Tag: tax reform

Tax Reform – Consolidated Appropriations Act Provides Added Bonus for LIHTC Projects

On March 23, the President signed the Consolidated Appropriations Act, 2018 (H.R. 1625), a $1.3 trillion dollar spending bill that funds the federal government through September 30, 2018. In addition to preventing a government shutdown, this omnibus spending bill incorporated the following key provisions that help to strengthen and expand the Low Income Housing Tax Credit (LIHTC):

  • A 12.5% increase in the annual per capita LIHTC allocation ceiling (after any increases due to the applicable cost of living adjustment) for calendar years 2018 to 2021.
  • An expansion of the definition of the minimum set-aside test by incorporating a third optional test, the income-averaging test. Pursuant to the Code, a project meets the 40-60 minimum set aside test when 40% of the units in the project are both rent restricted and income restricted at 60% of the area median income. Under the new law, the income test is also met if the average of all the apartments within the property, rather than every individual tax credit unit, equals 60% of the area median income. Notwithstanding, the maximum income to qualify for any tax credit unit is limited to 80% of area median income.

This legislation is a great win for affordable housing advocates who have been pushing for LIHTC improvements through the Affordable Housing Credit Improvement Act, introduced in both the Senate (S. 548 sponsored by Senators Cantwell and Hatch) and the House (H.R. 1661 now sponsored by Congressmen Curbelo and Neal) in 2017, as discussed previously in a prior blog post.

We will continue to provide updates on legislation related to Tax Reform.

Read more coverage on tax reform on the National Law Review’s Tax page.

Copyright © by Ballard Spahr LLP
This post was written by Maia Shanklin Roberts of Ballard Spahr LLP.

Reduction in U.S. Corporate Tax Rates Will Significantly Impact Outbound Tax Planning by U.S. Individuals

The Tax Cuts and Jobs Act (“TCJA”) represents the most significant tax reform package enacted since 1986. Included in this reform are a number of crucial changes to existing international tax provisions.  While many of these international changes relate directly to U.S. corporations doing business outside the United States, they nevertheless will have a substantial impact on U.S. individuals with the same overseas activities or assets.

One notable change under the new law was the reduction of the maximum U.S. corporate income tax rate from 35% to 21%. Not surprisingly, this change will have a corresponding impact on the ability of U.S. shareholders (both corporations and individuals) of controlled foreign corporations (“CFCs”) to qualify for the Section 954(b)(4) “high-tax exception” from Subpart F income.  This is because the effective foreign tax rate imposed on a CFC that is needed to qualify for this purpose must be greater than 90% of the U.S. corporate tax rate.  Therefore, this exception now will be available when the effective rate of foreign tax is greater than 18.9% (as opposed to 31.5% under prior law).

In addition to the reduction in corporate tax rates, the TCJA includes a partial shift from a worldwide system of taxing such U.S. corporate taxpayers to a semi-territorial system of taxation.  This “territorial” taxation is achieved through the creation of a dividends received deduction (“DRD”) for such domestic corporate taxpayers under Section 245A.[1]  This provision will allow a U.S. C corporation to deduct the “foreign-source portion” of any dividends it receives from a 10%-or-more-owned foreign corporation (other than a PFIC), as long as the recipient has owned the stock of the payor for more than one year during the prior two year period.  Assuming the foreign payor has no income that is effectively connected to a U.S. trade or business (“ECI”) and no dividend income from an 80%-owned U.S. subsidiary, the entire dividend generally will be exempt from U.S. federal income tax under this provision.[2]  In a corresponding change to Section 1248, when the relevant stock of a CFC is sold or exchanged, any amount of gain that is recharacterized as a dividend to a corporate U.S. shareholder under Section 1248 also is eligible for this DRD assuming the stock has been held for at least one year.

Despite these shifts toward partial territoriality, the new law retains the Subpart F rules that apply to tax currently certain income earned by CFCs (i.e., foreign corporations that are more than 50% owned by 10% U.S. shareholders (under the new law, both the 10% and 50% standards are measured by reference to either vote or value), as well as introducing a new category of income puzzlingly called “global intangible low-taxed income” (GILTI), though it has almost nothing to do with income from intangibles.[3]  GILTI will include nearly all income of a CFC other than ECI, Subpart F income (including Subpart F income that is excludible under the Section 954 (b)(4) high-tax exception), or income of taxpayers with very significant tangible depreciable property used in a trade or business.

The GILTI tax, imposed under Section 951A, applies to U.S. shareholders (both corporate and individual) of CFCs at ordinary income tax rates. Accordingly, U.S. individual shareholders of CFC typically will be subject to tax on GILTI inclusions at a 37% rate (the new maximum individual U.S. federal income tax rate).   U.S. C corporations that are shareholders of CFCs, on the other hand, are entitled under new Section 250 to deduct 50% of the GILTI inclusion, resulting in a 10.5% effective tax rate on such income.  Additionally, such corporate shareholders are permitted to claim foreign tax credits for 80% of the foreign taxes paid by the CFC that are attributable to the relevant GILTI inclusion.  Accounting for the 50% deduction and foreign tax credits, if any, a corporate U.S. shareholder’s GILTI inclusion that is subject to a rate of foreign income tax of at least 13.125% should result in no further U.S. federal income tax being due.[4]

In addition to the above GILTI provisions, Section 250 also permits U.S. corporations to deduct 37.5% of “foreign-derived intangible income” (FDII), resulting in an effective U.S. federal income tax rate of 13.125% on such income. FDII is the portion of the U.S. corporation’s net income (other than GILTI and certain other income) that exceeds a 10% rate of return on the U.S. corporation’s tangible depreciable business assets and is attributable to certain sales of property (including leases and licenses) to foreign persons or to the provision of certain services to any person located outside the United States.

Impact on Individual U.S. Taxpayers

While the TCJA substantially reduced the top U.S. corporate tax rate from 35% to 21%, individual U.S. income tax rates were not materially altered (i.e., the maximum individual U.S. federal income tax rate was reduced from 39.6% to 37%).  Nevertheless, the reductions in corporate tax rates and other relevant entity-level changes should be expected to have a dramatic impact on outbound U.S. tax planning for individual shareholders of CFCs.

Planning Using Section 962

Section 962, which has been a part of the Code since 1962, allows an individual (or trust or estate) U.S. shareholder of a CFC to elect to be subject to corporate income tax rates on amounts which are included in income under Section 951(a) (i.e., subpart F inclusions and amounts included under Section 956). The purpose behind this provision is

…to avoid what might otherwise be a hardship in taxing a U.S. individual at high bracket rates with respect to earnings in a foreign corporation which he does not receive. This provision gives such individuals assurance that their tax burdens, with respect to these undistributed foreign earnings, will be no heavier than they would have been had they invested in an American corporation doing business abroad.[5] (emphasis added).

