The New Federal Tax Law: Business Provisions · income tax). • Corporate ... for joint filers),...

The New Federal Tax Law:Business Provisions

February 15, 2018

Tim GoodmanDorsey & Whitney(612) [email protected]

Adam SchurleStoel Rives(612) [email protected] Emily Chad

Fredrikson & Byron(612) [email protected]

Overview

• Provisions impacting businesses– Choice of entity impacts of new legislation– Other business changes– International changes– Benefits and compensation issues

2

3

Overview of Business Topics

• Corporate tax rate• Pass-through deduction • Depreciation (expensing)• Business interest deduction and NOLs• Accounting provisions• Partnership provisions• Business credits• Benefits and compensation provisions• International provisions

Effective Dates

• Act is generally effective for tax years beginning in 2018• Certain changes take effect in 2017, including deemed

repatriation of foreign income• Most corporate provisions are permanent • Many provisions, including Section 199A, expire after

2025

4

Roster of Entity Types

• C corporations– Corporate level income tax– Tax on dividend distributions (to the extent of earnings)

• S corporations– Income and loss passed through to shareholders– Limitations on eligible shareholders

• Partnerships (and LLCs taxed as partnerships)– Income and loss passed through to partners– Special allocations available

• Sole proprietorship

Tax Rate Changes

• Corporate tax rate is a flat 21%– Permanent change from graduated rates of 15-35%.

• Individual tax rates generally graduated 10-37%– For taxable years beginning before 2026.– Highest rate down from 39.6%.

• Dividends distributed to non-corporate shareholders– Taxed at top rate of 23.8% (including 3.8% net investment

income tax).

• Corporate alternative minimum tax (AMT) repealed

6

Prior conventional wisdom: preference for pass-through entities

• Example: $100 of net income; individual owner– Pass-through: 39.6% rate

• $39.60 owner-level tax• $60.40 after-tax proceeds

– C Corporation: 50.47% effective rate• $35.00 corporate level tax • $15.47 dividend tax on owner (23.8% of $65.00 after-

tax dividend from corporation)• $49.53 after-tax proceeds

• Difference: 11% better off with pass-through– Note: Foregoing considers federal rates only

7

Impact of rate changes

• Example: $100 of net income; individual owner– Pass-through: 37% rate

• $37.00 owner-level tax• $63.00 after-tax proceeds



• Difference: 2.8% better off with pass-through• Note: Foregoing considers federal rates only


• Before– Individual rate of 39.6% vs. effective corporate rate of 50.47%– Roughly 11% difference

• Now– Individual rate of 37% vs. effective corporate rate of 39.8%– 2.8% difference

9


• Planning considerations– New entities– Existing entities– Accumulate income in C corp?

• No one-size-fits-all

10

What about new deduction for pass-through income?

• New Code section 199A• Up to 20% deduction for individuals, trusts and

estates on “qualified business income” from pass-through entities

• Applies to income from S corporations, partnerships and sole proprietorships– Applies even if owner does not itemize– Special provisions for cooperatives

Section 199A

• Note that deduction reduces taxable income –this is not a rate reduction as originally proposed by House of Representatives

• Tremendous complexity!– Regulations will flesh out rules, and that means more

complexity to come

• Scheduled to expire for tax years after 2025

Effective rates: pass-through deduction

• Example: $100 of net income; individual owner– Pass-through: 29.6% effective rate

• $80.00 taxable income to owner after deduction• $29.60 individual level tax (37% of $80.00) • $70.40 after-tax proceeds



• Difference: 10% better off with pass-through– Note: Foregoing considers federal rates only

Effective rates: pass-through deduction

• No pass-through deduction: Individual rate of 37% vs. effective corporate rate of 39.8%– 2.8% difference

• Pass-through deduction applies in full: Effective individual rate of 29.6% vs. effective corporate rate of 39.8%– 10.2% difference

14

Section 199A

• Preliminary considerations– How does the taxpayer hold the trade or business?

• Partnership, S corp, sole proprietorship, C corp– What type of business is it?– Is it a trade or business at all?– Reputation or skill of taxpayer as primary asset?– What is the taxpayer’s income or projected income from the

trade or business?

