On November 2, 2017, the Tax Cuts and Jobs Act was published by the Chairman of the House Committee on Ways and Means. The bill is the latest effort to enact comprehensive reform of the U.S. tax code for the first time since 1986. However, passage of the bill faces a number of hurdles in moving through Congress, including complex procedural requirements imposed by the budget reconciliation process. Therefore, uncertainty remains as to whether the Tax Cuts and Jobs Act or any similar tax reform will ultimately be enacted.

If enacted, the proposed changes will be effective for taxable years beginning after December 31, 2017, unless otherwise noted below.

The following summarizes the major changes of the legislation that will apply to all taxpayers regardless of industry:

  • Corporate Taxation
    • Rates. Reduces the corporate tax rate to a flat 20 percent rate. Under current law, corporations are subject to a maximum tax rate of 35 percent.
    • Capital Investment. Allows taxpayers to fully and immediately expense 100 percent of the cost of qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023. Under current law, a 50 percent write-off is generally available for new property placed in service before January 1, 2020. In addition, the 100 percent write-off is expanded to certain used property acquired by the taxpayer. Special rules apply to property acquired before September 28, 2017 and placed in service after September 27, 2017.
    • Interest Deductions. With certain exceptions, limits the deduction in any taxable year for business interest to the sum of (i) business interest income for that year, plus (ii) 30 percent of the adjusted taxable income for the year. For this purpose, “business interest” is interest paid or accrued on indebtedness properly allocable to a trade or business. “Business interest income” is interest income properly allocable to a trade or business. “Adjusted taxable income” is a taxpayer’s taxable income, computed without regard to, among other items, business interest or business interest income, net operating loss deductions, and deductions for depreciation, amortization or depletion. Any interest disallowed is carried forward to the succeeding five taxable years and, in the case of corporate taxpayers, preserved as a tax attribute in certain asset acquisitions. The limitations on interest deductions contained in the “earnings stripping” rules of present Internal Revenue Code §163(j) are repealed. See “Taxation of U.S. Multinational Entities—Interest Deductions” below for additional rules restricting interest deductions.
    • Alternative Minimum Tax. Repeals the corporate alternative minimum tax (AMT). Also, allows a corporation with AMT credit carryforwards to claim a refund of 50 percent of the remaining credits (to the extent the credits exceed regular tax for the year) in tax years beginning in 2019, 2020 and 2021, and allows a refund of all remaining credits in the tax year beginning in 2022.
    • Net Operating Losses. For net operating losses arising in taxable years beginning after December 31, 2017, no carryback is permitted but losses can be carried forward indefinitely. Loss carryforwards are increased each year by an interest factor but are permitted to offset only 90 percent of taxable income for the year (computed without regard to the carryover). With respect to net operating losses arising in years beginning before January 1, 2018, current law carryback and carryforward rules would apply, but those losses, to the extent carried forward to taxable years beginning after December 31, 2017, would be subject to the 90 percent limitation and would not be entitled to the interest factor increase.
    • Like-Kind Exchanges. Allows tax-deferred like-kind exchange treatment only for real property used in a trade or business or for investment, eliminating like-kind exchange treatment for other property such as automobiles and art, for example. The new limitation would generally apply to exchanges completed after December 31, 2017, unless property part of a like-kind exchange was either disposed of or received on or before that date.
    • Capital Contributions. Gross income of a corporation includes any contribution to its capital in excess of the value of stock received. Under current law, contributions to the capital of a corporation (including transfers of money or property to the corporation by a nonshareholder, such as a government entity) are tax free to the corporation. The bill also applies to a contribution to an entity other than a corporation. These changes are intended to impose a tax on certain state and local incentives and concessions.
    • Tax Credits. Repeals rehabilitation tax credits, the new markets tax credits and the ability of taxpayers to deduct certain unused business credits. Certain other business tax credits (including in the energy sector) have been changed.
    • Compensation Deductions. Expands the limitation on deductions for compensation in excess of $1 million in any year to compensation (in any form) paid to any proxy officer. In addition, once an employee is a proxy officer, the employee continues to be treated as such even if that status changes.
    • Entertainment Expenses. Broadens the limitation on the deductibility of expenses relating to entertainment, amusement, recreation activities and certain other similar expenses.
