At two o’clock in the morning on Saturday December 2, 2017, the Senate took another major step towards accomplishing comprehensive tax reform – on a near party line vote, it passed its version of the most sweeping legislation to overhaul the US Tax Code in a generation. Although Republicans have made significant progress on tax reform – at lightning speed – they still have more work to do before the bill becomes law. This week, House and Senate leaders are expected to begin the process of conferencing their respective versions of the bill. In particular, they will have to reconcile differences between the two Chambers, including the phase-in of the corporate rate, pass-through rates, Byrd-rule compliance, repeal of the Obamacare individual mandate and the mortgage interest deduction (to name a few). With hopes of passing the reconciled bill and getting it to the President prior to December 25, 2017, the GOP could be mere weeks away from securing their long-awaited and hard-fought legislative “win.” (NB: Though we are currently predicting a formalized conference process between the two chambers, the possibility remains that the Senate will simply say to the House, “this is the best we can do – take it or leave it.”)

In our previous alerts, available here and here, we have discussed the substance of the House and Senate bills, respectively. Tax-writers have made important changes since those were published, so, in this alert, we take stock of the latest developments. Below we highlight key aspects of the Senate-passed bill, starting with a brief overview of some domestic provisions, followed by more detailed points applicable to multinationals.

DOMESTIC PROVISIONS

Businesses

  • Corporate Tax Rate and Incentives
    • For tax years beginning after 2018, reduces the corporate tax rate to 20%
  • Net Operating Losses
    • Repeals rules allowing carryback of NOLs (other than for farming), but allows indefinite carryforward of post-2017 NOLs
    • Limits the NOL deduction to 90% of taxable income (and to 80% for tax years beginning after 2022)
  • Section 179 Expensing
    • Allows section 179 expensing for up to $1 million of section 179 assets placed in service during the year with a phase-out if more than $2 million of section 179 assets are placed in service and makes other changes benefiting small businesses, including:
      • Expands types of property eligible for section 179 expensing
      • Modifies the gross receipts test for use of cash accounting
      • Modifies uniform capitalization rules
      • Modifies the gross receipts test for construction contract accounting exceptions
    • Immediate Expensing
      • Allows all businesses to expense (deduct when placed in service) a specified percentage of the cost of certain assets:
        • 100% if placed in service after September 27, 2017 and before 2023
        • 80% if placed in service in 2023 (100% for assets with longer production periods)
        • 60% if placed in service in 2024 (80% for assets with longer production periods)
        • 40% if placed in service in 2025 (60% for assets with longer production periods)
        • 20% if placed in service in 2026 (40% for assets with longer production periods)
        • 20% for assets with longer production periods placed in service in 2027
      • Balance is recovered under general cost recovery rules applicable to the property; provision applies to same assets as current law “bonus depreciation” and to qualified film or television production and live theater production expenses
    • Deductions
      • Limits the net interest deduction to the sum of business interest income and 30% of “adjusted taxable income,” but allows indefinite carryforward of the denied interest deductions
      • Repeals corporate deduction for income attributable to domestic production activity
      • Reduces dividend received deduction percentages
      • Eliminates deductions for entertainment expenses; qualified transportation fringes; certain employer paid transportation expenses; local lobbying expenses; meals provided for the convenience of the employer; and cash, gift cards, gift coupons, vacations, meals, lodging, and tickets to theater and sports events provided as employee achievement awards
      • Limits the deduction for meal expenses to 50% in all cases
    • Cost Recovery Period
      • Sets the cost recovery period for nonresidential real and residential rental property at 25 years, reduces the alternative depreciation life for residential real property to 30 years and creates a class of property called “qualified improvement property” that has 10-year general recovery period and a 20-year alternative depreciation system recovery period
    • Like Kind Exchanges
      • Repeals favorable treatment of like kind exchanges for all property other than real property
    • Recognition of Income
      • Affects timing or recognition of income by requiring accrual basis taxpayers to include:
        • Amounts in income no later than the year in which it is included in income in certain financial statements that a taxpayer may prepare
        • Certain advance payments in income not later than the taxable year following the year in which they are received
      • Tax Credits
        • Spreads the 20% rehabilitation credit over five years beginning with the year the rehabilitation is placed in service (rather than all in the year “placed in service” or in some cases when the rehabilitation expenditures were incurred) and limits the credit to qualified historic structures
        • Adds an employer credit for paid family and medical leave
      • Executive Compensation
        • Eliminates deductions for compensation in excess of $1 million for public companies and introduces a companion excise tax on such compensation for tax-exempt employers
        • Reduces current and long-established fringe benefits
      • Other Changes
        • Unlike the House bill and the bill approved by the Senate Finance Committee, no repeal of the corporate and individual minimum taxes
        • Leaves most business credits untouched, although the last minute restoration of the AMT will affect the use of some credits compared to the earlier planned AMT repeal

