Congress Finalizes Tax Reform

Transcription

1 December 21, 2017 SIDLEY UPDATE Cngress Finalizes Tax Refrm On December 20, 2017, the United States Cngress passed legislatin knwn as the Tax Cuts and Jbs Act (the Tax Act), the first cmprehensive refrm f the U.S. tax cde since This Sidley Update details hw the Republicans n the cnference cmmittee reslved majr differences between the Huse bill and the Senate bill t prduce a tax refrm bill that ultimately passed bth chambers f Cngress. The legislatin is expected t be signed by President Trump and enacted int law. The changes will be effective fr taxable years beginning after December 31, 2017, unless therwise nted belw. With few exceptins, the changes applicable t crprate, business-related and internatinal tax prvisins are permanent, while the changes applicable t individuals (including the deductin fr certain wners f pass-thrugh entities but excluding the eliminatin f the individual healthcare mandate) are set t expire December 31, Like the bills that came befre it, the Tax Act will have substantial effects n taxpayers acrss all industries. Fr a cmplete list f Sidley resurces summarizing the majr changes t the U.S. tax cde generally and with respect t particular industries and subject matters, as well as links t register fr upcming Sidley webinars n tax refrm, please click here t access ur Tax Refrm Develpments and Insights webpage. Ntewrthy Develpments fr Year-End Tax Planning Itemized Deductin fr State and Lcal Incme Taxes. The Tax Act prvides that, in the case f an amunt paid in a taxable year beginning befre January 1, 2018, with respect t a state r lcal incme tax impsed fr a taxable year beginning after December 31, 2017, the payment will be treated as paid n the last day f the taxable year fr which the tax is impsed. As a result, under the prvisin, an individual will nt be able t claim an itemized deductin in 2017 n a pre-payment f incme tax fr a future taxable year in rder t avid the dllar limitatin n the deductin f such taxes applicable fr taxable years beginning after Securities Sld n a First-in-First-ut Basis. The Tax Act rejects the first-in-first-ut apprach t the sale f stck r securities that was adpted by the Senate. As such, taxpayers selling nly part f their hldings f a particular stck r security will cntinue t be able t identify which shares r securities are being sld. Hme Sale Gain Exclusin. Rejecting prpsals included in bth the Huse and Senate bills, the Tax Act preserves current law allwing taxpayers t exclude up t $500,000 fr jint filers ($250,000 fr ther filers) f gain frm a sale f a primary residence prvided certain cnditins are met. Attrney Advertising: Fr purpses f cmpliance with New Yrk State Bar rules, ur headquarters are Sidley Austin LLP, 787 Seventh Ave., New Yrk, NY 10019, ; 1 S. Dearbrn, Chicag, IL 60603, ; and 1501 K St., NW, Washingtn, DC 20005, Sidley Austin prvides this infrmatin as a service t clients and ther friends fr educatinal purpses nly. It shuld nt be cnstrued r relied n as legal advice r t create a lawyer-client relatinship.

