The Act simplifies the Internal Revenue Code (the “Code”) for individuals by consolidating various exemptions and deductions into a larger Standard Deduction. The Act does not make changes with respect to the maximum rate for capital gains and qualified dividends. The Act lowers overall income tax rates but does not reduce the number of brackets. The Act does eliminate the individual mandate tax related to the Affordable Care Act.
Tax Rates. The tax brackets and rates below expire and revert to the previous rates beginning in 2026.
The New Tax Brackets are as follows:
For Joint Filers (based on taxable income):
- 10% from $0 to $19,050
- 12% from $19,050 to $77,400
- 22% from $77,400 to $165,000
- 24% from $165,000 to $315,000
- 32% from $315,000 to $400,000
- 35% from $400,000 to $600,000
- 37% from $600,000 and above
For Single Filers:
- 10% from $0 to $9,525
- 12% from $9,525 to $38,700
- 22% from $38,700 to $82,500
- 24% from $82,500 to $160,000
- 32% from $160,000 to $200,000
- 35% from $200,000 to $500,000
- 37% from $500,000 and above
Repeal of ACA Individual Mandate: The individual mandate under the Affordable Care Act is repealed.
“Kiddie Tax” Changes: Both the ordinary and capital unearned income of a child will be taxed at the same rates as applied to trusts and estates.
Standard Deduction. This provision will expire and revert to the previous system in 2026.
- Increased Standard Deduction: The Standard Deduction for individuals is increased as follows:
- For Single Individuals, to $12,000.
- For a Head of Household, to $18,000
- For Married Joint return, to $24,000.
Itemized Deductions. This provision will expire and revert to the previous system in 2026.
Reduction in Itemized Deductions: In concert with simplifying the tax brackets and increasing the Standard Deduction, several itemized deductions are reduced or eliminated:
- Miscellaneous Itemized Deductions: The Act eliminates all miscellaneous itemized deductions subject to the 2% floor.
- Mortgage Interest Deduction: For new mortgages entered into for first or second homes after November 2, 2017, the deduction for home mortgage interest is limited to mortgages of $750,000 or less.
- Exception: Mortgages entered into before November 2, 2017, or the refinancing of such mortgages, are not subject to this limitation.
- Home Equity Loans: The deduction for interest on home equity loans is eliminated.
- State and Local Taxes: The deduction for state and local income taxes, property taxes, and sales taxes is capped at a total of $10,000 in the aggregate.
- Exception for Businesses: State and local income and property taxes paid or accrued in the carrying on of a trade or business are still fully deductible by the business.
- Itemized Deduction Limitation: The Act eliminates the overall limitation on itemized deductions for high-income taxpayers earning over $261,500 a year.
- Increase in Charitable Giving Deduction Amount: The limitation on the charitable giving deduction is raised to 60% of the donor’s adjusted gross income.
- Medical Expense Deductions: The threshold for deducting medical expenses is 7.5% of adjusted gross income.
- Deductions Eliminated: The following deductions are eliminated:
- Alimony payments (beginning in 2019)
- The recognition of income by the recipient is also eliminated
- Personal exemptions and dependents
- Personal casualty losses (e.g. fire, storm, theft, etc.)
- Exception: Losses incurred from a Federally Declared Disaster will be deductible
- Student loan interest payments
- College Stadium Seating Licenses (e. licenses which permit the purchase of season tickets at a college sports stadium)
- Moving expenses
- Exception: Moving expenses incurred by members of the Armed Forces related to a deployment will remain deductible.
- Trade or business expenses related to being an employee.
Exclusions for Income. This provision will expire and revert to the previous system in 2026.
Exclusions Eliminated: The following exclusions from income are eliminated:
- Qualified Bicycle Commuting Reimbursements.
- Employer moving expense reimbursements.
- Income on the interest of a U.S. Savings Bond which is used to pay for education.
- Income related to Employer-Provided Education Assistance.
- Employee Achievement Awards (i.e. retirement gifts) which are composed of cash, cash equivalents, gift coupons, vacations, meals, lodging, or tickets.
Tax Credits. This provision will expire and revert to the previous system in 2026.
Child Tax Credit Increased: The Child Tax Credit is increased to $2,000 a year, plus an additional $500 a year nonrefundable credit for all qualifying non-child dependents. The amount of income at which these credits begin to phase out begins at $400,000 a year for joint filers. The earned income threshold for a refund of the credit is lowered to $2,500, and the $1,400 maximum refund per child will be indexed for inflation.
Changes to Educational Incentives. This provision will expire and revert to the previous system in 2026.