15

Section 199A

• “Qualified business income”– Means income from a qualified trade or business, less

deductions and losses attributable to the trade or business– Includes: rents, royalties and gain from sale of inventory if

earned in a qualified trade or business– Does not include:

• Capital gains or losses• Dividends• Interest and certain other investment income

16

Section 199A

• Not qualified business income:– Reasonable compensation

• Historically, S corps required to pay reasonable compensation to shareholder/employees

• Employment taxes– Guaranteed payments from a partnership

• Payments to a partner without regard to the partnership’s income

– Payments to a partner not acting in his or her partner capacity

17

Section 199A: exceptions & limitations

• Deduction generally limited to greater of:– 50% of W-2 wages with respect to business OR– sum of 25% of W-2 wages with respect to or business,

plus 2.5% of unadjusted (i.e., before depreciation) tax basis of qualified property of business

• Also generally not available to specified service trade or business (SSTOB)– Health, law, accounting, actuarial science, performing

arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.

– Certain investment services


• Exception from W-2 wage/property basis limitation if individual’s taxable income is less than $157,500 ($315,000 for joint filers)– W-2 wage limitation “phases in” over next $50,000 of taxable

income for individual ($100,000 joint)– Result:

• For non-SSTOB, W-2 wage/property basis limitations apply in full if taxable income from trade or business is more than $207,500 ($415,000 for joint filers)

19


• SSTOB:– If individual’s taxable income is less than $157,500 ($315,000

for joint filers), deduction for SSTOB available– Deduction for SSTOB phases out over next $50,000 of taxable

income for individual ($100,000 joint)– Result: Deduction unavailable if taxable income is more than

$207,500 ($415,000 for joint filers)

20

Section 199A: cheat sheet

Individual taxable income (total) Specified service trade or business

Most other trades or businesses

Less than $157,500 ($315,000 married filing jointly)

Deduction equals 20% of qualified business income

Deduction equals 20% of qualified business income

Greater than $157,500 ($315,000 married filing jointly) but less than $207,500 ($415,000 married filing jointly)

Deduction phased out, also subject to W-2wage/property basis limitations phase in

Deduction equals 20% of qualified business income, but subject to W-2 wage/property basis limitations phase in

Greater than $207,500 ($415,000 married filing jointly)

No deduction Deduction limited to 20% of qualified business income or the greater of (i) 50% of W-2 wages or (ii) 25% of W-2 wages plus 2.5% of unadjusted property basis

21

Section 199A example: W-2/property limits

22

Section 199A example: entity issues

• Example: Taxpayer has $1 million of net income from TOB, and pays independent contractors $100,000. 20% of QBI = $200,000– Sole proprietor: $0 deduction.

• What if employees? – 50% of $100,000 is $50,000, so $50,000 deduction

– S corp: $0.• What if employees?

– 50% of $100,000 is $50,000, so $50,000 deduction– Pay self W-2 wages of $100,000, so $100,000 deduction

– Partnership: $0.– No ability to pay herself wages

23

Section 199A

• Computed for each qualified trade or business• Computed for each taxable year• Losses “carried over”• Partnerships and S corporations

– Applies at partner or shareholder level– Allocable share of each qualified item of income, gain,

deduction and loss– W-2 wage and unadjusted basis

• Allocable share determined in same manner as underlying deductions

24

Section 199A

• Special computation rules for taxpayers with REIT dividends and income from publicly traded partnerships

• Special rules for cooperatives and their patrons

25

Section 199A: questions & coming attractions

• Open issues:– Application to multiple businesses– What is a trade or business?– S corporation vs. partnership issues– Specified service trades or businesses

• IRS has said guidance is in the works– Employees vs. independent contractors– Reasonable compensation

26

Section 199A: questions & coming attractions

• Regulations– General regulations to carry out purpose of Section 199A– Rules for allocation of W-2 wages and unadjusted basis for

partnerships and S corporations– Rules relating to acquisitions, dispositions, of a trade or

business or a major portion thereof– Anti-abuse rules for related party transactions and

computing property basis

• Technical corrections

27

Section 199A: practical considerations

• Practical guidelines for thinking through 199A• Which types of business will it help the most?• Which types of business will not benefit?