2 Page 2 The fllwing summarizes the majr changes f the legislatin that will apply t all taxpayers regardless f industry: Crprate Taxatin Rates. Reduces the crprate tax rate t a flat 21 percent rate. Under current law, crpratins are subject t a maximum tax rate f 35 percent. Observatin. The reduced flat crprate rate may prmpt a review f the chice f legal entity. Capital Investment. Allws taxpayers t fully and immediately expense 100 percent f the cst f qualified prperty acquired and placed in service after September 27, 2017 and befre January 1, Under current law, a 50 percent write-ff (subject t phase-ut) is generally available fr new prperty placed in service befre January 1, The Tax Act adpts the Huse prpsal by expanding the 100 percent write-ff t certain used prperty acquired by the taxpayer, and generally fllws the Senate s schedule fr phasing ut the percentage f the cst that may be expensed fr prperty placed in service after January 1, Special rules apply t prperty acquired befre September 28, 2017 and placed in service after September 27, Taxpayers may elect t expense nly 50 percent in the first taxable year after September 27, Observatin. Expanding the write-ff t used prperty culd increase the incentive fr buyers in M&A transactins t structure taxable acquisitins as actual r deemed asset purchases. Dividend Received Deductin. Under current law, crpratins are entitled t a 70 percent dividend received deductin (DRD) n dividends received frm crprate subsidiaries. If the crpratin receiving the dividend wns mre than 20 percent, but less than 80 percent f the crpratin paying the dividend, the DRD is 80 percent f the dividend received. The Tax Act reduces the 80 percent DRD t 65 percent, and the 70 percent DRD t 50 percent. Observatin. This dwnward adjustment is generally intended t preserve the current law effective tax rates n dividends entitled t the DRD. Interest Deductins. Generally adpts the Senate s apprach but with mdificatins. With certain exceptins, limits the deductin in any taxable year fr business interest t the sum f (i) business interest incme fr that year; plus (ii) 30 percent f the adjusted taxable incme fr the year. Fr this purpse, business interest is interest paid r accrued n indebtedness prperly allcable t a trade r business. Business interest incme is interest incme prperly allcable t a trade r business. Adjusted taxable incme is a taxpayer s taxable incme, cmputed withut regard t, amng ther items, (a) any items f incme, gain, deductin r lss that are nt prperly allcable t a trade r business; (b) any business interest r business interest incme; (c) the amunt f any net perating lss deductin; (d) the 20 percent deductin fr certain pass-thrugh incme (described mre fully belw); and (e) in the case f taxable years beginning befre January 1, 2022, any deductin allwable fr depreciatin, amrtizatin r depletin. Any interest disallwed is carried frward indefinitely and, in the case f crprate taxpayers, preserved as a tax attribute in certain asset acquisitins. This limitatin des nt apply t taxpayers with grss receipts that d nt exceed $25 millin.

3 Page 3 Observatin. Taxpayers with substantial cst recvery deductins shuld plan ahead f 2023, when such csts are scheduled t begin reducing the 30 percent adjusted taxable incme cap n interest deductins. Alternative Minimum Tax. Adpts the Huse apprach and repeals the crprate alternative minimum tax (AMT). Als, allws a crpratin with AMT credit carryfrwards t claim a refund f 50 percent f the remaining credits (t the extent the credits exceed regular tax fr the year) in tax years beginning in 2018, 2019 and 2020, and allws a refund f all remaining credits in the tax year beginning in Net Operating Lsses. Fr net perating lsses (NOLs) arising in taxable years ending after December 31, 2017, n carryback is permitted but lsses can be carried frward indefinitely. NOLs arising in taxable years beginning after December 31, 2017 are permitted, hwever, t ffset nly 80 percent f taxable incme fr the year (cmputed withut regard t the carryver). Like-Kind Exchanges. Allws tax-deferred like-kind exchange treatment nly fr real prperty used in a trade r business r fr investment, eliminating like-kind exchange treatment fr ther prperty such as autmbiles and art. The new limitatin wuld generally apply t exchanges cmpleted after December 31, 2017, unless prperty that is part f a like-kind exchange was either dispsed f r received n r befre that date. Capital Cntributins. Under current law, grss incme f a crpratin des nt include any cntributins t its capital, except fr cntributins in aid f cnstructin frm a custmer r ptential custmer. The Tax Act expands the exceptins t als tax cntributins frm any gvernment r civic grup (ther than as a sharehlder). This prvisin applies t cntributins made after the date f enactment, except fr cntributins made after the date f enactment by a gvernmental entity pursuant t a master develpment plan that has been apprved prir t such date by a gvernmental entity. Observatin. These changes are intended t impse a tax n certain state and lcal incentives and cncessins. The uncertainty in the Huse apprach regarding capital cntributins by sharehlders withut shares actually being issued (i.e., the applicatin f the meaningless