The Tax Cuts and Jobs Act (the Act or TCJA) became law approximately nine months ago, significantly transforming the federal tax code. This edition of the Tax Reform Progress Report focuses on: the new tax reform package introduced in the House of Representatives; IRS-proposed regulations on section 951A, global intangible low-taxed income (GILTI), providing guidance for determining a CFC’s GILTI income; and the IRS-proposed regulations to counter state legislation that provides workarounds to the state and local tax (SALT) itemized deduction cap of $10,000.
In this issue
- House Republicans unveil tax reform 2.0 package
- IRS and Treasury release proposed regulations on section 951A
- IRS proposes regulations to eliminate SALT limitation workaround
- Status of regulations
House Republicans introduced the “Tax Reform 2.0” legislative package on Sept. 10 and are expected to bring it up to a vote by the full House by the end of the month. The package consists of three separate bills, which strive to make permanent the individual and small business tax cuts currently expiring in 2025, expand retirement savings, and incentivize new businesses.
The Tax Reform 2.0 package includes:
- HR 6756, American Innovation Act of 2018
- HR 6757, Family Savings Act of 2018
- HR 6760, Protecting Family and Small Business Tax Cuts Act of 2018
It is unlikely this package will clear the Senate given the need to muster 60 votes for passage. The budget reconciliation process used to pass the TCJA with a simple majority is not available, as the cost of enactment would increase deficits beyond the 10-year budget window. The individual rate reductions were enacted in temporary form when the TCJA was passed to avoid the associated costs extending beyond the 10-year window. In addition, it is unclear whether Tax Reform 2.0 can even pass the House. The $10,000 cap on the state tax itemized deduction is unpopular with those House Republicans in high-taxed states, making it questionable as to whether they would vote for the package in its entirety.
HR 6756, American Innovation Act of 2018
The aggregate amount of startup and organizational expenses for an active trade or business would be deductible up to $20,000. It phases out when the aggregate amount exceeds a threshold starting at $120,000. Any remainder would be capitalized and amortized over 180 months. The $20,000 deductible amount and $120,000 threshold would be indexed for inflation using the cost-of-living adjustment. Upon liquidation or disposition of such trade or business, remaining unamortized costs would be deductible under section 165.
In addition, net startup losses can be excluded from limitations under section 382 in the event of an ownership change. Net startup losses would be defined as those incurred within the first three years of a corporation beginning its trade or business. However, if the new loss corporation does not continue the trade or business, the exclusion would not apply.
HR 6757, Family Savings Act of 2018
Multiple retirement savings plans would be expanded under this bill, including:
- pooled employer plans
- safe harbor 401(k) status
- certain taxable nontuition fellowship and stipend payments treated as compensation for IRS purposes
- repeal of maximum age for traditional IRA contributions
- portability of lifetime income investments
In addition, the bill extends the plan adoption date to the filing due date for the year as opposed to the close of the plan year. Nondiscrimination rules would change to protect older participants. Penalty-free withdrawals from retirement plans to assist with the costs of the birth or adoption of a child would also be included.
HR 6760, Protecting Family and Small Business Tax Cuts Act of 2018
This bill would make permanent the rate modifications from the TCJA, the new section 199A deduction as well as the loss limitations for noncorporate taxpayers. Further, certain individual tax changes would be modified, including:
- increase in standard deduction
- increase and modification of child tax credit
- increased limitation for certain charitable contribution
The deduction cap on the state tax deduction would remain at $10,000. The expiration of the TCJA repeal of personal exemptions, termination of miscellaneous itemized deductions and limitation on the qualified personal residence mortgage interest deduction would be removed.
The IRS and Treasury released proposed regulations on Sept. 13, 2018, implementing section 951A of the Internal Revenue Code (Code) as added by the Act. Section 951A annually subjects GILTI earned by a controlled foreign corporation (CFC) to U.S. tax on a current basis in the same manner as subpart F income. The proposed regulations provide guidance for determining a CFC’s GILTI income — but do not cover the GILTI deduction in section 250 or the GILTI-related foreign tax credit provisions of the Act. The preamble to the proposed regulations states that guidance covering the GILTI deduction and foreign tax credit rules is expected to be addressed separately in IRS notices.
Neither 951A nor the proposed regulations define income attributable to intangible assets. Instead, a CFC’s annual “GILTI inclusion amount” is determined by a formula and applies to the extent that a CFC’s “net CFC tested income” (defined below) exceeds an aggregate 10 percent deemed return on certain tangible assets (referred to as qualified business asset investment, or QBAI).
Due to the formulaic nature of the GILTI inclusion amount in section 951A and the rules contained in the proposed regulations, it is essential to understand the basic GILTI calculation. GILTI inclusion amount is the excess (if any) of:
- the U.S. shareholder’s aggregate net CFC tested income; over
- “net deemed tangible income return” (broadly, the U.S. shareholder’s aggregate pro rata share of 10 percent of QBAI less certain interest expense).
