1. Tax Reform: What you Need to Know Margaret Amsden, Sarah Russell, and
Sue Tuson
January 30, 2018

2. Agenda Business Tax Provisions Individual Tax Provisions
International Provisions
Takeaways:
Common Misconceptions
Potential Opportunities
Potential Landmines

3. Business Provisions

4. Business Provisions C Corporation tax rates Depreciation
Domestic Production Activity Deduction
Methods of Accounting
Interest Expense
Net Operating Loss Utilization
Meals & Entertainment
R&D Expenses
Other provisions

5. C Corporation tax rates
Remove graduated rate structure replaced with flat 21% for C Corporations
Removed higher rate applied to Personal Service Corporations

6. C Corporation Change in Tax Rates
Alternative Minimum Tax repealed
AMT credit carryovers will be available to offset tax
50% of the excess AMT credit over regular tax will be refundable in 2018 – 2020
AMT refundable percentage increases to 100% in years beginning in 2021
IMPACT: AMT Credit Carryovers are fully refundable by 2022

7. Bonus Depreciation Bonus depreciation has increased from 50% to 100%
Applicable to property placed in service after September 27, 2017
Bonus depreciation is now available for purchases of used personal property
Bonus depreciation begins to phase out by 20% per year 2022 until it is reduced to 0% in 2027
Bonus depreciation is automatic unless taxpayer elects out, must elect out on an entire class of property in any year

8. Section 179 New limits indexed for inflation:
Section 179 maximum expensing deduction increased to $1M
Limit will be reduced if total assets placed in service exceed $2.5M dollar for dollar
At the taxpayer’s election Qualified Property is expanded to include “Qualified Real Property” which includes improvements to non-residential real property after the date the property was first placed in service (roofs, hvac, fire protection, alarm and security systems)
This is a permanent increase
Section 179 is an asset by asset election

9. Luxury Autos
Current law: luxury autos are subject to limitations under IRC 280F resulting in lengthening the period necessary to recover the cost of the property
New limits (without bonus depreciation) for luxury automobiles are essentially tripled - new limitations:
Year 1:                  $10, ($18,000 cap w/bonus depreciation)
Year 2:                  $16,000
Year 3:                  $ 9,600
Year 4 and future: $ 5,760
Luxury auto continues to not include vehicles with a gross weight over 6,000 lbs

10. Domestic Production Activities Deduction
The DPAD:
Provided an effective tax rate reduction of 3% on domestic production activity has been repealed
The repeal is effective beginning in 2018

11. Change in Character – Self Created Asset
Patents, inventions, model or design (whether or not patented), a secret formula or process, copyright, a literary, musical or artistic composition, a letter or memorandum or similar property that are disposed of after 12/31/17 are not a capital asset in the hands of:
The taxpayer whose personal efforts created the property or
A taxpayer with a substituted or transferred basis from a taxpayer whose person efforts created the property
Patents may still qualify for capital treatment under IRC §1235

12. Methods of Accounting
Cash Method - increases the number of taxpayers that may be eligible
263A - decreases the number of taxpayers required to capitalized indirect costs
Long-term contracts – increases the number of taxpayers eligible for completed contract method of accounting
The new legislation increases the limitation to $25M average annual gross

13. Business Interest Expense Limitation
Taxpayers with gross receipts in excess of $25M face possible limitations with regard to interest expense deductions
Interest in excess of 30% of Adjusted Taxable income will not be deductible
Amounts disallowed may be carried forward indefinitely
Applies to Net Interest Expense (i.e., Interest Expense - Interest Income)
Adjusted Taxable Income is:
Taxable Income before NOL + Interest + Taxes + Depreciation + Amortization through 2021 (EBITDA)
Beginning in 2022, the limit is based on Taxable Income before NOL + Taxes + Interest (EBIT)