gesture dctrine) is reslved by nt changing the current exceptin, and instead nly adding a new categry f taxable cntributins. Tax Credits and Passive Activity Bnds. Generally adpts the Senate apprach. Retains the rehabilitatin tax credit, but limits the amunt f the tax credit t certified histric buildings and spreads this credit ver five years. The Tax Act preserves current law regarding the new markets tax credits, energy tax credits, the deductibility f certain unused business credits, and the exemptin fr private activity bnds. Accunting Methds. Adpts the Senate prpsal and requires an accrual methd taxpayer must include items in grss incme n later than the taxable year in which that item is taken int accunt in any applicable financial statement (including any GAAP financial statement, Frm 10-K annual statement, audited financial statement r a financial statement filed with any Federal agency fr nn-tax purpses). This rule applies befre accrual rules therwise applicable t debt instruments

4 Page 4 (including rules applicable t market discunt and riginal issue discunt (OID) f existing debt instruments), althugh in the case f a debt instrument having OID the new rules apply fr taxable years beginning after December 31, An exceptin is prvided fr any grss incme attributable t a mrtgage servicing cntract. In additin, the Tax Act effectively cdifies Revenue Prcedure , which permits taxpayers t defer the inclusin f incme frm certain advance payments t the fllwing year if the incme als is deferred n the taxpayer s financial statements. Partnership Taxatin Rates. Under current law, incme f pass-thrugh entities (e.g., sle prprietrships, partnerships, limited liability cmpanies and S crpratins) is allcated amng the wners r sharehlders, wh pay the crrespnding tax n their individual tax returns. As a result, the incme (including business incme) f pass-thrugh entities is subject t rdinary individual incme tax rates with a current maximum marginal rate f 39.6 percent. The Tax Act generally adpted the Senate s deductin apprach, but with certain mdificatins. Fr taxable years beginning befre January 1, 2026, nncrprate wners and sharehlders f pass-thrugh entities may take a deductin fr certain passthrugh incme equal t (i) 20 percent f their dmestic qualified business incme; plus (ii) 20 percent f any qualified dividends frm real estate investment trusts (i.e., thse that are nt capital gains dividends r therwise cnstitute qualified dividend incme), a taxpayer s allcable share f qualified incme frm a publicly traded partnership, and gain recgnized upn the sale f an interest in such partnership that wuld therwise be taxed as rdinary incme. Fr this purpse, qualified business incme is defined as all dmestic business incme ther than investment incme (e.g., dividends, incme equivalent t a dividend, interest incme nt allcable t a trade r business, shrt- and lng-term capital gains, etc.). The deductin fr qualified business incme applies t the first $157,500 f incme (if single; $315,000 fr jint filers) earned frm pass-thrugh entities. Once thse incme threshlds are met, the deductin is limited t the greater f (i) 50 percent f the W-2 wages paid by the business; and (ii) 25 percent f the W-2 wages paid by the business plus 2.5 percent f the cst f tangible depreciable assets in the business. Incme frm persnal service businesses (e.g., accuntants, lawyers, cnsultants, financial service prviders, thse in the perfrming arts, and thse investing, trading r dealing in securities, but excluding engineering and architecture services) is nt entitled t the deductin unless the wner s incme is less than $207,500 (if single; $415,000 fr jint filers). The benefit f the deductin is phased ut fr these taxpayers ver a $50,000-range (if single; $100,000-range fr jint filers) fr taxable incme exceeding the $157,500 incme threshld (if single; $315,000 fr jint filers). Observatin. The 20 percent deductin fr qualified business incme in the Tax Act is lwer than the 23 percent deductin included in the Senate bill but, because f the drp in the maximum marginal tax rate fr rdinary individual incme, results in a slightly better effective tax rate f 29.6 percent n pass-thrugh business incme, unless the deductin is therwise limited as described abve. Ntably, the additin f the secnd prng t the W-2 wage limitatin added by the cnference cmmittee expands the 20 percent deductin t businesses that d nt have many emplyees (e.g., partnerships in which all service prviders are partners) r that are capitalintensive (e.g., real estate firms). Fund managers rganized as pass-thrugh entities are nt