The U.S. federal income tax consequences of a U.S. individual making a Section 962 election are as follows. First, the individual is taxed on amounts included in his gross income under Section 951(a) at corporate tax rates. Second, the individual is entitled to a deemed-paid foreign tax credit under Section 960 as if the individual were a domestic corporation. Third, when an actual distribution of earnings is made of amounts that have already been included in the gross income of a U.S. shareholder under Section 951(a), the earnings are included in gross income again to the extent they exceed the amount of U.S. income tax paid at the time of the Section 962 election.[6]

Historically, elections under Section 962 were made infrequently. Under the new law, however, this is likely to change as such elections will have much more significance to many more U.S. individual shareholders of CFCs.  As noted above, the new GILTI provisions will cause U.S. individual shareholders of CFCs to be subject to U.S. federal income tax at a 37% rate on a new category of income, which will be taxed in the same manner as Subpart F income (including with respect to eligibility to make a Section 962 election as to such income).[7]

The lower 21% corporate income tax rate under the new law coupled with the inability of individual shareholders to claim indirect foreign tax credits under Section 960 mean that, in some cases, U.S. individuals investing in CFCs through U.S. corporations will be better off from a tax perspective under the TCJA than U.S. individual shareholders making such investments in CFCs directly. For this reason, individual U.S. shareholders should consider whether it is beneficial to make Section 962 elections going forward, which would allow them to claim indirect foreign tax credits on any amounts included under subpart F, as well as under the GILTI provisions.[8]

Some of the unanswered questions facing taxpayers in this context are, first, whether individuals owning their CFC interests through S corporations or partnerships may make a Section 962 election at all. The IRS previously refused to issue a requested private letter ruling confirming the availability of the election in such cases,[9] though it appears based on informal discussions with Treasury and IRS officials as well as a footnote in the legislative history to Section 965 that the IRS may have since adopted a different view.[10]

Another issue that is not clear is whether an individual U.S. shareholder who makes a Section 962 election is eligible to claim the 50% GILTI deduction under Section 250 (which would have the effect of reducing the effective U.S. tax rate on such income to 10.5%). Based on the clear intent behind Section 962, which is to ensure that an individual U.S. shareholder who has an inclusion under Subpart F (including for this purpose, inclusions under Section 951(A) is subject to tax under Section 11 as if the shareholder invested abroad through a U.S. C corporation, such deduction should be allowed.  The IRS seems to have agreed with this logic in FSA 200247033, when it cited to the legislative history behind Section 962 and calculated the tax on a U.S. individual shareholder who made a Section 962 election as if the taxpayer actually invested through a separate U.S. C corporation doing business abroad.  The IRS noted that “…section 962 was enacted to relieve a U.S. individual shareholder of a CFC from a hardship that might otherwise result from a section 951(a) inclusion by ensuring that the tax burden for such individual would be ‘no heavier’ than it would be if the individual had instead invested in a U.S. corporation doing business abroad. If the amount included in income under Section 951(a) were derived by a taxpayer’s domestic corporation, such amount would have been subject to tax at the applicable corporate rates.” It also should be pointed out that while the regulations under Section 962 specifically state that the hypothetical corporate taxpayer may not reduce its taxable income by any deductions of the U.S. shareholder[11] the regulations make no mention of any prohibition against corporate level deductions, such as the 50% GILTI deduction allowable under Section 250 (emphasis added).

Finally, a third potential issue that may arise in this context is the tax characterization of an actual distribution of earnings and profits that were previously included in the U.S. shareholder’s gross income under Section 951(a). This issue arises whenever the CFC is located in a non-treaty jurisdiction, such that dividends paid by such a CFC could not qualify for the reduced “qualified dividend” rate under Section 1(h)(11).  When an actual distribution is made from such a company, the question is whether the distribution should be treated as coming from the CFC (and therefore be classified as ordinary income), or instead as coming from the deemed C corporation created by the Section 962 election (and thus be classified as qualified dividends). As explained above, the objective behind Section 962 is to tax the individual U.S. shareholder in the same amount that she would have been taxed had the investment in the CFC been made through a domestic C corporation. To achieve this objective and avoid exposing the shareholder to a significantly higher rate of tax in the United States, where962 election is in place, any distribution of earnings and profits by the CFC must be treated as coming from a domestic C corporation.  This issue is currently pending in the United States Tax Court.

Impact Under Section 1248(b)

Another outbound provision that should become more relevant to U.S. individual shareholders of CFCs is the limitation imposed under Section 1248(b) when a U.S. shareholder, directly or indirectly, sells the shares of a CFC. Under Section 1248(a), gain recognized on a U.S. shareholders’ disposition of stock in a CFC is treated as dividend income to the extent of the relevant earnings and profits accumulated while such person held the stock.  Significantly, where the U.S. seller is a C corporation, under the new quasi-territorial system, this conversion of gain into a dividend triggers an exemption from tax pursuant to the Section 245A dividends received deduction.

With respect to individual U.S. shareholders who sell stock in a CFC, recharacterization under Section 1248(a) also remains significant due to the rate differential between the taxation of qualified dividends and long-term capital gains (which are subject to a maximum federal income tax rate of 23.8% under Section 1(h)(11)), and non-qualified dividends (which are subject to a maximum federal income tax rate of 40.8%).

Section 1248(b), however, provides for a ceiling on the tax liability that may be imposed on the shareholder receiving a Section 1248(a) dividend if the taxpayer is an individual and the stock disposed of has been held for more than one year. The Section 1248(b) ceiling consists of the sum of two amounts.  The first amount is the U.S. income tax that the CFC would have paid if the CFC had been taxed as a domestic corporation, after permitting a credit for all foreign and U.S. tax actually paid by the CFC on the same income (the “hypothetical corporate tax”).  For example, assume a Cayman Islands CFC has $100 of income and pays $0 of foreign taxes.  Also assume the Cayman CFC would be in the 21% income tax bracket for U.S. federal income tax purposes under Section 11 based on its taxable income levels if it were a domestic corporation.  In this case, the hypothetical corporate tax would be $21 ($21 U.S. tax minus $0 of foreign tax credits).

The second amount is the addition to the taxpayer’s U.S. federal income tax for the year that results from including in gross income as long-term capital gain an amount equal to the excess of the Section 1248(a) amount over the hypothetical corporate tax (the “hypothetical shareholder tax”). Continuing with the same example and assuming the shareholder’s gain on the sale is $100, this hypothetical shareholder tax would be 23.8% of $79 ($100 Section 1248(a) amount less the hypothetical corporate tax of $21), or $18.80.

Adding together the hypothetical corporate tax and the hypothetical shareholder tax in this example thus yields $39.80 in U.S. tax on the $100 gain, for an effective tax rate of 39.8%. Given that the CFC in this example is not resident in a treaty country (i.e., the United States does not have an income tax treaty with the Cayman Islands), the amount of gain that is recharacterized as a dividend under Section 1248(a) (i.e., $100) would be taxable at a maximum federal rate of 40.80%, resulting in $40.80 of tax. Because this is greater than the Section 1248(b) ceiling of $39.80, the ceiling will apply, and the U.S. shareholder will pay U.S. tax of $39.80.  As a consequence of the significant reduction in U.S. corporate tax rates, it appears that the Section 1248(b) limitation will now always yield a lower effective tax than the tax that would be imposed under Section 1248(a).  While this may seem somewhat odd, it makes sense given that the U.S. corporate tax rate (which the hypothetical corporate tax rate is based on) was reduced from 35% to just 21%.