14. Business Interest Expense Limitation
The limitation is determined at the filer level (i.e., at the Corporation; S Corporation or Partnership level) -- in the case of an affiliated group filing a consolidated return, at the consolidated tax return level
Partnership limited interest expense is allocated on the Schedule K-1 and deducted in future periods based on the partners share of income in excess of the threshold
Adjusted Taxable Income (i.e., EBITDA /EBIT beginning in 2022) is calculated before the 20% pass-through deduction

15. Business Interest Expense Limitation
Real estate businesses can elect NOT to apply the limitation
Businesses making this election would be required to use the alternative depreciation system (ADS) to depreciate certain property

16. Business Interest Expense Limitation
NOTE: Replaces old IRC Section 163(j)
No direction on what happens to any existing carryover under old Interest stripping rules

17. Net Operating Losses (NOLs)
Net operating losses arising in tax years beginning after 2017 will be limited to 80% of taxable income
NOLs arising in years ending after December 31, 2017 will no longer be available to carryback two years
IMPACT: An NOL arising in the 2017/2018 fiscal-year may not be carried back two years since it arose in a tax year ending after However, the same NOL is not subject to the 80% of taxable income limitation because the NOL did not arise in a tax year beginning after 2017.

18. Net Operating Losses (NOLs)
NOLs available for carryover that arose in years prior to 2018 will not have limitation on utilization
Under the previous law AMT NOLs would have been limited to 90% of alternative minimum taxable income under the AMT
Carryforward period is now indefinite (rather than 20 years)
20% deduction for Qualified Business Income (QBI) of pass-through entities and the deduction for Foreign-Derived Intangible income (FDII) are not allowed as deductions in computing an NOL

19. Meals & Entertainment Expenses
Meals continue to be subject to the 50% limitation
The 50% limitation will also apply to certain meals provided by an employer that were previously 100% deductible
Food and beverages provided to employees as de minimis fringe benefits
Meals provided at an eating facility which meets the requirements for an on-premises dining facility
Meals provided on premises to employees under section 119 for the convenience of the employer
The 50% deduction limit applies for years after 2017 and before The on-premises meals and section 119 meals expenses would be nondeductible after 2025.

20. Meals & Entertainment Expenses
Even if there is a substantial and bona fide business discussion, are no longer deductible
The conference agreement would provide that no deduction is allowed for
An activity considered entertainment, amusement, or recreation
Membership dues for any club organized for business, pleasure, recreation, or other social purposes
A facility or portion of a facility used in connection with any of the above

21. Research and Development Expenses (R&D)
Currently R&D expenses are expensed as incurred
Beginning in 2021, such expenses will be required to be capitalized and amortized over a five-year period (15 years for research conducted outside the US)
Software development costs are subject to these rules
DOES NOT IMPACT THE R&D CREDIT

22. 2017 Versus 2019 Comparison Assumptions
Book income before depreciation $1,000,000
Interest expense $1,000,000
Capital expenditures $1,000,000
Entertainment expense $ 250,000
Meals expense $ 200,000
NOL C/F, from previous year $1,500,000
Taxpayer not subject to AMT prior to repeal
Example

23. Other Provisions Carried Interest :
Beginning in 2018 three-year holding period will be required in the case of certain applicable partnership interests held by the taxpayer in order to qualify for long-term capital gain treatment

24. Individual Provisions

25. Most of these changes expire in 2025

26. Individual Provisions
Pass-through tax treatment
Excess business losses
Net Operating Losses
Above the line deductions
Itemized deductions
Tax brackets
Alternative Minimum Tax
Child tax credit
Education savings accounts
Estate, Gift and GST

27. Pass-through Tax Treatment
Beginning in 2018, a 20% deduction will apply to a taxpayer’s Qualified Business Income (QBI)
QBI is domestic business income
QBI does not include: interest, dividends (see exception for REIT’s), short/long term capital gains/losses, commodities gain, foreign currency gains, etc.
The deduction applies to pass-through entities which includes: Sole proprietorships, partnerships, S Corporations, LLCs, trusts and estates, REITs, qualified cooperatives, tiered pass-through entities

