2018 Federal Tax Update Jon Karp January 2018

Transcription

1 2018 Federal Tax Update Jon Karp January 2018

2 Disclaimer This presentation and related materials are designed only to provide general information regarding the subject matter discussed during this presentation. The statutes, authorities, and other laws cited in this presentation are subject to change. This presentation and related materials are not intended to provide tax, accounting, legal, or other professional advice to any specific person or entity. Any advice or opinion regarding the application of the subject matter for a specific person or entity should be provided by a competent professional advisor based on an application of the appropriate law and authorities to the facts and circumstances applicable to thatperson or entity.

3 The Trump Tax Plan and What You Need to Know

4 I. Unified Framework For Fixing Our Broken Tax Code On September 27, 2017, the framework of the Big Six group of Congressional and White House tax-reform precepts was released. The document is titled Unified Framework For Fixing Our Broken Tax Code President Trump lays out four principles for tax reform: 1. Make the tax code simple, fair, and easy to understand 2. Give American workers a pay raise by allowing them to keep more of their hard-earned paychecks 3. Make America the jobs magnet of the world by leveling the playing field for American businesses and workers 4. Bring back trillions of dollars that are currently kept offshore to reinvest in the American economy The stated aim is to create a fairer system that levels the playing field and extends economic opportunities to American workers, small businesses, and middle-income families

5 B. Goals of the Framework Trump s administration, the House Committee on Ways and Means, and the Senate Committee on Finance seek to deliver a 21 st century tax code that achieves fiscally responsible tax reform by broadening the tax base, closing loopholes, and growing the economy. It includes: 1. Tax relief for middle-class families 2. The simplicity of postcard tax filing for the vast majority of Americans 3. Tax relief for businesses, especially small businesses 4. Ending incentives to ship jobs, capital, and tax revenue overseas 5. Broadening the tax base and providing greater fairness for all Americans by closing special interest tax breaks and loopholes This framework is intended to serve as a template for the tax-writing committees, and bipartisan support and participation are specifically welcomed and encouraged

6 The Tax Cuts & Jobs Act Finalized Legislation

7 Conference Committee Reconciles Legislation Passed Separately by House & Senate On December 15, 2017, the Conference Committee released its Conference Report on the Tax Cuts & Jobs Act. This legislation is the most sweeping, categorical change to the Code in over 30 years. This writing refers to the Act by its former and commonly used name the Tax Cuts and Jobs Act Generally, the Tax Cuts and Jobs Act takes effect 1/1/18 unless otherwise noted in materials Many of the sunset provisions made it into this final legislation. As such, a number of individual provisions are temporary, generally expiring as of 1/1/26

8 Timing The law passed both the House and Senate. President Trump signed the bill into law on December 22, 2017 Not pushing the date of enactment into 2018 is a negative for corporate accountants since the book accounting effects of changes to the corporate tax are accounted for in the period of enactment (2017, not 2018). Companies, especially calendar year ones, will be inundated with considerable effort regarding earnings releases and fourth quarter financial statements

9 Marginal Tax Rates Senate would include 7 individual brackets with the following taxable income thresholds for the respective filing statuses. Phase out 1/1/2026 MFJ 10%, up to $19,050; 12%, $19,050 to $77,400; 22%, $77,400 to $165,000; 24%, $165,000 to $315,000; 32%, $315,000 to $400,000; 35%, $400,000 to $600,000; 37%, $600,000 and up.

10 Marginal Tax Rates Single 10%, up to $9,525; 12%, $9,525 to $38,700; 22%, $38,700 to $82,500; 24%, $82,500 to $157,500; 32%, $157,500 to $200,000; 35%, $200,000 to $500,000; 37%, $500,000 and up.

11 Marginal Tax Rates HOH 10%, up to $13,600; 12%, $13,600 to $51,800; 22%, $51,800 to $82,500; 24%, $82,500 to $157,500; 32%, $157,500 to $200,000; 35%, $200,000 to $500,000; 37%, $500,000 and up.

12 Marginal Tax Rates MFS 10%, up to $9,525; 12%, $9,525 to $38,700; 22%, $38,700 to $82,500; 24%, $82,500 to $157,500; 32%, $157,500 to $200,000; 35%, $200,000 to $300,000; 37%, $300,000 and up.

13 Marginal Tax Rates Estates and Trusts (Only 4 Rates) 10%, up to $2,550; 24%, $2,550 to $9,150; 35%, $9,150 to $12,500; 37%, $12,500 and up.

14 Standard Deduction; Personal Exemptions; HOH Due Diligence The law increases the standard deduction to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers. The current-law additional standard deduction for the elderly and blind would be retained. Phase out 1/1/2026 The deduction for personal exemptions is effectively suspended to zero. Phase out 1/1/2026 The due diligence requirements imposed on the earned income credit, child tax credit, and American opportunity credit will also include due diligence for paid preparers filing a taxpayer as Head of Household

15 JCT Estimate of change Estimates cost of standard deduction through 2025 will decrease revenues by $720 billion over 10 years Estimate increased revenue of repealed deductions and personal exemptions will be $1.21 trillion over 10 years.