In conjunction with the increase in the Standard Deduction and the elimination of most itemized deductions, changes will be made to certain educational incentives, including the exclusion of income related to a discharge of student debt resulting from death or disability, as well as permitting the use of Section 529 accounts for up to $10,000 per year of elementary and secondary education.
Changes to Executive and Deferred Compensation. The Act makes several changes to the taxation of executive compensation and deferred compensation:
Non-Performance Based Compensation: The Sec. 162(m) “$1 million pay cap” on non-performance-based compensation has been changed to eliminate exemptions provided for tax deductibility of qualified performance‐based compensation, including stock options. The Act also applies the deduction limitations to any individual deemed a covered employee for as long as they receive compensation from the company. Finally, the Chief Financial Officer (or Principal Financial Officer as defined by the SEC) is now subject to the limitation.
Expansion of Executive Compensation Excise Tax: The Corporate Excise tax on Executive Compensation is now applied to tax exempt organizations as well, and imposes a new 20 percent tax on any compensation over $1 million paid to a ‘covered employee’. The definition of a ‘covered employee’ encompasses the organization’s five highest‐paid current or former employees. Employees retain that status for as long as they receive compensation from the organization (or any successor organization). The Act also imposes excise tax penalties on excess severance pay (similar to the Section 280G tax penalties for excessive parachute payments in for-profit companies). The tax‐exempt organization is responsible for paying this new tax.
Qualified Equity Grants for Private Companies: Effective in 2018, the Act allows private companies to offer rank-and-file employees the opportunity to defer income attributable to stock received following a stock option exercise or settlement of an RSU for up to five years if the stock is not tradeable on an established securities market. The Act’s guidance has a number of very specific rules that must be followed and excludes from this favorable tax treatment the CEO, CFO and the next four highest paid executives and certain shareholders.
Qualified Deferred Compensation: Generally speaking, the changes to deferred compensation plans make it easier for taxpayers to withdraw amounts from their plan at a younger age:
- Disaster Distributions: Qualified Plan holders may make a 10% early distribution related to a presidentially declared disaster which occurred in 2016 and may pay income tax on such distribution ratably over 3 years.
- Extended Rollover Period for Plan Loan Offsetting: Any employee who takes out a loan from their 401k plan and then ends their employment will have until the due date for next year’s tax filing, up from 60 days, to contribute the loaned amount to an IRA.
- Roth IRA Unwinds Disallowed: Taxpayers are no longer able to unwind a Roth IRA conversion.
ESTATE AND GIFT TAXATION
Increase in Exclusion Amount for Gift and Estate Taxes. The lifetime exclusion available for taxable gifts and bequests is increased from $5.490 million to $11.2 million beginning on January 1st 2018. A married couple can now transfer up to $22.4 million of taxable gifts and bequests before being subject to federal tax. This new provision is currently set to expire in 2026. Upon expiration this provision reverts back to prior law.
Deduction for Business-Related Income. Business owners of pass-through entities (e.g. sole proprietorships, partnerships, LLCs, S-Corporations, trusts, and estates) are now allowed to deduct 20% of their domestic Qualified Business Income (i.e. the net of a taxpayers items of income, gain, deduction, and loss related to such taxpayers business).
Deduction Limit: The deduction will be equal to 20% of the sum of:
- The lesser of:
- The Combined Qualified Business Income for such taxable year or
- 20% of the taxpayer’s taxable income over any net capital gain and qualified cooperative dividends,
- Plus, the lesser of 20% of:
- Qualified Cooperative Dividends, or
- Taxable gain (reduced by capital gains)
- For taxpayers earning income from an S-Corporation or Partnership greater than the $315,000 threshold amount, the deduction is limited to the greater of (A) 50% of the business’ W-2 wages, or (B) 25% of the business’ W-2 wages plus 2.5% of the unadjusted basis of all qualified property used in the trade or business.
- Qualified Property: Tangible property subject to depreciation.
Limitation for Specified Service Businesses: The deduction is not available to Specified Service Businesses, except for taxpayers with $315,000 or less of income, and is phased in for income over $315,000 over the next $100,000 of income.
- Specified Service Businesses: Those in fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or any other where the principal asset is the skill or reputation of the employees or owners.
Substantial built in Losses: The Substantial built in loss rules are expanded to create a Substantial Built-In Loss where a partner will be allocated a net loss in excess of $250,000 were such partner to transfer their interest.
Basis Limitation on Partner Losses: The basis limitation of losses now applies to a partner’s distributive share of charitable contributions and foreign taxes.
Partnership interests received in connection with the performance of services will now be subject to a 3-year holding period in order to qualify for long-term capital gains.
Self-Created Intellectual Property.