As illustrated in the above example, going forward, even where no foreign corporate income taxes are paid, the Section 1248(b) limitation will result in a lower tax liability than the tax that would be imposed under Section 1248(a). As the foreign tax burden increases, the Section 1248(b) limitation becomes more significant.  In fact, as long as the foreign corporate tax rate is at least 21%, the Section 1248(b) limitation will yield an effective tax rate of 23.8%, which is equal to the maximum individual U.S. federal income tax rate on qualified dividends.  Therefore, if a U.S. individual shareholder sells shares of stock in a CFC that is tax resident, for example, in Ecuador (a non-treaty country which currently has a corporate tax rate of 22%), the effective tax rate imposed on such shareholder based on the Section 1248(b) limitation will be the same as if the CFC were resident in a treaty country.

Even more interesting is the fact that it would appear to be possible to qualify for the reduced qualified dividend rates caused by the Section 1248(b) limitation even in situations where the foreign tax rate is less than 21%. This is due to the ability of such shareholders to take deductions for purposes of the hypothetical U.S. tax computations that may not be available under relevant foreign law. At least one federal court has confronted this issue. In Hoover v. the United States,[12] for purposes of determining the amount of corporate taxes that would have been paid if the CFC had been a domestic corporation, the U.S. District Court for the Central District of California allowed the hypothetical corporation to claim the former deduction available under Section 922 for Western Hemisphere Trade Corporations. This special deduction is available only to domestic corporations all of the business of which was conducted in North, Central, or South America, or in the West Indies, if, among other items, at least 95 percent of the company’s gross income was derived from foreign sources during a three-year testing period.  Clearly this deduction is not available for U.S. federal income tax purposes when computing the earnings and profits of a CFC, so it is noteworthy that the court allowed the taxpayer in Hoover to claim this special deduction in calculating the hypothetical corporate tax under Section 1248(b).

While the Section 922 deduction for Western Hemisphere Trade Corporations no longer exists, other relevant provisions are available that may provide a benefit to U.S. taxpayers in calculating the hypothetical corporate tax under Section 1248(b). For example, as noted above, Section 250 now provides a 37.5% deduction on FDII. This provision could provide a major income tax benefit to a U.S. taxpayer that owns a CFC that sells goods or provides services to non-U.S. persons when calculating the hypothetical corporate income tax under Section 1248(b).  This results from the fact that FDII is subject to an effective corporate tax rate of only 13.125% (which is much lower than the current 21% corporate tax rate).

Conclusion

As illustrated above, despite the negligible reduction of maximum U.S. individual tax rates from 39.6% to 37%, individual shareholders of CFCs nevertheless will benefit greatly from the more significant reduction in U.S. corporate tax rates. While there are a number of unanswered questions relating to the interaction between Section 962, GILTI, and qualified dividends, direct or indirect U.S. individual shareholders of CFCs now, more than ever, should seriously consider the impact of making a Section 962 election, especially where the CFC is tax resident in a treaty country and/or is subject to a relatively high rate of tax.

[1] All Section references are to the Internal Revenue Code of 1986, as amended (the “Code”), and the Treasury Regulations promulgated under the Code.

[2] No foreign tax credits are permitted as to such dividends for which a foreign-source DRD is allowed.

[3] Unlike subpart F inclusions, there is no high-tax exception to GILTI inclusions under Section 951A. Instead subpart F income that is excluded from a U.S. shareholder’s gross income under the Section 954(b)(4) high-tax exception also is excluded from the GILTI provisions.  Query whether it makes sense to cause certain non-subpart F income that is otherwise subject to an effective foreign tax rate greater than 18.9% to be recharacterized as subpart F income in order to avoid GILTI (e.g., by creating a related party transaction).

[4] For tax years after 2025, the deduction is scheduled to decrease from 50% to 37.5%, resulting in an effective tax rate of 13.125% rather than 10.5% assuming corporate rates remain capped at 21%.

[5] S. Rep. No. 1881, 87th Cong., 2d Sess. (1962), reprinted at 1962-3 C.B. at 798.

[6] Section 962(d); Treas. Reg. Section 1.962-3. The most obvious reason why a taxpayer would choose to make a Section 962 election is the ability to defer the U.S. federal income tax on the actual distribution from the CFC, as well as the possibility of obtaining “qualified” dividends under Section 1(h)(11) on the subsequent distribution.

[7] Section 951A(f)(1)(A).

[8] Section 951A(f)(1)(A). See also TCJA Conference report at p. 517

[9] See Rubinger and LePree, “IRS Takes Flawed Approach to Inclusion under Subpart F,” Tax Notes, v.123, no.7, 2009 May 18, p.903-910.

[10] Section 965(a) imposes a one-time deemed repatriation tax on any deferred earnings of certain “specified foreign corporations.” This tax applies to C corporations as well as U.S. individual shareholders of these corporations.  A Section 962 election also may be useful when calculating the tax due under Section 965 for an individual.

[11] Treas. Reg. Section 1.962-1(b)(1)(i).

[12] Hoover v. United States, 348 F. Supp. 502, 504 (CD Cal. 1972).

© 2018 Bilzin Sumberg Baena Price & Axelrod LLP

Overview of the Tax Cuts and Jobs Act

On December 27th, 2017 President Trump signed into law what is the most consequential tax reform in thirty years, by signing the Tax Cuts and Jobs Act (the “Act”). Most business changes took effect after December 31, 2017, some changes were effective immediately and others, like expensing of capital expenditures, had specialized retroactive effective dates. The following is an overview of the Act:

Individual Income and Transfer Taxes

For individuals, the new law reduces tax brackets, curbs the effect of the Alternative Minimum Tax, alters some tax credits, simplifies many returns by increasing the standard deduction, and increases the amount of property that can pass free of the estate, gift and generation skipping transfer tax. One area untouched by the new law is the adjustment to tax basis for capital assets upon death, allowing for “step-up” or “step-down” depending upon the cost basis vs. the value at date of death. Please see the following summary explanations:

  • Rates. Beginning in 2018, the highest individual income tax rate was reduced from 39.6% to 37%. Other rate adjustments are illustrated in this table:

Rate

Unmarried Individuals, Taxable Income Over

Married Individuals Filing Jointly, Taxable Income Over

Heads of Households, Taxable Income Over

10%

$0

$0

$0

12%

$9,525

$19,050

$13,600

22%

$38,700

$77,400

$51,800

24%

$82,500

$165,000

$82,500

32%

$157,500

$315,000

$157,500

35%

$200,000

$400,000

$200,000

37%

$500,000

$600,000

$500,000

  • Standard Deduction and Personal Exemptions. Beginning in 2018, the doubling of the standard deduction and curtailment of state and local taxes and mortgage interest deductions have the effect of simplifying many returns by eliminating the complexity associated with the preparation of Schedule A. Elimination of personal exemptions and limits on deductions for those who itemize will dramatically change the benefit to individuals of the deductions for mortgage interest, state income and property taxes and charitable contributions.

  • Credits. The new legislation creates a patch-work quilt of how many tax credits are treated. For example, the American Opportunities Tax Credit for education remained untouched, but other credits were modified.

  • Alternative Minimum Tax. Fewer individual taxpayers will be subject to this tax as a result of the increase of the exemption to just over $109,000 (indexed).

  • Estate, Gift and Generation Skipping Tax Exemptions. Beginning in 2018 and through 2025, these exemptions have been doubled to $11.2 million per person, and indexed to inflation.