– Specified service businesses– Those without significant W-2 wages or property investment

28

461(l) excess business loss disallowance

• “Excess business loss” disallowed• Excess business loss equals

– Taxpayer’s aggregate deductions attributable to trades or businesses OVER

– Taxpayer’s aggregate gross income or gain attributable to those trades or businesses PLUS $250,000 ($500,000 married filing jointly)

29


• Example: Single individual taxpayer has $600,000 deductions from a business, and gross income from the business of $240,000. Excess business loss is $110,000 ($600,000 – ($240,000+$250,000))

• Excess business loss carried forward as NOL

30


• Limits ability of taxpayers to shelter wage, compensation, interest, and non-business income

• Does not apply to C corporations• Determined at partner and S corporation shareholder

levels• Applies to tax years beginning after 12/31/17 and

before 1/1/26

31

Dividends received deduction

• Corporations that receive dividends from other corporations are entitled to a dividends received deduction (DRD) equal to:– 50% (formerly 70%) if taxpayer owns less than 20% of stock

of other corporation;– 65% (formerly 80%) if taxpayer owns at least 20% but less

than 80%;– 100% DRD continues to apply to dividends from 80%-or-

more-owned subsidiaries.

32

What about the exit event?

• Acquirers typically willing to pay more for assets than for stock– Stepped-up basis– Asset sales by C corporations often prohibitively expensive

from tax perspective because to levels of tax: first, to corporation on sale of assets, and second to shareholders on distribution of proceeds

• Tax-free reorganizations– Corporations (C and S) able to engage in tax-free

reorganizations, mergers, and stock-for-stock or asset-for-stock exchanges

What about the exit event: Section 1202 QSB stock

• Provides for exclusion of gain on sale of qualified small business (QSB) stock held more than 5 years – 100% exclusion for stock acquired after September 27,

2010– Exclude up to greater of $10 million or 10x stock basis

• Available only for C corporation stock• Not available for specified services businesses• Numerous other requirements and limitations

Accumulated earnings tax

• 20% tax on “accumulated taxable income” of C corporations if corporation formed or availed of for purpose of avoiding shareholder-level income tax

• Accumulated earnings to the extent amounts not distributed to shareholders in excess of “reasonable needs” of business

• Assessed by IRS on audit

35

Personal holding company tax

• “Incorporated pocketbooks”• 20% tax on undistributed personal holding company

income (dividends, interest, royalties, some rents)• Small group of shareholders own 50%+• Income test – 60% is investment-type income• “Self-assessed” tax – must be calculated and reported

on return• Accumulated earnings tax and personal holding

company tax don’t apply at same time

36

Where does that leave us?

• Practical considerations– Does 199A apply?

• Will the limitations apply?– Do the owners need distributions?– What is the projection for business income?– Other considerations

• Ultimately, unique considerations for every taxpayer

37

Other business provisions

• Repeal of DPAD• Net operating losses• Expensing and depreciation• Business interest deductibility limitations• Partnership provisions• Accounting provisions• Credits

38

Section 199 Domestic Production Activities Deduction Repealed

• Under pre-Act law, taxpayers could claim 9% deduction (6% for oil and gas activities) of taxpayer’s qualified production activities income (or taxable income, if less). Deduction was limited to 50% of W-2 wages paid

• TCJA repeals deduction

39

Net Operating Losses

• Formerly: NOLs carried back 2 years and forward 20• Now: NOLs cannot be carried back, but can be carried

forward indefinitely• NOL deduction is limited to 80% of taxable income• Industry rules: farming and insurance companies

– 2-year carryback applies to farming and insurance (may elect out)

40

Capital Expenses: Increased Section 179 Expensing

• Cost of certain property placed in service during tax year can be expensed instead of recovered through depreciation deductions

• The maximum amount taxpayer can expense in tax year is $1 million (up from $500,000). The $1 million limit is reduced dollar-for-dollar by the amount by which the cost of property exceeds $2.5 million (up from $2 million)

41

Capital Expenses: Temporary Bonus Depreciation

• 100% “full expensing” deduction for cost of property acquired and placed in service after September 27, 2017 and before 2023 – Increase to amounts that were scheduled to apply (50% in 2017,

40% in 2018, and 30% in 2019).

