Dawn of a new tax era

Transcription

1 J.P. MORGAN WASHINGTON WATCH Dawn of a new tax era By Thomas McGraw, Head of Tax Advisory, and Jordan Sprechman, Practice Lead, U.S. Wealth Advisory, J.P. Morgan Private Bank December 21 Congress has passed sweeping legislation that reshapes the U.S. tax landscape. President Trump, who has championed this overhaul, is expected to sign the bill into law. Most of its important changes would be effective January 1, The legislation brings lower rates to many, but not all, and expands the tax base by eliminating or scaling back key deductions. Whether individuals will see their tax obligations increase or decrease depends not only on where they live, but also on how they earn their incomes and the tax classifications of their employers (e.g., partnership, corporation or sole proprietorship). Although 2017 is drawing to a close, there are still some actions you may want to take to reduce your 2017 taxes before the new law goes into effect. And early in 2018, we strongly recommend you visit with your estate-planning lawyer and other advisors, including your J.P. Morgan representatives, to revisit your tax and wealth plans. Here is your potential to-do list. To help you begin to see how you will fare in this new tax era, we also offer highlights of the law and a list of much-discussed proposals that were not adopted. The act was written with broad strokes, so expect more law to come in the form of regulations, technical corrections, case law and directions for implementation. That said, we know a great deal now, and for our insights, see the attached. 10 ACTIONS TO CONSIDER Before year-end Speak with your accountant about whether you should: Pay 2017 state and local income taxes in 2017 or complete purchases of expensive items subject to sales tax so long as this action would not make you subject to the alternative minimum tax (AMT) Ask local property tax authorities for bills to pay in 2017 and pay them in 2017 if you are not subject to the AMT Make charitable donations in 2017 If you are in the AMT system in 2017, exercise deep-in-the-money, non-qualified stock options (NQSOs) and stock appreciation rights (SARs) with little time value, or recognize other discretionary ordinary income items Start like-kind exchanges of personal property you use in a trade or business, or for investment (such as art) before December 31, if possible Early in 2018 Speak with your advisors and estate-planning attorney to determine if these strategies make sense for you: ESTATE PLANNING 06 Lifetime gifting Consider making gifts to, or in trust for the benefit of, other family members up to the new gift tax exclusion amount of $11.2 million (up from $5.49 million) before this increased exclusion sunsets after Bequests Determine if you should revise your estate-planning documents and life insurance coverage contracts, both of which may use formulas referencing values that have changed significantly under the new law (e.g., the estate tax exclusion amount, which is increasing from $5.49 million to $11.2 million) FINANCIAL PLANNING 08 Re-evaluate the tax efficiency of your asset allocation in light of the new law to determine whether you should alter the composition of, or method of holding, your investments MORTGAGES 09 Consider structuring debt so that mortgage indebtedness does not exceed the new mortgage deduction limit, with additional debt structured in such a way that the interest may be deductible as either an investment, or trade or business expense CLOSELY HELD BUSINESSES 10 Consider reorganizing a closely held business either to take advantage of a new deduction available to pass-through entities or, in certain instances, to benefit from lower corporate tax rates, the temporary 100% capital expensing rules and deductions unavailable to individuals (such as for state and local taxes) INVESTMENT AND INSURANCE PRODUCTS ARE: NOT FDIC INSURED NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

