On December 20th the U.S. House of Representatives and the U.S. Senate passed and sent to the President for signature legislation that makes significant changes to the U.S. tax code (the “Tax Act”). The changes are the broadest rewrite of the U.S. tax code since 1986 and will have a widespread impact on both individuals and businesses. The legislation results in a net reduction in taxes, but the sweeping changes will have a broad impact and, depending on the circumstances, may not bring a tax reduction to any particular taxpayer or industry. The legislation is generally effective for taxable years beginning on or after January 1, 2018, however, certain provisions could have a retroactive impact.
The following is a summary of certain highlights of the Tax Act. The provisions discussed below are subject to numerous exceptions and special rules, including transition rules, which are not described herein. This summary does not describe all aspects of the Tax Act, including provisions related to Estate and Gift taxes or Employee Benefits and Executive Compensation.
Highlights of the Tax Act include:
- Reduction in Corporate Rates from 35% to 21%
- Elimination of Corporate Alternative Minimum Tax
- Temporary Business Expensing Provisions
- 100% deduction allowed for “qualified property” acquired and placed in service after September 27, 2017. The allowable deduction is phased out for property placed in service after 2022.
- Subject to certain exceptions, qualified property includes new and used property, other than property acquired from related parties.
- Limitations on the Deductibility of Interest Expense
- The deduction for net interest expense incurred by a business is generally limited to the sum of (a) business interest income (b) 30% of “adjusted taxable income” and (c) floor plan financing interest.
- Disallowed interest may be carried forward indefinitely.
- Businesses with average annual gross receipts of $25 million or less would be exempt from these limitations.
- Repeal of Deduction for Domestic Production Activities
- Limitation on Deduction for Net Operating Losses (NOLs)
- The deduction for NOLs is limited to 80% of taxable income.
- Subject to certain exceptions, the carryback of NOLs is eliminated, but NOLs may be carried forward indefinitely.
- Adoption of a Territorial Regime for Taxation of Foreign Corporate Earnings
- Subject to certain limitations, a 100% dividend received deduction is allowable for foreign-source dividends paid by foreign corporations to 10% U.S. corporate shareholders. The indirect foreign tax credit under section 902 is repealed.
- Accumulated untaxed foreign earnings are deemed repatriated and taxed at reduced rates of 15.5% for cash and cash equivalents and 8% for illiquid assets. Taxpayers may elect to pay such tax in installments over an 8-year period.
- Base erosion measures are enacted, including limitations on deductions for interest expenses and with respect to certain hybrid transactions, as well as taxation of certain global intangible income.
- The Subpart F rules and the foreign tax credit under section 960 continue to apply in modified form.
- Reduction of Tax on Certain Income Earned By Pass-Through Entities
- A deduction of 20% is allowed by taxpayers who have domestic “qualified business income” from a partnership, S corporation, or sole proprietorship, subject to certain limitations.
- Qualified business income generally excludes income from “specified service businesses,” which includes businesses involving the performance of services in certain fields, such as health, law and accounting. This exclusion does not apply to income below certain thresholds.
- Provisions Affecting the Taxation of Carried Interests
- Capital gain with respect to the transfer of any applicable partnership interest would be treated as short-term capital gain unless the holding period for such interest is more than three years.
- Certain Provisions Affecting Taxation of Individuals
- Reduction in Individual Rates.
- Increase in Standard Deduction and elimination of Personal Exemptions.
- Limitations on Itemized Deductions, including a $10,000 limitation with respect to State and Local Income, Property or Sales Taxes.
- Retention of Individual Alternative Minimum Tax but with higher exemption amounts.
- Certain Other Provisions
- Nonrecognition for like-kind exchanges is limited to exchanges of real property not held primarily for sale.
Over the coming weeks, we plan to provide a focused analysis on various aspects of the Tax Act as it applies to certain industries, as well as its impact on domestic and cross-border Mergers & Acquisitions, and the structuring and financing of such transactions.