The components (and the inputs of the components) of this formula are described in the proposed regulations as follows: Proposed section 1.951A-1 provides a general GILTI inclusion amount calculation and defines terms used to make this determination. Proposed section 1.951A-2 and 1.951A-3 provide detailed guidance on items included in the GILTI inclusion amount formula — that is, tested income and tested loss (proposed section 1.951A-2) which are used to calculated net CFC tested income and the QBAI component of the formula (proposed section 1.951A-3). Proposed section 1.951A-4 provides rules for determining the interest expense required to calculate net CFC tested income and QBAI; and proposed section 1.951A-5 contains guidance applicable to domestic partnerships. CFC earnings and profits (E&P) and basis adjustments and dates of applicability are discussed in proposed sections 1.951A-6 and -7, respectively.
The proposed regulations also modify the pro rata rules in section 952(a)(2) (proposed section 1.951-1(b) and (e)) to account for the differences between application of the rules to subpart F income and the components of the GILTI calculation. Additionally, the proposed regulations amend the relevant consolidated group rules (proposed sections 1.1502-12, 1.1502-13, 1.1502-32 and 1.1502-51) to incorporate the section 951A requirements applicable to group members of CFCs.
Finally, new GILTI reporting requirements are included in proposed sections 1.6038-2, and 1.6038-5.
The TCJA limits individual deductions for state income and real estate taxes by imposing a $10,000 cap on this deduction. In response, several high-income-tax states began formulating long-term solutions around this $10,000 limitation.
Governors in high-tax states such as Maryland, New Jersey and New York have indicated they are exploring legal options to block the federal government from implementing the deduction limitation. States are also introducing and passing legislation with the intent to provide relief for residents living in high-tax states through swapping income taxes with different revenue-raising strategies that would result in an unlimited federal deduction. The most prevalent workarounds include charitable donations to state funds, elective payroll taxes and entity-level taxes on pass-through businesses. The legislation allows for donations to the state funds to produce a federal charitable deduction on the resident taxpayer’s federal income tax return. This would allow the state to collect its full tax revenue and allow taxpayers to reduce their federal tax liability via a larger charitable contribution deduction.
Earlier this year, New York state approved contributions to state-operated charitable funds allowing taxpayers to claim a state tax credit equal to 85 percent of the donation to healthcare and education funds. New Jersey enacted its own credits plan that permits municipalities, counties or school districts to establish charitable funds and allow donors to receive a 90 percent property tax credit in exchange for donations. Other states are considering similar legislation.
In the proposed regulations, the IRS and Treasury state that when a taxpayer receives a state credit in return for a payment to an entity listed in section 170(c), which includes government and private charities, that tax benefit constitutes a quid pro quo. The taxpayer must reduce the charitable deduction by the amount of any state or local credit received for the donation. Exceptions are provided for dollar-for-dollar state tax deductions and for tax credits of no more than 15 percent of the payment amount or of the fair market value of the property transferred.
The Treasury and the IRS said that although deductions could be considered quid pro quo benefits in the same manner, sound policy considerations warrant making an exception to quid pro quo principles in the case of dollar-for-dollar SALT deductions. The proposed regulations state: “Because the benefit of a dollar-for-dollar deduction is limited to the taxpayer’s state and local marginal rate, the risk of deductions being used to circumvent section 164(b)(6) is comparatively low.”
Thus, the proposed rules allow taxpayers to disregard dollar-for-dollar SALT deductions. However, if the taxpayer receives a SALT deduction exceeding either the amount of the payment or the FMV of the property transferred, the individual’s charitable contribution deduction must be reduced.
Example: If a state grants a 70 percent state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer would have to reduce the $1,000 contribution by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer's federal income tax return.
Caution: These regulations are highly controversial in the affected states. Several states are considering their options including challenging the validity of such regulations in the courts. We urge any taxpayer considering making contributions to any state-established charity to consult with his or her tax advisor as to the risk of deductibility of the donation.
Treasury has slowly released regulations and guidance addressing various provisions in the TCJA over the last few months. We’ve already seen the first rules relating to the section 199A pass-through deduction, repatriation of foreign income and bonus depreciation. At this time, we’re still awaiting guidance addressing critical areas such as the business interest limitations under section 163(j), carried interests, Opportunity Zone incentives and rules under section 451(b) that prohibit the deferral of revenue for tax purposes beyond the period in which it is recognized for financial statement purposes. At this time, the Opportunity Zone rules were sent from the Treasury to the Office of Management and Budget for review and, therefore, are expected to be released soon, based on a timing requirement agreed to by the Treasury and OMB. There is no word on timing of other such regulations, but we expect to see them over the remaining course of the year.
Please visit our Tax Reform Resource Center for additional information.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.