5 Page 5 likely t, and investment funds rganized as pass-thrugh entities will nt, benefit frm this deductin. Carried Interest. Under current law, a taxpayer wh wns an interest in a partnership that recgnizes lng-term capital gain will include in incme the taxpayer s allcable share f such lngterm capital gain. Under the Tax Act, if a nn-crprate taxpayer wns a partnership interest received in cnnectin with the perfrmance f services (and nt fr the cntributin f capital) in an applicable trade r business, any capital gain allcable t such taxpayer in respect f assets held by the partnership fr mre than ne year that wuld have therwise been treated as lng-term capital gain will be cnverted int shrt-term capital gain unless the assets are held by the partnership fr mre than three years. An applicable trade r business means the business f raising r returning capital r investing in r develping specified assets. Specified assets cnsist f securities, cmmdities, real estate held fr rental r investment, derivatives relating t the freging, and partnership interests t the extent f such partnership s interest in the freging assets. Observatin. Althugh the legislative language is nt entirely clear, the cmmittee reprt accmpanying the Huse bill indicates that the hlding perid is determined at the partnership level. Accrdingly, a taxpayer hlding a partnership interest may get the benefit f lng-term capital gain treatment even if the taxpayer has held the partnership interest fr three years r less. Interest Deductins. With certain exceptins, limits the deductin in any taxable year fr business interest t the sum f (i) business interest incme fr that year; plus (ii) 30 percent f the adjusted taxable incme fr the year. See Crprate Taxatin Interest Deductins abve. In the case f partnerships, this limitatin applies at the entity level. Any interest disallwed is carried frward indefinitely, subject t certain restrictins. Mandatry Basis Adjustments. Under current law, a partnership is required t adjust the basis in its assets upn the sale f a partnership interest if the partnership has an verall net built-in lss f mre than $250,000 in all f its assets. The Tax Act adpts the Senate prvisin requiring a partnership t make the same dwnward basis adjustments if the partner buying a partnership interest wuld be allcated a net lss f mre than $250,000, ntwithstanding the verall built-in gain in the partnership s assets, such as when lsses are specifically allcated t nly sme f the partners. Technical Terminatins. Adpts the Huse prvisin repealing the technical terminatin rule, thereby treating a partnership as cntinuing even if mre than 50 percent f the ttal capital and prfits interests f the partnership are sld r exchanged during any 12-mnth perid. New electins are nt required r permitted.

6 Page 6 Taxatin f U.S. Multinatinal Entities Mdified Territrial System. Implements dramatic changes t the taxatin f freign incme earned by U.S. businesses by adpting a mdified territrial system f taxatin, the mst imprtant features f which are summarized belw. U.S. multinatinals will need t examine their freign hldings t determine the extent t which rerganizatin f them will maximize their benefits frm these new rules. Participatin Exemptin System. Adpts a participatin exemptin system in which 100 percent f the freign-surce prtin f dividends paid by a freign crpratin t a U.S. crprate sharehlder that wns 10 percent r mre f the freign crpratin are exempt frm U.S. taxatin by means f a 100 percent DRD. N freign tax credit r deductin is allwed fr any freign taxes (including withhlding taxes) paid r accrued with respect t any exempt dividend, and n deductins fr expenses prperly allcable t an exempt dividend (r stck that gives rise t exempt dividends) are taken int accunt fr purpses f determining the U.S. crprate sharehlder s freign-surce incme. A minimum hlding perid f 365 days is required in rder fr the exemptin t apply. In additin t actual dividends, the participatin exemptin als applies t the deemed-dividend prtin f a crpratin s gain frm the sale f stck f a 10 percent-wned freign crpratin. The participatin exemptin des nt apply t amunts fr which the paying freign crpratin receives a benefit against freign cuntry taxes. Repatriatin f Prir Deferred Incme. Ensures that the adptin f the participatin exemptin system des nt allw the previusly untaxed deferred earnings (estimated t be apprximately $2 trillin) f a cntrlled freign crpratin (CFC) r ther freign crpratin with a 10 percent U.S. crprate sharehlder t escape U.S. tax entirely by requiring a U.S. sharehlder (as defined in the subpart F rules) t include as subpart F incme, in its last taxable year beginning befre January 1, 2018, its share f the freign crpratin s earnings that have nt been previusly subject t U.S. tax. The earnings are classified either as cash r cash equivalents (including net accunts receivable) taxed at a rate f 15.5 percent r as earnings reinvested in the crpratin s business (e.g., in prperty, plant and equipment) taxed at a rate f eight percent. A U.S. sharehlder may elect t pay the tax liability ver a perid f up t eight years withut an interest charge. The eight-year installment perid fr payment f the tax is back-laded by requiring nly eight percent f the tax t be paid in each f the first five years, 15 percent in the sixth year, 20 percent in the seventh year, and 25 percent in the eighth year. Each sharehlder f an S crpratin that is a U.S. sharehlder may elect t defer payment f its tax liability withut an interest charge until a triggering event ccurs, such as a dispsitin f shares f the S crpratin. Observatin. The mandatry inclusin f untaxed deferred earnings applies t all U.S. sharehlders even thugh nly 10 percent crprate sharehlders benefit frm the participatin exemptin. As a practical matter, a U.S. sharehlder in a freign crpratin that is nt a CFC may nt be able t knw hw much untaxed earnings are allcable t it.