Income from the sale of a self-created patent (other than a musical work) is now ordinary income rather than capital.
Like-kind exchanges are now only allowed for real property not held primarily for sale.
Technical Termination Rules Eliminated.
The Technical Termination rules for partnerships (treating a transfer in a year of 50% or more of the total interest in partnership capital and profits as a liquidation of the partnership and formation of a new partnership) are eliminated.
Contributions to a Business in Excess of Value of Shares.
Contributions of capital to a business no longer includes the following, which are now taxable as income:
- Contributions made in aid of construction
- Contributions made as a customer or potential customer
- Contributions made by a civic group or governmental entity
Alternative Minimum Tax. The Act retains the AMT for individuals but eliminates it for corporations.
Threshold for Individuals: The Act increases the threshold for application of the AMT for individuals to $109,400 for joint filers, $70,300 for single taxpayers, and $54,700 for married taxpayers filing separately.
Corporate Tax Rate. The previous tiered corporate tax rate is replaced with a flat 21% rate.
Accelerated Cost Recovery.
Recovery Period for Real Estate: The recovery periods for qualified leasehold improvements, qualified restaurant property and qualified retail improvement property are all consolidated as “qualified improvement property” and given a 15-year recovery period. Residential real property and non-residential real property remain at 27.5 years and 39 years respectively. These changes apply to property placed in service beginning in 2018.
Depreciable Property: Property which has been permitted bonus depreciation under 168(k) which is placed in service between September 27, 2017, and January 1, 2023, can, at the taxpayer’s election, be 100% deducted in the year in which it is placed in service, rather than depreciated. The property need not be new property but must not be previously used by the taxpayer. Thereafter, the amount of basis which can be immediately expensed will decrease by 20% every year from January 1, 2023 through January 1, 2027.
- Exception: This change excludes property used by a public utility.
- Exception: Property which was acquired prior to September 27, 2017 but placed in service thereafter is not eligible for 100% expensing. Rather, such property will be eligible for 50% bonus depreciation if placed in service in 2017, 40% if placed in service in 2018, 30% if placed in service in 2019, and 0% thereafter.
Personal Automobiles and Computers: Deduction limitations for automobiles are increased. Rules treating computers as special property are removed.
Farm Equipment: The recovery period is shortened to five years at taxpayer’s election.
Section 179 Property: Up to $1 million in Section 179 property can be immediately expensed, with a phase-out beginning when over $2.5 million of Section 179 property is placed in service in a given year. These limitations will be indexed for inflation beginning for years after 2017.
- Expanded Definition: Section 179 now includes personal property used to furnish lodging, as well as property used in a qualified film, television, and live theatrical production. The Act also expands the definition of Qualified Real Property eligible for Section 179 expensing to include improvements to nonresidential real property including roofs, HVAC, fire, alarm, and security systems.
Reduction in Dividends Received Deduction: The 80% and 70% dividends received deductions are reduced to 65% and 50% respectively.
Limitation on Deductible Interest: All businesses with $25 million or more in gross receipts (other than public utilities, certain electric cooperatives, and real estate businesses which elect to use the Alternative Depreciation System) will suffer the disallowance of interest deductions in excess of the sum of 30% of adjusted taxable income, business interest income, and floor plan financing interest.
- Adjusted Taxable Income: Defined as taxable income calculated without regard to any item of income, gain, deduction, or loss which is not properly allocable to a trade or business, any business interest or business interest income, any NOL under section 172, and any deduction allowed under section 199 or 199A.
Excess Business Loss Limitation: Excess Business Losses (i.e. the excess of aggregate deductions attributable to trades or business over the sum of aggregate gross income of taxpayer plus a Threshold Amount) will be carried forward as part of the taxpayer’s NOL.
Inclusion in Charitable Contributions and Foreign Taxes: A partner in a partnership may include in losses their share of charitable contributions and foreign taxes paid by the partnership.
Research and Development Expenses: Beginning in 2022, all Section 174 R&D expenditures will be required to be capitalized and amortized over 5 years rather than deducted immediately.
Worker Safe Harbor: A safe harbor will be created to provide certainty as to whether a service provider is an employee of a business.
Deductions Eliminated: The following business deductions are eliminated:
- Local lobbying expenses
- Amounts paid under a settlement subject to a non-disclosure agreement in connection with sexual harassment or sexual abuse
- FDIC Premiums
- The Domestic Production Activity Deduction
- The Entertainment Expense Deduction
- Exception: 50% of food and beverage expenses related to operating a trade or business would be retained until 2026.
- Employer deductions for fringe benefits provided to employees.