Basis Adjustment at Death. This adjustment, often mistakenly referred to as “step-up basis”, remains unchanged. Property owned at death will be afforded a new basis equal to the value of such property at date of death. Adjusting the basis at date of death may mean the basis is increased, but can also result in a decrease in basis as happened for some deaths occurring during our last recession.

Provisions of Tax Cuts and Jobs Act Affecting Businesses

In addition to the changes impacting individual taxpayers, the Act included a substantial revision to the tax laws governing businesses. These changes begin with a reduction of the corporate tax rate to a flat 21% (down from a maximum of 35%) and permit unlimited expensing of capital expenditures, repeal the corporate Alternative Minimum Tax and change the deductions available to businesses. A substantial difference between the individual and business tax law changes is that some of the business changes are permanent (i.e. corporate tax rate), while others are temporary (immediate expense treatment for capital expenditures).

  • Tax Rate. The new law creates a flat 21% income tax rate for C Corporations to replace the marginal rate bracket system which had imposed tax rates between 15% and 35%.

  • Corporate Dividends. The dividends received deduction which allowed a C corporation to deduct 70 or 80 percent of dividends received from another C corporation has been reduced to a deduction of either 50 or 65 percent (the higher rate is available where the stock of the dividend paying corporation is owned at least 20% by the corporation receiving the dividend).

  • AMT. The corporate Alternative Minimum Tax has been repealed for tax years beginning after December 31, 2017.

  • Section 179 Expensing Business Capital Assets. Internal Revenue Code Section 179 allows a business to deduct the cost of certain “qualifying property” in the year of purchase in lieu of depreciating the expense over time. The Act allows a year of purchase deduction of up to an inflation indexed $1 million (increased from $500,000) with a total capital investment limitation of $2.5 million. While these changes provide businesses with increased deductions, they have little meaning given the new 100% year of purchase deduction for capital expenditures available under amended Code Section 168(k).

  • Section 168(k) Accelerated Depreciation. The Act allows a 100% deduction of the basis of “qualifying property” acquired and placed in service after September 27, 2017 and before January 1, 2023. Qualifying property generally includes depreciable tangible property with a cost recovery period of 20 years or less, computer software not acquired upon purchase of a business and nonresidential leasehold improvements.

    The bonus depreciation deduction is then reduced to 80% in 2023 and drops by an additional 20% after each subsequent two year period until disappearing entirely for periods beginning January 1, 2027. The allowed deduction percentages are applied on a slightly extended time frame for certain property with longer production periods. In addition to increasing the available deduction, the Act also allows used property to qualify for the deduction. After a phase-out beginning in 2023, this provision lapses after December 31, 2026.

  • Business Interest. Net business interest will not be deductible in excess of 30% of the “adjusted taxable income” of a business. For 2018 through 2021, adjusted taxable income will be determined without consideration of depreciation, amortization, depletion or the 20% qualified business income deductions. In 2022 and thereafter, the 30% limit will be applied to taxable income after deductions for depreciation and amortization. An exemption from the 30% limitation exists for taxpayers with annual gross receipts (determined by reference to the three preceding years) of $25 million or less. Disallowed business interest can be carried forward indefinitely. If a taxpayer’s full 30% adjusted taxable income limit is not met with respect to one business, the unused limitation amount can be applied to another business of the taxpayer which otherwise would have excess interest that is nondeductible after application of the 30% adjusted taxable income limit to that business.

  • Net Operating Losses. Generally, the two year NOL carryback has been repealed. While the losses can be carried forward indefinitely, the deduction will generally be limited to 80% of taxable income.

  • Other.

    • Domestic Production Activities Deduction has been repealed.

    • Like Kind Exchanges are limited to real property.

    • Fringe Benefits. Entertainment expenses and transportation fringe benefits (including parking) are no longer deductible. The 50% meals expense deduction is expanded to include on premises cafeterias of employers.

    • Penalties and Fines. Certain specifically identified restitution payments may be deductible.

    • Sexual Harassment Payments. No deduction will be allowed for amounts paid for or in connection with settlement of sexual harassment or abuse claims if such payments are subject to nondisclosure agreements.

Provisions of Tax Cuts and Jobs Act Affecting Pass-Through Entities and Sole Proprietorships

Before the Act passed, the pass-through of business income from a partnership or S corporation meant a lower overall tax rate would be paid on company income (compared to C corporations) as such income was not subject to double taxation and a lower overall income tax rate generally applied. However, with the reduction of the corporate income tax rate to a flat 21%, and individual rates that reach up to 37%, pass-through entities and sole proprietorships could face a higher tax burden than their C corporation counterparts.

To address the disparate effects of the flat 21% C corporation income tax rate, the Act allows owners of pass-through entities and sole proprietorships a deduction equal to 20% of their “qualified business income” subject to certain limitations. The calculation of what constitutes the qualified business income deduction amount is complex as are the applicable limitations. For example, upon sale of substantially all of the assets of a business, it is likely the 20% qualified business deduction will be significantly limited. Going forward, an analysis of the comparative tax savings as a C corporation or a pass-through entity will be appropriate for all businesses looking to maximize tax savings.

One further complication of the 20% qualified business deduction is that it is currently not applicable in calculating the state tax liability of most businesses. For example, the 20% deduction is currently inapplicable to the state income tax liabilities of Wisconsin businesses.

Family Owned Businesses

With the higher estate and gift tax exemptions and retention of the basis adjustment at death provisions of the tax law, the transfer of family owned businesses will need to re-focus, as follows:

  • Entrepreneurial families may prioritize family governance issues over estate tax issues for many businesses in transition. The changes to the valuation rules from August of 2016 have now been neutralized, and higher exemptions allow more effective estate tax freeze types of transactions.

  • Changes to how pass-through entities are taxed will re-position family businesses to place more emphasis on leasing entities, intellectual property licensing and real estate rental arrangements.

  • With corporate income tax rates reduced, the resurgence of a “management company” or “family office” may take center stage to house key employees who desire different classes of equity and debt ownership, unique compensation arrangements and generous employee benefits. However, IRS rules regarding how management agreements are negotiated and operate will need to be addressed before venturing into this area.

Buying and Selling Businesses

For those clients engaged in buying or selling businesses, the most powerful aspects of the bill have to do with changes to how capital expenditures are taxed, the loss of state and local tax deductions (individuals) and the lower corporate tax rates. We are making the following general observations on the effect of the new law on business sale transactions:

  • Even after the so-called “double tax” stigma associated with the regular corporate tax regime, when all aspects are considered, pass through entities are less attractive for many buyers and sellers. For example, a C corporation can deduct state and local taxes, while shareholders of S corporations, non-corporate owners of LLCs and individual sole proprietors cannot. This negative consequence is amplified by the fact that the 20% qualified business income deduction will not be available for state income tax purposes in most states, including Wisconsin.

  • Because many business valuations are based on income streams that do not consider taxes, those valuations do not reflect the effect of the now lower income tax rates for those businesses. However, lower tax rates should result in more cash flow to the buyers of those businesses, thereby increasing their internal rate of return on invested capital. The result will be that higher valuations will apply in the future because of the tax benefits of the new tax law.

