tax reform 12.1.2017 - joe cruz ey

Tax legislative and policy update

Current as of November 22, 2017


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Legislative status update

Health care

► Administration to stop making cost-sharing reduction (CSR) payments

► Alexander-Murray legislation would ensure CSR payments through 2019; provide

states greater flexibility to meet ACA requirements; restore funding for ACA outreach,

enrollment assistance

► Individual mandate “repeal” added to tax reform; other reform could be part of year-end

discussions on government funding

Budget

► October 26: House approved Senate-passed budget resolution 216-212

► Approval by both chambers authorized reconciliation process, allowing tax bill to pass

Senate with the votes of as few as 50 senators (with the Vice President breaking tie)

► Reconciliation instructions provide for $1.5 trillion tax cut; other tax cuts must be offset

► Government funding expires December 8: negotiations will be bipartisan, failure could

mean government shutdown

Tax reform

► House passed its Tax Cuts and Jobs Act November 16

► Senate Finance Committee released summary text of its version of the Tax Cuts and

Jobs Act November 9, and passed a modified Chairman’s Mark November 16

► Full Senate floor action expected in late November, early December


Business tax highlights of House and Senate tax reform plans*

• 20% corporate rate, beginning 2018; AMT repealed

• 25% tax rate generally applied to passive business activity

income plus “capital percentage” (generally 30%) of active

income

• Limits interest deduction to 30% of earnings before interest, tax,

depreciation and amortization (EBITDA) with additional limit

based on global group income

• Immediate expensing – five years

• Expands definition of covered employee (§162m)

• Establishes territorial exemption system for dividends received

by US corporations from 10%-owned foreign corporations

• One-time transition tax – 14% / 7%

• New broad-based anti-deferral provision taxes “foreign high-

return amount” on a current basis at 10% effective tax rate (some

foreign tax credits (FTCs) available)

• 20% excise tax on certain deductible payments to related foreign

persons

House

• 20% corporate rate, beginning 2019; AMT repealed

• 17.4% deduction for domestic qualified business income from a

partnership, S corporation, or a sole proprietorship

• Limits interest deduction to 30% of earnings before interest and tax

(EBIT) with additional limit based on global debt to equity

• Immediate expensing – five years

• Expands definition of covered employee (§162m)

• Establishes territorial exemption system for dividends received by

US corporations from 10%-owned foreign corporations

• One-time transition tax – 10% / 5%

• New broad-based anti-deferral provision taxes “global intangible

low-taxed income” on a current basis at 10% effective tax rate

(some FTCs available)

• New deduction available for “foreign-derived intangible income”

• Anti-base erosion measures include minimum tax of 10%, applied

on income determined after adding back deductible payments

made to related foreign persons

Senate Finance Committee

Note: These provisions are detailed and highly complex. This chart, and the ones that follow, are intended to provide a high-level overview, and no inference is made that these provisions equate to one another. * “Plans” refer to the language as released and all amendments passed as of the date of these materials.


Corporate and business provisions

Provision House Senate Finance

Corporate income tax

rate

20% rate, beginning 2018; personal services

corporations taxed at 25%; AMT repealed

20% rate, beginning in 2019; 35% rate for

certain personal services corporations

repealed; AMT repealed

Expensing

Immediate write-off of qualified property placed

in service after September 27, 2017, and

before January 1, 2023. Repeals “original use”

requirement. Excludes from the definition of

qualified property certain public utility property

and property of real property trade or business

Immediate write-off of qualified property placed

in service after September 27, 2017, and

before January 1, 2023, by increasing bonus

depreciation percentage to 100%. Excludes

from the definition of qualified property certain

public utility property (real property excluded by

requirement that recovery period be 20 years

or less), but includes qualified film, television

and live theatrical productions.

Interest expense

Limits deduction of net interest expense to

30% of the business’s adjusted taxable

income not taking into account interest,

depreciation, amortization, depletion, or net

operating losses (NOLs), (disallowed

amounts may be carried forward five tax

years). Exclusion for taxpayers that meet a

$25 million gross receipts test and certain

regulated public utilities and real property

trades or businesses (not eligible for full

expensing).

Limits deduction of net interest expense to

30% of the business’s adjusted taxable

income not taking into account interest, pass-

through deduction, or NOLs (disallowed

amounts may be carried forward indefinitely).

Exclusion for taxpayers that meet a $25

million gross receipts test, certain regulated

public utilities and certain electric

cooperatives. Farming businesses could elect

to not be subject to the limitation, but would

have to use alternative depreciation rules.