16 Kiddie Tax Taxable income of a child attributable to earned income would be taxed under the rate for single individuals, while income attributable to net unearned income would be taxed under the trust and estate rates

17 Capital Gains The Act retains 0%, 15%, and 20% rates Breakpoints between the 0% and 15% rates and the 15% and 20% rates are the same amounts as the breakpoints under present law indexed for inflation For 2018, the 15% breakpoint is $38,600 for Single and $77,200 for MFJ. The 20% breakpoint is $425,800 for Single and $479,000 for MFJ Conference agreement also left in place the 3.8% NII tax.

18 20% Deduction for Certain Pass-through Income Individuals are now allowed a deduction for 20% of their domestic qualified passthrough business income, subject to the following limitations: Greater of: 50% of wages paid with respect to the qualified trade or business Sum of 25% of wages with respect to the qualified trade or business plus 2.5% of their unadjusted basis The 50% wage limitation does not apply to a taxpayer in the following scenarios: Married filing jointly, income of $315,000 or less Single filer, income of $157,500 or less Phase out over the next $100,000 of taxable income for MFJ filers. $50,000 for single filers A qualified business generally does not include professional service companies However, deduction may apply to income from a PSC if taxable income doesn t exceed $315,000 for MFJ filers or $157,500 for other individuals

19 Pass-Through Income For tax years after 12/31/17 and before 1/1/26, a new Code 199A allows a non-corporate taxpayer, including a trust or estate, with qualified business income (QBI) from a partnership, S corporation, or sole proprietorship to deduct: a) The lesser of: (1) the combined qualified business income amount of the taxpayer, or (2) 20% of the excess, if any, of the taxable income of the taxpayer for the tax year over the sum of net capital gain and the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year; plus b) The lesser of: (1) 20% of the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year, or (2) taxable income (reduced by the net capital gain) of the taxpayer for the tax year

20 Pass-Through Income The combined qualified business income amount means, for any tax year, an amount equal to: The deductible amount for each qualified trade or business of the taxpayer (defined as 20% of the taxpayer s QBI subject to the W-2 wage limitation); plus 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of taxpayer for the tax year As such, an individual taxpayer generally may deduct 20 percent of qualified business income from a partnership, S corporation, or sole proprietorship. As we ll see, a limitation based on W-2 wages paid is phased in above a threshold amount of taxable income. A disallowance of the deduction with respect to specified service trades or businesses is also phased in above the threshold amount of taxable income QBI is generally defined as the net amount of qualified items of income, gain, deduction, and loss relating to any qualified trade or business of the taxpayer

21 Pass-Through Income QBI does not include: certain investment items; reasonable compensation paid to the taxpayer by any qualified trade or business for services rendered with respect to the trade or business; any guaranteed payment to a partner for services to the business; or a payment to a partner for services rendered with respect to the trade or business Limitations. For pass-through entities, other than sole proprietorships, the deduction cannot exceed the greaterof: 1) 50% of the W-2 wages with respect to the qualified trade or business; or 2) The sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property o Qualified property is defined as tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year.

22 Pass-Through Income Let s look at this in a real life situation. A manufacturing company has a net profit of $2M in 2018 and pays $500,000 in wages to its employees during the year. That company would only be able to take the qualified business income deduction for $250,000 since 50% of the total employee wages ($500,000 x 50% = $250,000) are less than 20% of the net income of the business ($2M x 20% = $400,000).

23 Pass-Through Income The W-2 wage limit phase out starts at $315,000 for MFJ and $157,500 for others, so the wage limitation does not apply to taxpayers under these thresholds. The W-2 wage limit is phased in for individuals with taxable income exceeding these thresholds, over the next $100,000 of taxable income for MFJ and $50,000 for other individuals The deduction is only allowed to service businesses (lawyers and accountants, but not engineers or architects) where taxpayer s income is under the $315,000 MFJ/$157,500 for all others threshold. The deduction for service businesses is phased out over the next $100,000 of income for MFJ and $50,000 for all others. Therefore, it is completely phased out at $415,000 MFJ and $207,500 for all others This pass-through rate specifically does not apply to the business of being an employee

24 Wage Limitation Phaseout The wage and basis limitations do not apply to a taxpayer in the following scenarios: Married filing jointly, income of $315,000 or less Single filer, income of $157,500 or less Phase out over the next $100,000 of taxable income for MFJ filers. $50,000 for single filers If taxable income is within the phaseoutrange ($315,001-$415,000) then the deduction is reduced based on the percentage of income which falls within the phaseoutrange Example: Single filer has $150,000 of pass-through income and total taxable income of $182,500. Business paid $40,000 of W-2 wages during the year. Pass-through deduction w/out limitation:.20 x $150,000 = $30,000 Maximum limitation if outside phase-out range:.5 x $40,000 = $20,000 ($10,000 reduction) Limitation within phase-out range: ($182,500 -$157,500) / $50,000 = 50% within phaseoutrange Actual deduction: $30,000 -($10,000 x.5) = $25,000

25 Specified Service Phaseout A qualified business generally does not include professional service companies However, deduction may apply to income from a PSC if taxable income doesn t exceed $315,000 for MFJ filers or $157,500 for other individuals Same phaseoutranges as wage limitation If business income exceeds the phaseoutrange, no deduction is allowed If income falls within the phaseoutrange, deduction is calculated using only a pro-rata share of all amounts from the business(w-2 wages, income, etc.) Example: Single filer with $150,000 of pass-through income and $170,000 of taxable income, 25% of phaseoutrange. Business paid $40,000 of W-2 wages Pass-through deduction w/out wage limitation:.75 *.2 * $150,000 = $22,500 Maximum limitation if outside phase-out range:.75 *.5 * $40,000 = $15,000 ($7,500 reduction) Actual deduction: $22,500 -($7,500 *.25) = $20,625