  • Under the new law, buyers of tangible business assets, certain software and leasehold improvements can deduct their cost, in full, in the year of purchase. This means capital intensive businesses will enjoy significantly reduced effective tax rates and, therefore, higher values than previously applicable. More important, however, is that the buyer of a business can fully deduct the cost of all tangible assets in the year of purchase. The result will be that buyers of substantially all of the assets of a business will likely have little taxable income (and therefore less tax liability) for several years after the purchase of the business.

  • As a result of the 100% deduction of tangible assets purchased on the sale of a business and the lack of any changes to the capital gain and qualifying dividend tax rates, we believe that asset purchases will become more beneficial than stock purchases to buyers who seek to minimize transactional taxes, while stock sales will be more beneficial to sellers.

  • The new tax law limits the deductibility of business interest to 30% of adjusted taxable income. This means buyers using debt financing may not be able to fully deduct interest on the debt used to purchase a business. As a rule of thumb, the interest limitation will become applicable whenever the debt to cash flow ratio is higher than the ratio of the effective interest rate to 30%. Note that starting in 2022, the 30% limitation is applied to adjusted taxable income after deducting depreciation and amortization. Therefore, if you are going to buy a business, the time to do it is before the 30% limit becomes more stringent in 2022.

Compensation and Benefits Changes in the Tax Cuts and Jobs Act

  • Section 162(m). Internal Revenue Code Section 162(m) imposes a $1 million cap on the deduction for compensation paid to certain officers of public companies. Before the Act, there was an exception to the deduction limit for compensation that was “performance-based” if certain conditions were met. The Act eliminates the exception for performance-based compensation. Performance-based compensation paid pursuant to a written binding contract in effect on November 2, 2017 will continue to be outside of the $1 million deductibility cap, if the contract is not materially modified on or after that date.

  • Excise Tax on Excess Compensation for Executives of Tax-Exempt Organizations. The Act imposes a new excise tax on “excessive” compensation paid to certain employees of certain tax-exempt organizations. The excise tax is 21% of the sum of:

    • any excess parachute payment paid to a covered employee; and

    • remuneration (other than an excess parachute payment) in excess of $1 million paid to a covered employee for a taxable year (remuneration is treated as paid when there is no longer a substantial risk of forfeiture).

Covered employees are the five highest compensated employees for the year, and any other person who was a covered employee for any prior tax year beginning after 2016. Certain payments to licensed nurses, doctors and veterinarians are excluded.

A “parachute payment” is a payment that is contingent on the employee’s separation from service, the present value of which is at least three times the “base amount” (i.e., average annual compensation includible in the employee’s gross income for five years ending before the employee’s separation from employment). If a parachute payment is paid, the excise tax applies to the amount of the payment that exceeds the base amount.

  • Extended Rollover Deadline for “Qualified Plan Loan Offsets.” Prior to the Act, a participant in a qualified retirement plan who wanted to roll over a “plan loan offset” (an offset to his or her plan account due to a default on a loan taken from the account) to another plan or IRA had only 60 days to do so. The Act gives a longer period of time to roll over a “qualified plan loan offset,” which is a plan loan offset that occurs solely because of the termination of the plan or failure to make payments due to severance from employment. Participants will have until the due date of the tax return for the year in which the qualified plan loan offset occurs.

  • Reduction of Individual Mandate Penalty. The Affordable Care Act generally imposes a penalty (the “individual shared responsibility payment”) on all individuals who can afford health insurance but who do not have coverage. The Act reduces the amount of the individual shared responsibility payment to $0, effective January 1, 2019.

  • Section 83(i) – Taxation of Qualified Stock. The Act adds a new Section 83(i) to allow certain employees of non-publicly traded companies to defer the tax that would otherwise apply with respect to “qualified stock.” Qualified stock is stock issued in connection with the exercise of an option or in settlement of a Restricted Stock Unit (“RSU”), if the options or RSUs were granted during a calendar year in which the corporation was an “eligible corporation.” An eligible corporation is a non-publicly traded company with a written plan under which at least 80% of its U.S. employees are granted options or RSUs with the same rights and privileges. Certain employees, including any current or former CEO or CFO, and anyone who is (or was in the prior 10 years) a 1% owner or one of the four highest paid officers of the company, are excluded from the ability to elect a Section 83(i) deferral.

©2018 von Briesen & Roper, s.c.

Impact of final Tax Reform Legislation on the Historic Tax Credit, New Markets Tax Credit, Low-Income Housing Tax Credit and Renewable Energy Tax Credits

On Dec. 22, 2017, President Donald Trump signed into law “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” – widely referred to as the Tax Cuts and Jobs Act, or simply, the Tax Reform Legislation. As has been widely reported, the Tax Reform Legislation makes sweeping and extensive changes to federal tax law on a scale not seen since 1986. Here, we will focus on the impact of the Tax Reform Legislation on certain federal project-based income tax credits, including the Low-Income Housing Tax Credit (LIHTC), the New Markets Tax Credit (NMTC), the Historic Tax Credit (HTC), and the Production Tax Credit (PTC) and Investment Tax Credit (ITC) for renewable energy projects.

Unlike the tax reform bill passed by the House of Representatives, which would have significantly altered many of these project-based tax credits, the final Tax Reform Legislation generally leaves the credits in place, although with some modifications.

The HTC endured the most adjustment under the Tax Reform Legislation. Prior to the enactment of that legislation, the HTC provided a taxpayer who rehabilitated a historic structure with a tax credit equal to 20% of the taxpayer’s “qualified rehabilitation expenditures” if the structure was listed on the National Register or was otherwise certified by the Secretary of the Interior as being historically significant, or 10% of the taxpayer’s qualified rehabilitation expenditures if the structure did not meet those criteria but was originally placed in service prior to 1936; the tax credit was claimed in its entirety in the year the building was placed in service, subject to a five-year recapture period. The newly revised law eliminates the 10% credit for pre-1936 buildings not listed on the National Register or otherwise certified by the Secretary of the Interior and restructures the 20% credit so that it is claimed ratably over a five-year period beginning in the year the building is placed in service. (A transition rule allows taxpayers who own historic buildings as of Dec. 31, 2017, to take advantage of the pre-amendment version of the HTC for a period of time.)

While the other project-based tax credits were left in place unchanged, the shift, under the Tax Reform Legislation, in how multi-national corporations are taxed will likely impact their relative value. These credits are rarely of value to the developers of the projects to which they apply, as those developers typically do not have sufficient tax liability to fully utilize the credits. Instead, developers will typically shift the benefit of these tax credits to investors, in exchange for cash infusions into the underlying projects. Historically, these investors have been banks and other large corporations with significant tax liability; in many cases, these investors have significant overseas operations. One of the more significant changes the Tax Reform Legislation makes to the taxation of corporations is the imposition of a Base Erosion and Anti-Abuse Tax (BEAT), which is designed to counteract efforts by multi-national corporations to shift income from the United States to lower-tax jurisdictions. In calculating their BEAT liability, corporations may claim none of their HTCs and NMTCs, and only 80% of their LIHTCs and PTCs and ITCs for renewable energy projects, reducing the value of those credits to those corporations and presumably reducing the amount investors will be willing to contribute to projects in exchange for them (either due to investors’ BEAT liability, or due to the decreased demand for the credits among investors). Moreover, beginning in 2026, LIHTCs and PTCs and ITCs for renewable energy projects will be treated like HTCs and NMTCs, and corporations will not be able to use any portion of these credits against their BEAT liability, effectively eliminating the value of those credits to investors subject to the BEAT.