• Phased down 20% per year for property placed in service after 2022– 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.

• Eliminates “original use” requirement

42

Real Property Recovery Period

• Residential and nonresidential real property recovery periods unchanged– 27.5 years for residential– 39 years for nonresidential

• Alternative depreciation system– 30 years for residential (shortened from 40)– 40 years for nonresidential

43

Real Property Recovery Period

• Improvements to interior portion of nonresidential real property building generally depreciable over 15 years using straight-line method and half-year convention, without regard to whether improvements are property subject to a lease, placed in service more than 3 years after building first placed in service, or made to restaurant building

• ADS recovery period for residential rental property shortened from 40 years to 30 years

44

Like-Kind Exchange Treatment Limited

• Section 1031 was amended to allow like-kind exchanges only with respect to real property

• For real property like-kind exchanges – Carefully analyze whether any personal property is included.

45

Limitation on interest deductibility

• Deduction for business interest in any year limited to sum of:– the interest income of the taxpayer allocable to a trade or

business, and– 30% of the “adjusted taxable income” of the taxpayer for the

taxable year.

• Adjusted taxable income means taxable income computed without regard to:– Business interest or business interest income– NOL deduction– IRC § 199A pass-through deduction– For years before 2022, depreciation, amortization and depletion

46


• Real property trades or businesses and cooperatives may elect out– Consequence is that they must use the alternative depreciation

system

• Rules don’t apply to businesses with gross receipts of less than $25 million

• Special rules for “floor plan financing indebtedness”– Car dealers essentially get to fully deduct interest paid on

inventory

• Disallowed interest deductions may be carried forward indefinitely

47


• Limitations applied at partnership/S corp levels• Rules to prevent double counting of income• Rules for excess amounts of unused adjusted taxable

income of entity

48

Partnerships: technical terminations

• Section 708(b)(1)(B) technical termination rules are repealed

• As a result, transfer of 50% or more of interests in partnership capital and profits within 12-month period will no longer terminate partnership, require short-year tax return, or restart deprecation period of partnership property

• Partnership level elections should be preserved

49

Partnerships: “substantial built-in loss”

• When a partnership interest is transferred, existing law provides that adjustments are made to transferee’s “inside” basis in partnership assets if partnership has “substantial built-in loss” – even if no section 754 election is in place. A substantial built-in loss exists if partnership’s adjusted basis in its property exceeds fair market value of the partnership property by more than $250,000

• The TCJA provides substantial built-in loss also exists if transferee would be allocated net loss in excess of $250,000 upon hypothetical disposition by partnership of all partnership assets in fully taxable transaction for cash equal to fair market value

50

Accounting Provisions

• Special provisions applicable to taxpayers with average annual gross receipts of $25M or less (previously $10M or less):– Ability of C corporations to use the cash method of accounting– Simplification of inventory accounting requirements– Exemption from uniform capitalization requirements– Exemption from percentage-of-completion accounting for

construction or improvement of real property

• Codifies existing deferral to end of year following year of payment for advance payments for good and services

51

Accounting Provisions

• Applicable financial statements conformity rule• Requires certain taxpayers to recognize income no

later than tax year in which the income is taken into account on “applicable financial statements”– Only applies to taxpayer with AFS– AFS is any statement certified as being prepared in

accordance with GAAP and which is:• A form 10-K or annual statement to shareholders filed with SEC• Any audited financial statement used for credit purposes,

reporting to shareholders, partners, or other owners, or any other substantial nontax purpose

• Any financial statement filed by the taxpayer with any federal agency

• Certain statements filed with foreign government bodies

52

Business Credits

• Largely preserved• “Orphan drug” credit reduced from 50% of qualified

clinical testing expenses to 25%• 10% rehabilitation credit for pre-1936 buildings repealed

– 20% credit for certified historic structures remains

• New credit for paid FMLA leave provided by employers– Based on wages paid during leave– Credit is equal to 12.5-25% of wages– No credit for wages paid after December 31, 2019