7 Page 7 Expansin f Subpart F Rules. Retains with mdificatins the subpart F regime fr taxatin f a CFC. T deal with the utbund shifting f incme frm intangible prperty t a CFC, the Tax Act fllws the Senate bill and creates a new categry f subpart F incme deemed t arise frm high-value intangibles, knwn as glbal intangible lw-taxed incme (GILTI). The effective tax rate n GILTI fr a crprate U.S. sharehlder is 10.5 percent fr taxable years beginning after December 31, 2017, while a nn-crprate U.S. sharehlder s share f a CFC s GILTI is subject t rdinary individual incme tax rates. GILTI is measured as the excess f the U.S. sharehlder s share f its CFC s net incme ver such sharehlder s share f 10 percent f the adjusted basis f the qualified business investment f such CFC, adjusted dwnward fr interest expense. GILTI des nt include incme effectively cnnected with a U.S. trade r business, subpart F incme, insurance and financing incme subject t a high effective rate f tax, certain related-party payments r freign il and gas extractin incme. As with ther subpart F incme, the U.S. sharehlder is taxed n GILTI each year, regardless f whether it leaves thse earnings ffshre r repatriates the earnings t the United States. Definitin f U.S. Sharehlder fr Subpart F Purpses. Under current law, a U.S. persn that wns at least 10 percent f the vting stck f a CFC is a U.S. sharehlder that is required t include its share f the CFC s subpart F incme in incme currently (whether distributed r nt). The Tax Act adpts the Senate s apprach and expands the definitin f a U.S. sharehlder t include U.S. persns that wn at least 10 percent f the value f a CFC. This expansin wuld cause sme freign crpratins t becme CFCs and wuld require additinal persns t becme subject t subpart F incme inclusins frm CFCs. Observatin. Under current law, a U.S. persn that has wned at least 10 percent f the vting stck f a CFC at any pint during the five-year perid prir t selling stck in such crpratin is required t treat any gain recgnized n such sale as rdinary incme t the extent f such sharehlder s pr rata share f the crpratin s previusly untaxed earnings and prfits. The Tax Act des nt expand this prvisin t apply t U.S. sharehlders that wn 10 percent by value. This may be an versight that will be addressed in future technical crrectins legislatin. Dwnward Attributin fr Determining CFC Status. Revises the attributin rules relevant fr determinatin f CFC status s that certain stck f a freign crpratin wned by a freign persn is attributed t a related U.S. persn fr purpses f determining whether the related U.S. persn is a U.S. sharehlder f the freign crpratin and, therefre, whether the freign crpratin is a CFC. This prvisin applies t the last taxable year f a freign crpratin beginning befre January 1, 2018 and each subsequent year f such freign crpratin and t taxable years f U.S. sharehlders in which r with which such taxable years f a freign crpratin end. Observatin. The cnference cmmittee reprt states that the intent f this prvisin is t render ineffective certain transactins that are used as a means f aviding the subpart F prvisins. The reprt accmpanying the Senate bill states that the prvisin is nt intended t cause a U.S. sharehlder t have subpart F inclusins if that U.S. sharehlder is unrelated t the ther U.S. persn t whm stck f the CFC

8 Page 8 is attributed. Hwever, the legislative language des nt cntain either f these limitatins. Therefre, unless this is clarified in technical crrectins r regulatins, the prvisin increases the likelihd f a freign crpratin being a CFC. Additinal Subpart F Changes. Amng ther changes, remves freign base cmpany il related incme frm subpart F incme and mdifies the deemed paid credit s that it applies n a current year basis nly. Bth the Huse and Senate bills repealed r mdified Internal Revenue Cde 956 and made permanent the rule under Internal Revenue Cde 954(c)(6) (prviding lk-thrugh treatment fr dividends, interest, rents and ryalties that ne CFC receives r accrues frm a related CFC). The Tax Act, hwever, adpts neither change. Observatin. It is unclear if there is any plicy reasn fr the cntinued applicatin f Internal Revenue Cde 956 with respect t taxpayers that are entitled t the benefits