Similarly, the change to the HTC – which is also generally shifted from developers of historic projects to investors in them – from a credit claimed all at once to a credit claimed ratably over five years will likely reduce the value of that credit to investors and/or impact the timing of investors’ cash infusions into the underlying projects, potentially amplifying the need for bridge financing and increasing developers’ borrowing costs.

Further, the reduction, under the Tax Reform Legislation, in the top corporate tax rate from 35% to 21% will reduce the value of depreciation deductions that are sometimes allocated to investors in low-income, historic and renewable energy projects, further reducing the tax benefits available to investors in those projects and likely further reducing the amount that investors are willing to deploy into those projects in exchange for those tax benefits.

While the actual impact of the Tax Reform Legislation on the market for these project-based tax credits will only become clear over time, it is safe to assume that the Tax Reform Legislation will negatively impact the sources of funds available to developers of low-income housing, historic rehabilitation and renewable energy projects, and projects located in disadvantaged areas eligible for the NMTC.

 

Copyright © 2018 Godfrey & Kahn S.C.
This post was written by Jed A. Roher of Godfrey & Kahn S.C.
Read more Tax News on the National Law Review.

U.S. tax reform – retirement plan provisions finalized

The tax reform bill is done.  President Trump signed the bill on December 22, meeting his deadline for completion by Christmas.

While there is much to be said about the Tax Cuts and Jobs Act (the “Act”), the update on the retirement plan provisions is relatively unexciting.  Recall that when the tax reform process started, there was a lot of buzz about “Rothification” and other reductions to the tax advantages of retirement savings plans.  For now, that pot of potential tax savings remains untapped (perhaps to pay for tax cuts in the future).  Nonetheless, the Act that emerged from the Conference Committee reconciliation continues to include a section entitled “Simplification and Reform of Savings, Pensions, Retirement”. The provisions that remain are effective on December 31, 2017.

Recharacterization of Roth IRA Contributions.

Current law allows contributions to a Roth or Traditional IRA (individual retirement account) to be recharacterized as a contribution to the other type of IRA using a trust-to-trust transfer prior to the IRA-owner’s income tax deadline for the year.

Under the Act, taxpayers can no longer unwind Roth IRA contributions that had previously been converted from a Traditional IRA.  In other words, if a taxpayer converts a Traditional IRA contribution to a Roth contribution, it cannot later be recharacterized back to a Traditional IRA.  Other types of recharacterizations between Roth and Traditional IRAs are still permitted.

Plan Loans. 

The Act gives qualified plan participants with outstanding plan loans more time to repay the loans when they terminate employment or the plan terminates.  In these situations, current law generally deems a taxable distribution of the outstanding loan amount to have occurred unless the loan is repaid within 60 days.  The Act gives plan participants until their deadline for filing their Federal income tax returns to repay their loans.

Length of Service Awards for Public Safety Volunteers. 

Under current law these awards are not treated as deferred compensation (and, thus, are not subject to the rules under Section 409A of the Internal Revenue Code) if the amount of the award does not exceed $3,000.  The Act increases that limit to $6,000 in 2018 and allows for cost-of-living adjustments in the future.

That’s all folks!  Happy Holidays!

© Copyright 2017 Squire Patton Boggs (US) LLP

Tax Bill Causes Alarm for Some Charities and Tax-Exempt Organizations

The Tax Cuts and Jobs Act, which has been renamed the Amendment of 1986 Code, was signed into law by President Trump on December 22, 2017. Many are calling it the most sweeping overhaul to the United States tax system in decades. The Act positively impacts many sectors, including corporations with the significant reduction in corporate rates. In the case of tax-exempt organizations, however, the Act may have a significant negative impact.

Impact on Charitable Giving

An increase in the standard deduction amount for individual filers and the increase in the estate tax exclusion are predicted to cause a meaningful decrease in overall charitable giving. A higher standard deduction means fewer taxpayers will itemize deductions, reducing their incentive to make charitable donations. Only taxpayers who itemize their deductions receive a tax benefit from charitable contributions. The Tax Policy Center has estimated that before the Act, more than 46 million tax filers would itemize their 2018 returns, but with the passage of the Act, this number could drop to less than 20 million. In the short-term, donors are advised to consider making additional charitable contributions in 2017 since it is uncertain whether their charitable gifts will create a tax benefit in future years. Similarly, the doubling of the estate tax exclusion will reduce the incentive to make testamentary gifts to charities.

New Excise Tax on Executive Compensation Paid by Certain Tax-Exempt Organization; Medical Services Excluded

The Act imposes a 21 percent excise tax on most tax-exempt organizations (defined as “applicable tax-exempt organizations”) on the sum of compensation paid to certain employees in excess of $1 million plus any excess parachute payments paid to that employee (defined as a “covered employee”).

An applicable tax-exempt organization means any organization that:

  • is exempt from tax under Section 501(a) (such as Section 501(c)(3) charitable organizations),
  • is a Section 521(b)(1) farmers’ cooperative organization,
  • has income excluded from tax under Section 115(1) (this includes certain governmental entities), or
  • is a political organization described in Section 527(e)(1) for the taxable year.

A “covered employee,” is any current or former employee who:

  • is one of the tax-exempt organization’s five highest compensated employees for the current taxable or
  • was a covered employee of the organization (or any predecessor) for any preceding tax year beginning after December 31, 2016.

Compensation is referred to as “remuneration” under the new provision and is defined as “wages” for federal income tax withholding purposes. It also includes remuneration paid by related organizations of the applicable tax-exempt organization.

There are certain exceptions to the inclusion in remuneration under the definition including compensation attributable to medical services of certain qualified medical professionals and any designated Roth contribution.

The new Section 4960 is effective for taxable years beginning after Dec. 31, 2017. Year-end compensation planning, such as accelerating incentive compensation, should be considered to help avoid or reduce the 2018 excise tax. Calendar year taxpayers have only a few days to engage in this planning while fiscal year-end taxpayers may have a few more months to plan.

Separate Computation of UBTI for Each Trade or Business Activity

Certain tax-exempt organizations are subject to income tax on their unrelated business taxable income (“UBTI”). Under the current unrelated business income (“UBI”) rules, an organization that operates multiple UBI activities computes taxable income on an aggregate basis. As a result, the organization may use losses from one UBI activity to offset income from another, thus reducing total UBI. The Act requires tax-exempt organizations with two or more UBI activities to compute UBI separately for each activity. Accordingly, the losses generated by UBI activities computed on a separate basis may not be used to offset the income of other UBI activities. Under the new provision, a net operating loss deduction will be effectively allowed only with respect to the activity from which the loss arose. The inability to offset losses from one UBI activity against income from another may increase an organization’s overall UBI, but the lower corporate tax rate may otherwise reduce the amount of tax paid.

