Party Like It’s 1986: Business Impacts of the Bill Formerly Known as the Tax Cuts and Jobs Act

Eversheds Sutherland (US) LLP

Eversheds Sutherland (US) LLP

On December 22, 2017, the President signed into law the bill formerly known as the Tax Cuts and Jobs Act (the Final Bill), which was passed by the House of Representatives and the Senate earlier in the week. The passage of the Final Bill came after the Senate parliamentarian ruled that the “Tax Cuts and Jobs Act” name violated Senate rules, forcing the Final Bill to be renamed the somewhat less catchy “To provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” and Congress secured a “pay-go” waiver allowing the President to sign the Final Bill in 2017.

The House-Senate Conference Committee released the Final Bill on December 15, 2017. The House previously passed its version of the Tax Cuts and Jobs Act (the House Bill) on November 16, 2017, and the Senate previously passed its version of the Tax Cuts and Jobs Act (the Senate Bill) on December 2, 2017. See the prior Eversheds Sutherland alerts on the House Bill and the Senate Bill.

Eversheds Sutherland Observation: The Final Bill is the most substantial overhaul of the Internal Revenue Code since 1986. The Final Bill is far-reaching and will make significant changes to how the US taxes individuals, domestic businesses and multinational businesses.

This alert summarizes the principal provisions impacting domestic and multinational businesses. See the Eversheds Sutherland Tax Reform Law blog for more information about the Final Bill, including alerts on the accounting methods, compensation and benefits, energy, insurance and international provisions of the Final Bill. 

Taxation of Domestic Businesses:

  • Rate Reduction: The centerpiece of the business tax reform measures in the Final Bill is a reduction in the corporate tax rate from 35% to 21%, effective for taxable years beginning after December 31, 2017. A corresponding change is made to the current dividends received deduction (DRD) for dividends paid by domestic corporations to other domestic corporations, specifically reducing the 80% and 70% DRDs to 65% and 50%. This means that the effective rate of tax on dividends received by domestic corporations from other domestic corporations remains nearly the same as under current law. 
  • Elimination of the Corporate Alternative Minimum Tax (AMT): The Final Bill eliminates the corporate AMT, adopting the approach taken by the House Bill. 
  • Limitation on the Use of New Net Operating Losses (NOLs): An 80% NOL limitation (determined without regard to the deduction) is enacted for losses arising in taxable years beginning after December 31, 2017. The Final Bill also eliminates the current rules that allow a two-year carryback of NOLs, but it expands existing carryforward rules to permit unlimited carryforwards for losses arising in taxable years beginning after December 31, 2017.
    • Eversheds Sutherland Observation: The 80% NOL limitation ensures that taxpayers cannot fully offset their taxable income with carried forward losses, and thus effectively ensures a 4.2% minimum rate of tax for any profitable year.
  • Limitation on the Ability to Deduct Interest: Existing interest expense limitations that apply to related party interest are expanded such that taxpayers may only deduct net business interest expense to 30% of adjusted taxable income. Adjusted taxable income generally is defined as income, not including any: (i) items not allocable to a trade or business; (ii) business interest or business interest income; (iii) NOLs; (iv) deduction for qualified business income; (v) for taxable years beginning before 2022, any deduction allowed for depreciation, amortization or depletion; and (vi) any other adjustments provided by the Internal Revenue Service (IRS). Disallowed business interest generally may be carried forward indefinitely.
    • For corporations that are members of consolidated groups, the Joint Explanatory Statement of the House-Senate Conference Committee provides that this limitation is intended to apply at the consolidated group level. Also, the limitation does not apply to certain regulated utilities or real property trades or businesses.
  • Reduced Rate for Certain Income from Pass-Through Entities: Generally allows a taxpayer other than a corporation to deduct 20% of the taxpayer’s qualified business income, qualified real estate investment trust dividends, qualified publicly traded partnership income and qualified cooperative dividends for the taxable year, subject to limitations based on the taxpayer’s taxable income for the taxable year.
    • The portion of the deduction that is attributable to qualified business income requires a separate deduction amount to be computed for each qualified trade or business of the taxpayer. The separate deduction amount computed for each qualified trade or business is subject to a limitation based on the W-2 wages and the unadjusted basis of qualified property with respect to the qualified trade or business (subject to a phase-in, as discussed below).
    • A qualified trade or business generally includes any trade and business of the taxpayer other than (i) the trade or business of performing services as an employee, and (ii) certain specified service trades or businesses (subject to a phase-in, as discussed below).
      • Specified service trades or businesses generally include businesses in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, including the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests or commodities. 
    • In the case of a partnership or S corporation, the deduction is computed and taken into account at the partner or shareholder level, respectively.
    • Both the wage/basis limitation and the exception of specified service trades or businesses from the definition of qualified trade or business are subject to a phase-in, such that the limitation and exception, respectively, apply to any taxpayer whose taxable income for the taxable year is greater than $315,000 for married couples filing jointly or $157,500 for other taxpayers, in each case as adjusted for inflation.
    • The deduction applies to taxable years beginning after December 31, 2017, but not to taxable years beginning after December 31, 2025.
  • Limitation on Excess Business Loss: Disallows a deduction for any excess business loss of a taxpayer other than a corporation for the taxable year but permits such loss to be carried forward and treated as part of the net operating losses carryforward of the taxpayer in subsequent taxable years.
    • Excess business loss is generally the amount by which the aggregate deductions attributable to trades or businesses of the taxpayer exceed the sum of the taxpayer’s aggregate gross income or gain attributable to such trades or businesses plus $500,000 for married couples filing jointly or $250,000 for other individuals, in each case as adjusted for inflation. 
    • In the case of a partnership or S corporation, the limitation is applied at the partner or shareholder level, respectively. 
    • A taxpayer applies the excess business loss limitation after applying the passive activity loss rules. 
    • The excess business loss limitation applies to taxable years beginning after December 31, 2017, and before January 1, 2026.
  • Limitation on Carried Interest: Requires a taxpayer to satisfy a three-year (rather than a one-year) holding period in order for gain with respect to an applicable partnership interest to be considered long-term capital gain.
    • An “applicable partnership interest” generally is defined as a partnership interest received in connection with the performance of substantial services in a trade or business of raising or returning capital and investing in or developing securities, commodities, real estate (held for rental or investment), options or derivatives on those assets. 
    • The three-year holding period requirement would not apply to (i) any partnership interest held by a corporation, or (ii) any capital interest in the partnership that entitles the taxpayer with a right to share in partnership capital commensurate with the amount of capital contributed (determined at the time of receipt of such partnership interest) or the value of such interest subject to tax as compensation upon the receipt or vesting of such interest. 
  • Full Expensing for Five Years: Expands bonus depreciation to allow full expensing of the cost of both new and used “qualified property” acquired and placed in service after September 27, 2017, and before January 1, 2023. The bonus depreciation rate is phased down for such property placed in service between 2023 and 2026 and is zero in 2027 and thereafter, and it is not available for certain regulated utilities or property used in a trade or business with certain floor plan financing.
  • Limitation on Like-Kind Exchanges: Permits like-kind exchange treatment only with respect to real property (i.e., an exchange of intangibles or tangible personal property would no longer be eligible for such treatment).
  • Capitalization of Certain Research or Experimental Expenditures: For taxable years beginning after December 31, 2021, requires specified research or experimental expenditures to be capitalized and amortized ratably over a five-year period (for activities conducted in the US) or over a 15-year period (for activities conducted outside the US).
  • Expanded $1 Million Limitation on Deductible Compensation:
    • Expands the definition of applicable employer to any employer with registered securities or that is required to file reports under the Securities Exchange Act of 1934. 
    • Expands the definition of covered employee to include the principal financial officer, in line with the Securities and Exchange Commission’s executive compensation disclosure rules. 
    • Provides that once an individual qualifies as a covered employee in 2017 or later, that individual remains a covered employee with respect to that employer for all future years (regardless of changes in position, amount of compensation or termination of employment).
    • Repeals the exceptions to the limit on deductible compensation for commissions and performance-based compensation. 
  • Expanded Limitation on Deduction for Meals: Disallows employer deductions for entertainment expenses such as meals, travel and club dues.
    • However, the Final Bill retains the 50% employer deduction for meals relating to the operation of the employer’s trade or business and, for 2018 through 2025, expands the 50% deduction limit to include expenses for food or beverage in the operation of on-site eating facilities. 