Although the Act retains the Low-Income Housing Tax Credit, the Work Opportunity Tax Credit, and R&D Tax Credit, several credits are modified or eliminated in order to balance the reduced corporate tax rate.
- Orphan Drug Credit: The Credit for Testing of Certain Drugs for Rare Disease or Conditions (the “Orphan Drug Credit”) is now limited to 25% of the qualified clinical tests expenses in the taxable year over the average qualified clinical test expenses for the preceding three years.
- Rehabilitation Credit: The 10% rehabilitation credit is eliminated, and the 20% rehabilitation credit is now claimed ratably over 5 years.
- Transition Rule: For buildings owned or leased by the taxpayer on or after January 1, 2018, rehabilitation costs will still qualify for old credits if work begins within 180 days of beginning of 2018.
- Credit for Wages Paid under FMLA: Employers are able to take credit of 12.5% on 50% of the wages paid to an employee under FMLA, increased by 0.25% for each 1% of wages paid above 50%.
- New Market Tax Credits: The Act is silent as to the NMTC but creates Qualified Opportunity Funds which may invest in Qualified Opportunity Zones which will be created. Income from investments in these Qualified Opportunity Funds will be deferred, with the amount of gain recognized will be reduced the longer the investment is held.
Tax Exempt Bond Interest.
Advanced Refunding Bonds: The Act eliminates the tax-free nature of interest for Advanced Refunding Bonds
Change to Accounting Method Rules.
Small Corporations: A corporation with up to $25 million in gross receipts is now permitted to use the cash method of accounting, even if such business has inventories. In addition, corporations with $25 million or less in gross receipts are now exempt from the UNICAP rules, and will be able to use the completed-contract method for long term contracts. Finally, businesses with $25 million or less in gross receipts are now exempt from the interest expense limitation rules noted above.
Craft Beverages: The aging period for beer, wine, and distilled spirts is now excluded from the UNICAP production period.
OID: Income included on financial statements related to OID is now included in the same year as the financial statement, rather than ratably over the life of the loan.
The rules allowing a roll-over of gain from the sale of stock if the proceeds are invested in Small Business Investment Corporations are repealed.
The Credit for FICA taxes attributable to tips in restaurants is updated to reflect the current minimum wage.
In addition to the broad changes to the taxation of businesses described above, the Act also contains a number of changes specific to insurance companies. The details of these changes are beyond the scope of this summary.
The Act lowers the excise taxes on beer, wine, and spirits.
Subsidiary Dividends. The foreign source portion of all dividends from a 10% or more owned foreign subsidiary (that is not a PFIC and that is also a CFC,) owned for at least 365 of the prior 731 days, is now 100% deductible. The deduction is not available for hybrid dividends (amounts received which also received a deduction or other benefit from foreign taxes paid). The foreign tax credit is disallowed for amounts that qualify for this new dividend deduction. This rule does not apply to dividends received from a “surrogate foreign corporation.”
Foreign Source Portion: The amount of the dividend which is composed of undistributed E&P not attributable to effectively connected income (“ECI”) or dividends from an 80% owned domestic corporation, determined on a pooling basis.
Sale of Subsidiary Stock: The amount of income received by the selling corporation which is treated as a dividend under Section 1248 is eligible for the new deduction.
- Exception: Gain from the sale of lower-tier CFC stock by a higher-tier CFC will be treated as Subpart F income and will not be eligible for the new 100% dividend received deduction.
Reduction in Basis of Subsidiary Stock: The basis of stock in a 10% foreign subsidiary will be reduced by exempt dividend income received from that subsidiary, but only for the calculation of any loss on disposition of the stock.
Inclusion of “Transferred Loss” in Income: If a 10% owned subsidiary acquires substantially all the assets of a foreign branch, the domestic owner will include in income the Transferred Loss Amount.
- Transferred Loss: The cumulative excess of losses of the foreign branch over the cumulative income of the foreign branch.
Recognition of Deferred Foreign Income: Any U.S. shareholder of a foreign corporation that has one or more “U.S. shareholders” must include as Subpart F income in its last taxable year prior to 2018 such Shareholder’s pro rata share of the earnings and profits (“E&P”) of such subsidiary, to the extent such profits have not yet been included in U.S. income. Such income will be taxed at 15.5% for earnings that are held in cash or cash equivalents and 8% for other assets. Taxpayers may elect to recognize such income over an eight-year period.
- Recapture: Any entity that becomes an “expatriated entity” within ten years of the Act’s enactment will be subject to a 35% tax rate on the mandatory inclusion amounts.
- PFICS: This provision does not apply to PFICS that are not also CFCs.