28. Pass-through Tax Treatment
Deduction is limited to the lesser of:
20% of QBI, or
The greater of:
50% of W-2 wages paid with respect to qualified business; or
Sum of 25% of W-2 wages plus 2.5% of the unadjusted basis of all qualified property
PLUS
20% of qualified REIT dividends
Qualified publicly traded partnership income

29. Pass-through Tax Treatment
Must be a qualified business to take the deduction
Specified service companies small taxpayer exception
If taxable income does not exceed $315K (MFJ), or $157K (Single) filers, the exclusion for specified service companies does not apply
Specified service company includes services in the fields of:
Health, law, accounting, actuarial sciences, consulting, financial services, brokerage services
Engineering and architecture are specifically excluded from being classified as a specified service company
Some ambiguity in the law, additional clarification expected

30. Pass-through Tax Treatment
The pass-through deduction is not a deduction in arriving at adjusted gross income
IMPACT: it is unlikely you will receive the deduction for purposes of calculating your state tax liability
All qualified pass-through activities must be aggregated when calculating the deduction
IMPACT: losses from one entity will offset income from another entity (if both have qualified business income) when calculating the deduction

31. Pass-through Tax Treatment
The pass-through deduction is not included in computation of Net Operating Loss
SE Taxes appear to be calculated on the full net business income before QBI deduction

32. Pass-through Example Assumptions: Entity is owned 100% by taxpayer
Taxpayer is non-passive
Pass-through income $1,000,000
Pass-through deduction $ 200,000
Wages from pass-through $ 250,000
Taxpayer is married filing joint
Taxpayer will take the standard deduction

33. Pass-through Example 2017 2018 Wages $250,000 Pass-through Income
1,000,000
Adjusted Gross Income
1,250,000
Less: Standard deduction
(12,500)
(24,000)
Less: Pass-through deduction
(200,000)
Taxable Income
$1,237,300
$1,006,000
Tax
435,202
311,599
Effective Tax Rate
35.2%
31.0%
Tax Savings
$123,603

34. Excess Business Losses
Under IRC Section 461(l) – Excess business losses of non-corporate taxpayers are not allowed for 2018 thru 2025
Any loss that is disallowed is treated as an NOL carryover to the following year
Applied at the partner/shareholder level based on their distributable share of items of income, gain, loss, or deduction
Passive activity limitations are applied first
What is an excess business loss?
The taxpayer’s aggregate deductions for the tax year from the taxpayer’s trades or businesses
The aggregate gross income or gain from such trades or businesses + $250,000 ($500,000 MFJ)

35. Excess Business Losses
Assumptions:
Taxpayer is single
Taxpayer is a non-passive owner of a retail business
Taxpayer’s share of gross income $1,000,000
Taxpayer’s share of deductions $1,400,000

36. Excess Business Losses
Aggregate Deductions
$1,400,000
Aggregate Gross income
$1,000,000
Plus ($250k / $500k MFJ)
250,000
Total
$1,250,000
Excess Business Loss
$150,000
Excess Business Loss = Net Operating Loss Carryover to next year

37. Net Operating Losses
See new rules related to NOLs above

38. Above the Line Deductions
Alimony:
Currently deductible by payer, includable in income of recipient
Agreements entered into after 12/31/18 no longer deductible by payer or taxed to recipient
Agreements modified that expressly say change applies may take advantage of this
Educator expense deduction of $250 still applies

39. Above the Line Deductions
Qualified Moving Expenses
Currently:
Employers may reimburse on a tax-free basis by excluding them from gross income
Employees may take an above the line deduction to the extent that they are not paid for by the employer
Under the Conference agreement, both of these provisions are generally suspended for the years 2018 through 2025
The one exception to this suspension applies to members of the U.S. Armed Forces

40. Itemized Deductions Increase the standard deduction:
From: $6,500 (single) and $13,000 (MFJ)
To: $12,000 (single) and $24,000 (MFJ)
Personal exemption are eliminated ($4,150 for each exemption)

41. Itemized Deductions State and local taxes limited to $10,000 per year
This limitation was accomplished by adding IRC Section 164(b)(6) which limits the taxes under Section 164(a)(1) – (3) and 164(b)(5) as follows:
State and local real property tax
State and local personal property tax
State, local, foreign income, war profits and excess profits taxes
State and local sales taxes

42. Itemized Deductions State and local tax limitation does not apply
If incurred in carrying on a trade or business;
If incurred in an activity described in IRC Section 212 for the production of income; or
GST tax on income distributions
Does not limit deduction for ½ of SS tax paid by person with self employment earnings. This is treated as attributable to a trade or business.