53

Benefits & Compensation

• Retirement plans– Nonqualified plans (Code § 409A)

• What almost was – Proposed freeze and eventual termination of nonqualified

plans (including plans subject to Code § 409A)– Proposed new Code § 409B (requiring substantial risk of

forfeiture to delay inclusion in income)– Significant because may be considered again in future

54


• Retirement plans (continued)– Defined contribution plans

• Loan rules (Act § 13613; Code § 402(c)(3); effective 2018 onward)– Prior to Act: Loan offset amount may be rolled over within 60 days– Act: Loan offset due to default from severance from employment may

be rolled over by individual’s tax filing deadline for year of loan offset– Impact: Relief for participants (extra time to avoid taxation of offset)

• 2016 disaster relief (Act § 11028; Code § 72(t); effective 2018 onward)

– Prior to Act: No special relief for 2016 storms and disasters– Act: Adds qualified 2016 disaster distribution for certain distributions

made in 2016 and 2017» No 10% penalty on early distribution» Taxed pro rata over 3-year period» May recontribute within 3 years» Not mandatory, but amendment could be required if adopted

– Impact: Relief for certain distribution made due to major disasters

55


• Fringe benefits– Mass transit (Act § 13304; Code § 274(a)(4) and § 274(l); effective 2018

onward)• Prior to Act: Employer may deduct qualified transportation fringe

benefits (including transit passes, qualified parking, and qualified bicycle commuting reimbursements)

• Act: – Employers can no longer deduct – Employees may exclude

• Impact: – Employers may change to wages

– Bicycle transit (bicycle commuting) (Act § 11047; Code § 132(f)(8); effective 2018-2025)

• Prior to Act: Employees may exclude qualified bicycle commuting reimbursements

• Act: Employees cannot exclude • Impact:

– Employers can continue to deduct until 2026– Employees will have additional income until 2026

56


• Fringe benefits (continued)– Tax-exempt employers (Act § 13703; Code § 512(a)(7); effective 2018

onward)• Prior to Act: Fringe benefits not considered unrelated business

taxable income (UBTI)• Act: UBTI expanded to include value of qualified transportation

fringe benefits, qualified parking benefits, and on-site athletic facilities (which would not be deductible by taxable employer)

• Impact: Employer may wish to tax benefits or provide taxable compensation and require payment for benefits

– Unreimbursed expenses (Act § 11045; Code § 67; effective 2018-2025)• Prior to Act: Employees who itemized allowed to deduct

unreimbursed trade and business expenses• Act: Employees not allowed to deduct unreimbursed trade and

business expenses • Impact: Employee loss of deduction (independent contractors still

able to take deduction)

57


• Fringe benefits (continued)– Achievement Awards (Act § 13310; Code § 274(j)(3); effective 2018

onward)• Prior to Act: Employers could deduct value of tangible personal

property, but term not defined by statute• Act: Codifies definition of tangible personal property• Impact: Employers to review programs for compliance

– Meals (Act § 13304; Code § 119(a) and § 274(o); effective 2026)• Prior to Act: Employers could deduct and employees exclude

meals provided for convenience of employer • Act: Eventual removes provision• Impact:

– Until 2026, employers can provide meals for their convenience– Employers may also continue to deduct 50% of expenses for food,

beverages, and related facilities that are furnished on its business premises primarily for its employees, such as in typical company cafeteria or executive dining room (Code § 274(e)(1))

58


• Fringe benefits (continued)– Entertainment expenses (Act § 13304; Code § 274(a)(1); effective 2018)

• Prior to Act: – Employers can deduct 50% of certain entertainment expenses

that relate to conduct of employer’s trade or business – Employers can deduct 50% of food and beverage expenses of

employees associated with employer’s trade or business (work travel)

– Employers can deduct 100% of food and beverage expenses that meet de minimis

• Act: – Employers generally cannot deduct entertainment expenses

that relate to conduct of employer’s trade or business – Employers can deduct 50% of food and beverage expenses of

employees associated with employer’s trade or business (work travel)