Provisions Affecting Tax-Exempt Bonds

The Act provides some welcome certainty for many tax-exempt organizations relative to tax-exempt bond financing. The House version of the Act had proposed an elimination of the ability of entities to issue “private activity bonds” Section 501(c)(3) bonds that are issued for the benefit of many tax-exempt Section 501(c)(3) organizations. This proposed elimination did not make it into the final bill. The Act does, however, adversely affect many tax-exempt organizations by eliminating their ability to undertake “advance refunding” transactions, where new tax-exempt bonds are issued to refinance existing tax-exempt bonds more than 90 days in advance of the redemption date or maturity date of such existing tax-exempt bonds.Under current law, tax-exempt Section 501(c)(3) organizations could undertake one “advance refunding” transaction, but the Act eliminates all “advance refundings” after Dec. 31, 2017.

Other Noteworthy Provisions

  • The Act imposes a new 1.4 percent excise tax on the investment income of private colleges and universities and their related organizations with at least 500 students and which have investment assets, including those of related entities, of at least $500,000 per student.
  • The existing income tax deduction for donations made in exchange for college athletic event seating rights will be repealed.
  • The charitable contribution deduction of an electing small business trust will be determined by the rules applicable to individuals, rather than those applicable to trusts.
  • The Act modifies the partnership rules to clarify that a partner’s distributive share of loss takes into account the partner’s distributive share of charitable contributions for purposes of the basis limitation on partner losses.
  • The top corporate tax rate for UBI is reduced to 21 percent.
  • The Act increases the annual limit on cash contributions to most public charities from 50 percent to 60 percent.
  • UBI will be increased by the amount of certain qualified transportation fringe benefit expenses for which a deduction is disallowed.
  • The Act repeals the deduction for local lobbying expenses which could impact Section 501(c)(6) rules.
  • The contribution limitation as to ABLE accounts is increased under certain circumstances.
  • The Act now allows for rollovers between qualified tuition programs and qualified ABLE programs.

The Act could have a significant impact on your tax-exempt organization.

© Polsinelli PC, Polsinelli LLP in California
For more Breaking Legal News go to the National Law Review.

Cheers! Brewers Will Have Reason to Toast if Proposed Tax Changes Become Law

Much press has been given to recent efforts in Congress to reform the federal tax code. The House and the Senate have each proposed their own bills to amend the tax laws, and congressional leaders are fervently trying to reconcile the two.  Amid all of this attention to tax changes, a rarely mentioned provision in the Senate bill currently under consideration grants temporary relief to brewers by reducing the federal excise tax on beer.

Beer is heavily taxed. Whether the historical policy rationale for beer’s steep taxation remains relevant today can be debated, but there is no debate that beer is currently one of the most heavily taxed industries in the United States.  However, brewers might feel some financial relief if the current congressional proposal to lower the federal excise tax on beer becomes law.

All beer sold in the United States is subject to federal excise tax which is calculated on a per-barrel basis. Currently, the excise tax is assessed at a rate of $18 per barrel of beer.  However, small domestic brewers, those who produce less than 2,000,000 barrels per year, enjoy a lower tax rate of only $7 per barrel for the first 60,000 barrels sold and $18 per barrel for any sales in excess of the 60,000 barrels.

Although the excise tax on beer is paid by the brewer, in reality the tax is passed on to the consumer in the form of a higher price for the product. Because a barrel contains 31 gallons, and each gallon is 128 fluid ounces, a barrel holds about 330 twelve ounce bottles or cans of beer.  This means the tax on a barrel could be passed on to as many as 330 beer drinkers!

The Senate bill, as written on November 28, 2018, would reduce the excise tax on beer in two ways. First, the excise tax for all brewers would be reduced from $18 per barrel to $16 per barrel on the first 6,000,000 barrels sold each year.  Every brewer, even the largest ones, would benefit from this reduced tax rate.  Second, domestic brewers producing less than 2,000,000 barrels per year would experience a reduction in the excise tax on the first 60,000 of barrels sold from the current rate of $7 per barrel to $3.50 per barrel.  These two changes to the tax law would apply only for years 2018 through 2020.  In 2021, the tax rates would return to their current levels.  Because the tax reduction is only temporary, consumers should not expect to see an immediate corresponding drop in beer prices.

The table below illustrates the tax savings various sized brewers would realize if the Senate proposal becomes law.

The proffered policy rationale for temporarily reducing the excise tax on beer is to encourage brewers to create jobs and make capital investment. The theory behind this policy is that if the tax burden on brewers is temporarily reduced, brewers could invest the savings into growing their operations and boosting the economy.

No new law is ever certain until it has been passed by both houses of Congress and signed by the President. Nonetheless, brewers should keep an eye on the ultimate fate of the Senate proposal and have a plan for how they will deploy the resulting tax savings if the bill ultimately becomes law.

This post was written by Zachary F. Lamb and Hayley R. Wells of Ward and Smith PA.

Trump Tax Reform Proposal

Trump tax reformOn April 26, 2017, Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn introduced the Trump Administration’s tax reform proposal (the “Trump Proposal”) in a briefing. The proposal appears to borrow heavily from the tax reform plan put out by Mr. Trump during his presidential campaign with the significant exception that this reform proposal advocates adoption of a territorial tax system.

The proposal, set forth in a bulleted one-page document, was notably short on detail, and Secretary Mnuchin stated that many details will be finalized in subsequent discussions with Congress. Below, we highlight the major components in the Trump Proposal that we anticipate will be of the greatest interest to our clients.

Major Proposals 

Reduce the number of individual tax rate brackets. Under the Trump Proposal, the top rate for individual income tax would go down to 35 percent from its current rate of 39.6 percent (which is above the top rate of 33 percent proposed by Mr. Trump during his presidential campaign). The number of tax brackets would also be reduced from seven to three (10 percent, 25 percent, and 35 percent). Effectively, these changes would reduce income tax rates for most individual taxpayers, though no determination has been made on the income levels where these brackets would be set.

Expanded standard deduction. The standard deduction for individuals would be doubled under the Trump Proposal, which would effectively create a zero rate for many lower income taxpayers. Additionally, a higher standard deduction would reduce the number of taxpayers who would use itemized deductions, thus simplifying the return filing process for many taxpayers.

Eliminate most individual deductions. Secretary Mnuchin noted that most individual deductions will be eliminated, with the exception of the mortgage interest deduction and the charitable contribution deduction. This change may prove controversial because it repeals the deduction for state and local income taxes.

Other individual provisions. Consistent with the Trump campaign’s position, the proposal also would repeal the alternative minimum tax, the estate tax, and the Affordable Care Act’s 3.8 percent tax on net investment income.

Adoption of a territorial system. The Administration would also shift the United States to a territorial tax system, a proposal that was also advocated in the House Republican Tax Reform Blueprint (the “House Blueprint”)1 released last year, as a way to “level the playing field” for U.S. companies. A territorial tax system generally would exempt from taxation the foreign earning of U.S. headquartered companies. This is a significant change from an early Trump campaign position that advocated a worldwide tax system without deferral.

One-time repatriation tax. The Trump Proposal includes a one-time repatriation tax on the foreign earnings of U.S. companies, which is consistent with the Trump campaign position. However, in his remarks, Secretary Mnuchin did not give a specific repatriation rate even though the Trump Administration in prior comments has advocated for a 10 percent repatriation rate. This may suggest that the Administration is moving to the House Blueprint’s suggested bifurcated rates of 3.5 percent for foreign earnings and profits invested in “hard” assets and 8.75 percent for earnings and profits held as cash equivalents.