Taxation of Multinational Businesses:

  • Participation Exemption System
    • 100% Dividends Received Deduction (DRD) for Certain Foreign Source Dividends: Implements a participation exemption system that generally provides for a 100% DRD for the foreign-source portion of dividends received from a foreign corporation by a United States shareholder (generally, a 10% owner) that is a corporation. The DRD is not available with respect to dividends received by a United States shareholder from a controlled foreign corporation (CFC) if the dividends are deductible by the CFC in computing its taxes (i.e., hybrid dividends). In addition, no foreign tax credits are allowed for any taxes paid or accrued with respect to any dividend that qualifies for the DRD.
    • Eversheds Sutherland Observation: The significance of the DRD for many multinational corporations may be limited by the transition tax imposed on existing earnings and profits (E&P), which will result in previously taxed income that could be distributed without additional US tax, and the tax on global intangible low-taxed income (GILTI), described below.
    • Eversheds Sutherland Observation: The Final Bill, unlike the House Bill and the Senate Bill, retains existing section 956. As a result, although dividends to United States shareholders of CFCs are not subject to US tax, investments in United States property will continue to result in inclusions subject to US tax at a 21% rate. 
    • Corollaries to the DRD: 
      • Reduces the basis in stock in foreign corporations to reflect distributions eligible for the DRD in calculating losses.
      • Permits the DRD with respect to deemed dividend distributions under section 1248 on sales of stock of CFCs.
      • Requires recapture of net losses of a foreign branch that is transferred to a foreign corporation – an expansion of existing recapture rules with respect to losses of foreign branches.
    • Transition Tax: The Final Bill imposes a one-time transition tax on a United States shareholder with respect to its investment in CFCs and certain other foreign corporations. The tax is generally imposed on the net aggregate amount of the United States shareholder’s pro rata shares of the previously untaxed foreign E&P of such CFCs and other foreign corporations. The tax is imposed at an effective rate of 15.5% to the extent of the amount of cash and cash equivalents held by such corporations, and 8% for any amount in excess thereof.
      • The tax is imposed by increasing the subpart F income of CFCs and other foreign corporations for their last taxable year beginning before January 1, 2018. The effective rate is achieved through a DRD on the deemed subpart F inclusion. 
      • Previously untaxed foreign E&P subject to tax is the greater of such amount as of November 2, 2017, and December 31, 2017. The amount of cash and cash equivalents is the greater of (i) the amount as of the close of the last taxable year beginning before January 1, 2018, and (ii) the average amount as of the close of the last two taxable years ending prior to November 2, 2017. 
      • Foreign tax credits are only permitted with respect to the portion of the previously untaxed E&P subject to tax. No section 78 gross-up applies, and no deduction is permitted, for any foreign taxes for which a foreign tax credit is disallowed.
      • Taxpayers may elect to pay the tax over eight years, paying 8% of the liability in each of the first five years, 15% in the sixth year, 20% in the seventh year and 25% in the eighth year. 
  •  Rules Related to Passive and Mobile Income
    • Current Taxation of Global Intangible Low-Taxed Income (GILTI): Imposes tax on a US taxpayer’s GILTI, which is generally amounts in excess of a proxy for routine returns on tangible property.
      • The combined earnings of CFCs in which a taxpayer is a United States shareholder are included in a manner similar to subpart F income and subject to US tax as such. A 50% deduction for such income is provided, generally resulting in a US tax rate of 10.5% for such income.
        • For taxable years beginning after December 31, 2025, the deduction is reduced to 37.5%.
        • A foreign tax credit is permitted for 80% of the foreign taxes paid with respect to such income. As a result, for a taxpayer able to utilize foreign tax credits, GILTI generally will not be subject to residual US tax if the average foreign tax rate imposed on such income is at least 13.125%.
        • Eversheds Sutherland Observation: The Final Bill adopts the GILTI provisions from the Senate Bill rather than the parallel provision from the House Bill imposing tax on foreign high return amounts. While the impact of the provisions was generally similar, the mechanics of the GILTI provision, with a full income inclusion and 50% deduction at the US level, present additional complexities. 
        • Eversheds Sutherland Observation: GILTI and the associated foreign tax credits are determined on an aggregate rather than on a country-by-country basis. As a result, a United States shareholder may not be subject to tax on its GILTI even though it owns individual CFCs the earnings of which are subject to tax at a rate of less than 13.125%. 
    • Deduction for Foreign Derived Intangible Income: Permits domestic corporations to deduct 37.5% of their foreign-derived intangible income (FDII), which calculates an amount similar to GILTI and multiplies that amount by the fraction of the income earned in the US that is attributable to property sold to a non-US person for foreign use or to services provided outside the US.
      • The FDII provision results in a reduced effective tax rate on covered income of 13.125%, subject to a taxable income limitation on the amount of the deduction allowed.
      • For taxable years beginning after December 31, 2015, the deduction is reduced to 21.875%.
      • Eversheds Sutherland Observation: The Final Bill did not adopt a provision in the Senate Bill that would have specifically allowed certain intangible property to be distributed from CFCs to United States shareholders without gain recognition. 
    • Expanded Constructive Ownership: Expands the constructive ownership attribution rules of section 958(b) to include “downward attribution” from a foreign person to a related person effective for the last taxable year of foreign corporations beginning before January 1, 2018.
      • Eversheds Sutherland Observation: Downward attribution may cause certain US persons to be treated as United States shareholders with respect to certain foreign corporations resulting in an inclusion under the transition rule even where their direct and indirect ownership is less than 10% and may cause certain corporations not previously treated as CFCs to be treated as CFCs going forward, resulting in additional reporting obligations and, in certain circumstances, potentially subpart F inclusions by certain United States shareholders.
    • Modified Definition of United States Shareholder: Modifies the definition of United States shareholder to include any US person that owns 10% or more of the total value of shares of all classes of stock of a foreign corporation effective for taxable years of foreign corporations beginning after December 31, 2017. 
    • Elimination of “30-Day Rule”: Eliminates the so called “30-Day Rule” pursuant to which a United States shareholder includes any subpart F income in its gross income only if the foreign corporation was a CFC for an uninterrupted period of 30 days or more during its taxable year.
    • Eversheds Sutherland Observation: The Final Bill, unlike the House Bill and the Senate Bill, did not make permanent the look-through rule for dividends, interest and royalties paid between related CFCs under section 954(c)(6), which is set to expire at the end of 2019. 
  • Prevention of Base Erosion