– Employers can deduct 50% of food and beverage expenses that meet de minimis

59


• Fringe benefits (continued)– Moving expenses (Act § 11048; Code § 132(g) and § 217; effective 2018-

2025)• Prior to Act:

– Employees could exclude from income value of qualified moving expenses received as payment or reimbursement

– Employees could deduct unreimbursed qualified moving expenses• Act:

– Employees cannot exclude from income value of qualified moving expenses received as payment or reimbursement

– Employees cannot deduct unreimbursed qualified moving expenses• Impact:

– Relocation is more expensive

60


• Fringe benefits (continued)– Paid Leave Benefits (Act § 13403; Code § 458; effective 2018 onward)

• Prior to Act: No provision• Act:

– Qualifying leave» Paid leave for purposes under FMLA» If paid leave can be used for other purposes (vacation), then not

qualifying leave» Employer must offer at least 2 weeks (credit not available for more

than 12 weeks)» Excludes leave mandated or paid by state or local government

– Qualifying employees» Employees employed for at least one year» Employees who earn less than 60% of amount under

Code § 414(q)(1)(B) (for 2018, less than $72,000)– Credit provided

» If employer pays 50% of salary, credit of 12.5% of salary» Increased pro rata up credit of 25% of salary

61


• Payroll and federal income tax– New withholding tables and new flat rate withholding

• Payroll and state income tax law (tax conformity)– Different impacts on different states based on state income tax law

• States with no income tax (9 states)– Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas,

Washington, and Wyoming• States which conform to federal law in automatic matter (“rolling

conformity”) (21 states and D.C.)– Alabama, Colorado, Connecticut, Delaware, District of Columbia, Illinois, Kansas,

Louisiana, Maryland, Massachusetts, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, North Carolina, North Dakota, Oklahoma, Rhode Island, and Utah

• States which conform to federal law but must revise state law to confirm (‘Static conformity”) (17 states)

– Arizona, California, Georgia, Hawaii, Idaho, Indiana, Iowa, Kentucky, Maine, Minnesota, Ohio, Oregon, South Carolina, Vermont, Virginia, West Virginia, and Wisconsin

• States with own tax laws (3 states) – Arkansas, New Jersey, and Pennsylvania• http://www.ncsl.org/research/fiscal-policy/federal-tax-reform-and-the-

states.aspx

62


• Section 162(m) – Act § 13601; Code § 162(m); effective 2018

• Prior to Act: Employers restricted (deduction limit of $1 million for compensation), but exception for performance-based compensation

• Act: – Expands definition of covered employees

» Includes CFO» Expands period of coverage (if covered employee in 2017 or later,

remains covered employee permanently even after termination)– Expands definition of public company

» Includes foreign private issuers» Includes private companies with registered debt offerings that must

report under Section 15(d) of Securities Exchange Act• Impact:

– Group of covered employees expands – Limit applies to more than 5 individuals– Termination of employment no longer ends application– Transition rule (next page)

63


• Section 162(m) (continued)– Act § 13601; Code § 162(m); effective 2018

• Impact: – Transition rule

» Exempted is compensation paid “pursuant to a written binding contract that was in effect on November 2, 2017 and not modified in any material respect on or after such date”

– Not clear what material modification is with respect to contract– Employers subject to Code § 162(m) may wish to avoid

amending nonqualified plans and other executive agreements

64


• New Section 4960 (Tax-exempt organizations and excess compensation) – Act § 13602; Code § 4960; effective 2018 - Compensation limitation


– Imposes 21% excise tax on compensation in excess of $1 million for covered employee

– Defines covered employees as 5 highest paid employees– Expands period of coverage (if covered employee in 2017 or

later, remains covered employee permanently even after termination)

• Impact: – Group of covered employees expands – Limit applies to more than 5 individuals– Termination of employment no longer ends application

65


• New Section 4960 (continued) – Act § 13602; Code § 4960; effective 2018 – Excess parachute payment


– Creates limit on payments on account of termination (excess parachute payments)

» Payment contingent on employee’s separation from service with employer (excluding payments under 403(b) and 457(b) plans