Corporate and business provisions (cont’d)


Rate for pass-through

entities

25% tax rate generally applied to passive

business activity income plus the “capital

percentage” of active business activity

income (generally 30%; 0% for certain

personal services businesses; special rules

for capital intensive business); 9% tax rate

on first $75k for small businesses (benefit

begins to phase out after $150k; 9% rate

phased in over five tax years).

17.4% deduction for domestic qualified

business income from a partnership, S

corporation, or sole proprietorship.

Deduction generally does not apply to

specified service businesses but available

to service providers with income under

certain monetary thresholds. For taxpayers

with qualified business income from a

partnership or S corporation, deduction

limited to 50% of W-2 wages (limit phased

in for individuals with taxable income over

$500k (married, filing jointly)

Net operating losses

(NOLs)

Deduction limited to 90% of the taxpayer’s

taxable income (determined without regard to

the NOL deduction). NOLs may be carried

forward indefinitely. Carrybacks repealed

(limited small business/farm

exception).Generally effective for losses

arising in tax years beginning after 2017.

Deduction limited to 80% of the taxpayer’s

taxable income (determined without regard to

the NOL deduction). NOLs may be carried

forward indefinitely. Repeals the two-year

carryback and the special carryback

provisions, but provides a two-year carryback

for certain farming losses. Preserves current

law for NOLs of property and casualty

insurance companies. Applies to tax years

beginning after 2022


Corporate and business provisions (cont’d)


Research and

development credit

Retained but research and experimental

expenditures must be capitalized and

amortized over a 5-year period (15 years in

the case of expenditures attributable to

research conducted outside the United

States) (applies to those paid or incurred

during tax years beginning after 2023)

Retained but research and experimental

(R&E) expenditures must be capitalized and

amortized over a 5-year period (15 years in

the case of expenditures attributable to

research conducted outside the United

States) (applies to those paid or incurred

during tax years beginning after 2025).

Reporting requirement for R&E

expenditures in tax years beginning after

2025

Section 199 deduction Repealed Repealed

Work Opportunity Tax

Credit (WOTC); New

Markets Tax Credit

(NMTC); Low-income

housing tax credit

(LIHTC)

WOTC repealed. No new NMTC allocated

after 2017. LIHTC retained.

Retained; modifications made to LIHTC,

including renaming it “Affordable Housing

Tax Credit”

Like-kind exchanges Limited to exchanges of real propertyLimited to exchanges of real property that is

not held primarily for sale

“Orphan drug credit” RepealedLimited. Rate set at 27.5%, certain limits for

previously approved drugs removed


Senate Finance plan – other key provisions affecting businesses and corporations

• Requires taxpayers to recognize income no later than the tax year in which the

income is taken into account on an applicable financial statement, with certain

exceptions

• Increases the maximum amount a taxpayer may expense under Section 179 to

$1,000,000 for property placed in service after 2017; increases the phase-out

threshold amount to $2,500,000 (more generous provision is in House W&M

Committee bill)

• Disallows deduction for entertainment, amusement, or recreation that is directly

related to or associated with the active conduct of a trade or business; may still

generally deduct 50% of food and beverage expenses associated with operating a

trade or business (also in House W&M Committee bill). Disallows an employer’s

deduction for expenses associated with meals provided for the convenience of the

employer on the employer’s business premises or through an employer-operated

facility

• Modifies certain rules governing partnerships, life insurance companies, and tax-

exempt organizations (see analogues in House W&M Committee bill)


Senate Finance plan – other key provisions affecting businesses and corporations (cont’d)

► Finance Committee Chairman Hatch remains interested in corporate

integration

► Senate tax reform bill would create a new Section 242 and would allow

eligible corporations a “dividend paid deduction” with a 0% rate

► Permits corporations to deduct 0% of dividends in computing taxable

income subject to tax under Section 11

► Adds a new requirement for corporate taxpayers that pay dividends to

shareholders

► Policy rationale for corporate integration

► Address debt/equity imbalance

► Unlock “trapped” offshore earnings

► Attack earnings stripping

► Close gap with pass-throughs


Senate Finance plan – international provisions

• Territorial System: ≥10% US corporate shareholders may deduct 100% of the foreign-

source portion of dividends from foreign corporations (excluding certain “hybrid”

dividends)

• One-time transition tax: Accumulated deferred foreign earnings subject to a transition

tax at two rates (payable over eight years):

• 10% for earnings held in cash and cash-equivalents; 5% for the balance

• Relevant foreign earnings are:

• Those accumulated in years beginning after 1986, during periods in which the

foreign corporation had a ≥10% US shareholder

• Measured as of Nov 9, 2017, or other measurement date (“as appropriate”)

• Mandatory inclusion year: Foreign corporation’s last year beginning before 2018

• No new limitation on use of foreign tax credit carryforwards or other attributes to

reduce the tax; foreign taxes on earnings deemed repatriated partially available;

may elect to preserve NOLs and opt out of utilizing them to offset the mandatory

inclusion

• Claw-back provision if a US shareholder inverts within 10 years; entire mandatory

inclusion taxed at 35% without allowance for foreign tax credits


Senate Finance plan – international provisions (cont’d)

• Current anti-deferral regime: Most categories of “includible” income retained, with some

important structural modifications (e.g., expanded definitions both of US shareholder and of

controlled foreign corporation (CFC))

• New broad-based subpart F category: global intangible low-taxed income (GILTI)

• GILTI (aggregated for the CFCs of a US shareholder) is the excess (if any) of (i) certain net items of income of the

CFCs, over (ii) a deemed return on related tangible property

• Credit to corporate US shareholders: 80% of attributable foreign income taxes

• US shareholder entitled to a deduction equal to 50% of recognized GILTI (reduced to 37.5% after 2025), resulting in

a 10% effective tax rate on GILTI (12.5% after 2025)

• New export incentive in the form of a deduction for US corporations for “foreign-

derived intangible income” (FDII)

• FDII is the “foreign-derived” portion of the excess (if any) of (i) certain net items of income, over (ii) a deemed return

on related tangible property

• Foreign-derived: Generally, product sales and services by the taxpayer to non-US persons outside of the

United States

• Applicable to certain GILTI inclusions and income earned directly (but excluding foreign branch income)

• Deduction equals 37.5% (for an ETR of 12.5%) of the lesser of (i) the sum of FDII and GILTI inclusion, and (ii)

taxable income (as otherwise calculated); (reduced to 21.875% after 2025, for an ETR of 15.625%)



• New intangible “inbounding” provision: Tax-free repatriation of intangible property

• New limitations on interest expense deduction

• All taxpayers (including pass-throughs): Disallowance of deduction for net business interest

expense exceeding 30% of adjusted taxable income for the year, which is generally analogous

to EBIT (i.e., pre-tax, pre-interest earnings after the deduction for depreciation, depletion and

amortization (DD&A))

• US corporate members of worldwide affiliated groups: Disallowance of deduction for a portion

of net interest expense, calculated with reference to “excess indebtedness” (generally, the

excess of US debt over 110% of proportionate worldwide group debt)

• Transfers of intangible property (IP): Expands the definition of IP (e.g., to include

goodwill) and authorizes the Commissioner to use certain methods to value IP (e.g.,

realistic alternative principle).

• New hybrid mismatch rule: Deductions disallowed for certain related party interest and

royalties paid or accrued (i) pursuant to a “hybrid transaction” or (ii) by/to a “hybrid entity”

• Repeal of special rules for DISCs and IC-DISCS

• New separate Section 904 “baskets” for both foreign branch income and GILTI



• New base erosion minimum tax

• Tax imposed on an “applicable taxpayer” equal to the excess of 10% of modified taxable

income over the regular tax liability for the year (increased to 12.5% after 2025).

• Modified adjusted taxable income is taxable income determined without regard to

any “base erosion tax benefit” from any “base erosion payment” for the year

• Base erosion payment is generally any amount paid or accrued to a related foreign

person with respect to which a deduction is allowable, but does not include

amounts included in cost of goods sold

• Base erosion tax benefit means any deduction allowed with respect to a base

erosion payment

• Applicable taxpayer is a corporation (other than a RIC, REIT, or S Corp):

• Which has average annual gross receipts of at least $500 million for the three-year

period ending with the preceding year; and

• Which has a “base erosion percentage” of 4% or higher for the year

• Base erosion percentage is the aggregate amount of base erosion tax benefits divided

by aggregate amount of allowable deductions


House Ways and Means plan – international provisions

• Territorial system: 100% deductions for foreign source dividends received from foreign

subsidiaries by a 10% or greater US corporate shareholder

• One-time transition tax: Accumulated foreign earnings subject to a transition tax at two

rates (payable over eight years):

• 14% for earnings held in cash and cash-equivalents; and 7% for the balance

• Mandatory inclusion equals the greater of foreign earnings accumulated in tax

years beginning after December 31, 1986, determined as of:

• November 2, 2017, or

• December 31, 2017

• Mandatory inclusion for last year of a specified foreign corporation beginning

before January 1, 2018

• Foreign tax credit carryforwards fully available, foreign tax credits triggered by

deemed repatriation partially available

• No overall foreign loss (OFL)/foreign oil and gas loss (FOGL) recapture


House Ways and Means plan – international provisions (cont’d)

• Current anti-deferral rules retained (other than foreign base company oil related income)

• Structural modification to subpart F rules made to expand definition of CFC

• New broad-based anti-deferral provision: A US shareholder must include in income

50% of any “foreign high-return amount” determined with respect to its CFCs

• The foreign high-return amount equals the excess, if any, of:

• The US shareholder’s CFCs’ “net tested income”, over

• A return (7% plus short-term AFR) on the CFCs’ qualified business asset

investment (“QBAI”) reduced by interest expense

• QBAI is the aggregate of the U.S. shareholder’s pro rata shares of its CFCs’ bases

in certain tangible property

• Tested income is all income other than specifically excluded amounts

• The US shareholder is entitled to a credit for 80% of the foreign taxes paid on that

income



• New excise tax: Nondeductible excise tax is imposed at a rate of 20% on specified

amounts paid by domestic corporations after December 31, 2018, to foreign corporations

that are members of the same international financial reporting group (“IFRG”)

• Specified amount includes an amount that is deductible, or includible as cost of goods

sold, inventory, or the basis of depreciable or amortizable asset

• Excludes interest, amounts paid or incurred to acquire certain commodities, any amount taxed

under Section 881(a) (effectively connected income, or “ECI”), and certain service fees

• An IFRG is a group of entities that files consolidated financial statements and that

contains at least one US member and one foreign member

• Foreign corporation can make an irrevocable election to instead treat specified amounts

as ECI and be subject to net-basis taxation

• A deemed expense amount is allowed to offset the deemed ECI

• Limited foreign tax credits can be used to offset the tax

• US branch profits tax may also apply if ECI election is made

• Limited to IFRGs with average annual aggregate outbound payments in excess of $100

million over 3-year period



• Limitations on interest expense deduction

• New 163(j) generally limits deduction for net business interest expense to 30

percent of adjusted taxable income for the year, which is generally analogous to

EBITDA

• New 163(n) limits deduction for net interest expense of a US corporation that is

member of an IFRG (see above) to 110% of the corporation’s share of the group’s

net interest expense, based on the ration of the US corporation’s EBITDA and the

group’s EBITDA (as determined under GAAP / IFRS)

• A US corporation subject to both provisions must apply the one that disallows the greater

amount of interest deduction

• Interest disallowed under either provision may be carried forward up to five years, usable

on first-in, first-out basis

• Limited to groups with average annual gross receipts in excess of $100 million over 3-

year period

• Applies to taxable years beginning after December 31, 2017


Final US tax reform legislation – what’s anticipated

Lower ratesFinal legislation is expected to reduce both the corporate and individual

income tax rates. A new rate for flow-through entities may be included.

Broader tax

base

To pay for the proposed lower rates, US tax reform proposals include a wide

array of base-broadening provisions (e.g., limitations on deductions). The

base-broadening proposals will likely extend to both business and individual

taxation (and may come with a series of complex transition rules).

A move to a territorial system of taxation is expected, and will likely include

some type of “toll charge” on previously untaxed accumulated foreign

earnings with the rate determined by whether the earnings are in cash or

non-cash assets.

New

international

tax system

Timing

While the timing is subject to change, Republicans are targeting:

► White House: Republican framework released September 27

► House: Legislative language – November 2; passed November 16

► Senate: Legislative description – November 9; legislative language

November 21; passage November/December

► Reconcile bills/signing: December (though may push into early 2018)

Next steps in tax reform

Senate Finance Committee’s tax reform plan

Preparing for change

Preparing for US tax reform involves understanding the leading proposals and their potential effects,

implementing strategies that account for these changes and educating policymakers on their real-world impact.

Model tax reform

proposals:

See how proposals

could affect your federal

and state liabilities and

business operations

Undertake

scenario

planning:

Use model output to run

scenario planning

Plan:

Prepare for change and

consider implementing

planning strategies

Influence:

Engage lawmakers on

provisions that could

significantly affect your

tax liability and business

operations

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Policy Perspectives | Ernst & Young LLP’s rapid response to the Senate Finance Committee’s tax reform plan

Senate Finance Committee’s tax reform plan

tax reform 12.1.2017 - joe cruz ey

Economy & Finance