26 Loss Limitation Rules Applicable to Individuals Excess business losses of a taxpayer are not allowed for the taxable year Such losses are carried forward and treated as part of the taxpayer s NOL carryforward in subsequent taxable years. This applies after the passive loss rules

27 Loss Limitation Rules Applicable to Individuals An excess business loss for the tax year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer, over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount The threshold amount for a taxable year is $500,000 for married individuals filing jointly, and $250,000 for other individuals. Ability to offset passive income with losses from an active trade or business affected by threshold amounts The $500,000 and $250,000 thresholds are indexed for inflation

28 Reform of the Child Tax Credit Child tax credit increased to $2,000 per qualifying child. Phase out 1/1/26 Income phase out is $400,000 for MFJ and $200,000 for all other taxpayers $500 nonrefundable credit for qualifying dependents other than qualifying children The proposal lowers the earned income threshold for the refundable child tax credit to $2,500 The refundable portion (payable even without tax liability) is $1,400 per child

29 Education-Related Provisions The contribution limitation to ABLE (Achieving a Better Life Experience) accounts, regarding contributions made by the designated beneficiary, is increased, and amounts from 529 plans are able to be rolled over to an ABLE account without penalty as long as the ABLE account is owned by the designated beneficiary of the 529 plan or a member of such designated beneficiary s family. Phase out 1/1/26 For distributions after 12/31/17, qualified higher education expenses for 529 plan purposes include tuition at an elementary or secondary public, private, or religious school, up to $10,000 per year Certain eligible student loans discharged on account of death or total/permanent disability are excluded from gross income. Phase out 1/1/26

30 Repeal of the Pease Limitation on Itemized Deductions Suspends the Pease limitation on itemized deductions. Phase out 1/1/26 Pease limit amounted to a 1.18% tax (3% x 39.6%) on high-income taxpayers

31 Home Mortgage Interest Deduction for interest on home equity indebtedness is suspended, and the deduction for mortgage interest is limited to debt of up to $750,000 ($375,000 for MFS). Phase out 1/1/26. Limit does not apply to any acquisition loan incurred before December 15, 2017 Taxpayer who entered binding written contract before December 15, 2017 to close before January 1, 2018, and who purchases by April 1, 2018, shall qualify for acquisition loan incurred before December 15, 2017 $1M/$500,000 limitation generally applies to refinancing existing debt incurred before December 15, 2017, but subject to indebtedness provision As a concession to the real estate industry, the deduction is available for both new mortgages on first and second homes on debt up to $750,000

32 State and Local Taxes State, local, and foreign property taxes and state and local sales taxes are allowed as a deduction only when paid or accrued in carrying on a trade or business or an activity described in 212 (relating to expenses for the production of income) Exception: $10,000 ($5,000 for MFS) itemized deduction for the aggregate of (a) state and local property taxes and (b) state and local income taxes (or sales taxes in lieu of income taxes). Foreign real property taxes are not deductible 2017 deduction for pre-paying 2018 taxes is specifically outlawed

33 Repeal of Deduction for Personal Casualty Losses; Disaster Relief Deduction for personal casualty losses suspended but deduction for personal casualty losses incurred in a federally declared disaster not affected. Phase out 1/1/26 If an individual has a net disaster loss, the standard deduction is increased by the net disaster loss. Phase out 1/1/26. For tax years 2016 and 2017, the $100 per casualty floor is increased to $500 For tax years 2016 and 2017, there is an exception to the retirement plan 10% early withdrawal tax for up to $100,000 of qualified 2016 disaster distributions. Income from a qualified 2016 disaster distribution can be included ratably over three years

34 Charitable Contributions/AGI Limitations for Cash Contributions 50% limit for cash contributions to public charities and certain private foundations increased to 60%. Phase out 1/1/26 Five-year carryover period retained to the extent that the contribution amount exceeds 60% of the donor s AGI

35 Miscellaneous Itemized Deductions Subject to 2% Floor Act suspends all miscellaneous itemized deductions that are subject to the 2% floor under present law. Examples are tax preparation expenses, safe deposit boxes, and unreimbursed employee expenses. Phase out 1/1/26

36 Moving Expenses Both the exclusion for qualified moving expense reimbursements and the deduction for moving expenses are suspended, except for members of the Armed Forces on active duty who move pursuant to a military order and incident to a permanent change of station. Phase out 1/1/26 Businesses recruiting talent would face higher cost after taking into account the gross-up for taxes.

37 AMT The individual AMT survives. The exemption amounts are increased to $109,400 for MFJ and surviving spouses, $70,300 for single filers, and $54,700 for MFS. Phase out 1/1/26 These amounts are reduced to an amount equal to 25% of the amount by which the alternative taxable income of the taxpayer exceeds the phase out amounts, increased as follows: $1M for MFJ and surviving spouses and $500,000 for all other taxpayers except estates and trusts For trusts and estates, the base figure of $22,500 and phase out amount of $75,000 are unchanged The JCT estimates that this will decrease revenues by $637 billion over the next 10 years.

