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Tax Reform: A common sense approach

Tax Reform: A common sense approach. Margaret Amsden. March 22, 2018. Agenda. What to expect and when to expect it Business / International Tax Provisions Individual Tax Provisions Planning. What to Expect and When to Expect It.

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Tax Reform: A common sense approach

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  1. Tax Reform: A common sense approach Margaret Amsden March 22, 2018

  2. Agenda • What to expect and when to expect it • Business / International Tax Provisions • Individual Tax Provisions • Planning

  3. What to Expect and When to Expect It • Only a few provisions apply to 2017, while most apply to 2018 and forward • Business and international provisions are largely permanent, although some phase in and other phase out • Individual provisions are largely temporary covering the years 2018 through 2025 • IRS has set 2017-2018 Priority Guidance Plan which includes initial implementation of the Tax Cuts and Jobs Act

  4. Business / International Provisions

  5. C Corporation tax rates • Remove graduated rate structure replaced with flat 21% for C Corporations • Removed higher rate applied to Personal Service Corporations

  6. C Corporation Change in Tax Rates • Alternative Minimum Tax repealed • AMT credit carryovers will be allowed to offset up to 50% of regular tax in 2018 – 2020 • AMT credit carryover percentage increases to 100% in years beginning in 2021 • IMPACT: AMT Credit Carryovers are fully refundable by 2022

  7. Bonus Depreciation • Bonus depreciation has increased from 50% to 100% • Applicable to property placed in service after September 27, 2017 • Bonus depreciation is now available for purchases of used personal property • Bonus depreciation begins to phase out by 20% per year 2022 until it is reduced to 0% in 2027 • Bonus depreciation is automatic unless taxpayer elects out, must elect out on an entire class of property in any year

  8. Section 179 • New limits indexed for inflation: • Section 179 maximum expensing deduction increased to $1M • Limit will be reduced if total assets placed in service exceed $2.5M dollar for dollar • Qualified property is expanded to include “Qualified Real Property” which includes improvements to non-residential real property after the date the property was first placed in service • This is a permanent increase • Section 179 is an asset by asset election

  9. Luxury Autos • Current law: luxury autos are subject to limitations under IRC 280F resulting in lengthening the period necessary to recover the cost of the property • New limits (without bonus depreciation) for luxury automobiles are essentially tripled - new limitations: • Year 1:                  $10,000 ($18,000 cap w/bonus depreciation) • Year 2:                  $16,000 • Year 3:                  $ 9,600 • Year 4 and future: $ 5,760 • Luxury auto continues to not include vehicles with a Gross weight over 6,000 lbs

  10. Domestic Production Activities Deduction • The DPAD: • Provided an effective tax rate reduction of 3% on domestic production activity has been repealed • The repeal is effective beginning in 2018

  11. Example 1: C Corporation • Assumptions: • $1,500,000 Taxable income before depreciation and Domestic Production Activity Deduction • $1,000,000 Capital Expenditure investment • 100% of income is qualified production income • New interest deduction limitation not applicable • Taxpayer not subject to AMT before repeal • De minims M&E expenses

  12. Example 1: C Corporation

  13. Methods of Accounting • The new legislation increases the average annual gross receipts limitation to $25M and will be adjusted for inflation • Cash Method • Inventory • IRC Section 263A • Long Term Contracts

  14. Business Interest Expense Limitation • Taxpayers with gross receipts in excess of $25M face possible limitations with regard to interest expense deductions • Interest in excess of 30% of Adjusted Taxable income will not be deductible • Amounts disallowed may be carried forward indefinitely • Applies to Net Interest Expense (i.e., Interest Expense – Interest Income) • Adjusted Taxable Income is: • Taxable Income before NOL + Interest + Taxes + Depreciation + Amortization through 2021 (EBITDA) • Beginning in 2022, the limit is based on Taxable Income before NOL + Taxes + Interest (EBIT)

  15. Business Interest Expense Limitation • Real estate businesses can elect NOT to apply the limitation. • Businesses making this election would be required to use the alternative depreciation system (ADS) to depreciate certain property. • For an electing real estate business, ADS would be used to depreciate • nonresidential real property, • residential rental property, and • qualified improvement property

  16. Example 2: Interest Deduction Limitation

  17. Net Operating Losses (NOLs) • Net operating losses arising in tax years beginningafter 2017 will be limited to 80% of taxable income • NOL’s arising in years ending after December 31, 2017 will no longer be available to carryback two years • IMPACT: An NOL arising in the 2017/2018 fiscal-year may not be carried back two years since it arose in a tax year ending after 2017 • The same NOL is not subject to the 80 percent of taxable income limitation because the NOL did not arise in a tax year beginning after 2017

  18. Meal Expense • Meals continue to be subject to the 50% limitation • The 50% limitation will also apply to certain meals provided by an employer that were previously 100% deductible; most significantly, food and beverages provided to employees as de minimis fringe benefits