  • Partnership Taxation
    • Rates. Reduces the rate for certain business income distributed by pass-through entities (e.g., sole proprietorships, partnerships, limited liability companies and S corporations) to owners or shareholders to a maximum tax rate of 25 percent, instead of ordinary individual income tax rates. Generally, passive investors in pass-through entities are subject to a lower effective tax rate than active investors: 100 percent of income from passive business activities (defined by reference to existing passive activity rules) qualifies for the reduced rate while generally only 30 percent of income from active business activities qualifies. The bill also includes anti-abuse rules designed to prevent taxpayers from turning what would otherwise be wage income (taxed at up to 39.6 percent) into business income taxed at the lower rate. Income from personal service businesses (e.g., accountants, lawyers, consultants and financial service providers) is not entitled to the reduced rate.
    • Self-Employment Tax. Repeals exclusions from self-employment tax for rental income and a limited partner’s distributive share of a limited partnership’s income.
    • Interest Deductions. With certain exceptions, limits the deduction in any taxable year for business interest to the sum of (i) business interest income for that year, plus (ii) 30 percent of the adjusted taxable income for the year. See “Corporate Taxation—Interest Deductions” above. In the case of partnerships, this limitation applies at the entity level. Any interest disallowed is carried forward to the succeeding five taxable years. See “Taxation of U.S. Multinational Entities—Interest Deductions” below for additional rules restricting interest deductions.
    • Technical Terminations. Repeals the technical termination rule, thereby treating a partnership as continuing even if more than 50 percent of the total capital and profits interests of the partnership are sold or exchanged New elections are not required or permitted.
  • Taxation of U.S. Multinational Entities
    • Modified Territorial System. Implements dramatic changes to the taxation of foreign income earned by U.S. businesses by adopting a modified territorial system of taxation, the most important features of which are summarized below. Should these provisions become law, U.S. multinationals will need to examine their foreign holdings to determine the extent to which reorganization of them will maximize their benefits from these new rules.
      • Participation Exemption System. Replaces the current-law system of generally taxing U.S. corporations on distributions of earnings from their foreign subsidiaries with a dividend-exemption system. Under the proposed exemption system, 100 percent of the foreign-source portion of dividends paid by a foreign corporation to a U.S. corporate shareholder that owns 10 percent or more of the foreign corporation are exempt from U.S. taxation. No foreign tax credit or deduction is allowed for any foreign taxes (including withholding taxes) paid or accrued with respect to any exempt dividend, and no deductions for expenses properly allocable to an exempt dividend (or stock that gives rise to exempt dividends) are taken into account for purposes of determining the U.S. corporate shareholder’s foreign-source income.
      • Repatriation of Prior Deferred Income. Ensures that the adoption of the participation exemption system does not allow foreign corporations’ previously untaxed deferred earnings (estimated to be approximately $2 trillion) to escape U.S. tax entirely by requiring a U.S. shareholder (as defined in the subpart F rules) to include as subpart F income, in its last taxable year beginning before January 1, 2018, its share of the foreign corporation’s earnings that have not been previously subject to U.S. tax. The earnings are classified either as cash or cash equivalents (including net accounts receivable) taxed at a rate of 12 percent or as earnings reinvested in the corporation’s business (e.g., in property, plant, and equipment) taxed at a rate of five percent. The mandatory inclusion of untaxed deferred earnings applies to all U.S. shareholders even though only 10 percent corporate shareholders benefit from the participation exemption. A U.S. shareholder may elect to pay the tax liability in equal installments over a period of up to eight years without an interest charge. Each shareholder of an S corporation that is a U.S. shareholder may elect to defer payment of its tax liability without an interest charge until a triggering event occurs, such as a disposition of shares of the S corporation.
      • Expansion of Subpart F Rules. Retains with modifications the subpart F regime for taxation of a controlled foreign corporation (CFC). To deal with the outbound shifting of income from intangible property to a CFC, a U.S. shareholder is subject to current U.S. tax on 50 percent of its share of foreign high returns. Foreign high returns are measured as the excess of the U.S. shareholder’s share of its CFC’s net income over a routine return (seven percent plus the federal short-term rate) on the CFC’s aggregate adjusted bases in depreciable tangible property, adjusted downward for interest expense. Foreign high returns do not include income effectively connected with a U.S. trade or business, subpart F income, insurance and financing income that meets the requirements for the active finance exemption from subpart F income, income from the disposition of commodities produced or extracted by the taxpayer, or certain related-party payments. As with other subpart F income, the U.S. shareholder is taxed on foreign high return earnings each year, regardless of whether it left those earnings offshore or repatriated the earnings to the United States.