f the new participatin exemptin system. Tax n Gain n Sale f Partnership Interest. Fr sales r exchanges ccurring n r after Nvember 27, 2017, adpts the Senate s prpsal and cdifies Revenue Ruling by treating gain recgnized by a freign persn n the sale f an interest in a partnership as effectively cnnected with a U.S. trade r business if the partnership is engaged in a U.S. trade r business. Als impses a new 10 percent withhlding tax n the sale unless a nn-freign affidavit is prvided by the seller. The new withhlding tax is effective fr sales r exchanges ccurring after December 31, Observatin. The change reverses a recent Tax Curt decisin, which held that gain recgnized by a freign persn n the sale f an interest in a partnership culd nt be subject t U.S. federal incme tax slely because the partnership is engaged in a U.S. trade r business. Fr additinal details n the Grecian Magnesite Mining case, please click here. Observatin. In the event the buyer f such partnership interest fails t withhld, the partnership is respnsible fr the withhlding tax. As a result, it is likely that mst partnership agreements wuld treat the partnership s payment f the withhlding tax as a distributin t the buyer. Interest Deductins. Des nt include either the Huse bill r Senate bill prvisins that wuld have limited the deductible net interest expense f a U.S. crpratin that is a member f a wrldwide affiliated grup t the extent the U.S. crpratin has disprprtinate interest cmpared t the wrldwide grup. Anti-Base Ersin. Fllws the Senate bill (with mdificatins) and requires an applicable taxpayer t pay a tax generally equal t its base ersin minimum tax amunt. Fr this purpse, a taxpayer s base ersin minimum tax amunt is the excess f 10 percent (five percent fr taxable years beginning in 2018) f the crpratin s taxable incme (determined withut regard t deductins and certain ther tax benefits frm base ersin payments r the base ersin percentage f any NOL deductin) ver its regular tax liability (cmputed generally withut regard t credits ther than research and develpment credits). Fr affiliated grups that include certain banks and securities dealers, the incme threshld is 11 percent (six percent fr taxable years beginning in 2018). Fr taxable years beginning after December 31, 2025, the incme threshld increases t 12.5 percent (13.5 percent fr affiliated grups that include certain banks and securities dealers) and all

9 Page 9 credits are als subtracted frm regular tax liability in cmputing the base ersin minimum tax amunt. A base ersin payment generally includes any amunt paid r accrued by a taxpayer t a freign persn that is a related party (generally, with a 25 percent affiliatin threshld) and that either is deductible r is paid in cnnectin with the acquisitin f depreciable r amrtizable prperty. The prvisin applies t crpratins (ther than RICs, REITs, and S crpratins) with average annual grss receipts f at least $500 millin fr the preceding three years (cmputed n a grup-wide basis) and a base ersin percentage f at least three percent (tw percent fr affiliated grups that include certain banks and securities dealers). The base ersin percentage is generally the taxpayer s base ersin tax benefits divided by its deductins (ther than the 100 percent participatin exemptin dividends received deductin, net perating lss deductins, and the deductin that implements the reduced tax n GILTI (described mre fully abve)). The Huse bill s excise tax n certain payments made by dmestic crpratins t certain related freign crpratins is nt included in the Tax Act. Outbund Transfers. The Tax Act adpts certain prvisins frm the Senate bill in respect f utbund transfers f prperty. Prperty Used in Active Trade r Business. Under Internal Revenue Cde 367(a), a U.S. persn generally is required t recgnize gain with respect t certain transfers t a freign crpratin that wuld therwise be tax-free. The Tax Act repeals an exceptin previusly prvided fr the transfer f certain prperty t be used by the transferee freign crpratin in the active cnduct f a trade r business utside f the United States. Intangible Prperty. Internal Revenue Cde 367(d)(2) and 482 cntain special rules, with respect t transfers by a U.S. persn f intangible prperty, in