2 2 HIGHLIGHTS OF THE NEW LAW For individuals: Income taxes Inflation adjustments One of the biggest long-term changes affecting how much tax individuals will pay in the future is the new bill s approach to calculating annual inflation adjustments to tax brackets. The net effect, over time, will be to subject more income to higher tax rates as the brackets are adjusted based on a slower measure of inflation. This is the only permanently enacted change for individuals, with other changes generally scheduled to sunset after To get a sense of what a difference this can make, see the chart below. New inflation adjustment what does it mean? Taxpayers can expect to move into higher brackets sooner, as the new method of calculating inflation has a slower rate of increase. Every year, income tax brackets are adjusted for inflation. Formerly, brackets were adjusted for inflation using the Consumer Price Index for all urban consumers (CPI-U), which assumes consumers buy the same basket of goods each year. That tends to rise faster than the method the new law uses, which is Chained Consumer Price Index- Urban (C-CPI-U). This measure accounts for consumer reaction to changes, such as product substitution (e.g., if the price of Brand X of soft drink rises, consumers may opt for the cheaper Brand Y instead). Projecting the income level at which the top tax bracket will kick in, over time 700, , , , ,000 Top Tax Bracket CPI-U Top Tax Bracket Chained CPI-U 575, Methodology: Analysis uses the average historical inflation adjustment based on both CPI-U and Chained CPI-U (C-CPI-U) going back to Source: J.P. Morgan, the U.S. Bureau of Labor Statistics and Internal Revenue Service. Rates The top ordinary income rate will be 37%, starting at $600,000 for married couples filing jointly and at $500,000 for single filers The top long-term capital gain and qualified dividend tax rate of 20% is retained Deductions Standard The standard deduction roughly doubles to $24,000, though the personal exemption is repealed Itemized Deductions for itemized expenses are largely eliminated or capped. Gone are deductions for: State and local income or sales taxes, and property taxes, to the extent those aggregate expenses exceed $10,000 (a threshold that is not indexed for inflation) Mortgage interest attributable to more than $750,000 of principal on a primary and one other residence Interest on home equity lines of credit Pease limitation This limitation, which further reduced the value of itemized deductions, is eliminated, though with the non-deductibility of so many expenses, the impact of its elimination is muted AMT The phase-out of the individual AMT exemption will apply only to taxpayers with income of more than $1 million (married filing jointly), up from $160,900 Transfer taxes Amounts that can transfer free of gift, estate and generation-skipping transfer (GST) taxes are roughly doubled to $11.2 million (plus annual adjustment for inflation) Education expenses Funds in 529 accounts may now be used to pay tuition for grades K 12 (previously limited to post-secondary school), up to $10,000 per child per year For corporations and pass-throughs: Corporations current top income tax rate of 35% is permanently reduced to a flat rate of 21% Corporate AMT is eliminated Pass-through owners will see a tax rate drop (via a 20% deduction), but only for certain types of income from certain types of businesses NOT ADOPTED Elimination of the deductions for donations to charity and for investment interest A rule that would have rendered ineffective the benefits of non-qualified deferred compensation and equity-based awards A rule that would have required investors to identify the cost basis of specified securities sold, exchanged or otherwise disposed of using a first-in-first out (FIFO) method, rather than by specific identification Changes to the taxation of qualified plans (e.g., 401(k)s, IRAs) Repeal of the tax exemption for private activity bonds Stricter limitations on the exclusion of capital gain on sale of a principal residence For more, see the attached TAX CHANGE WATCH LIST. Your J.P. Morgan team is available to help answer questions you may have about these issues and to address any of your financial planning needs.

3 3 INDIVIDUAL INCOME TAXES Item Current law 2017 Tax Bill Passed by Congress Insights Ordinary Income Brackets Seven brackets. Maximum rate is 39.6% for single filers earning more than $418,400 and married couples filing jointly earning more than $470,700 Preserves seven brackets. Maximum rate is 37% for single filers earning more than $500,000 and married couples filing jointly earning more than $600,000 Slight reduction of top marginal rate, which is imposed at somewhat higher levels. Benefit to many of lower marginal rate is offset by loss of most itemized deductions $600,000 top bracket for joint filers relative to $500,000 bracket for single filers preserves substantial marriage penalty Historically, changes to individual income tax rates (1980s and 2000s) have only a modest effect on municipal market yields, and the relatively small changes in this bill likely will not affect the municipal market materially, almost surely not as much as the larger corporate tax rate changes The bill simplifies and increases the kiddie tax by applying ordinary and capital gains rates applicable to trusts and estates to the net unearned income of a child through 12/31/25 Inflation Adjustments Brackets are indexed using Consumer Price Index-Urban (CPI-U) Brackets are indexed using Chained Consumer Price Index-Urban (C-CPI-U). The provision requiring C-CPI-U for indexing does not sunset. C-CPI-U differs from the current Consumer Price Index measure (CPI-U) in that it accounts for the ability of individuals to alter their consumption patterns in response to price changes Chained-CPI indexation will result in higher tax rates being imposed at lower income levels than under the traditional CPI indexation method. Over time, one would expect this permanent law change to result in substantially more federal revenue Ordinary Income Cost Basis Investors may choose which tax lots to sell Silent The final bill struck the Senate provision that would have required the cost basis of specified securities sold, exchanged or otherwise disposed of to be determined on a first-in-first-out (FIFO) basis rather than specifically identified. Most taxpayers and their advisors, and most financial firms, were relieved this provision was not in the final bill because its adoption was anticipated to increase compliance costs and decrease investors net proceeds from the sale of capital assets