Eversheds Sutherland Observation: The Final Bill, unlike the House Bill and the Senate Bill, did not adopt the additional limitation on interest expense of certain US taxpayers that are members of worldwide groups.

  • Base erosion and anti-abuse tax (BEAT):
    • Generally imposes a 10% minimum tax (5% in 2018) on a taxpayer’s income determined without regard to tax deductions arising from base erosion payments (including the portion of a taxpayer’s NOL treated as related to base erosion payments) which generally cannot be reduced by credits other than the R&D credit and, until 2025, 80% of the PTC and ITC renewable energy credits and the low income housing credit.
      • For taxable years beginning after December 31, 2025, the rate increases to 12.5%. For affiliated groups that include a bank or securities dealer, the rates are increased by 1%.
      • Base erosion payments generally are amounts paid by a taxpayer to a related foreign person that are deductible to the taxpayer or that create depreciable or amortizable asset basis.
      • The BEAT applies to US corporations (other than regulated investment companies, real estate investment trusts or S corporations), which have average annual gross receipts of at least $500 million for the preceding three taxable years and which have a base erosion percentage (generally, deductible payments to foreign affiliates over total deductions) of 3% (2% for affiliated groups that include a bank or securities dealer) or higher for the taxable year.
      • Eversheds Sutherland Observation: The Final Bill adopts the BEAT provision from the Senate Bill rather than the provision from the House Bill imposing an excise tax on certain amounts paid by US taxpayers to related foreign recipients.
    • Anti-Hybrid Rules: Denies deductions for interest or royalties paid between related parties where the recipient is not required to include the payment in income, is permitted a deduction with respect to such amount, or the payor is a “hybrid entity.”
      • Eversheds Sutherland Observation: The Final Bill contains a broad grant of authority for the IRS to issue guidance clarifying and potentially expanding the scope of this anti-hybrid provision.
    • Rules for Transfers of Intangibles and Partnership Interests:
      • Provides that outbound transfers of foreign goodwill or going concern value by a US transferor would be subject to current tax.
      • Permits the IRS to specify the method used to determine the value of intangible property transferred, effectively reversing the result in Veritas Software Corp. & Subsidiaries, et al. v. Comm., 133 TC 297 (2009). 
      • Treats a foreign partner’s gain or loss from the sale or exchange of a partnership interest as effectively connected with a US trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange, legislatively overturning the recent decision in Grecian Magnesite, Industrial & Shipping Co., SA v. Commissioner, 149 T.C. 3 (2017).
        • In general, if any portion of any gain on the disposition of a partnership interest would be considered effectively connected with a US trade or business under this provision, the transferee of the partnership interest is required to withhold 10% of the amount realized by the transferor, unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation. 
        • If the transferee fails to withhold the correct amount, the partnership is required to deduct and withhold from distributions to the transferee partner an amount equal to the amount the transferee failed to withhold.
        • Eversheds Sutherland Observation: The Final Bill delays the effective date for the requirement to withhold on sales or exchanges of partnership interest to after December 31, 2017, while the substantive tax is imposed effective after November 27, 2017.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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