therwise tax-free exchanges r t a related persn, that require the U.S. transferr s incme t be increased in the future t reflect amunts that are cmmensurate with the incme derived frm the intangible (the s-called super ryalty rules). The Tax Act revises the definitin f intangible prperty t include gdwill, ging cncern value, wrkfrce in place, and any ther item f value r ptential value that is nt attributable t tangible prperty r the services f any individual. Such revisins direct the Internal Revenue Service t require the valuatin f transfers f intangible prperty n an aggregate basis with ther prperty r services transferred r n the basis f the realistic alternatives t such a transfer if the Internal Revenue Service determines that such basis is the mst reliable means f valuatin f such transfers. Observatin. It appears these prvisins are intended t limit shifting incme t freign affiliates thrugh intangible prperty transfers. The extent t which these prvisins wuld d s is unclear. Inventry Incme Surcing. Allcates and apprtins incme frm the sale f inventry prperty prduced within and sld utside f the U.S. (r vice versa) between surces within and utside f the U.S. slely n the basis f the prductin activities with respect t the inventry. Observatin. This will likely reduce the amunt f freign surce incme realized by taxpayers exprting gds prduced in the U.S. and, therefre, reduce their ability t utilize freign tax credits.

10 Page 10 Individual Taxatin Rates. Under current law, rdinary incme is subject t a seven-bracket prgressive system: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent. Generally adpting the Senate s prpsal, under the Tax Act rdinary incme is subject t the fllwing seven brackets: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent (dwn frm the Senate s 38.5 percent). Fr jint returns, the threshlds generally are as fllws: $19,050 fr the 12 percent rate; $77,400 fr the 22 percent rate; $165,000 fr the 24 percent rate; $315,000 fr the 32 percent rate, $400,000 fr the 35 percent rate; and $600,000 fr the 37 percent rate. The rates are effective fr taxable years 2018 thrugh Individual Mandate. Under current law, taxpayers must maintain minimum essential cverage fr health insurance r pay a penalty (therwise knwn as the individual mandate ). The Tax Act adpts the Senate s apprach and effectively repeals the individual mandate by reducing the amunt f the penalty t zer. The permanent change is effective fr taxable mnths after December 31, Standard Deductin. Fr taxable years 2018 thrugh 2025, increases the standard deductin fr jint filers t $24,000, up frm the current deductin f $12,700. Observatin. Increasing the standard deductin cmes at the expense f persnal exemptins and itemized deductins, many f which are eliminated. Itemized Deductins. Under current law, individuals are allwed t take itemized deductins fr medical expenses, mrtgage interest expense (n up t $1.1 millin f acquisitin and hme equity debt fr jint filers), persnal casualty lsses, real estate taxes, state and lcal incme taxes, charitable cntributins, unreimbursed emplyee expenses, and tax preparatin fees. Belw is a list f sme f the changes included in the Tax Act with respect t itemized deductins f individuals. Unless therwise nted, these changes are effective fr taxable years 2018 thrugh Repeals the verall limitatin n itemized deductins. Repeals the deductin fr state and lcal taxes, ther than (A) prperty taxes paid r accrued in a trade r business r fr the prductin f incme and (B) $10,000 f prperty and incme (r sales) tax. Repeals the deductin fr freign real prperty taxes ther than thse paid r accrued in a trade r business. Fr mrtgage debt incurred after December 15, 2017, interest n n mre than $750,000 f such debt is deductible, dwn frm the current limit f $1 millin. The deductin fr interest n lans fr secnd hmes is retained, but the deductin fr interest n hme equity lines f credit is n lnger available. Acquisitin indebtedness incurred n r befre December 15, 2017 r pursuant t binding cntracts t purchase a hme befre such date are subject t certain grandfathering rules. After 2025, the current $1 millin limitatin n mrtgage interest applies regardless f when the debt was incurred.