4 4 Item Current law 2017 Tax Bill Passed by Congress Insights Ordinary Income Tax-Exempt Bond Treatment Gross income does not generally include interest on state and local bonds Retains tax-exempt bond treatment, except for advance refunding bonds. Effective for advance refunding bonds issued after 12/31/17 The House bill s proposed repeal of tax-exempt treatment for private activity bonds was struck in the final bill Repeal of tax-exempt treatment of advance refunding bonds will eliminate the ability of municipal issuers to refinance existing debt with tax-free debt, likely hindering them from reducing financing costs. There has been a rush of issuance of new advance refunding bonds in the last weeks of 2017, before the effective date of the tax bill Advance refunding bonds comprised approximately 20% of the issuance in the tax-exempt market in 2017 Ordinary Income Like-Kind Exchanges No gain or loss is currently recognized for private property used in a business or held for investment when exchanged for like-kind property Limits like-kind exchanges to real property not held primarily for sale Before 1/1/18, taxpayers may want to initiate like-kind exchanges with personal property (e.g., artwork) or certain property used in a trade or business. The final bill grandfathers exchanges of personal property if the taxpayer has disposed of the relinquished property, or acquired replacement property, in 2017 Long-Term Capital Gains (LTCG) and Qualified Dividend Income (QDI) Maximum rate for both forms of income is 20% Keeps the same top rates but changes bracket breakpoints after 2017 based on Chained CPI. So, for joint filers in 2018, 15% bracket begins at $77,200 and 20% bracket at $479,000 ($38,600 and $425,800 for single individuals, respectively) Relative parity with current tax rates should result in minimal implications for investment allocations and the use of certain hedging transactions, such as qualified covered calls Capital Gains Exclusion on Sale of Principal Residence Taxpayers may exclude $250,000 ($500,000 for joint filers) of gain from the sale of a personal residence if property was owned and used as a principal residence for two out of the last five years. May use exclusion once every two years Silent Proposed increased limitations on exclusion, which would have generally reduced the value of more expensive personal residences, were struck in the final bill, leaving this exclusion unchanged from prior law

5 5 Item Current law 2017 Tax Bill Passed by Congress Insights Affordable Care Act (including Medicare surtax) 3.8% on net investment income above certain income thresholds. A 0.9% additional Medicare tax applies to wage income above certain income thresholds Imposes a penalty ( individual responsibility payment ) on those who can afford to buy health insurance but choose not to ( individual mandate ) Effectively repeals individual mandate by reducing the amount of individual responsibility payment to zero after December 31, 2018 Comprehensive repeal or reform of the Medicare surtax would be part of healthcare reform legislation, not tax reform law Repeal of the individual mandate was added relatively late in the legislative process, likely in part because of the significant savings its repeal is projected to generate (over $300 billion over 10 years). Loss of revenue from individual responsibility payment is projected to be more than offset by elimination of subsidies to low-income taxpayers, who may now not buy healthcare insurance at all The 3.8% annual excise tax on net investment income for individual taxpayers with AGI >$250,000 (joint filer) or trusts with AGI >$12,500 remains in effect (not adjusted annually for inflation) Alternative Minimum Tax (AMT) The AMT is a separate income tax system created to ensure that taxpayers do not completely avoid tax through the use of deductions, exemptions, losses and credits. The maximum AMT rate is 28%. Many expenses treated as deductible under the regular tax system are not deductible under the AMT system. Conversely, certain preference items are taxable under the AMT system, but not under the regular tax system. AMT exemption of $84,500 phases out for alternative minimum taxable income (AMTI) above $160,900 for joint filers AMT retained, with increases in the income levels at which it would apply (AMT exemption of $109,400 phased out for AMTI above $1 million for joint filers) Retention of the AMT in the final bill was likely driven by the need to assuage Republican deficit hawks, without whose support passage would have been impossible The elimination of most itemized deductions, as well as the higher phase-out threshold, renders this more limited version of the AMT system less relevant to most taxpayers than under current law Executives subject to AMT in 2017 but not anticipated to be subject to it next year may want to, before 12/31/17, exercise deep-inthe-money non-qualified stock options or stock appreciation rights with little time value up to their AMT breakeven point to take advantage of the lower tax rate and SALT deductibility against the Medicare surtax. (Of course, non-tax factors such as stock outlook, intrinsic and time value, diversification, cash needs and dividends should inform decisions about whether to exercise)