43. Itemized Deductions Mortgage interest
Current Law: Qualified Residence Interest includes:
$1,000,000 of Acquisition Indebtedness
$ 100,000 of Home Equity Indebtedness
Change: Qualified Residence interest now includes:
$750,000 of Acquisition Indebtedness
Home Equity Indebtedness is eliminated
Acquisition Indebtedness = funds spent to buy, build or substantially improve the principal residence
NOTE: it does not matter what the bank calls it, it is based on the used of funds

44. Itemized Deductions
Deduction for medical expenses will be expanded by reducing the floor to 7.5% of income (from 10%)
This change applies to 2017 and 2018 only
Charitable Contribution Limitation:
Cash contributions to public and certain private charities are now limited to 60% of AGI (prior 50% limitation)
Miscellaneous deduction, such as tax preparation fees, investment advisory fees, unreimbursed business expenses, etc. will no longer be deductible

45. Individual Brackets (MFJ)
Seven brackets remain, however rates are lowered and brackets expanded
Change
10% - $ 0 – 18, % - $0 - $19,050
15% - $18,551 - $75, % - $19,051 - $77, % rate
25% - $75,301 - $151, % - $77,401 - $165, % rate
28% - $151,901 - $231, % - $165,001 - $315,000 4% rate
33% - $231,451 - $413, % - $315,001 - $400, % rate
35% - $413,451 - $466, % - $400,001 - $600,000 Bracket size
39.6% - $466, % - $600, % rate

46. Individual Alternative Minimum Tax
AMT has NOT been repealed - Income thresholds for when it applies have been increased:
From: $84,500 (MFJ) and $54,300 (single)
To: $109,400 (MFJ) and $70,300 (single)
The amount at which the exemption phases out also increases
From: $160,900 (MFJ) and $120,700 (single)
To: $1,000,000 (MFJ) and $500,000 (single)

47. Child Tax Credit Child tax credit
Increased to $2,000, of which $1,400 is refundable
AGI phase out: $400,000 (MFJ); $200,000 (all other taxpayers)

48. Education Savings Programs
Current Law: Beneficiaries of IRC Section 529 plans are not subject to tax on the earnings of a plan as long as they use the proceeds withdrawn to pay qualified higher education expenses
New Law:
Up to $10,000 per student per year
May be used for elementary and secondary schools
The schools may be public or private
States currently allowing a deduction for contributions to 529 plans are considering revising their laws

49. Estate, Gift and GST
Estate, Gift and Generation Skipping Transfer Tax exemption increased:
From: $5.6M per person
To: $11.2M per person
Exemptions will continue to be increased for inflation
The step-up in basis at death will remain in intact

50. Individual Provisions - Example
Assumptions:
Married filing joint status
2 Children
Wage income $350,000
Interest income $ 10,000
Child care Expenses $ 6,000
State income/property taxes $ 20,000
Mortgage interest $ 5,000
Charitable contributions $ 5,000

51. Individual Provisions
2017
2018
Wages
$350,000
Interest
10,000
AGI
$360,000
Personal Exemptions
(16,200)
n/a
Itemized Deduction
(30,000)
Standard Deduction
(24,000)
Taxable Income
$313,800
$336,000
Tax before Credit
$78,966
$70,899
Child Tax Credit
(4,000)
Net Tax Liability
$66,899

52. International Provisions

53. International Provisions
New penalties
Participation Exemption
Transition tax (more commonly referred to as repatriation tax)
Base Erosion Anti-Abuse Tax (BEAT)
Foreign Derived Intangible Income (FDII)
Global Intangible Low-Taxed Income (GILTI)

54. International Provisions
New Penalties
Form 5472s now subject to $25,000 failure to file penalty
No change to penalties on 5471, 8858, 8865 etc.