» Excess parachute payment is if amount exceeds 3 times base amount

» Base amount is average annual compensation over prior 5 years determined based on Code § 280G

• Impact: – Not limited to 5 highest paid employees or covered employees

(but excludes non-highly compensated employees based on Code § 414(q))

– Rule for amounts vested and included in income before 2018

66


• New Section 83(i) – Act § 13063; Code § 83(i); effective 2018

• Prior to Act: No provision– Generally, transfers of stock subject to Code § 83

• Act: – Allows private companies to offer rank and file employees opportunity to

defer taxation on certain qualified stock– Qualified stock includes:

» Stock received in connection with exercise of options» Stock received to settle RSUs

– Eligible corporation» Privately held» Written plan under which at least 80% of employees providing

services receive qualified stock – Certain employees not eligible (current and former CEO, CFO, and

certain highly compensated employees) and 1% owners not eligible• Impact: uncertain whether employers will use

67

International Tax Reform

• Old System:– Ostensibly: U.S. persons taxed on worldwide income, with a tax

credit for foreign taxes paid.– Reality: U.S. persons pay U.S. tax currently on certain earnings of

foreign subsidiaries (“Subpart F” income, which generally includes certain types of sales income and passive income), and navigate a complex array of treaties and local laws to determine where to pay tax on non-Subpart F income.

– Active income from foreign subsidiaries is taxed when repatriated into the United States

– Foreign tax credit or deduction available to reduce burden if:• Corporate taxpayer: foreign income taxes paid by a foreign subsidiary on

dividended earnings• All taxpayers: foreign taxes withheld

68


• Problems:– Allocating income between U.S. and foreign sources (i.e., “transfer

pricing”) critical to both compliance and optimizing tax outcomes• Widespread ignorance => noncompliance• Squishy standards are hard for IRS to enforce

– Bringing accumulated foreign-source income back into the U.S. => U.S. income tax applied to previously untaxed amounts at high tax rates

– Essentially meant that only Subpart F income could be repatriated; active foreign income likely re-invested abroad

– Encouraged artificial movement of assets overseas

69


• New System– “Quasi-Territorial” regime– Multi-layered Tax on both Foreign Earnings and Outbound Payments

• Subpart F income still taxed currently• “Global Intangible Low-Tax Income” (GILTI)• Interest Deduction Limitation• Base Erosion Anti-Abuse Tax (BEAT)• Foreign Derived Intangible Income (FDII) Deduction

– U.S. corporations can deduct the foreign-source portion of any dividend received from a specified foreign corporation in which such U.S. corp owns at least 10%

– Goal: encourage U.S. companies to bring assets and foreign earnings back to the U.S. on a continuing basis

70


• Transition Tax:– MANDATORY tax at reduced rate for U.S. Shareholders of foreign

entities on foreign sub’s E&P, reduced by previously taxed Subpart F E&P

• Corporate shareholders can offset with foreign tax credits• Shareholders of Subpart S owner can elect to defer until a triggering

event• Can elect to pay over 8 years, at increasing % per year• Applies for last tax year ending before January 1, 2018 (i.e., retroactive)• Tax rate reduction: 15.5% for cash and cash equivalents, 8% for illiquid

assets

71


• New System (cont):– Goals of Mandatory Repatriation: Raise revenue and encourage

repatriation of IP and offshore profits• Goal: the additional cash will be reinvested in American jobs and

workers– Apple has already announced that it will save $43 billion in taxes, and will

give employees a bonus of $2,500 in restricted stock, invest in small acquisitions, and build new facilities in the U.S. with the repatriated amounts (https://www.nytimes.com/2018/01/17/technology/apple-tax-bill-repatriate-cash.html)

• BUT –– Not seeing a clear increase in wages yet; only short term bonuses– The 2004 repatriation tax holiday resulted in most of the repatriated amounts

distributed to corporate shareholders as dividends and stock buybacks (see http://money.cnn.com/2018/01/07/investing/stocks-week-ahead-tax-law-wall-street/index.html)

72


• Example: XYZ Ltd. is a UK company with a U.S. corporate subsidiary (ABC). ABC is developing a new technology. XYZ provides de minimis equity, but makes a loan to ABC to cover start up expenses, and has an intercompany agreement whereby XYZ pays ABC a “developer fee” and ABC pays XYZ for management services. ABC has de minimis tangible assets.