6 6 Item Current law 2017 Tax Bill Passed by Congress Insights Carried Interest Carried interest income (typically earned by principals of investment funds and also common in certain industries such as real estate, and oil and gas) is generally treated as capital gain income, and therefore subject to a lower effective tax rate Extends the holding period for long-term gains treatment for carried interest and attributable gain realizations on fund assets to three years, notwithstanding any Internal Revenue Code 83 elections Preserves preferential taxation, but extension of the holding period for long-term gains treatment from one to three years could have a significant impact on hedge fund principals, whose funds typically generate material long-term capital gains Private equity firms generally have longer holding periods and should be less affected Operating partnerships in industries not engaged primarily in capital market and other investment transactions would not be subject to this provision Deductions Standard Deduction Standard deduction is $6,350 for single taxpayers and $12,700 for married taxpayers filing jointly Roughly doubles standard deduction for married couples to $24,000 (indexed to Chained CPI); adds separate deduction for single parents; preserves enhanced standard deduction for the blind and elderly Increase in standard deduction will reduce the need for many affluent taxpayers to itemize deductions. One ripple effect could be to decrease donations to charity, as the benefits of itemized deductions would diminish, and the expenses that warrant itemization would be fewer Deductions Personal Exemptions The personal exemption is $4,050, reduced incrementally once a threshold is exceeded Repeals Repeal of personal exemption is thought to be largely, if not entirely, compensated for by increases in the standard deduction, except for larger families (four or more children or other dependents) Deductions Itemized Deductions Itemized deductions may be taken for a variety of expenses, including: Donations to charity Payments of state and local taxes ( SALT ) Mortgage interest Investment interest expenses Investment management expenses Unreimbursed medical expenses in excess of 10% of adjusted gross income (AGI) Eliminates most itemized deductions Preserves charitable deduction; increases limitation on deductibility of cash donation to a public charity from 50% of AGI to 60% of AGI Caps deduction for aggregate state and local income and property taxes (or sales taxes in lieu of income taxes) at $10,000 for joint filers Reduces cap on mortgage indebtedness, the interest on which is deductible, from $1 million to $750,000 (on primary residence and one other residence) Preservation of the charitable deduction helps all charities, including donor-advised funds (DAFs) But charities fear that taxpayers impetus to donate would be reduced by lesser need of taxpayers to itemize Repeal of deductibility of state and local taxes affects high-income earners in high-tax states the most. These individuals may benefit from adding to their portfolios insurance-dedicated funds and municipal bonds, which generate non-taxable or tax-exempt income. The cap on deductibility of property, sales and state income taxes will likely give states and municipalities greater pause before raising these taxes in the future Continued on next page Continued on next page Continued on next page

