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Friday, 17 November 2017

US Tax reform bill: Tax Cuts and Jobs Acts

17/11/2017 - On November 2, the House Republican's tax reform bill – the Tax Cuts and Jobs Act – was released. This bill is 429 pages and should provide for extensive tax reform. The bill would immediately reduce the statutory tax rate to 20% and move to a territorial system of taxing foreign profits with anti-base erosion provisions for both US-based and foreign-based multinational companies. A new excise tax of 20% will be introduced on deductible payments from US companies to related foreign companies that in fact acts similar to the border adjustment in the House Republican Blueprint, but only for outbound payments. A brief summary of the other key provisions is provided below. President Trump intends to sign the bill before the Thanksgiving holiday, but there are several unpopular provisions that will potentially get push-back and changes are likely to be made. Given the current political US landscape and the unprecedented situation, the last major US tax reform took place in 1986, this seems an optimistic outlook. Of course we will keep you posted on updates following the legislative process.

International Tax proposals

  • Provides for a 100% exemption on dividends paid by a foreign corporation to U.S. corporate shareholders that own at least 10% or more of the foreign corporation. This means that U.S. corporations can generally bring future earnings back into the U.S. tax-free.
  • Repeals the tax imposed when untaxed foreign subsidiary earnings are reinvested in U.S. property.
  • Provides for a one-time tax on earnings currently held offshore as a deemed-repatriation. The tax rate is 12% for any portion of earnings and profits that are cash or cash equivalents, and 5% for all other amounts. This tax can be paid over an 8 year period.
  • Repeals the availability of certain foreign credits, including the Section 902 indirect foreign tax credit.
  • Modifies Subpart F income in generally tax-favorable ways, including making permanent the current look-through rule that allows many controlled foreign corporations to avoid recognizing Subpart F income on passive income (e.g., dividends, royalties, rents) received from foreign related parties. 
  • Introduces a new tax regime on U.S. shareholders with foreign high returns, designed to prevent erosion of the U.S. tax base.
  • All deductible payments except interest paid to a related foreign company would be subject to a 20% excise tax unless the related foreign company elected to treat those payment as effectively connected income (ECI) and thus taxable in the US. If the ECI election were made to treat the payments as taxable in the US, the income would be taxed on a net basis. The deduction allowed to offset the income would be determined by reference to the profit margins reported on the group's consolidated financial statements for the relevant product line. No foreign tax credits would be allowed to reduce the US tax on that income. If no election were made to treat the payments as taxable income, the excise tax paid would not be deductible. It should be noted that the reform proposal does not currently change the top tax rates for capital gains and dividends (20%) nor does it impact the Affordable Care Act's 3.8% net investment income tax imposed on high earners.

Business Tax proposals

  • Reduces the corporate tax rate to a flat 20% (25% for personal services corporation).
  • Allows corporations to fully and immediately expense 100% of the cost of qualified property acquired and placed in service after September 2017 and before January 1, 2023. 
  • Disallows deduction for net interest expense in excess of 30% of the business's adjusted taxable income (a comparable rule would apply to partnerships). 
  • Repeals the Section 163(j) rule that can limit a corporation's ability to deduct interest expense if debt-to-equity ratio exceeds 1.5 to 1.
  • Provides that taxpayers will only be able to take NOL carryovers or carrybacks to the extent of 90% of taxable income for that year, and repeals carrybacks in most cases. These rules will apply generally for losses arising in tax years after 2017.
  • Amends the contribution to capital rules to provide that a corporation will recognize gain on contributions to the extent the amount contributed exceeds the value of the stock issued to the contributor.
  • Taxes gain or loss from the disposition of a self-created patent, invention, model, or secret formula as ordinary in character (currently capital in nature).
  • Repeals the rule triggering a technical termination of partnerships where there is an exchange of 50% or more of the partnership interests within a 12 month period.
  • Terminates the new markets tax credit, although credits that have already been allocated may be used.
  • Modifications of many energy tax credits.

Individual Income Tax proposals

  • Reduces the number of tax brackets from 7 to 4 (12%, 25%, 35% and 39.6%), but the top tax rate remains the same.
  • Repeals the alternative minimum tax.
  • Doubles the standard deduction (for those that do not itemize deductions).
  • Repeals personal exemption deductions (currently, $4,050 each for taxpayer, spouse, and any dependents).
  • Provides for a lower 25% tax rate for individuals that earn their income through certain sole proprietorships, partnerships and S corporations. Generally, 30% of the income from these entities can qualify for this lower rate. 
  • Repeals the adoption tax credit and the electric vehicle credit.
  • Repeals the limitation on itemized deductions (the so-called Pease limitation that can limit itemized deductions to 80% for high earners).
  • Limits the mortgage interest deduction to indebtedness up to $500,000 (as compared to $1 million currently).  In addition, the mortgage must be on the taxpayer's principal residence. This proposal repeals the deduction for mortgages on second homes or for home equity loans.
  • Repeals itemized deductions for state and local income or sales tax, although individuals can itemize up to $10,000 of real property taxes. 
  • Repeals deductions for personal casualty losses (from fires, storms, theft), although this does not apply where there is special disaster relief legislation.
  • Increases the charitable contribution limitation from 50% to 60% of adjusted gross income for cash contributions to public charities and certain private foundations.
  • Repeals deductions for tax preparation expenses, medical expenses, employee expenses, and moving expenses.
  • Repeals deductions for alimony payments, although this is for agreements executed or modified after 2017.
  • Increases the number of years (from 2 out of 5 years to 5 out of 8 years) that a taxpayer must live in a principal residence to qualify for the $500,000 exclusion from gain recognition on the sale of such residence. The bill also provides for a phase-out of this exclusion for taxpayers with adjusted gross income in excess of $500,000. 

The bill covers a lot of provisions which are this week’s subject of the Ways and Means Committee of the U.S. House of Representatives. Subsequently, these provisions will be subject to negotiation as the Senate moves forward with its own version of a tax reform bill (released on 10 November 2017). The goal is for both the House and Senate to pass their tax reform bills before Thanksgiving. After which the differences need to be solved and agreement has to be concluded on a single bill. We’re currently investigating the Senate Finance Committee’s tax reform bill. The US tax team of T/A International shall closely monitor the process and keep you updated accordingly on the developments.

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