House GOP Releases Major Tax Reform Bill
On
The Act must be approved by both the House and the
If enacted, the Act would make a number of major changes to the
A. Business Tax Reform
1. Tax Rates - Corporations
Corporate graduated tax rates of up to 35 percent would be replaced with a 20 percent flat rate, with one exception: personal service corporations would be subject to a 25 percent flat rate.
2. Tax Rates - Business Income of Sole Proprietorships and Passthrough Entities
"Business income" from sole proprietorships and passthrough entities (i.e., entities classified as partnerships and S corporations) would be subject to a maximum tax rate of 25 percent, instead of the applicable individual rates.
The amount of income derived from a sole proprietorship or passthrough entity that would be treated as "business income" eligible for the 25 percent maximum tax rate would depend, in part, on whether the individual owner is actively involved in the business (determined under the existing passive activity loss rules). Generally, where an individual owner is actively involved in the business, 30 percent of the income derived from the business would be treated as "business income" subject to the maximum 25 percent rate, and 70 percent of the income would be treated as non-business income taxed at applicable individual rates. Taxpayers would have the option to elect out of the default rule to treat more than 30 percent of their income as "business income" based on the income of the business and the amount of capital invested in the business. The election would be binding for five years. Absent such an election, 100 percent of the income of personal service businesses, such as law firms, accounting firms, and professional service firms, would be treated as non-business income not eligible for the 25 percent rate. Individuals who are actively involved in the business would also be subject to self-employment tax on their distributive shares of non-business income, and the exemption from self-employment tax for limited partners would be eliminated.[1] In contrast to income generated from businesses in which a taxpayer is actively engaged, all of the income derived from business activities in which the taxpayer is not active (i.e., passive activities) would be eligible for the 25 percent maximum rate.
Income already subject to preferential rates, such as net capital gains and qualified dividend income, would not be affected by these rules. However, dividends from real estate investment trusts that are not qualified dividends generally would be eligible for the 25 percent rate.
3. Limitation on Business Interest
In general, a taxpayer would not be permitted to deduct business interest in excess of its business interest income and 30 percent of its "adjusted taxable income" (generally income before interest income and expense, net operating losses, depreciation, amortization, and depletion). For partnerships, the limitation would be determined at the partnership level. Any interest amount disallowed may be carried forward to the succeeding five taxable years, subject to certain limitations. This rule would apply to taxable years beginning after
The limitation on interest deductions would not apply to real property trades or businesses (as currently defined under section 469[2]) or certain public utilities. The limitation also would not apply to "small businesses" (i.e., businesses with average gross receipts of
Due to the limitation on interest deductions, the "earnings stripping" rules of section 163(j) would be repealed. Those rules generally limit the deductibility of interest by a thinly capitalized corporation where the interest is paid to certain related party lenders.
4. Net Operating Losses
The Act would make substantial changes to the net operating loss ("NOL") rules. First, deductions arising from NOLs generated in taxable years beginning after
5. Cost Recovery
The Act would replace the current 50 percent bonus depreciation deduction for "qualified property" placed in service before
The Act also would expand immediate expensing of any "section 179 property" (including certain tangible property) placed in service in any taxable year by increasing the amount a business is entitled to expense from
6. Renewable Energy Credits
Among the Act's changes to the renewable energy-related tax credit provisions of the Code are modifications to the production tax credit ("PTC") (generally relevant to wind energy projects) and the investment tax credit ("ITC") (generally relevant to solar energy projects).
For the wind PTC, the Act would reduce from 2.3 to
The modifications to the ITC are less material. The existing 30 percent ITC for utility scale solar projects (including the rules for its gradual phase-out) is left untouched by the Act. The permanent 10 percent ITC, however, would be completely eliminated under the Act.