7 7 Item Current law 2017 Tax Bill Passed by Congress Insights Deductions Itemized Deductions, cont. See prior page Eliminates $100,000 home equity line of credit (HELOC) deduction Preserves, through silence, deduction for investment interest expense Eliminates Pease limitation on itemized deductions Interest due on mortgage indebtedness incurred before 12/15/17 is deductible up to the current $1 million principal limit under a grandfathering provision Preservation of the deductibility of investment interest expenses preserves taxpayers incentives to borrow for taxable investment purposes Repeals all miscellaneous itemized deductions subject to the 2% AGI floor under current law Temporarily expands deduction for out-of-pocket medical expenses to amounts in excess of 7.5% of AGI for 2017 and 2018, returning to amounts in excess of 10% of AGI in 2019 and beyond Repeals deduction and payee income recognition for alimony paid under divorce or separation agreements executed or modified after 12/31/18 Taxpayers limited by the prior $1 million mortgage cap (the principal indebtedness of which is grandfathered for deductibility under the new law) should consider paying down mortgages in excess of the deductible amounts, as well as HELOCs, and at some time later borrowing against those properties and investing the proceeds in a trade or business, or in taxable investments. Investment interest on such debt should be fully deductible Taxpayers who entered into binding contracts before 12/15/17 to close on the purchase of a principal residence before 1/1/18, and who purchase the residence before 4/1/18, are also grandfathered up to the $1 million limit For purposes of the $1 million mortgage interest grandfathering, refinanced debt is treated as incurred on the date of the original debt to the extent the debt amount is not increased, subject to certain term limitations Taxpayers should consider paying, by 12/31/17, 2017 state and local taxes normally not due until 2018, but not pay so much as to tip into AMT and lose the SALT deduction. AMT taxpayers may also benefit from paying 2017 state and local taxes before year-end, as 2017 payment can still reduce the effect of the 3.8% Medicare surtax Prepayments in 2017 of expected state or local income tax liability to be incurred in future years (even 2018) will not entitle the taxpayer to claim in 2017 a deduction for SALT paid The conference agreement provides somewhat incongruously that the state and local tax provision is effective for tax years beginning after 12/31/16. This provision may be meant to capture the prohibition on all prepayments, even those made early in the year. If this is a typographical error, it likely would be addressed in a technical corrections bill

8 8 Item Current law 2017 Tax Bill Passed by Congress Insights Retirement Plans Contributions to traditional IRAs and qualified plans are deductible (subject to certain limitations); assets in these accounts are generally taxable only when distributions are made Preserves current tax rules, including contribution limits, to IRAs, 401(k) accounts, and other qualified plans Eliminates ability to recharacterize to undo Roth conversions, but recharacterizations are still permitted with respect to other contributions (e.g., recharacterize a contribution to a Roth IRA to a contribution to a traditional IRA) No change to non-qualified deferred compensation and equity-based award tax rules Both the House and Senate bills had originally eliminated the main benefits of non-qualified deferred compensation plans and various equity-based awards (likely as an alternative to a discussed alteration to 401(k) rules, but without the public scrutiny), but later those provisions were struck from both bills and remained struck in the final bill Therefore, non-qualified deferred compensation plans and equity-based compensation awards remain viable means for employers to incentivize company executives and other employees Education 529 plans provide tax-free earnings growth and tax-free withdrawals when funds are used to pay for qualified higher education expenses Expands 529 plans to cover up to $10,000 per year of elementary and secondary school expenses Preserves current law treatment with respect to tuition waivers for graduate students For 529 plans, $10,000 limit applies to designated beneficiaries. So an individual (presumably a minor) may have paid, from all 529 accounts of which he or she is a designated beneficiary, no more than $10,000 for primary and secondary school expenses Sunset All of the above individual provisions are scheduled to sunset after 2025, restoring pre-2018 law, with the exception of the so-called Chained CPI change that would index the tax brackets and other parameters to a slower measure of inflation, which would be implemented on a permanent basis Sunsetting of individual tax relief provisions allows the bill to comply with Senate budget rules and fund permanent corporate tax reform, which likely would be largely ineffective if perceived as temporary. It also in effect calendars a national discussion about taxes until no later than 2025

