INDIVIDUAL TAXATION
The Act simplifies the Internal Revenue Code (the “Code”) for individuals by consolidating various exemptions and deductions into a larger Standard Deduction. The Act does not make changes with respect to the maximum rate for capital gains and qualified dividends. The Act lowers overall income tax rates but does not reduce the number of brackets. The Act does eliminate the individual mandate tax related to the Affordable Care Act.
Tax Rates. The tax brackets and rates below expire and revert to the previous rates beginning in 2026.
The New Tax Brackets are as follows:
For Joint Filers (based on taxable income):
For Single Filers:
Repeal of ACA Individual Mandate: The individual mandate under the Affordable Care Act is repealed.
“Kiddie Tax” Changes: Both the ordinary and capital unearned income of a child will be taxed at the same rates as applied to trusts and estates.
Standard Deduction. This provision will expire and revert to the previous system in 2026.
Itemized Deductions. This provision will expire and revert to the previous system in 2026.
Reduction in Itemized Deductions: In concert with simplifying the tax brackets and increasing the Standard Deduction, several itemized deductions are reduced or eliminated:
Exclusions for Income. This provision will expire and revert to the previous system in 2026.
Exclusions Eliminated: The following exclusions from income are eliminated:
Tax Credits. This provision will expire and revert to the previous system in 2026.
Child Tax Credit Increased: The Child Tax Credit is increased to $2,000 a year, plus an additional $500 a year nonrefundable credit for all qualifying non-child dependents. The amount of income at which these credits begin to phase out begins at $400,000 a year for joint filers. The earned income threshold for a refund of the credit is lowered to $2,500, and the $1,400 maximum refund per child will be indexed for inflation.
Changes to Educational Incentives. This provision will expire and revert to the previous system in 2026.
In conjunction with the increase in the Standard Deduction and the elimination of most itemized deductions, changes will be made to certain educational incentives, including the exclusion of income related to a discharge of student debt resulting from death or disability, as well as permitting the use of Section 529 accounts for up to $10,000 per year of elementary and secondary education.
Changes to Executive and Deferred Compensation. The Act makes several changes to the taxation of executive compensation and deferred compensation:
Non-Performance Based Compensation: The Sec. 162(m) “$1 million pay cap” on non-performance-based compensation has been changed to eliminate exemptions provided for tax deductibility of qualified performance‐based compensation, including stock options. The Act also applies the deduction limitations to any individual deemed a covered employee for as long as they receive compensation from the company. Finally, the Chief Financial Officer (or Principal Financial Officer as defined by the SEC) is now subject to the limitation.
Expansion of Executive Compensation Excise Tax: The Corporate Excise tax on Executive Compensation is now applied to tax exempt organizations as well, and imposes a new 20 percent tax on any compensation over $1 million paid to a ‘covered employee’. The definition of a ‘covered employee’ encompasses the organization’s five highest‐paid current or former employees. Employees retain that status for as long as they receive compensation from the organization (or any successor organization). The Act also imposes excise tax penalties on excess severance pay (similar to the Section 280G tax penalties for excessive parachute payments in for-profit companies). The tax‐exempt organization is responsible for paying this new tax.
Qualified Equity Grants for Private Companies: Effective in 2018, the Act allows private companies to offer rank-and-file employees the opportunity to defer income attributable to stock received following a stock option exercise or settlement of an RSU for up to five years if the stock is not tradeable on an established securities market. The Act’s guidance has a number of very specific rules that must be followed and excludes from this favorable tax treatment the CEO, CFO and the next four highest paid executives and certain shareholders.
Qualified Deferred Compensation: Generally speaking, the changes to deferred compensation plans make it easier for taxpayers to withdraw amounts from their plan at a younger age:
ESTATE AND GIFT TAXATION
Increase in Exclusion Amount for Gift and Estate Taxes. The lifetime exclusion available for taxable gifts and bequests is increased from $5.490 million to $11.2 million beginning on January 1st 2018. A married couple can now transfer up to $22.4 million of taxable gifts and bequests before being subject to federal tax. This new provision is currently set to expire in 2026. Upon expiration this provision reverts back to prior law.
BUSINESS TAXATION
Deduction for Business-Related Income. Business owners of pass-through entities (e.g. sole proprietorships, partnerships, LLCs, S-Corporations, trusts, and estates) are now allowed to deduct 20% of their domestic Qualified Business Income (i.e. the net of a taxpayers items of income, gain, deduction, and loss related to such taxpayers business).
Deduction Limit: The deduction will be equal to 20% of the sum of:
Limitation for Specified Service Businesses: The deduction is not available to Specified Service Businesses, except for taxpayers with $315,000 or less of income, and is phased in for income over $315,000 over the next $100,000 of income.
Substantial built in Losses: The Substantial built in loss rules are expanded to create a Substantial Built-In Loss where a partner will be allocated a net loss in excess of $250,000 were such partner to transfer their interest.