38 Medical Expenses Preserves medical expense deduction and reduces the floor to 7.5% for all taxpayers for tax years beginning after December 31, 2016, and ending before January 1, 2019

39 IRA Recharacterization Eliminates ability to recharacterize a Roth IRA conversion after December 31, 2017 As such, recharacterization can only be utilized to unwind a Roth conversion through December 31, 2017

40 Alimony For a divorce or separation agreement executed after December 31, 2018, or one executed before December 31, 2018 but modified after it (as long as the modification expressly provides that the new amendments apply), alimony and separate maintenance are not deductible by the payor and are not included in the income of the payee So if divorce or separation agreement is pre-12/31/18 and not modified, payor still gets deduction and payee declares it as income

41 Section 199 Domestic Production Activities Deduction This section of the Code is repealed

42 Like-Kind Exchanges Law eliminates like-kind exchanges for tangible personal property Law modifies the provision providing for nonrecognition of gain in the case of like-kind exchanges by limiting its application to real property not held primarily for sale with a transition rule if taxpayer has either disposed of the relinquished property or acquired the replacement property on or before 12/31/2017

43 Carried Interest The law imposes a three-year holding period requirement for qualification as long-term capital gain with respect to certain partnership interests received in connection with the performance of services If the three-year period is not met, gain will be treated as short-term gain taxed at ordinary rates

44 Repeal of Individual Mandate The amount of the ACA individual shared responsibility payment is zero after December 31, The repeal is permanent There are no changes to the 3.8% net investment income tax or the 0.9% Medicare tax

45 Increase in Estate and Gift Tax Exemption The law doubles the estate and gift tax exemption amount $5 million to $10 million The $10 million amount is indexed for inflation occurring after 2011 ($11.2 million in 2018). Phase out 1/1/26 A married couple is therefore able to shield $22.4M from estate tax

46 Reduction in Corporate Tax Rate Corporate tax rate is flat 21% beginning in 2018 The law reduces the 70% dividends received deduction to 50% and the 80% dividends received deduction to 65% JCT has estimated that this rate reduction would decrease revenues by $1.35 trillion over 10 years

47 Tax Rate Structure for Corporations Let s compare the 21% corporate rate to some other countries top rates: Argentina 35% Ireland 12.5% Bahamas 0% Italy 31.4% Canada 26.1% Mexico 30% France 33.3% Spain 25% Iceland 20% U.K. 19%

48 Converting to a corporation The tax law aims to make converting to a C corporation a little easier for companies that do so in the next two years. First, if the conversion requires the company to change its accounting method, and that results in more taxable income, that income is spread out over six years, rather than four (as was the case the end of December) Secondly, a new C corporation that distributes previously earned income can do so indefinitely under favorable pass-through instead of just in the year after the conversion.

49 Corporate AMT Corporate AMT is repealed for tax years beginning after December 31, 2017

50 Golden Era of C Corporations - Consider the following fact pattern: - Husband and Wife own a manufacturing business. Both materially participate in the business. - The business earns $3,000,000 annually before wages or distributions - Should the business be a C corporation or S corporation? - Case study #1: - Corporation would pay $500,000 out as wages to H&W and the remaining $2.5M is distributed

51 Golden Era of C Corporations Tax on $500,000 of wages: old law: 51

52 Golden Era of C Corporations Tax on $500,000 of wages: proposed law:

53 Golden Era of C Corporations Fact pattern 1: $500,000 of wages, remainder of $2.5 million distributed: old law As you can see, the double taxation of C corporations was extremely punitive.

54 Golden Era of C Corporations Fact pattern 1: $500,000 of wages, remainder of $2.5 million distributed: current law The gap has narrowed significantly. And that is with FULL access to cash.

55 Case Study #1, Current Law Variation: what if the corporation leaves the $2.5M in? Subject to the AET and PHC taxes, there is a lot of motivation to leave cash in the C corporation, at a 21% rate.

56 Case Study #1, Current Law Variation: what if the corporation makes only a $1M dividend?

57 Case Study #1, Current Law Variation: what if this were an accounting firm and all cash were paid out? The default is that service business get no benefit from the 21% deduction.

58 Case Study #1, Current Law Variation: what if this were an accounting firm and only $500K is paid out in wages? Leaving cash in (at least in part) offers a significant advantage to a C over a service business S corporation. 21% versus 45.6%.

59 Case Study #1, Current Law Variation: what if this were an accounting firm and $1,000,000 is distributed?

60 Golden Era of C Corporations Why did this happen? Corporate rate down to 21% All of the S corporation income is taxed at ordinary rates That means the gap between corporate tax rate and top individual rate has gone from 4.6% to 16.0%.

61 Golden Era of C Corporations But here s the kicker: Only C corporations are eligible for Section 1202 benefits. Gain from the sale of qualified small business stock eligible for 100% exclusion (subject to limitations) MUST be a C corporation Must have assets less than $50M Can t be a service business (accounting, law, etc ) Must acquire stock at original issuance If you couple Section 1202 with lowered rates on corporate income and stillreduced rates on dividend income, suddenly C corporations look pretty good!