9 9 CORPORATIONS & PARTNERSHIPS Item Current Law 2017 Tax Bill Passed by Congress Insights Domestic C Corporations Max Rate Maximum rate = 35% Permanently lowers corporate tax rate from 35% to flat 21% starting 1/1/18 Repeals the corporate AMT The substantial cut in corporate tax rates is expected to boost equity markets, as tax savings will likely go to shareholders via dividends or stock buybacks, because recent low borrowing rates provided little hurdle to capital investment The Senate bill s proposed retention of corporate AMT would have undone many of the benefits of other corporate reform provisions, and so was struck from the final bill Reducing the corporate tax rate could have a modestly negative impact on demand for municipal bonds from corporations such as banks and insurance companies, which represent approximately 30% of the muni buyer base A lower corporate income tax rate should serve to increase after-tax free cash flow, while at the same time making debt issuance more expensive relative to equity. All else equal, this is a positive for credit markets and should serve to modestly tighten credit spreads Domestic C Corporations Dividends Received Deduction Corporations may deduct a fraction of the dividends received from their taxable income as follows: If corporation receiving the dividend owns <20% of the stock of the corporation paying the dividend, then deduction = 70% Reduces the 70% deduction to 50% and the 80% deduction to 65% after 12/31/18 These proposals reflect the proposed reduction in the corporate income tax rate to 21% (from 35%) If receiving corporation owns 20%, then deduction = 80% If both corporations are in the same affiliated group, deduction = 100%

10 10 Item Current Law 2017 Tax Bill Passed by Congress Insights Domestic C Corporations CAPEX Expensing Generally, new business capital investments may be depreciated over a term of years, or expensed immediately, subject to certain limits Allows immediate expensing of 100% of the cost of new and used investments for five years, then reduces by 20% each year until 2026 (i.e., 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026) Effective for property acquired and placed in service after 9/27/17 Provision is designed to promote greater capital investments and stimulate economic growth. Industrials and materials companies may benefit if this provision incentivizes additional capital orders Provision increases existing bonus depreciation percentage; qualifying assets for expensing generally mirror those eligible for bonus Domestic Corporations Interest Deduction Corporations generally have an unlimited deduction for business interest as incurred Caps deduction for business interest at 30% of adjusted taxable income. Adjusted taxable income is roughly defined as EBITDA from 2018 through 2021, after which it is roughly defined as EBIT. Disallowed deductions above this cap may be carried forward indefinitely. Real estate firms and small businesses (defined as those with <$25 million of average gross receipts) are exempt from this cap The bill would also allow real property businesses that use a version of straight line depreciation to avoid being subject to the interest deduction limitation Greater limitations on the interest deduction may cause many companies to alter their capital structures The interest deduction limit calculation for 2018 through 2021 adds depreciation and amortization back in; after 2021, they are not added back in the calculation. The effect of these two approaches is to make the base on which corporations may deduct interest expense larger in the first four years than after 2021 The vast majority of companies will not be affected by this provision. However, profitable companies with high interest coverage ratios could see their taxes increase Companies that use free cash flow to pay down debt could see credit spreads widen Domestic Corporations Compensation Deduction Public companies may not deduct applicable employee remuneration (generally, salary but not performance-based bonuses or commission) of any covered employee greater than $1 million per year Repeals exceptions to the $1 million deduction limitation for commissions and performance pay above $1 million. Provides a transition rule for existing agreements Effect would be to discourage excessive compensation for public company CEOs as well as four (4) other highly compensated officers through material limitation to corporate deduction even if the compensation is performance-based Under a transition rule, compensation provided for under a binding, written contract in effect on 11/2/17, and not materially modified thereafter, would be excepted from this provision