Basis Limitation on Partner Losses: The basis limitation of losses now applies to a partner’s distributive share of charitable contributions and foreign taxes.
Carried Interest.
Partnership interests received in connection with the performance of services will now be subject to a 3-year holding period in order to qualify for long-term capital gains.
Self-Created Intellectual Property.
Income from the sale of a self-created patent (other than a musical work) is now ordinary income rather than capital.
Like-Kind Exchanges.
Like-kind exchanges are now only allowed for real property not held primarily for sale.
Technical Termination Rules Eliminated.
The Technical Termination rules for partnerships (treating a transfer in a year of 50% or more of the total interest in partnership capital and profits as a liquidation of the partnership and formation of a new partnership) are eliminated.
Contributions to a Business in Excess of Value of Shares.
Alternative Minimum Tax. The Act retains the AMT for individuals but eliminates it for corporations.
Threshold for Individuals: The Act increases the threshold for application of the AMT for individuals to $109,400 for joint filers, $70,300 for single taxpayers, and $54,700 for married taxpayers filing separately.
Corporate Tax Rate. The previous tiered corporate tax rate is replaced with a flat 21% rate.
Accelerated Cost Recovery.
Recovery Period for Real Estate: The recovery periods for qualified leasehold improvements, qualified restaurant property and qualified retail improvement property are all consolidated as “qualified improvement property” and given a 15-year recovery period. Residential real property and non-residential real property remain at 27.5 years and 39 years respectively. These changes apply to property placed in service beginning in 2018.
Depreciable Property: Property which has been permitted bonus depreciation under 168(k) which is placed in service between September 27, 2017, and January 1, 2023, can, at the taxpayer’s election, be 100% deducted in the year in which it is placed in service, rather than depreciated. The property need not be new property but must not be previously used by the taxpayer. Thereafter, the amount of basis which can be immediately expensed will decrease by 20% every year from January 1, 2023 through January 1, 2027.
Personal Automobiles and Computers: Deduction limitations for automobiles are increased. Rules treating computers as special property are removed.
Farm Equipment: The recovery period is shortened to five years at taxpayer’s election.
Section 179 Property: Up to $1 million in Section 179 property can be immediately expensed, with a phase-out beginning when over $2.5 million of Section 179 property is placed in service in a given year. These limitations will be indexed for inflation beginning for years after 2017.
Business Deductions.
Reduction in Dividends Received Deduction: The 80% and 70% dividends received deductions are reduced to 65% and 50% respectively.
Limitation on Deductible Interest: All businesses with $25 million or more in gross receipts (other than public utilities, certain electric cooperatives, and real estate businesses which elect to use the Alternative Depreciation System) will suffer the disallowance of interest deductions in excess of the sum of 30% of adjusted taxable income, business interest income, and floor plan financing interest.
Excess Business Loss Limitation: Excess Business Losses (i.e. the excess of aggregate deductions attributable to trades or business over the sum of aggregate gross income of taxpayer plus a Threshold Amount) will be carried forward as part of the taxpayer’s NOL.
Limitation on Carryforward of Net Operating Losses ("NOLs"): NOLs which are carried forward will now only be allowable up to 80% of a taxpayer's taxable income. Such NOLs can now be carried forward indefinitely.
Inclusion in Charitable Contributions and Foreign Taxes: A partner in a partnership may include in losses their share of charitable contributions and foreign taxes paid by the partnership.
Research and Development Expenses: Beginning in 2022, all Section 174 R&D expenditures will be required to be capitalized and amortized over 5 years rather than deducted immediately.
Worker Safe Harbor: A safe harbor will be created to provide certainty as to whether a service provider is an employee of a business.
Deductions Eliminated: The following business deductions are eliminated:
Tax Credits.
Although the Act retains the Low-Income Housing Tax Credit, the Work Opportunity Tax Credit, and R&D Tax Credit, several credits are modified or eliminated in order to balance the reduced corporate tax rate.
Tax Exempt Bond Interest.
Advanced Refunding Bonds: The Act eliminates the tax-free nature of interest for Advanced Refunding Bonds
Change to Accounting Method Rules.
Small Corporations: A corporation with up to $25 million in gross receipts is now permitted to use the cash method of accounting, even if such business has inventories. In addition, corporations with $25 million or less in gross receipts are now exempt from the UNICAP rules, and will be able to use the completed-contract method for long term contracts. Finally, businesses with $25 million or less in gross receipts are now exempt from the interest expense limitation rules noted above.
Craft Beverages: The aging period for beer, wine, and distilled spirts is now excluded from the UNICAP production period.
OID: Income included on financial statements related to OID is now included in the same year as the financial statement, rather than ratably over the life of the loan.
Other Changes.
The rules allowing a roll-over of gain from the sale of stock if the proceeds are invested in Small Business Investment Corporations are repealed.
The Credit for FICA taxes attributable to tips in restaurants is updated to reflect the current minimum wage.