- S-Corporation and REIT Exception: This provision does not apply if the U.S. Shareholder is a REIT. In the case of an S-Corporation, the tax on repatriation may be deferred until the entity ceases to be an S-Corporation or otherwise liquidates; however, if such tax is deferred, the S-Corporation must be made jointly and severally liable for the tax.
- Foreign Tax Credit: The Foreign Tax Credit is partially disallowed for dividends exempt under the Act to the extent of E&P not subject to the tax. The Foreign Tax Credit is still available with respect to Subpart F income, but only to the extent such income is included in a U.S. Shareholder’s gross income.
- The Foreign Tax Credit is available for the taxes related to affiliated payments and foreign affiliates’ routine returns. A separate foreign tax credit limitation basket is now added for foreign branch income.
Apportionment of Gain Based on Production Location of Property: Income from the sale of property produced within the U.S. and sold outside (or vice versa) is now sourced exclusively based on the production location. The former split sourcing rule based on location of production and location of sale has been eliminated.
Sale of Partnership Interest: Gain or loss from sale or partnership interest is ECI to extent that the transferor would have had ECI, had the partnership sold all its assets for FMV. This is a reversal of the court holding in the recent Grecian Magnesite case.
- Withholding: Transferee of interest must withhold 10% of amount realized in sale unless the transferor certifies they are not a nonresident alien or foreign corporation.
Subpart F Income. In addition to the changes discussed with respect to dividend income, the following changes have also been made to expand Subpart F income:
Deemed Ownership of Foreign Held Stock: U.S. corporations may be treated as owning stock in a subsidiary which is held by foreign shareholders under certain circumstances.
Deletion of Timing Exception for Controlled Foreign Corporations (“CFCs”): A U.S. Shareholder will be taxed on its share of a CFC’s Subpart F income even if the Shareholder has not held stock in the CFC for more than 30 days during the year in which the Subpart F income was earned by the CFC. This is an elimination of the former 30-day rule.
Limitations on Subpart F Income: New rules will help to limit Subpart F income, including the elimination of the foreign oil related income basket from Subpart F income.
Base Erosion. The Act seeks to reduce “base erosion” through the use of transfer pricing and tax treaty shopping.
Global Intangible Low-Taxed Income (“GILTI”): U.S. shareholders of CFCs will now be taxed currently on 50% of all GILTI, with a 37.5% deduction for all foreign-derived intangible income (reduced to 21.875% after 2025).
Hybrid Transactions: Related party deductions related to hybrid transactions or hybrid entities will now be denied.
Base Erosion Anti-Abuse Tax: Certain corporate taxpayers with gross receipts of at least $500 million are required to pay the Base Erosion Anti-Abuse Tax (the “BEAT Tax”). The BEAT Tax is equal to the “base erosion minimum tax.”
- Base Erosion Minimum Tax: Is a tax imposed on “base erosion payments” paid by a taxpayer to a foreign related person. The Tax is imposed on the excess of 10% (increased to 12.5% after 2025) of the modified taxable income of the taxpayer over the regular tax liability under section 26 of the taxpayer for such taxable year, reduced by the excess of credits allowed under Chapter 1 of the Internal Revenue Code over the sum of R&D credits plus all other Section 38 credits (not in excess of 80% of the lessor the amount of such credits or the Base Erosion Minimum Tax amount).
- Exception: Base erosion payments won’t include amounts paid or accrued for services which qualify for the use of the services cost method under Treas. Reg. 1.482-9, without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure, and only if the payments are made for services that have no mark-up component.
Foreign Investment Income.
Insurance Company Exception on PFICs: The exception from the Passive Foreign Investment Corporation “(PFIC”) rules, excluding income earned in the active sale of insurance, are amended so that such income will only be excluded if the PFIC will be treated as an insurance company under U.S. law.
TAX EXEMPT ENTITIES
The Act changes several rules with respect to Not- for-Profit entities (“NFPs”). Generally, the changes increase the instances in which a NFP will incur the Unrelated Business Income Tax (“UBIT”) and investment income.
UBIT Income: UBIT is now be calculated separately for each trade or business of the NFP.
Taxation of Fringe Benefits: NFPs will now be taxed on fringe benefits provided to employees.
Standardizing Investment Income Excise Tax: Private Foundations will now be subject to a 1.4% excise tax on investment income, rather than the 2% or 1% variable system which was previously in place.
University Endowment Taxation: Private colleges and universities having at least 500 full-time students in the U.S. and assets (excluding those used directly in carrying out its exempt purpose but including those held by third parties for the university) worth at least $500,000 per student will now be subject to the 1.4% excise tax on investments.
The summary information in this document is being provided for educational purposes only. Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.