  19. Entertainment Expense • Entertainment expense: • Even if there is a substantial and bona fide business discussion, entertainment expenses are no longer deductible • No deduction for: • An activity considered entertainment, amusement, or recreation • Membership dues for any club organized for business, pleasure, recreation, or other social purposes • A facility or portion of a facility used in connection with any of the above • EXCEPTION: Entertainment expenses incurred by a taxpayer which are directly related to business meetings of his employees, stockholders, agents, or directors, are still a permissible deduction

  20. Example 3: 2017 Versus 2019 Comparison Assumptions • Book income before depreciation • Interest Expense • Capital Expenditures • Entertainment expense • Meals expense • NOL C/F, from previous year • Taxpayer not subject to AMT prior to repeal • $1,000,000 • 1,000,000 • 1,000,000 • 250,000 • 200,000 • 1,500,000

  21. Example 3: 2017 Versus 2019 Comparison

  22. Example 3: 2017 Versus 2019 Comparison

  23. Example 3: 2017 Versus 2019 Comparison

  24. Other Provisions • Repeal of Partnership Technical termination rules • Carried Interest or Re-characterization of Certain Gains • Change in Character - Self Created Asset

  25. International Provisions • New Penalties • Form 5472s now subject to $25,000 failure to file penalty • No change to penalties on 5471, 8858, 8865 etc. • US Participation Exemption for C Corporations • A C Corporation receiving a dividend from a foreign subsidiary where they own at least 10% of the voting stock for 365 days in a 731 day period will no longer pay tax on such dividend • Previously such dividends would be taxed at the applicable corporate income tax rate

  26. International Provisions • Mandatory Repatriation • As a transition to the Participation Exemption, a mandatory inclusion of accumulated earnings and profits is required and will be taxed at 15.5% to the extent attributable to liquid assets and 8% attributable to other assets • This is often times referred to as the “toll charge” THIS TAX IS CALCUATED BASED ON 2017 NUMBERS AND IS DUE WITH THE 2017 TAX LIABILITY

  27. International Provisions • Mandatory Repatriation • An election may be made to pay the transition tax in eight annual installments; triggering events included in legislation could accelerate installment payments • Special rule applies to S Corporations allow deferral of transition tax payment until a triggering event occurs • Foreign tax credits will be available to offset a portion of the transition tax due by C Corporations • Tax is considered a new Subpart F category and is expected to be calculated on Form 5471

  28. International Provisions • Base Erosion Anti-Abuse Tax (BEAT) • Applies to domestic C Corporations that are part of a group with at least $500M of gross receipts • Must apply controlled group rules • Subsidiary of foreign parent company is most likely a member of a controlled group with the parent company and therefore must count the gross receipts of the parent company as well as other subsidiaries owned by the parent

  29. International Provisions • BEAT • Almost all payments except purchased of inventory will be considered BEAT • If such payments are 3% or more of total deductions, the BEAT tax may apply • Additional information regarding base erosion payments expected to be added to Form 5472 for specific reporting • IMPACT: We need to make sure we fully understand the corporate structure of our multinational groups.

  30. International Provisions - FDII • Foreign Derived Intangible Income (FDII) - Overview • New IRC §250(a) allows a domestic C corporation to deduct an amount which is the lesser of 1. The sum of 37.5% of its foreign derived intangible income plus 50% of its GILTI that is not included in its gross income, OR 2. Its taxable income • Deduction will be allowed equal to 37.5% of it’s “FDII” through 2025, when the deduction decreases to 21.875% • Results in an effective tax rate of 13.125% through 2025 and 16.406% thereafter

  31. FDII • Framework • Only available to domestic C Corporations — NOT Applicable to S Corp, Partnership, Estate, trust etc. • Deduction Eligible Income • The gross income of a US C Corporation excluding: Subpart F, GILTI, financial services income, dividends received from a CFC, foreign branch income, and domestic oil and gas income

  32. FDII • Observations • Foreign-derived intangible income is somewhat misleading • The application of the provision does not turn on the presence or absence of intangible property • Based on the definitions and calculations, it seems any US Corporation that engages in transactions with foreign persons/entities can potentially earn FDII

  33. International Provisions - GILTI • Global Intangible Low-Taxed Income • A US shareholder of a controlled foreign corporation is required to include its global intangible low-taxed income (GILTI) in gross income for the tax year in a manner similar to Subpart F inclusions • Effect is to subject a US shareholder to tax on the combined net income of its CFCs that: • Is not otherwise taxed in the US on a current basis • Exceeds a fixed “routine return” on the CFC’s associated business assets • A 50% deduction (37.5% after 2025) is allowed for C Corporations, so the effective tax rate is 10.5% (13.125% after 2025)