62 Golden Era of C Corporations Assume a shareholder is considering a new business, and will invest $500,000. It will earn $200K annually, distribute half its earnings as a dividend, and the s/h expects the business to be worth $3M in five years Landscape: Corporate rate: 35% Dividend rate: 15% Section 1202: limited benefit (50% exclusion but remaining 50% taxed at 28%) 1. Entity-level tax: $1,000,000 * 35% = $350, Dividend tax: $500,000 * 15% = $75, Tax on sale of stock: $2,500,000 * 15% = $375,000 TOTAL TAX OVER LIFECYCLE: $800,000

63 Golden Era of C Corporations 2018 Landscape Corporate rate: 21% Dividend rate: 23.8% Section 1202: 100% exclusion 1. Entity-level tax: $1,000,000 * 21% = $210, Dividend tax: $500,000 * 23.8% = $119, Tax on sale of stock: $0! TOTAL TAX OVER LIFECYCLE: $329,000

64 Golden Era of C Corporations Other proposed changes that make C corporations more attractive Expansion of the cash method Current law: Section 448 prohibits the use of the cash method to: C corporations, and Partnerships with a C corporation partner When, in either scenario, the C corporation has average gross receipts over the prior three years of > $5 million. The House bill would expand the use of the cash method to C corporations and partnerships with a C corporation partner provided average gross receipts for the previous three years do not exceed $25 million.

65 Increased Expensing The law extends and modifies the additional first-year depreciation deduction through 2022 (through 2023 for longer production period property) The 50% allowance is increased to 100% for property placed in service after 9/27/2017, and before 1/1/2023 In subsequent years, the first year bonus depreciation deduction would phase down as follows: 80% for property placed in service after 12/31/2022 and before 1/1/2024, 60% for property placed in service after 12/31/2023 and before 1/1/2025, 40% for property placed in service after 12/31/2024 and before 1/1/2026, and 20% for property placed in service after 12/31/2025 and before 1/1/2027. Phase out 1/1/27 For first tax year ending after 9/27/17, taxpayer can elect to claim 50% bonus first-year depreciation Proposal maintains the 280F increased amount of $8,000 for passenger automobiles placed in service after 12/31/2017

66 Increased Expensing/Listed Property For passenger automobiles placed in service after 12/31/17, maximum amount of allowable depreciation is: $10,000 for the year in which the vehicle is placed in service; $16,000 for the second year; $9,600 for the third year; and $5,760 for the fourth and later years in the recovery period Removes computer or peripheral equipment from the definition of listed property

67 Expansion of 179 Expensing The law increases the maximum amount a taxpayer may expense under 179 to $1 million, and increases the phase out threshold amount to $2.5 million Expands the definition of 179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging

68 Expansion of 179 Expensing Definition of qualified real property eligible for 179 expensing includes any of the following improvements to nonresidential real property after the date such property was first placed in service: Roofs; Heating, ventilation, and air-conditioning property; Fire protection and alarm systems; and Security systems

69 Applicable Recovery Period for Real Property Separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property eliminated Qualified improvement property is generally depreciable over 15 years using the S/L method and half-year convention

70 Cash Method of Accounting The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25 million for the three prior tax years to use the cash method Exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations are retained meaning they are allowed to use the cash method without regard to the $25 million gross receipts test

71 Accounting for Inventories Taxpayers that meet the $25 million gross receipts test may use a method of accounting for inventories that either: Treats inventories as non-incidental materials and supplies; or Conforms to the taxpayer s financial accounting treatment of inventories This provision results in a change of accounting method for purposes of 481

72 Exception from UNICAP Businesses with average gross receipts of $25 million or less fully exempt from UNICAP. Exemptions from UNICAP that are not based on gross receipts are retained This provision results in a change of accounting method for purposes of 481

73 Business Interest Act limits business interest deductions to 30% of adjusted taxable income. For tax years before 1/1/22, adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion. Each business would be generally subject to a disallowance of net interest in excess of 30% of the adjusted taxable income of the business Businesses with average annual gross receipts for the three-tax year period ending with the prior tax year that do not exceed $25 million would be exempt Any interest amounts disallowed would be carried forward to the succeeding taxable year. Business interest may be carried forward indefinitely

74 Net Operating Loss Deduction For net operating losses arising in tax years ending after Dec. 31, 2017, the law repeals the two-year carryback and the special carryback provisions (except for certain farming losses). For losses arising in tax years beginning after Dec. 31, 2017, the law limits the net operating loss deduction to 80% of taxable income (determined without regard to the deduction) Carryovers to other years would be adjusted and could be carried forward indefinitely

75 Entertainment, etc., Expenses 50% limit expanded to meals provided through an in-house cafeteria or otherwise on employer s premises Deductions for employee transportation benefits (parking, mass transit) are denied, but employee exclusion from income is retained For tax years beginning in 2026, law disallows deduction for meals provided for the convenience of employer on the employer s premises No deduction allowed for other entertainment expenses

76 New Credit for Employer-Paid Family and Medical Leave The law allows businesses a general business credit of 12.5% of the amount of wages paid to qualifying employees on family and medical leave if the rate of payment is 50% of the wages normally paid to the employee The credit is increased by.25 percentage points (not above 25%) for each percentage point by which the rate of payment is over 50% The change is effective for wages paid in tax years beginning after 12/31/17, but is not applicable to wages paid in tax years beginning after 12/31/19

