Congress is expected to pass The Tax Cuts and Jobs Act of 2017 and send it to President Trump for his expected signature by Christmas. While we have had numerous tax bills over the last several years, the 2017 bill will bring dramatic changes to most taxpayers and be the most comprehensive overhaul since the Tax Reform Act of 1986. Significant changes will take place to taxation of individuals, corporations, pass-through entities such as Subchapter S corporations, partnerships and limited liability companies and tax-exempt entities. In addition, the concept of U.S. taxation of whole worldwide income has been eroded and a modified territorial approach has been adopted at least for multinational corporations.
The Act retains the current seven tax brackets but generally lowers the rates slightly. The new rates are 10, 12, 22, 24, 32, 35 and 37 percent compared to the current rates of 10, 15, 25, 28, 33, 35 and 39.6 percent. The top rate applies to singles with incomes of $500,000 and married taxpayers filing joint returns with incomes over $600,000. The maximum rate of 20 percent on long-term capital gains and dividends remains unchanged. The net tax on investment income of 3.8 percent passed as part of the Affordable Care Act also remains in place.
Probably the biggest change for individuals is the increased standard deduction coupled with the elimination of personal and dependency exemptions and several itemized deductions. The result will be an expected decrease of two-thirds of the 31 percent of filers who currently itemize. The standard deduction will increase in 2018 to $12,000 for single filers, $18,000 for heads of households and $24,000 for married couples filing jointly.
Deductions for state and local income or sales taxes and property taxes will be limited to $10,000 per return per year. The deduction for interest on home equity indebtedness has been eliminated. Interest on home mortgages is limited to the first $750,000 of indebtedness as opposed to the current limit of $1,000,000. Deductions for tax preparation fees, moving expenses, unreimbursed employee business expenses and investment expenses are no longer allowed.
The child credit for dependent children under the age of 17 has been doubled to $2,000 of which $1,400 would be refundable over and above what the individual pays in income taxes. The income limit for receiving the credit would rise to $400,000 for joint filers and $200,000 for other taxpayers from the current $110,000 and $75,000 levels.
The lifetime exclusion from gift and estate taxes has been doubled from $5,000,000 to $10,000,000 per individual. The individual mandate imposed by the Affordable Care Act has also been repealed.
The first $1,000,000 of assets other than real estate used in a trade or business by any taxpayer are now eligible for immediate deduction. Currently, only the first $500,000 of such assets may be expensed. The ability to expense these assets phases out once the taxpayer has acquired more than $2,500,000 of such assets during the year, up from the current $2,000,000. In addition, businesses will be able to immediately expense all new business assets with a useful life of 20 years or less. This immediate expensing option begins to go away in 2023 when only 80 percent of such assets may be expensed. It goes down by 20 percent per year until 2027 when it expires.
The tax rate applicable to corporations will be a flat 21 percent, down from the current graduated rates ranging from 15 to 35 percent. The dividends received deduction for dividends from other domestic corporations is reduced from 70 to 50 percent.
One of the most significant changes the Act makes is the allowance of a 20 percent deduction of business income for owners of partnerships, Subchapter S corporations and sole proprietorships. The entity providing the income must be a qualified business which excludes any business primarily performing personal or professional services or dealing with investments. The deduction will begin to phase out if the taxpayer’s taxable income exceeds $315,000 if married filing jointly or $157,500 for other taxpayers. The deduction is also subject to limits based upon wages paid by the business and investment in depreciable property.
The Act changes the long-standing U.S. tax policy of subjecting all foreign source income earned by U.S. corporations to tax when repatriated. The Act does not change the policy of taxing all foreign source income earned by U.S. taxpayers to U.S. taxation nor change the complex set of rules requiring direct inclusion of income earned by foreign subsidiaries of U.S. corporations in what are deemed to be abusive or tax avoidance transactions. The Bill allows any 10 percent or more shareholder of a foreign corporation a deduction equal to 100 percent of any dividend paid by the foreign corporation out of its foreign source earnings. Essentially, a foreign corporation can distribute its entire foreign source earnings to its large U.S. shareholders tax free. This provision should help end the problem of cash ”trapped” overseas.
In addition, the new law imposes a deemed repatriation on all foreign earnings of foreign corporations earned between 1987 and 2017 by any U.S. shareholder that owns more than 10 percent of the foreign corporation albeit at lower than standard tax rates. Any 10 percent or more shareholders must include in its taxable income Dec. 31, 2017, its share of the foreign corporation’s undistributed foreign source income. The income is taxed at a 15.5 percent rate to the extent is represents the shareholder’s proportionate ownership of the foreign corporation’s cash or cash equivalents. The noncash assets are taxed at an 8 percent rate. Presumably since these U.S. shareholders are taxable on this undistributed income, the corporation will distribute at least part of it so they can pay their tax. The tax on the deemed distribution is payable over eight years.
The Bill also adds a Base Erosion Anti-Abuse Tax which is a sort of alternative minimum tax, which disallows for purposes of the tax payments to foreign affiliates.
Richard Leaman is professor of accountancy for the Daniels College of Business. He joined the College as assistant professor in 1991. After receiving a JD from the University of Chicago in 1979, he was admitted to the Colorado Bar and served as tax partner and manager for KPMG Peat Marwick. Leaman has also served as adjunct professor for the Drake University graduate tax program.