  34. International Provisions - GILTI • Observations • Additional clarification guidance expected • Foreign tax credit computations are more cumbersome and require more tracking than regular Subpart F • It appears taxes paid or accrued by CFCs with tested losses are lost and cannot be used to offset tax owed on GILTI inclusion -- don’t forget, no carryforward for disallowed credits is provided • INTANGIBLE INCOME IS NOT THE TRADITIONAL DEFINITION – IT IS POSSIBLE FOR ANY CFC TO HAVE RISK OF THIS INCOME

  35. International Provisions - GILTI • Observations • Expense allocation will likely result in FTC limitation, therefore a residual US tax may be owed even with a foreign effective rate of 13.125% • Seems as though a foreign effective tax rate of 14.125% will be needed for this not to apply • CAUTION: DON’T FORGET ABOUT DOWNWARD ATTRIBUTION RULES NOW. A 10% US SHAREHOLDER WHO PREVIOUSLY DID NOT HAVE TO WORRY ABOUT SUBPART F BECAUSE THE FOREIGN SUBSIDIARY WAS NOT OWNED GREATER THAN 50% BY US SHAREHOLDERS COULD HAVE AN ISSUE.

  36. Individual Provisions

  37. Most of these changes expire in 2025

  38. Pass-Through Tax Treatment • Beginning in 2018, a 20% deduction will apply to a taxpayer’s Qualified Business Income (QBI) • QBI is domestic business income • QBI does not include: interest, dividends (exception for REITs), short/long term capital gains/losses, commodities gain, foreign currency gains • The deduction applies to pass-through entities which includes: Sole proprietorships; partnerships; S Corporations; LLC’s; trusts and estates; REITs; qualified cooperatives; tiered pass-through entities

  39. Pass-Through Tax Treatment • Deduction is limited to the lesser of: • 20% of QBI, or • The greater of: • 50% of W-2 wages paid with respect to qualified business; or • Sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of all qualified property PLUS • 20% of qualified REIT dividends • Qualified publicly traded partnership income

  40. Pass-Through Tax Treatment • Must be a qualified business to take the deduction • Specified service companies will not qualify unless taxpayers taxable income does not exceed $315K (married filing joint), or $157,500 for single filers • Specified service company includes services in the fields of: • Health, law, accounting, actuarial sciences, consulting, financial services, brokerage services • Engineering and architecture are specifically excluded from being classified as a specified service company Some ambiguity in the law, additional clarification expected

  41. Pass-Through Tax Treatment • The pass-through deduction is not a deduction in arriving at adjusted gross income. • IMPACT: it is unlikely you will receive the deduction for purposes of calculating your state tax liability • All qualified pass-through activities must be aggregated when calculating the deduction • IMPACT: losses from one entity will offset income from another entity (if both have qualified business income) when calculating the deduction

  42. Pass-Through Tax Treatment • The pass-through deduction is not included in computation of Net Operating Loss • SE Taxes appear to be calculated on the full net business income before QBI deduction

  43. Example 4: Pass-through Deduction • Assumptions: • Entity is owned 100% by taxpayer • Taxpayer is non-passive • Pass-through income $1,000,000 • Pass-through deduction $200,000 • Wages from pass-through $250,000 • Taxpayer is married filing joint • Taxpayer will take the standard deduction

  44. Example 4: Pass-through Deduction

  45. Excess Business Losses • Under IRC Section 461(l) – Excess business losses of non-corporate taxpayers not allowed for 2018 thru 2025 • Any loss that is disallowed is treated as an NOL carryover to the following year • Applied at the partner/shareholder level based on distributable share of items of income, gain, loss, or deduction • Passive activity limitations are applied first • What is an excess business loss? • The taxpayer’s aggregate deductions for the tax year from the taxpayer’s trades or businesses; over • The aggregate gross income or gain from such trades or businesses + $250,000 ($500,000 MFJ)

  46. Example 5: Excess Business Losses • Assumptions: • Taxpayer is single • Taxpayer is a non-passive owner of a retail business • Taxpayer’s share of gross income $1,000,000 • Taxpayer’s share of deductions $1,400,000

  47. Example 5: Excess Business Losses

  48. Above the Line Deductions • Alimony: • Currently deductible by payer, includable in income of recipient • Agreements entered into after 12/31/18 no longer deductible by payer or taxed to recipient • Qualified Moving Expenses: • Employers may reimburse on a tax-free basis by excluding them from gross income • Employees may take an above the line deduction to the extent that they are not paid for by the employer

  49. Itemized Deductions • Increase the standard deduction: • From: $6,500 (single) and $13,000 (MFJ) • To: $12,000 (single) and $24,000 (MFJ) • Personal exemption are eliminated ($4,150 for each exemption)

  50. Itemized Deductions • Deduction for medical expenses will be expanded by reducing the floor to 7.5% of income (from 10%) • This change only applies to 2017 and 2018 • State and local taxes limited to $10,000 per year • Charitable Contribution Limitation: • Cash contributions to public and certain private charities are now limited to 60% of AGI (prior 50% limitation)

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