporations are eligible for a deduction equal to 50% of the GILTI inclusion, and the resulting 10.5% tax (50% of 21%) can be further reduced by 80% of the foreign tax credits on the CFCs’ underlying income. Thus, the impact of the GILTI tax will be greatest for U.S. corporations whose CFCs earn income with a very low blended foreign tax rate. Individuals can elect to be taxed as corporations to obtain the benefit of foreign tax credits on GILTI.
GILTI, once included in income, can be actually repatriated to the U.S. shareholder without further tax, subject to foreign exchange gain or loss.
Participation Exemption
A U.S. corporation is entitled to a 100% dividends received deduction for dividends it receives from any 10%-or-greater owned foreign corporation. To qualify for the DRD, the U.S. corporation must own the dividend-paying stock for 366 or more days during the 731-day period beginning 365 days before the stock becomes ex-dividend. The deduction is disallowed for hybrid dividends, i.e., dividends for which the foreign corporation received a deduction or other tax benefit.
No credit or deduction is allowed for foreign taxes (e.g., withholding taxes) with respect to dividends qualifying for the 100% DRD or hybrid dividends.
Foreign-Derived Intangible Income
If a U.S. corporation earns “foreign-derived intangible income” directly from foreign market transactions (rather than through a foreign corporation), it is allowed a 37.5% deduction, resulting in a 13.125% tax rate. Foreign-derived intangible income, or FDII, is calculated in a manner similar to GILTI. It is the U.S. corporation’s aggregate foreign market income to the extent it exceeds a fixed return on tangible assets.
To qualify as foreign market income, the U.S. corporation must earn the income from the sale, exchange, lease or license of property to foreign persons for a foreign use, or from services provided to foreign persons or with respect to foreign property. Special rules apply in the case of sales or services provided to intermediaries, including related parties.
Base Erosion and Anti-Abuse Tax
A new 10% (5% for the first tax year beginning in 2018) “base erosion minimum tax” applies to a corporation’s “modified taxable income.” Modified taxable income means taxable income computed without allowing deductions for certain “base erosion” payments to related foreign persons. A base erosion payment means (i) any payment that is deductible, (ii) the depreciation or amortization deduction in respect of any payment for the purchase of depreciable or amortizable property, and (iii) in the case of a company that engages in an “inversion” transaction after November 9, 2017, any payment for the cost of goods or any other amount that reduces gross receipts. Certain payments under derivative financial instruments are not considered base erosion payments.
A foreign person is considered related based on a 25% common ownership threshold, after applying certain stock ownership attribution rules or if the foreign person is otherwise under commonly controlled.
The base erosion minimum tax only applies to corporations with average annual gross receipts of $500 million for the three preceding tax years. All corporations treated as a single employer are treated as one corporation for this purpose. A foreign corporation’s gross receipts are taken into account in the $500 million test only to the extent they are effectively connected with a U.S. trade or business.
Other International Provisions
The “active trade or business” exception, allowing the tax-free transfer to a foreign corporation of property used in an active foreign business, is repealed.
For purposes of the exit tax on a transfer of intangibles by a U.S. taxpayer to a foreign corporation, the term “intangible” includes goodwill, going concern value and workforce in place, and any other item the value or potential value of which is not attributable to tangible property or the services of any individual. Additionally, the IRS may require that intangibles be valued on an aggregate basis or on the basis of the taxpayer’s realistic alternatives to the transfer, if the IRS determines that basis is the most reliable means of valuation.
The indirect foreign tax credit is repealed for actual dividends and applied on an annual basis (rather than on the basis of multi-year earnings pools) for Subpart F inclusions. The foreign tax credit limitation is computed separately for GILTI and branch income, in addition to the existing passive and general income categories.
No deduction is allowed for certain disqualified interest or royalty amounts paid or accrued to a foreign related party as part of a hybrid transaction or if either party to the transaction is a hybrid entity. Interest and royalty amount is disqualified if, under the tax laws of the foreign related party’s country of residence, it is not included in the foreign related party’s income or the foreign related party is allowed a deduction.
A foreign partner’s gain from the sale of an interest in a partnership engaged in a U.S. business is treated as “effectively connected” with that business and taxable to the foreign partner in the same proportion as if the partnership had sold all of its assets. The buyer of the partnership interest must withhold a 10% tax. If the buyer fails to withhold, the partnership must withhold on distributions to the foreign partner.