11 11 Item Current Law 2017 Tax Bill Passed by Congress Insights Domestic Corporations Income Recognition Corporations may only use cash method accounting if their average annual gross receipts <$5 million for all prior years A cash basis taxpayer must generally recognize income when received. An accrual basis taxpayer must recognize income when all events have occurred that fix its right to receive such income Taxpayers with average gross receipts <$25 million for the prior three years may use cash method accounting Requires that income be recognized no later than the year in which taken into account as income on financial statement The provision expands the universe of closely held business owners eligible to use a cash method of accounting and avoid various complexities of accrual tax accounting conventions Pass-Through Entities (Partnerships, LLCs, and S Corporations) There is generally no tax on pass-through entities at the entity level. Taxes are payable at the owner s or partner s individual tax rate Net operating losses (NOLs) can be carried back two years and forward 20 Allows a 20% deduction for domestic qualified business income Deduction is available for specified service business owners with taxable income <$315,000 for joint filers, $157,500 for single filers. This deduction is phased out for specified service business owners over the next $100,000 for joint filers, $50,000 for single filers Deduction limited to the greater of: (a) 50% of W-2 wages with respect to the qualified trade or business for high-income taxpayers (>$315,000 income for joint filers; >$157,500 single filers), or (b) 25% of W-2 wages + 2.5% of the unadjusted basis of all qualified property. W-2 wages includes deferred compensation arrangements. Taxpayers earning above the threshold amount mentioned above would see the deductible amount phased out over the next $50,000/$100,000 of additional income Trusts and estates are eligible for the deduction Publicly traded partnerships, including master limited partnership (MLP) unit holders, can claim the 20% deduction The intent of these provisions is to encourage growth of small businesses. It should be anticipated that taxpayers may try to reorganize their affairs in such a way as to qualify for this deduction, and that Treasury will over time issue anti-abuse regulations to clarify what businesses, what income, and which taxpayers, will and will not qualify for the deduction The last-minute addition of an alternative capital component test to the wage limit test enables real estate businesses to take advantage of the deduction A top marginal rate of 37% with a 20% deduction provides a roughly equivalent benefit to the 38.5% marginal rate with a 23% deduction proposed in the final Senate bill before the conference committee The deduction is available to both itemizers and non-itemizers. It is a below-the-line deduction that reduces taxable income (as opposed to AGI) Restrictions on specified service businesses address concern that professionals not targeted for these provisions would reorganize to allow income from their businesses to benefit from this deduction Continued on next page Continued on next page

12 12 Item Current Law 2017 Tax Bill Passed by Congress Insights Pass-Through Entities, cont. (Partnerships, LLCs, and S Corporations) See prior page Qualified dividends from REITs are qualified business income eligible for the deduction Business interest deduction applied at partnership level The definition of specified service trade or business was modified in the final bill to exclude architecture and engineering (meaning that principals in those industries could benefit from this deduction, regardless of their income) Treats the sale by a non-u.s. person of an interest in a partnership that conducts a U.S. trade or business as effectively connected income (ECI) subject to tax in the United States to the extent it would have had ECI had the partnership sold all its assets State and local taxes deductible only in connection with carrying on a trade or business, or activities relating to expenses for the production of income under Internal Revenue Code 212 All pass-through provisions would sunset after 2025 Specified service trades or businesses principals of which are ineligible for the deduction include health, law, consulting, athletics, financial and brokerage services (including investing and investment management, trading, or dealing in securities, partnership interests or commodities), and any trade or business where the principal asset is the reputation or skill of its employees However, those in specified service businesses (e.g., lawyers at law firms) who earn above the threshold amounts ($157,500/$315,000) may benefit from doing that job from a qualified trade or business (e.g., in-house counsel at a pass-through industrial client) so as to benefit from the deduction The reduction in the threshold amounts relative to the Senate bill is meant to deter the recharacterization of compensation as business profits. The Secretary of the Treasury is directed to provide additional anti-abuse rules regarding the limitation based on W-2 wages and capital Although MLPs would benefit from the 20% deduction, the lower corporate tax rate may make the relative value of the MLP partnership structure somewhat less attractive Regarding the sale by a non-u.s. person of an interest in a partnership that conducts a U.S. trade or business, the Secretary of the Treasury may provide guidance permitting a broker to withhold 10% of the amount realized