77 Excise Tax on an Applicable Private College or University 1.4% excise tax imposed on net investment income of certain private colleges and universities For purposes of the law, the tax would apply to a private college or university: That has at least 500 students, with more than 50% of the students located in the U.S.; With assets (other than those used directly in carrying out the institution s exempt purpose) of at least $500,000 per student

78 Bipartisan Budget Act /Partnership Audit Adjustments Streamlined audit procedures Tax years after 2017 Tax Matters Partner replaced by Partnership Representative, does not need to be a partner Partnership Liable for tax on adjustments Assumed at highest rates, option to demonstrate lower rates, or issue adjusted information returns, (not amended K-1). 100 or fewer partners can opt out, use general rules Adjustments flow through to the partners for the adjustment year, rather than the reviewed year under audit

79 Disclaimer This presentation and related materials are designed only to provide general information regarding the subject matter discussed during this presentation. The statutes, authorities, and other laws cited in this presentation are subject to change. This presentation and related materials are not intended to provide tax, accounting, legal, or other professional advice to any specific person or entity. Any advice or opinion regarding the application of the subject matter for a specific person or entity should be provided by a competent professional advisor based on an application of the appropriate law and authorities to the facts and circumstances applicable to thatperson or entity.

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81 Whitley Penn Tax Seminar Brian Mitchell January 2018

82 Disclaimer This presentation and related materials are designed only to provide general information regarding the subject matter discussed during this presentation. The statutes, authorities, and other laws cited in this presentation are subject to change. This presentation and related materials are not intended to provide tax, accounting, legal, or other professional advice to any specific person or entity. Any advice or opinion regarding the application of the subject matter for a specific person or entity should be provided by a competent professional advisor based on an application of the appropriate law and authorities to the facts and circumstances applicable to thatperson or entity.

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84 Agenda Outbound Changes Section 965: Mandatory Deemed Repatriation (Transition tax) Section 245A: Dividends received deduction (Territorial tax) Section 951A: Global intangible low-taxed income (GILTI) Deduction for foreign-derived intangible income (FDII) and GILTI Repeal of Active Trade or Business Exception under 367(a) Expansion of definition of Intangible Property for Outbound Transfers

85 International Tax Changes Inbound and Other Changes Section 267A: Hybrid arrangements and hybrid entities Section 59A: Base erosion and anti-abuse tax (BEAT) Section 163(j) Sale of a Partnership interest by a Foreign Person CFC and Subpart F changes

86 Changes Affecting Outbound Companies 965: Repatriation Transition Tax

87 Section 965: Mandatory Deemed Repatriation Section 965 provides that in the last taxable year of a specified foreign corporation (SFC) beginning before January 1, 2018 (transition year) the SFC s subpart F income is increased by the greater of its accumulated post-1986 deferred foreign income determined as of December 31, 2017 (or November 2 nd anti-abuse date). A SFC is a controlled foreign corporation (CFC) or any foreign corporation with at least one 10% domestic corporate shareholder; SFC status determined by including foreign-to-u.s. attribution rules Applies to: All U.S. Shareholders of Controlled Foreign Corporations Any U.S. Shareholder of a foreign corporation if at least one U.S. Shareholder is a domestic corporation.

88 Section 965: Mandatory Deemed Repatriation Accumulated post-1986 deferred foreign income means: E&P accumulated in years beginning after December 31, 1986, but only during periods in which the foreign corporation was a SFC, Dividends distributed during the transition year are excluded, Effectively connected E&P and previously-taxed E&P (PTI) are excluded. The income inclusion is reduced by an allocable amount (if any) of the US shareholder s aggregate foreign E&P deficit with respect to other SFCs. Whether an SFC has a foreign E&P deficit is determined as of November 2, 2017.

89 Section 965: Mandatory Deemed Repatriation Transition tax rates: 15.5% for cash or other specified assets;8% for the remainder 15.5% rate applies to amount of mandatory inclusion equal to a US shareholder s aggregate foreign cash position US shareholder can elect to pay transition tax over eight years (8% of liability in years 1-5, 15% in year 6, 20% in year 7, 25% in year 8). S Corporations can elect to maintain deferral until the S corpchanges its status, sells substantially all its assets, ceases to conduct business, or transfer of S Corp stock.

90 Section 965: Mandatory Deemed Repatriation Aggregate Foreign Cash position. Means the greater of US shareholder s pro rata share of aggregate cash position of its SFCs determined on last day of SFCs yearin which mandatory inclusion occurs, or, average of US shareholder s aggregate pro rata share of cash position of its SFCs determined in two years ending immediately before November 2, Cash position on Balance Sheet: Cash Net accounts receivable Fair value of: Personal property that is actively traded and established financial market Commercial paper, CDs and securities Any foreign currency Short-term obligations (<1 year) Other economically equivalent assets

91 Section 965: Mandatory Deemed Repatriation Transition tax rates achieved by allowing a deduction against the mandatory inclusion. Indirect Foreign Tax Credit is available in connection with the mandatory inclusion, but reduced in proportion to the deduction allowed against the mandatory inclusion. Reduced by 55.7% for Cash Position inclusions Reduced by 77.1% for other inclusions Are ALL actual withholding taxes creditable?