73

Tax Type Application

Subpart F N/A – no CFC

GILTI N/A – no CFC

Interest Deduction Limitation Possible, if interest payments to XYZ exceed 30% of ABC’s EBITDA

BEAT If XYZ’s related companies have 3-year revenue in excess of $500M, alternative minimum tax may apply

FDII Deduction Characterization of developer fee is critical – may receive 37.5% deduction


• Example: ThreadBare Inc. is a U.S. corporation that owns a Dominican Republic subsidiary taxed as a corporation for U.S. income tax purposes. The DR sub acts as a captive contract manufacturer producing clothing items, pursuant to a cost-plus intercompany agreement. The DR entity’s assets are limited to sewing machines and office furniture.

74


Subpart F Possible but unlikely; DR entity is a CFC, but U.S. likely books all sales

GILTI Possible if very high return; unlikely that transfer pricing would support such high returns

Interest Deduction Limitation N/A

BEAT N/A – COGS excluded

FDII Deduction N/A – no IP license


• Example: FunCo! is a U.S. corporation that owns the IP rights for a number of well-known cartoon characters. FunCo! owns subsidiaries in France and Japan, which run theme parks based on these cartoon characters. The foreign subsidiaries pay a royalty to FunCo! to use the likenesses of the characters. These subsidiaries have tangible assets valued at approximately $100M each, and earn profits of approximately $20M per year, which are taxed in the foreign jurisdictions.

75


Subpart F Possible

GILTI Likely – FunCo! will get deduction of 50% of GILTI and may claim tax credits up to 80% of foreign taxes attributable to GILTI inclusion

Interest Deduction Limitation N/A

BEAT N/A – no base erosion payments

FDII Deduction Likely receive deduction of 37.5% of foreign-derived royalty payments


• U.S. Parent Entity Choice Matters

76

Tax Type Corporate Owner All Other U.S. Owners

Subpart F Taxed at 21% rates FTC Available

Ordinary income tax ratesNo FTC

GILTI Deduction of 50% of GILTICan use FTCs to offset

No DeductionCannot use FTCs to offset

Interest Deduction Limitation

Applies Applies

BEAT Applies Applies

FDII Deduction Eligible for Deduction Not Eligible

Foreign Dividend Deduction

Yes No

Repatriation Tax Can use FTCs to offset No FTCs

Total Score: 7 points! 0 points


• Foreign Subsidiary Entity Choice Matters

77

Tax Type Corporate Subsidiary Passthrough Subsidiary

Subpart F 21% tax rateOnly Subpart F income currently taxed

Ordinary income tax ratesAll income currently taxed

GILTI Applies N/A, see above re: tax rates

Interest Deduction Limitation

N/A N/A

BEAT Applies Applies

FDII Deduction N/A N/A

Foreign Dividend Deduction

Yes No

Repatriation Tax Yes, at lower rates No; income already taxed

Total Score: 4 points 0 points


• To-Do Items for the Small and Mid-Size Business– Changes in Equity Ownership – look for deferrals of mandatory

repatriation tax, especially for S corporations– Inbound Investment – watch for (a) debt from foreign parent

company and (b) intercompany agreements that give rise to payments outside the U.S. that are deductible by the U.S. sub

– Transfer Pricing – refresh your existing transfer pricing studies– Cash Management – debt may not be the best way to shift money

between different jurisdictions– Attribution Rules – attribution of ownership from foreign persons– IP – be thoughtful about where your IP is located for tax purposes,

and document how you share IP between related companies– Accountant Relationship – matters more than ever before

78

Legal Notice

• This presentation is intended for general information purposes only and should not be construed as legal advice or legal opinions on any specific facts or circumstances. An attorney-client relationship is not created through this presentation.

79

The New Federal Tax Law: Business Provisions · income tax). • Corporate ... for joint filers),...

Documents

Transcript of The New Federal Tax Law: Business Provisions · income tax). • Corporate ... for joint filers),...