15 Percent business income rate and treatment of pass-through entities. The Trump Proposal would impose a 15 percent rate on all business income, including corporations and individuals receiving business income from S corporations, partnerships and other pass-throughs. It is uncertain whether this 15 percent rate will apply to all pass-through income. Secretary Mnuchin has previously stated that the 15 percent business rate would apply to small business income but would not be “a loophole for people that should be paying a higher rate.”

No mention of a cash-basis tax system or the border adjustability tax. The Trump Proposal did not contain any discussion of a cash-basis tax system or the border adjustability approach under the House Blueprint. Under the tax reform proposals of the Trump campaign, U.S. manufacturers would have been allowed to elect full and immediate expensing (subject to loss of the interest deduction) or retain current law depreciation and interest deductions. The Trump Proposal did not contain this earlier campaign proposal. On the issue of the border adjustable tax, Secretary Mnuchin noted that the Administration was continuing discussions with the House. Because the Trump Proposal briefing only provided a general overview of the Administration’s proposals, it is possible that President Trump could endorse either of these ideas at a later date.

At this point, it remains unclear how the Trump Proposal will affect the current tax policy debate or the ongoing tax reform process.

ARTICLE BY Ed McClellan, Dirk J.J. Suringa & Michael J. Caballero of Covington & Burling LLP
© 2017 Covington & Burling LLP

1 The House Republican tax reform proposal is formally titled “A Better Way: A Pro-Growth Tax Code for All Americans.”

Congress Set to Embark on Ambitious Tax Reform Package in First 100 Days of Trump Administration Fundamental Tax Reform

Congress, Capitol, Congressional Tax ReformThe 2016 elections have laid the foundation for the most significant Congressional tax reform effort since the enactment of the Tax Reform Act of 1986. In the past several years, the leadership of the Congressional tax-writing committees (i.e., the House Ways and Means Committee and the Senate Finance Committee) have produced the blueprint for tax reform. More recently, President-elect Trump offered his own tax reform package and pledged to work with the Congress to enact tax reform this year. Against this backdrop, we anticipate that the House Ways and Means Committee will move a comprehensive tax reform bill during the first 100 days of the Trump administration. The Senate Finance Committee will likely move at a slower pace, but its leadership is equally committed to tax reform this year.

While the final version of the tax reform legislation is still under development, it may include the following elements:

  1. a compressed rate structure for individuals with a top rate of 33 percent on ordinary income, a 50 percent deduction for investment income, and a corresponding reduction in the availability of various personal credits, deductions, and exclusions

  2. a top corporate rate of 20 percent (although Trump has called for a rate as low as 15 percent) together with a similar reduction of various business tax preferences and credits

  3. a general elimination of depreciation in favor of immediate expensing for depreciable business assets

  4. a repeal of the estate tax and replacement with, for example, a capital gains tax on death, and

  5. a transition to a territorial international tax system under which foreign profits of American companies would generally not be subject to U.S. tax, together with a deemed repatriation provision for previously accumulated earnings

As a result, this legislation will likely impact virtually every taxpayer in the United States.

ARTICLE BY Jesse (Jay) Adams, William (Bill) Backstrom, Andre Burvant, John F. Fletcher, Matthew A. Mantle & Justin Stone of Jones Walker LLP

© 2017 Jones Walker LLP

Senate Takes on Business Tax Reform; Treasury to Have “Intense Comment Period” for Inversion Regulations

Legislative Activity

Senate to Consider Business Tax Reform Proposals

Following multiple hearings on tax reform thus far this year in the House Ways and Means Committee, this week the Senate Finance Committee will hold a hearing on business tax reform. During the hearing, the difference between Republican and Democrat approaches to taxing corporate income, including what the top rate on corporations should be, will be on full display. In advance of the hearing, the Joint Committee on Taxation (JCT) has released an overview of various proposals for business tax reform, including: (1) the President’s framework; (2) reforms that both maintain and change the structure of the current business tax regime; and (3) proposals to shift to a consumption-based regime. As part of the Committee’s efforts on business tax reform, Senator Orrin Hatch (R-UT) last week reaffirmed his commitment to move forward with his “corporate integration” proposal by the end of June, noting that he is still awaiting a score from JCT before proceeding. For his part, Senate Finance Committee Ranking Member Ron Wyden (D-OR) this week is expected to introduce a proposal that would modify current corporate depreciation schedules – something former Senate Finance Committee Chairman Max Baucus (D-MT) also did during his time in the Senate.

As for tax reform efforts in the House, Ways and Means Committee Chairman Kevin Brady (R-TX) has announced his plans to release a comprehensive tax reform “blueprint” by June of this year as part of Speaker Paul Ryan’s (R-WI) Tax Reform Task Force efforts, while Representative Charles Boustany (R-LA) is expected to continue with his efforts on international tax reform – though whether we will see any action this year on his plan remains to be seen.

Notably, as both House and Senate tax-writers debate the best path forward for tax reform, Republicans lawmakers are pushing for the adoption of Representative Bob Goodlatte’s (R-VA) plan (H.R. 29, Tax Code Termination Act) that would repeal the Internal Revenue Code by 2019 and require Congress to approve a new system of taxation by July of that year. While the future of this legislation is uncertain – and no Senate counterpart exists – there are presently more than 130 co-sponsors in the House.

This Week’s Hearings:

  • Tuesday, April 26: The Senate Finance Committee will hold a hearing titled “Navigating Business Tax Reform.”

Regulatory Activity

Treasury Open to “Intense Comment Period” on Inversion Regulations

Following intense scrutiny and pushback from industry, last week Treasury Deputy Assistant Secretary Bob Stack acknowledged that Treasury “may have missed things” in its latest rulemaking targeting  inversions and the ability of multinational corporations to engage in so-called “earnings-stripping” practices. This acknowledgement comes at the same time that 18 former Treasury officials sent a strongly-worded letter to Treasury Secretary Jack Lew urging his Department to focus on reforming the tax Code, not on inversions as a standalone issue.

In looking ahead, Mr. Stack has promised that Treasury “will have an intense comment period, [and] be listening to taxpayers.” He also suggested that Treasury “want[s] to do things that are both right from a policy point of view and also minimize burdens on companies…[but] [t]he answer to inversions is not to join the race to the bottom so that we have ultimately a zero tax rate.” Notably, Internal Revenue Service (IRS) Commissioner John Koskinen has indicated that the IRS does not intend to put out any “significant” regulations past Labor Day, which creates a rather tight timeframe for Treasury to digest the responses to its proposed regulations and still finalize the regulations this year.

Separately, partly spurred by fallout from the “Panama Papers” fiasco, the Treasury Department has announced that it also soon plans to finalize rules proposed in 2014 that would require the beneficial owners of single-member LLCs to identify themselves to the IRS. According to Treasury Secretary Lew, this, along with widespread implementation of the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Project and its proposal to require country-by-country reporting of certain tax information by large multinational corporations will help combat tax evasion.

Article By Brandon C. Roman & Stephanie L. Shaker of Squire Patton Boggs (US) LLP
© Copyright 2016 Squire Patton Boggs (US) LLP