55. International Provisions
US Participation Exemption for C Corporations
C Corporation receiving a dividend from a foreign subsidiary of which they own at least 10% of the voting stock for 365 days in a 731 day period will no longer pay tax on such dividend
Previously such dividends would be taxed at the applicable corporate income tax rate

56. International Provisions
Mandatory Repatriation
As a transition to the Participation Exemption, a mandatory inclusion of accumulated earnings and profits is required and will be taxed at 15.5% to the extent attributable to liquid assets and 8% attributable to other assets
This is often times referred to as the “toll charge”
THIS TAX IS CALCUATED BASED ON 2017 NUMBERS AND IS DUE WITH THE 2017 TAX LIABILITY

57. International Provisions
Mandatory Repatriation
An election may be made to pay the transition tax in eight annual installments. If elected, 8% of the net tax liability will be due for each of the first 5 installments, 15% for the sixth installment, 20% for the seventh installment, and 25% for the final installment.
Specific triggering events included in the legislation which could accelerate installment payments

58. International Provisions
Mandatory Repatriation
Special rule applies to S Corporations which will allow deferral of transition tax payment until a triggering event occurs
Foreign tax credits will be available to offset a portion of the transition tax due by C Corporations
Tax is considered a new Subpart F category and is expected to be calculated on Form 5471

59. International Provisions
Mandatory Repatriation
Downward attribution under 958(b) has been repealed which could create some surprises
Foreign owned US subsidiaries will now be deemed to own the stock its foreign parent owns
Other foreign subsidiaries of the parent company are now considered CFCs
If there is a 10% US shareholder of the parent company, that person could have repatriation tax due
Notice clarified that 5471s are not required for these CFCs

60. Sample Org Chart

61. Sample Model

62. International Provisions
Base Erosion Anti-Abuse Tax (BEAT)
Applies to domestic C Corporations that are part of a group with at least $500M of gross receipts
Must apply controlled group rules
Subsidiary of foreign parent company is most likely a member of a controlled group with the parent company and therefore must count the gross receipts of the parent company as well as other subsidiaries owned by the parent

63. International Provisions
BEAT, Cont
Almost all payments except purchased of inventory will be considered BEAT
If such payments are 3% or more of total deductions, the BEAT tax may apply
Additional information regarding base erosion payments expected to be added to Form 5472 for specific reporting
IMPACT: Documentation and understanding of the full corporate structure of multinational groups will be essential!!

64. International Provisions
BEAT Calculation
Step 1: On a controlled group basis is the three-year avg gross receipts over $500M?
If yes, continue to Step 2, if no STOP
Step 2: Are Base Erosion Payments 3% or more than total deductions (deductions do not include COGS)?
If yes, continue to Step 3, if no STOP
Step 3: Calculate Modified Income = Taxable income + base erosion payments
Step 4: Determine BEAT

65. Sample Model

66. International Provisions - FDII
Foreign Derived Intangible Income (FDII) - Overview
New IRC §250(a) allows a domestic C corporation to deduct an amount which is the lesser of
(1) the sum of 37.5% of its foreign derived intangible income plus 50% of its GILTI that is not included in its gross income, OR
(2) its taxable income
Deduction will be allowed equal to 37.5% of it’s “FDII” through 2025, when the deduction decreases to %
Results in an effective tax rate of % through 2025 and % thereafter

67. FDII
Framework
Only available to domestic C Corporations -- NOT Applicable to S Corp, Partnership, Estate, trust etc.
Deduction Eligible Income
The gross income of a US C Corporation excluding: Subpart F, GILTI, financial services income, dividends received from a CFC, foreign branch income, and domestic oil and gas income

