Over the last several months Tax Reform has been one of the stories dominating the national headlines. Speculation on the impact and the final form of this legislation has been growing ever since the first version of the bill was introduce in the House of Representatives on November 2. Now, two months and five votes after the bill was first introduced, the completed legislation has been approved by Congress and signed by the President.
Although the ultimate impacts of this legislation won’t be known for several more years, tax professionals can now at the very least begin to familiarize themselves with the intricacies of the new law. Although the majority of the final provisions should be familiar to those of us who have been following the legislation through both the House and the Senate, several items from each have been dropped or amended by the Conference Committee.
Corporations and other businesses will most likely see the most impactful changes from this new legislation. The corporate tax rate has been dropped from 35 percent at its highest bracket, to a flat rate of 21 percent. In addition to the reduction in rate, the corporate Alternative Minimum tax has also been repealed. Businesses will also be allowed to expense 100 percent of the cost of certain IRC § 179 property in the year it is placed in service.
Net operating losses (NOLs) and interest deductions were also changed by the legislation. With a few exceptions, business will no longer be permitted to carry back NOLs. Although NOLs may now be carried forward indefinitely, taxpayers may not utilize NOLs in excess of 80 percent of their taxable income in any one year.
In addition to the NOL limitation, certain businesses will also be limited in the amount of interest they may deduct each tax year. Both corporations and pass-through entities with assets of $25 million or more are limited to claiming interest deductions not to exceed 30 percent of earnings before adjusting for interest, depletion, depreciation, amortization, and taxes, plus the taxpayer’s interest income and the floor-plan financing for the taxable year. Excess business interest will be deemed to be paid in the succeeding taxable year. Partners in a partnership are further limited to claiming excess business interest up to the amount of excess business income of the partnership.
Pass-through entities also received an incentive in the final version of the bill. New IRC § 199A provides taxpayers a 20 percent deduction for qualified business income (QBI). QBI is defined as the net amount of qualified items of income, gain, deduction, and loss from any qualified business of the taxpayer. The deduction is limited to 50 percent of the qualified business’s W-2 wages or the sum of 25 percent of the qualified business’s W-2 wages plus 2.5 percent of the unadjusted basis in qualified property immediately after that property’s acquisition.
Lastly, taxpayers doing business internationally will also see significant changes to the way their taxes are calculated. Previously, the U.S. employed a world-wide tax system for U.S. based companies. This means that the U.S. had the ability to tax all of a U.S. citizen’s global income. However, under this world-wide system certain income would not be taxed until it was brought back to the country. This process is known as repatriating the income. This in turn encouraged taxpayers to implement tax deferral strategies by keeping these earning abroad. Foreign tax credits for income taxes paid to foreign jurisdictions were also available under this former system.
The final legislation moves the U.S. away from the world-wide system and in its place creates a territorial system of taxation. It should be noted that this new territorial system has some major differences from a traditional territorial system. For one, much of the foreign income currently taxed by the U.S. would continue to be taxed as Subpart F income. The new system also broadens the taxable base. Some of the major changes include:
- Transitioning to the new system by deeming certain income held overseas as repatriated. Items deemed to be repatriated will be subject to a one-time tax of 15.5 percent of liquid assets and 8 percent for illiquid assets.
- Allowing U.S. taxpayers receiving dividends from 10 percent owned foreign companies a 100 percent dividend received deduction on the foreign source portion of those dividends.
- Preventing base erosion through the use of the Base Erosion Anti-abuse Tax (BEAT).
These new provisions are a significant departure from the way that multinational companies were taxed in the U.S. Furthermore, the majority of these reforms go into effect for tax years beginning Jan. 1, 2018. This means that taxpayers doing business internationally will not have much time to get up to speed on many of these new concepts.
In addition to the major revisions and reforms found in this legislation, these new laws will also lead to the issuance of many new regulations. Taxpayers would be best suited to consult with a tax professional to determine how they will be affected by these sweeping changes to the tax code. Should you have any questions regarding complex tax issues please contact Steven Miller, alliantgroup, LP’s National Director of Tax, at Steven.Miller@alliantgroup.com.