7. Other Business Tax Reforms
The Act would make a number of other significant business tax reforms: (i) self-created patents and copyrights for musical compositions would no longer be treated as capital assets or eligible for long-term capital gain treatment; (ii) a sale or exchange of 50 percent or more of the total interest in partnership capital and profits within a 12-month period would no longer cause a "technical termination" of a partnership; (iii) section 1031 like-kind exchanges would be limited to exchanges of real property; (iv) multiple business tax credits would be repealed (e.g., the credit for qualified clinical testing expenses for certain drugs, the new markets tax credit, and the historic rehabilitation credit); and (v) the Act would repeal the exclusion from gross income for interest earned on certain types of bonds, including certain private activity bonds, advance refunding bonds, certain tax credit bonds, and bonds for professional sports stadiums, increasing significantly the borrowing cost for infrastructure and other projects that have historically relied on tax-exempt financing.
8. Compensation-Related Reforms
The Act would substantially limit the amount of non-qualified deferred compensation on which taxes can be deferred by taxing employees on compensation as soon as such compensation is no longer subject to an obligation to perform future substantial services. The scope of the provision is very broad, going well beyond section 409A to include stock options and various other types of compensation that are not "deferred compensation" under current law. In addition, the Act would expand section 162(m) so that performance-based compensation would not be excluded from the
The Act also would repeal or limit various exemptions from employees' gross income, such as employer-provided housing, employee achievement awards, dependent care assistance programs, qualified moving expense reimbursements, and adoption assistance programs.
B. International Tax Reform
1. Establishment of Partial Participation Exemption
The Act would fundamentally alter the current international tax regime by moving
Under existing law,
The Act would generally exempt from
Other rules would be modified as a result of the move to a territorial tax system. First, the Act would modify the rules applicable to controlled foreign corporations ("CFCs"), which include foreign subsidiaries of
2. Transitional Rule for Current Earnings
A transitional rule would address existing earnings held offshore by foreign subsidiaries. Under this rule,
3. Current Inclusion for Certain Passive Income (Base Erosion)
The Act would introduce several new rules to combat
A second provision designed to combat base erosion would introduce a worldwide thin-cap rule that limits the deductible net interest expense of a
The final base erosion provision would impose a 20 percent excise tax on payments (other than interest) that are deductible or includible in either the cost of goods sold or the basis of a depreciable or amortizable asset and that are made by a
C. Tax Reforms for Individuals
1. Individual Tax Brackets, Deductions and Credits
The Act would replace the existing seven individual income tax brackets with four brackets: 12 percent, 25 percent, 35 percent, and 39.6 percent. However, the Act would phase out the 12 percent bracket for certain high-income taxpayers. The Act also would roughly double the size of the standard deduction, reduce certain deductions such as the mortgage interest deduction, and repeal or revise other deductions, exemptions, and credits. In particular, the Act would eliminate the deduction for state and local income taxes, although property taxes of up to
The Act also would repeal the alternative minimum tax ("AMT"). Taxpayers would be entitled to claim a refund of unused AMT credit carryforwards.
2. Changes to Estate Tax
The Act would double the exemption for the estate and gift tax from
D. Provisions Affecting Exempt Organizations
The Act would make a number of changes that would adversely affect the taxation of exempt organizations and private foundations, as well as sponsors in the private equity sector. Notably, the Act would subject all entities that are exempt from tax under section 501(a) to the unrelated business income tax ("UBIT"), including state pension plans that are exempt from tax under section 115(l) (i.e., "super tax-exempt" investors) and historically have taken the position that they are not subject to any UBIT. This amendment could have a significant impact on the future structuring considerations for private equity funds as well as the willingness of super tax-exempt investors to make a direct investment in a partnership or other passthrough entity that generates unrelated business taxable income.
[1] The Act appears to make all passthrough income, even for "passive" owners, subject to self-employment tax, but we believe this is a drafting error that will be corrected.
[2] Unless indicated otherwise, all "section" references are to the Internal Revenue Code of 1986, as amended (the "Code").
The following Gibson Dunn lawyers assisted in the preparation of this client alert:
Gibson Dunn's lawyers are available to assist with any questions you may have regarding these developments. For further information, please contact the Gibson Dunn lawyer with whom you usually work or any of the following members of the
This document was posted showing the date:
Rep. Roe Supports Funding for Children’s Health Insurance
Advisor News
Annuity News
Health/Employee Benefits News
Life Insurance News