68. FDII
Framework, Con’t
Step 1: Determine corporation’s Deemed intangible income
Generally = 10% of the corporation’s aggregate adjusted basis in depreciable tangible property used:
In the corporation’s trade or business and
For the production of “deduction eligible income”, as determined by averaging the property’s basis on the four quarter ends of the year
Objective is to carve out a routine return that is not eligible for the preferential tax rate

69. FDII
Framework, Con’t
Step 2: Determine “foreign-derived deduction eligible income”
= “deduction eligible income” that corporation derives in connection with:
Property the corporate sells, leases, licenses, exchanges, or otherwise disposes of :
(a) to a non US person
(b) for use, consumption, or disposition outside the US
Services that the taxpayer provides to any person, or with respect to property, that is not located in the US
NOTE: Sales to unrelated parties for further manufacture or modification in the US do not generate “foreign-derived deduction eligible income” even if there is subsequent foreign use

70. FDII Framework, Con’t Step 3: Complete the computation
= “Deemed Intangible Income” * Foreign-derived deduction eligible income
Total deduction eligible Income

71. FDII
Observations
Foreign-derived intangible income is somewhat misleading
The application of the provision does not turn on the presence or absence of intangible property
Based on the definitions and calculations, it seems any US Corporation that engages in transactions with foreign persons/entities can potentially earn FDII

72. Sample Model

73. International Provisions - GILTI
Global Intangible Low-Taxed Income (GILTI) - Overview
A US shareholder of any controlled foreign corporation is required to include its global intangible low-taxed income (GILTI) in gross income for the tax year in a manner similar to Subpart F inclusions
Effect is to subject a US shareholder to tax on the combined net income of its CFCs that:
Is not otherwise taxed in the US on a current basis (e.g. not ECI, not Subpart F) or specifically excluded (related dividends) and
Exceeds a fixed “routine return” on the CFC’s associated business assets
A 50% deduction (37.5% after 2025) is allowed for C Corporations, so the effective tax rate is 10.5% (13.125% after 2025)

74. International Provisions - GILTI
Global Intangible Low-Taxed Income (GILTI) – Framework
Routine rate of return calculated similar to FDII deduction
Excess return is the greater than 10% of QBAI
If the CFC has an effective tax rate under 15%, it likely will be subject to tax under these provisions.
Income and losses from all CFCs are aggregated when determining amount of GILTI
Unlike FDII, GILTI applicable to all US shareholders of a CFC - - not just C Corporations
Provisions are more punitive to non-C Corporate shareholders

75. International Provisions - GILTI
Observations
Additional clarification guidance expected
Foreign tax credit computations are more cumbersome and require more tracking than regular Subpart F
It appears taxes paid or accrued by CFCs with tested losses are lost and cannot be used to offset tax owed on GILTI inclusion -- no carryforward for disallowed credits is provided
INTANGIBLE INCOME IS NOT THE TRADITIONAL DEFINITION – IT IS POSSIBLE FOR ANY CFC TO HAVE RISK OF THIS INCOME

76. International Provisions - GILTI
Observations
Expense allocation will likely result in FTC limitation, therefore a residual US tax may be owed even with a foreign effective rate of %
Seems as though an foreign effective tax rate of % will be needed for this not to apply
CAUTION: DON’T FORGET ABOUT DOWNWARD ATTRIBUTION RULES NOW. A 10% US SHAREHOLDER WHO PREVIOUSLY DID NOT HAVE TO WORRY ABOUT SUBPART F BECAUSE THE FOREIGN SUBSIDIARY WAS NOT OWNED GREATER THAN 50% BY US SHAREHOLDERS COULD HAVE AN ISSUE.

77. International Provisions - Other
We covered items that are most likely to impact part of our client base, but there are other items that may need to be considered:
Modifications other than GILTI and Transition Tax have been made to Subpart F Income
Modifications to the foreign tax credit system
PFIC rules have been slightly modified
Sale of partnership interest by a foreign partner may be treated as ECI

78. Questions
Answers

79. Thank you!