11 Page 11 Increases the limitatin n deductin fr charitable cntributins t 60 percent f the taxpayer s cntributin base, up frm the current verall 50 percent limitatin. The deductin fr medical expenses wuld apply t expenses that exceed 7.5 percent f the taxpayer s adjusted grss incme fr the 2017 and 2018 taxable years, and expenses that exceed 10 percent f the taxpayer s adjusted grss incme thereafter. Repeals ther itemized deductins, such as mving expenses, tax preparatin, and all itemized deductins subject t the tw-percent flr (e.g, hme ffice deductins, license and regulatry fees, dues t prfessinal scieties, etc.). Observatin. Eliminating the need fr itemized deductins was intended t lead t a mre simplified filing prcess. Because the Tax Act ultimately retains mre deductins and exemptins than riginally prpsed, hwever, a simplified pstcard filing prcess seems unlikely. Alternative Minimum Tax. Preserves the individual AMT, and generally fllws the Senate s prpsal by increasing (i) the exemptin amunt frm $78,750 t $109,400; and (ii) the phase-ut threshld frm $150,000 t $1 millin, in each case, fr jint filers. These prvisins are effective fr taxable years 2018 thrugh Child Tax Credits. Fr taxable years 2018 thrugh 2025, increases the amunt f the child tax credit frm $1,000 t $2,000 and increases the phase-ut threshld amunt t $400,000 fr jint filers. Up t $1,400 f the tax credit is refundable, and a new nn-refundable $500 credit is available fr ther dependents. The earned incme threshld fr the refundable credit is reduced frm $3,000 t $2,500. Estate, Gift and Generatin-Skipping Transfer Taxes. Fr taxable years 2018 thrugh 2025, increases the basic exclusin amunt fr estate, gift and generatin-skipping transfer taxes t $10 millin, up frm the current $5 millin limit. Sme f the changes described abve, as well as ther aspects f the Tax Act, will have particular effect n certain industries. We expect t publish summaries f prvisins in the Tax Act affecting the insurance industry, the energy industry, and cmpensatin. These summaries will be psted n ur Tax Refrm Develpments and Insights webpage, which can be accessed by clicking here.

12 Page 12 If yu have any questins regarding this Sidley Update, please cntact the Sidley lawyer with whm yu usually wrk, r Laura M. Barzilai Partner lbarzilai@sidley.cm Rbert M. Kreitman Partner rkreitman@sidley.cm Edwin L. Nrris Partner enrris@sidley.cm Sharp Srensen Partner ssrensen@sidley.cm Tara M. Lancaster Assciate tara.lancaster@sidley.cm Sidley Tax Practice Our Tax Practice prvides legal services in transactins, planning and cntrversy related t United States federal, state and lcal and United Kingdm tax laws. Our lawyers wrk clsely with ur clients and with lawyers in the firm s ther practice grups t develp timely, cst-effective tax strategies and t identify and slve ptential tax-related prblems. This Tax update has been prepared by Sidley Austin LLP fr infrmatinal purpses nly and des nt cnstitute legal advice. This infrmatin is nt intended t create, and receipt f it des nt cnstitute, a lawyer-client relatinship. Readers shuld nt act upn this Tax update withut seeking advice frm prfessinal advisers. Furthermre, this Tax update was nt intended r written t be used, and cannt be used, by any persn fr the purpse f aviding any U.S. federal, state r lcal tax penalties that may be impsed n such persn. T receive Sidley Updates, please subscribe at BEIJING BOSTON BRUSSELS CENTURY CITY CHICAGO DALLAS GENEVA HONG KONG HOUSTON LONDON LOS ANGELES MUNICH NEW YORK PALO ALTO SAN FRANCISCO SHANGHAI SINGAPORE SYDNEY TOKYO WASHINGTON, D.C. Sidley and Sidley Austin refer t Sidley Austin LLP and affiliated partnerships as explained at