Flow Thru Entities

  • Flow Thru Rate
    • Allows individual owners of pass-through businesses to deduct 23% of their qualified business income, subject to a variety of limitations, such as:
      • Qualified business income is limited to 50% of W-2 wages, subject to exceptions for low-income taxpayers
      • Qualified business income does not include reasonable compensation or “guaranteed payments”
      • Qualified business income does not include income from trades or businesses involving the performance of services unless the taxpayer’s taxable income is less than $300,000 ($600,000 on a joint return)
    • Capital Gains
      • Increases the long-term capital gain holding period to three years for capital gains with respect to partnership interests held in connection with the performance of services, but does not otherwise address “carried interests”

Tax-Exempt Bonds

  • Refunding Bonds – Eliminates tax-exempt advance refunding bonds but, as the Senate Finance Committee did in its earlier draft but unlike the House bill, leaves untouched tax-exempt qualified private activity bonds, the use of tax-exempt bonds to finance professional sports stadia, and tax credit bonds; the reintroduction of the AMT with some changes from existing law will affect some bond holders; for more in-depth analysis, visit our Public Finance Tax Blog here.

Individuals

  • Estate Tax
    • For 10 years, doubles the estate and gift tax lifetime exemption from $5M to $10M
  • State and Local Tax Deduction
    • Preserves $10,000 property tax deduction like the House bill – note, there is no change to the treatment of state and local taxes for corporations
  • Mortgage Interest Deduction
    • Unlike the House bill, leaves the upper limit of $1M unchanged; eliminates home equity line interest deductions

INTERNATIONAL PROVISIONS

  • Territorial System
    • Exempts most foreign dividends from US tax
      • Not applicable to PFICs or to hybrid payments
      • Not applicable to certain lower-taxed income from offshore intangibles
        • “Global intangible low-taxed income” or “GILTI” is subject to current tax in the US as it is earned
        • Although the tax is ostensibly aimed at low-taxed offshore intangibles income, it is generally calculated as the excess over a specified rate of return on tangible assets and thus may have a broader reach than just income from intangible assets
        • Negative impact offset by:
          • Increased tax deductions for US companies that exploit intangibles outside the US
          • Incentivizes the “onshoring” of intangibles from foreign subsidiaries by deeming the fair market value of such intangibles to be equal to the US tax basis resulting in no current US tax cost
        • Disallows deduction of certain related-party payments to hybrid entities
        • Significant changes to the foreign tax credit and Subpart F regimes
      • Transition Tax
        • Imposes one-time, current tax on all offshore earnings
        • Effective rates on foreign sourced earnings repatriated from most 10% owned foreign subsidiaries are:
          • Cash and other liquid offshore earnings at 14.5%
          • Illiquid earnings at 7.5%
        • Taxpayers can elect to pay this tax over eight years, with the portion of tax payable ramping up over that period
      • Strong limits on US tax base erosion, including:
        • Expanded section 163(j) limits on interest deductions and a new limit for US companies that are part of a global group and have disproportionately large indebtedness as compared to the global group
        • US tax on certain “base erosion payments” made by US companies to foreign related parties where the US company receives a deduction or other tax benefit with respect to the payment; importantly, such payments that are reflected in cost of goods sold are generally not taxed except in the case of certain global groups that have engaged in an inversion transaction
        • Preferential capital gains rate treatment for dividends from inverted companies is eliminated
        • Harsher tax treatment on outbound transfers of intangible property

What Is Next

So here we are with tax bills passed in the House and Senate, a President (and an entire party) eager for a win and all the momentum driving Republicans toward delivering on a signature legislative achievement. That said, important differences remain between the two bills, as we mentioned earlier. The conference committee will have to work diligently to find agreement while maintaining the necessary number of votes. And let us not forget the Senate’s 51-49 vote in which Sen. Bob Corker (R-TN) voted against the bill along with every Democrat. Stating the obvious, the margin for error is razor thin. What is more, the winner of Alabama’s special Senate election is adding even more pressure to move quickly. If elected and seated before the Senate votes on the conferenced bill, Republican candidate Roy Moore would be a major wild card after he has openly and repeatedly antagonized GOP leadership. What has worked so far for the GOP is moving at a dizzying pace – it will be important to see if they can keep it up in the home stretch. On the other side of the Capitol, House vote-counters cannot afford to lose 10 votes off of the 227 Republicans who voted for their version of the bill last month. House GOP leadership, however, appears confident that they can maintain their unified front, overcome differences between the two Chambers and have the President sign the bill before year’s end. Stay tuned for a flurry of activity over the coming weeks.