      • Additional Subpart F Changes. Among other changes, exempts a U.S. corporate shareholder of a CFC from tax on a CFC’s investments in U.S. property and modifies the deemed paid credit so that it applies on a current year basis only.
  • Interest Deductions. Limits the deductible net interest expense of a U.S. corporation that is a member of an international financial reporting group (IFRG) to the extent the U.S. corporation’s share of the group’s global net interest expense exceeds 110 percent of the U.S. corporation’s share of the group’s global EBITDA. Any disallowed interest expense would be carried forward for up to five taxable years. For this purpose, an IFRG includes a group of entities that has at least one domestic corporation and a foreign corporation, prepares consolidated financial statements and has annual global gross receipts of more than $100 million.
  • New Excise Tax. Imposes an excise tax (at the highest corporate rate) on certain payments made by domestic corporations to certain foreign corporations where the domestic corporation payor and the foreign corporation payee are part of the same IFRG. The tax is generally imposed on payments from a domestic corporation (i) that are deductible or includible by the U.S. payor in costs of goods sold, inventory or the basis of a depreciable or amortizable asset and (ii) that the foreign corporation payee does not treat (or elect to treat) as effectively connected with a U.S. trade or business. For this purpose, an IFRG is generally any group of entities that prepares consolidated financial statements and has annual payments subject to the excise tax that meet certain thresholds. Payments to or from a partnership which is a member of an IFRG are treated as paid or received by the partners of that partnership.
  • Inventory Income Sourcing. Allocates and apportions income from the sale of inventory property produced within and sold outside of the U.S. (or vice versa) between sources within and outside of the U.S. solely on the basis of the production activities with respect to the inventory. This will likely reduce the amount of foreign source income realized by taxpayers exporting goods produced in the U.S. and, therefore, reduce their ability to utilize foreign tax credits.
  • Individual Taxation
    • Rates. Consolidates the seven existing tax brackets down to four: 12 percent, 25 percent, 35 percent and 39.6 percent. For joint returns, the thresholds generally are as follows: $90,000 for the 25 percent bracket; $260,000 for the 35 percent bracket; and $1 million for the 39.6 percent bracket.
    • Standard Deduction. Increases the standard deduction for joint filers to $24,000, up from the current deduction of $12,700.
    • Itemized Deductions. Proposes the following changes with respect to itemized deductions of individuals.
      • Repeals the overall limitation on itemized deductions.
      • Repeals the deduction for state and local income taxes unless paid or accrued in a trade or business.
      • Limits the deduction for domestic real property taxes to $10,000. The deduction for non-business foreign real property taxes is eliminated.
      • For primary residences purchased after November 2, 2017, interest on loans up to $500,000 is deductible, down from the current limit of $1 million. The deduction for interest on loans for second homes is eliminated.
      • Increases the limitation on deduction for charitable contributions to 60 percent of the taxpayer’s contribution base, up from the current overall 50 percent limitation.
      • Repeals other itemized deductions, such as those for certain medical expenses, alimony payments and moving expenses.
  • Home Sale Gain Exclusion. Requires that, in order to exclude from taxable income up to $500,000 for joint filers ($250,000 for other filers) of gain from a sale of a primary residence, taxpayers must have owned and lived in the residence for at least five of the last eight years. Under current law, the residency requirement is only two of the last five years. Also, limits the use of the exclusion to only once every five years. The exclusion is phased out on a dollar-for-dollar basis for every dollar by which a taxpayer’s adjusted gross income exceeds $500,000 ($250,000 for single filers). The provision would be effective for sales after 2017.
  • Alternative Minimum Tax. Eliminates the individual AMT. Certain AMT credit carryforwards may be refunded beginning in 2019 to varying extents.
  • Tax Credits. Expands the child tax credit to cover dependents, increases the amount from $1,000 to $1,600, and increases the phase-out threshold (from $115,000 to $230,000 for married filers). Certain other nonrefundable tax credits are repealed.
  • Estate Tax. Increases the estate tax exemption to $10 million, up from the current $5 million limit, and repeals the tax entirely for tax years beginning after December 31, 2023.

Some of the proposed changes described above, as well as other aspects of the Tax Cuts and Jobs Act, will have particular effect on certain industries. For a summary of provisions affecting REITs, please click here. For a summary of provisions affecting the insurance industry, please click here. We expect to publish summaries of provisions affecting compensation (which include significant changes to the taxation of deferred compensation, stock options and stock appreciation rights) and energy-related credits.