13 13 Item Current Law 2017 Tax Bill Passed by Congress Insights Pass-Through Entities NOL Carryback up to two years and carryforward up to 20 years Repeals carryback for NOLs (except for one year for disaster and small business losses), but allows indefinite carryforward. Amount deductible limited to 80% of taxable income in any given year Not anticipated to have a major effect on use of NOLs against business income, other than more immediate recoupment in certain instances due to immediate refund claims on prior year filings Multinational Business Operations Profits earned by U.S. corporations in foreign jurisdictions are taxed by the United States at the U.S. corporate rate only when the corporations choose to repatriate those profits, subject to foreign tax credit calculation, if any Shifts to a hybrid territorial system Exempts 100% of earnings from foreign-sourced dividends (assuming the corporation owns at least 10% of the foreign company). This exemption is not available to C corporations that are RICs or REITs Imposes a minimum tax on global intangible low-taxed income (GILTI) U.S. corporate shareholders may deduct 37.5% of foreign-derived intangible income + 50% of GILTI Imposes a base erosion anti-abuse tax (BEAT) on corporations with gross receipts in excess of $500 million and with deductions of more than 3% of their total expenses resulting from payments to related foreign persons. This tax is 5% in 2018, rises to 10% from 2019 through 2025, and to 12.5% after 2026 and is essentially an AMT-like tax on a base of income that backs out deductible payments to affiliated foreign entities (cost of goods sold excepted) A territorial tax system would benefit sectors with overseas operations and intellectual property other than those with material operations in tax havens (e.g., tech, healthcare) over sectors with largely domestic operations (e.g., utilities, industrials) The final bill struck a special provision for multinational companies regarding deductibility of business interest, which would have placed further limits on interest deductibility for multinational corporations by examining U.S. interest expense and equity relative to those metrics on a worldwide basis Deemed repatriation would result in a one-time spike in tax revenues, though payments may be made over eight years Repatriation of U.S. corporate cash held overseas is likely to result in lower corporate credit issuance, all else equal Our Investment Bank estimates that over $2 trillion is held overseas and subject to repatriation Imposes 35% tax on deemed repatriated earnings and profits (E&P) of a U.S. shareholder that inverts within 10 years of enactment Shareholders who receive dividends from a company that inverts after enactment of this bill are not eligible for the preferential rate on qualified dividends Deems historic unrepatriated earnings repatriated at 15.5% rate for cash and 8% for non-cash

14 14 TRANSFER TAXES Item Current law 2017 Tax Bill Passed by Congress Insights Gift Tax Maximum rate = 40%; exclusion amount = $5.49 million No change to gift tax rate Increases exclusion on 1/1/18 from $5.49 million to $11.2 million, an amount that will continue to be subject to inflation adjustments. Exclusion increase sunsets after 2025 Retains annual exclusion of $14,000 ($15,000 on 1/1/18) Taxpayers with the means and desire to do so should consider sizable gifts early in 2018 to take advantage of the increased exclusions, whether by outright gifts or (what we consider to be a better practice) transfers into tax-efficient, creditor-protected, long-term irrevocable trusts Estate Tax Maximum rate = 40%; maximum exclusion amount = $5.49 million No change to estate tax rate Increases exclusion on 1/1/18 from $5.49 million to $11.2 million, an amount that will continue to be subject to inflation adjustments. Exclusion increase sunsets after 2025 Doubling the exemption amount and then sunsetting that provision so that it is halved after 2025 could result in different applicable exclusion amounts at the time of a gift versus at death. The bill directs Treasury to promulgate regulations instructing taxpayers on how to deal with this mismatch and prevent a claw-back Generation- Skipping Transfer Tax Maximum rate = 40%; exemption amount = $5.49 million No change to GST tax rate Increases exclusion on 1/1/18 from $5.49 million to $11.2 million, an amount that will continue to be subject to inflation adjustments. Exclusion increase sunsets after 2025 The bill is silent on income tax basis adjustment rules. As a result, property received as a lifetime gift from a donor generally will continue to take a carryover basis, and property acquired from a decedent s estate generally will continue to take a stepped-up basis JPMorgan Chase & Co. and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on, for tax, legal or accounting advice. You should consult your personal tax, legal and accounting advisors for advice before engaging in any transaction.

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