92 Section 965: Mandatory Deemed Repatriation Example Foreign Corporation #1: E&P $1,000 Foreign Tax Credits $200 Foreign Corporation #2: E&P <$100> Foreign Tax Credits $0 965 Inclusion Amount: $1,000 -$100 = $900 Deduction for rate equivalent method = <$694> Net Taxable 965 Inclusion $ % (before Foreign Tax Credit) = $72 Foreign Tax Credit ($200*(1-77.1%)): <$45.80> Net U.S. Tax Due on 965 Inclusion: $26.20

93 Section 965: Mandatory Deemed Repatriation Special Elections 1. 90% of the repatriation tax be paid on or before April 17, 2018 (assuming that no changes or adjustments are made to the new legislation). The election to pay installments must be made by the due date for the tax return installment payments must be made annually by the original due date (without extensions) for the tax return. 2. S Corporation Shareholders may elect to defer 965 inclusion indefinitely 3. Election not to use NOLs to offset the 965 inclusion

94 Section 965: Mandatory Deemed Repatriation Initial Guidance : IRS Notice (12/29/2017) and Notice (1/19/2018) Clarification and modification Regulations will be effective beginning the first taxable year of a foreign corporation (and with respect to US shareholders, the taxable years in which or with which such taxable years of the foreign corporations end) to which Section 965 applies. Before the issuance of the regulations taxpayers may rely on the rules described in the Notice. SEC Staff Accounting Bulletin No. 118

95 Section 245A: Territorial Tax (DRD)

96 Section 245A: Dividends received deduction 100% deduction for foreign source portion of dividends received by domestic corporation from specified 10%-owned foreign corporations Section 904 applied without foreign source portion of dividend Deductions properly allocable/apportioned to income or stock of specified 10% owned foreign corporation, except to the extent of subpart F income and global intangible low-taxed income (GILTI) Holding period requirement: 365 days during the 731-day period that begins on the date that is 365 days before the ex-dividend date Deduction not available for hybrid dividends; CFC to CFC hybrid dividends treated as subpart F income Repeal of 902 credit. No foreign tax credit available for foreign tax paid or accrued on qualifying dividends or hybrid dividends Effective for distributions made after December 31, 2017.

97 951A: Global intangible low-taxed income (GILTI)

98 GILTI A US shareholder of any CFC for any taxable year must include in gross income its GILTI for such taxable year. A US shareholder s GILTI for any taxable year equals the excess (if any) of: Such US shareholder's net CFC tested income for such taxable year, over Such US shareholder's net deemed tangible income return for such taxable year. Net CFC tested income less Net deemed tangible income return GILTI The inclusion of GILTI is generally similar to inclusion of subpart F income. Effective for tax years of foreign corporations beginning after December 31, 2017, and for tax years of US shareholders in which or with which such tax years of foreign corporations end.

99 GILTI Net CFC tested income with respect to any US shareholder is the excess (if any) of: The aggregate of such shareholder's pro rata share of the tested income of each CFC with respect to which such shareholder is a US shareholder for such taxable year of such US shareholder, over The aggregate of such shareholder's pro rata share of the tested loss of each CFC with respect to which such shareholder is a US shareholder for such taxable year of such US shareholder. Net deemed tangible income return with respect to any US shareholder is the excess (if any) of: 10% of the aggregate of such shareholder's pro rata share of the qualified business asset investment (QBAI) of each CFC, over The amount of interest expense allocable to net CFC tested income for the taxable year to the extent the interest income attributable to such expense is not taken into account in determining net CFC tested income. Net CFC tested income = Tested income Tested Loss less Net deemed tangible income return = 10% of QBAI Certain interest expense GILTI

100 GILTI QBAI equals the CFC s average aggregate adjusted bases for specified tangible property during the taxable year. Measured quarterly. Adjusted basis is determined by using the alternative depreciation system under Section 168(g). Depreciation is allocated ratably to each day during the period in the taxable year to which such depreciation relates. Specified tangible property is any tangible property used in the production of tested income. Must be used in a trade or business of the corporation. A deduction under Section 167 (depreciation) must be allowable for such property. Property is treated as specified tangible property in the same proportion that property generates tested income bears to total gross income produced by the property.

101 GILTI Interests in partnership: A CFC that holds an interest in a partnership at the close of the CFC s taxable year includes as part of its QBAI its distributive share of the partnership s aggregate adjusted bases in tangible property. CFC s distributive share of the adjusted basis of any property shall be the CFC s distributive share of income with respect to such property. Broad regulatory authority provided to Treasury and expectation that regulations will be issued to address certain detailed implementation matters.

102 GILTI New Section 960(d): A domestic corporation is deemed to have paid foreign income taxes equal to 80% of: Its inclusion percentage (GILTI divided by the aggregate of its pro rata shares of the tested income of its CFCs); multiplied by The aggregate tested foreign income taxes (foreign income taxes paid or accrued by a CFC properly attributable to tested income taken into account by the domestic corporation) New Section 904(d) limitation for non-passive GILTI; no carryback or carryforward of excess FTCs. Section 78 gross-up equals 100% of deemed paid taxes (except for purposes of Sections 245 and 245A).