In addition to the broad changes to the taxation of businesses described above, the Act also contains a number of changes specific to insurance companies. The details of these changes are beyond the scope of this summary.
The Act lowers the excise taxes on beer, wine, and spirits.
INTERNATIONAL TAXATION
Subsidiary Dividends. The foreign source portion of all dividends from a 10% or more owned foreign subsidiary (that is not a PFIC and that is also a CFC,) owned for at least 365 of the prior 731 days, is now 100% deductible. The deduction is not available for hybrid dividends (amounts received which also received a deduction or other benefit from foreign taxes paid). The foreign tax credit is disallowed for amounts that qualify for this new dividend deduction. This rule does not apply to dividends received from a “surrogate foreign corporation.”
Foreign Source Portion: The amount of the dividend which is composed of undistributed E&P not attributable to effectively connected income (“ECI”) or dividends from an 80% owned domestic corporation, determined on a pooling basis.
Sale of Subsidiary Stock: The amount of income received by the selling corporation which is treated as a dividend under Section 1248 is eligible for the new deduction.
Reduction in Basis of Subsidiary Stock: The basis of stock in a 10% foreign subsidiary will be reduced by exempt dividend income received from that subsidiary, but only for the calculation of any loss on disposition of the stock.
Inclusion of “Transferred Loss” in Income: If a 10% owned subsidiary acquires substantially all the assets of a foreign branch, the domestic owner will include in income the Transferred Loss Amount.
Recognition of Deferred Foreign Income: Any U.S. shareholder of a foreign corporation that has one or more “U.S. shareholders” must include as Subpart F income in its last taxable year prior to 2018 such Shareholder’s pro rata share of the earnings and profits (“E&P”) of such subsidiary, to the extent such profits have not yet been included in U.S. income. Such income will be taxed at 15.5% for earnings that are held in cash or cash equivalents and 8% for other assets. Taxpayers may elect to recognize such income over an eight-year period.
Apportionment of Gain Based on Production Location of Property: Income from the sale of property produced within the U.S. and sold outside (or vice versa) is now sourced exclusively based on the production location. The former split sourcing rule based on location of production and location of sale has been eliminated.
Sale of Partnership Interest: Gain or loss from sale or partnership interest is ECI to extent that the transferor would have had ECI, had the partnership sold all its assets for FMV. This is a reversal of the court holding in the recent Grecian Magnesite case.
Subpart F Income. In addition to the changes discussed with respect to dividend income, the following changes have also been made to expand Subpart F income:
Deemed Ownership of Foreign Held Stock: U.S. corporations may be treated as owning stock in a subsidiary which is held by foreign shareholders under certain circumstances.
Deletion of Timing Exception for Controlled Foreign Corporations (“CFCs”): A U.S. Shareholder will be taxed on its share of a CFC’s Subpart F income even if the Shareholder has not held stock in the CFC for more than 30 days during the year in which the Subpart F income was earned by the CFC. This is an elimination of the former 30-day rule.
Limitations on Subpart F Income: New rules will help to limit Subpart F income, including the elimination of the foreign oil related income basket from Subpart F income.
Base Erosion. The Act seeks to reduce “base erosion” through the use of transfer pricing and tax treaty shopping.
Global Intangible Low-Taxed Income (“GILTI”): U.S. shareholders of CFCs will now be taxed currently on 50% of all GILTI, with a 37.5% deduction for all foreign-derived intangible income (reduced to 21.875% after 2025).
Hybrid Transactions: Related party deductions related to hybrid transactions or hybrid entities will now be denied.
Base Erosion Anti-Abuse Tax: Certain corporate taxpayers with gross receipts of at least $500 million are required to pay the Base Erosion Anti-Abuse Tax (the “BEAT Tax”). The BEAT Tax is equal to the “base erosion minimum tax.”
Foreign Investment Income.
Insurance Company Exception on PFICs: The exception from the Passive Foreign Investment Corporation “(PFIC”) rules, excluding income earned in the active sale of insurance, are amended so that such income will only be excluded if the PFIC will be treated as an insurance company under U.S. law.
TAX EXEMPT ENTITIES
The Act changes several rules with respect to Not- for-Profit entities (“NFPs”). Generally, the changes increase the instances in which a NFP will incur the Unrelated Business Income Tax (“UBIT”) and investment income.
UBIT Income: UBIT is now be calculated separately for each trade or business of the NFP.
Taxation of Fringe Benefits: NFPs will now be taxed on fringe benefits provided to employees.
Standardizing Investment Income Excise Tax: Private Foundations will now be subject to a 1.4% excise tax on investment income, rather than the 2% or 1% variable system which was previously in place.
University Endowment Taxation: Private colleges and universities having at least 500 full-time students in the U.S. and assets (excluding those used directly in carrying out its exempt purpose but including those held by third parties for the university) worth at least $500,000 per student will now be subject to the 1.4% excise tax on investments.
The summary information in this document is being provided for educational purposes only. Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.