103 Deduction for foreign-derived intangible income (FDII) and GILTI

104 Deduction for FDII and GILTI For taxable years of domestic corporations beginning after December 31, 2017, but on or before December 31, 2025, a domestic corporation is allowed a deduction equal to the sum (capped at taxable income) of: 37.5% of its FDII (effective % tax rate on FDII), and 50% of GILTI and corresponding Section 78 gross-up For taxable years of domestic corporations beginning after December 31, 2025, the percentages are changed to: % of its FDII (effective % tax rate on FDII), and 37.5% of GILTI and corresponding Section 78 gross-up

105 What is FDII? A domestic corporation s FDII is the amount that bears the same ratio to the deemed intangible income of such corporation as the foreign-derived deduction eligible income of the corporation bears to the deduction eligible income of the corporation. FDII Foreign-derived deduction eligible income Deduction eligible income Deemed intangible income

106 Deduction for FDII and GILTI Deduction eligible income equals the excess of the domestic corporation s gross income (determined without regard to certain amounts) over the deductions properly allocable to such gross income. Items excluded from gross income: Any amount included in gross income under Section 951(a)(1), i.e., traditional subpart F GILTI income Financial services income Dividends from CFCs of the domestic corporation Domestic oil and gas extraction income Foreign branch income Allocable deductions include taxes and interest. Open question as to how interest is allocated these purposes because the allowable deduction against GILTI and FDII is included in the domestic corporation s adjusted taxable income for purposes of Section 163(j).

107 Deduction for FDII and GILTI Foreign-derived deduction eligible income means: Any deduction eligible income which is: Property sold (or leased, licensed, or exchanged) to non US persons for use, consumption, or disposition outside the US; and Services provided to any person, or with respect to property, located outside the US. Special rules for related party transactions Property or services provided to unrelated domestic intermediaries does not qualify, even if ultimately a foreign sale/use arises. Deemed intangible income equals the excess of deduction eligible income over deemed tangible income return of the corporation. The deemed tangible income return of the corporation equals 10% of the corporation s QBAI. QBAI determined under GILTI rules except: Includes QBAI that produces deduction eligible income, instead of tested income ; and Determined without regard to whether the corporation is a CFC.

108 What is FDII? FDII Gross income from property sold to non-us persons for use outside the U.S., or services provided to any U.S. person not located in the U.S. (not including certain items of gross income) Gross income (not including certain items of gross income) minus properly allocable deductions Deemed intangible income

109 GILTI EXAMPLE CFC tested income: $10,000 Non US % <$1,312.50> Qualified Business Asset Investment (Quarterly Average): $800 $10,000 (10% * $800): $9,200 GILTI income inclusion 50% Deduction for GILTI: <$4,600> Net Taxable GILTI inclusion: $4,600 Section 78 Gross up (($9.2K / $10K )* $1, ) * 80% $ 966 Deduction for 78 Gross up <$966> U.S. Taxable Income $4,600 U.S. Tax at 21% (before Foreign Tax Credit) $966 Foreign Tax Credit <$966> Residual U.S. tax from GILTI Inclusion $0

110 Repeal of Active Trade or Business Exception Repeal of the exception to gain recognition under 367(a) for outbound transfer of property that is used in a trade or business. Effective: For transfers after 12/31/2017

111 Expansion of 936 definition of Intangible Property Expands the definition of Intangible Property under Section 936(h)(3)(B) to include goodwill, going concern value, workforce in place and other similar intangibles. Overturns several Tax Court losses on 367(d) or 482 cases. Mandate to issue Treasury Regulations on outbound Intangible Property valuation principals. Effective: For transfers occurring after December 31, Expressly provides that the changes are not to be construed as an inference on application in pre-effective date cases.

112 Changes Affecting Inbound Companies

113 Section 267A: Hybrid arrangements and hybrid entities

114 Section 267A: Hybrids No deduction is allowed for any disqualified related party amount paid or accrued pursuant to a hybrid transaction or by, or to, a hybrid entity. A disqualified related party amount is any interestor royaltypaid or accrued to a related party to the extent that: There is no corresponding inclusion to the related party under the tax law of the country where the related party is resident for tax purposes; or The related party is allowed a deduction with respect to the amount under the tax law of the residence country. A hybrid transaction is any transaction, series of transactions, agreement, or instrument one or more payments with respect to which are treated as interest or royalties for federal income tax purposes, and which are not so treated under the tax law of the residence country of the recipient (or the country where the recipient is subject to tax).

115 Section 267A: Hybrids A hybrid entity is any entity that is either (1) treated as fiscally transparent for federal income tax purposes but is not so treated in the country where the entity is resident for tax purposes or is subject to tax; or (2) treated as fiscally transparent for purposes of the tax law of the country where the entity is resident for tax purposes or is subject to tax, but is not so treated for purposes of federal income tax. Broad grant of regulatory authority for the Treasury Department to issue regulations, including to extend application of the provision to foreign and domestic branches and domestic entities (even if such branches or entities are not within the statutory definition of a hybrid entity). Effective for taxable years beginning after December 31, 2017.

116 Section 59A: Base erosion and anti-abuse tax (BEAT)

117 Section 59A: BEAT Applicable taxpayers. Imposed on a corporation (other than RIC, REIT or S-corporation) that has: Average annual gross receipts of at least $500 million for three-year period ending with preceding taxable year. A base erosion percentage of at least 3%. Base erosion percentage is generally the aggregate amount of base erosion tax benefits divided by aggregate amount of all allowable deductions.