On December 2, the Senate, by a vote of 51 to 49, passed its version of the “Tax Cuts and Jobs Act” (the Act). Among the many significant business changes, the Act would reduce the corporate tax rate to a flat 20% rate; increase expensing to $1 million; provide a temporary 100% first year qualifying business asset deduction; provide a 5-year write-off period for R&D expenses; limits the deduction for business interest, and eliminate the domestic production activities deduction.
This article describes the business tax changes that would be made under the Act.
For provisions related to individual taxpayers, see ¶ 1 .
For provisions related to foreign income and persons, see ¶ 30 .
Changes to Corporate Tax Rates
Under the Act, effective for tax years beginning after Dec. 31, 2018, the corporate tax rate would generally be a flat 20% rate, eliminating the current graduated rates of 15% (for taxable income of $0-$50,000), 25% (for taxable income of $50,001-$75,000), 34% (for taxable income of $75,001-$10,000,000), and 35% (for taxable income over $10,000,000).
Dividends-Received Deduction Percentages Reduced
Under current law, corporations that receive dividends from other corporations are entitled to a deduction for dividends received. If the corporation owns at least 20% of the stock of another corporation, an 80% dividends received deduction is allowed. Otherwise, a 70% deduction is allowed.
Under the Act, the 80% dividends received deduction would be reduced to 65%, and the 70% dividends received deduction would be reduced to 50%. The changes would be effective for dividends received by a corporation after Dec. 31, 2018, in tax years ending after such date.
Increased Code 179 Expensing
Under the Act, for purposes of Code Sec. 179 small business expensing, the limitation on the amount that could be expensed would be increased to $1 million (from the current $500,000), and the phase-out amount would be increased to $2.5 million (from the current $2 million).
“Qualified real property.” The Act would also expand the definition of qualified real property eligible for Code Sec. 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
The above provisions would apply to property placed in service in tax years beginning after Dec. 31, 2017.
Temporary 100% Cost Recovery of Qualifying Business Assets
Under current law, additional first-year depreciation deduction is allowed equal to 50% of the adjusted basis of qualified property acquired and placed in service before Jan. 1, 2020 (Jan. 1, 2021, for certain property with a longer production period) The 50% allowance is phased down for property placed in service after Dec. 31, 2017 (after Dec. 31, 2018 for certain property with a longer production period). A first-year depreciation deduction also is electively available for certain plants bearing fruit or nuts planted or grafted after 2015 and before 2020. Film productions aren’t eligible for bonus depreciation.
The Act would permit a 100% first-year deduction for the adjusted basis of qualified property placed in service after Sept. 27, 2017, and before Jan. 21, 2023 (after Sept. 27, 2017, and before Jan. 1, 2024, for certain property with longer production periods).
RIA caution: The Act refers to the new 100% depreciation deduction in the placed-in-service year as “100% expensing,” but the tax break should not be confused with expensing under Code Sec. 179, which is subject to entirely separate rules (see above).
In subsequent years, the first year bonus depreciation deduction would phase down, as follows:
- 80% for property placed in service after Dec. 31, 2022 and before Jan. 1, 2024.
- 60% for property placed in service after Dec. 31, 2023 and before Jan. 1, 2025.
- 40% for property placed in service after Dec. 31, 2024 and before Jan. 1, 2026.
- 20% for property placed in service after Dec. 31, 2025 and before Jan. 1, 2027.
First-year bonus depreciation would sunset after 2026.
The above percentages, and beginning and end-dates would also be available for certain plants bearing fruit or nuts. For example, a 100% first year deduction would be available for certain plants bearing fruit or nuts planted or grafted after Sept. 27, 2017, and before Jan. 21, 2023.
For certain property with longer production periods, the beginning and end dates in the list above would be increased by one year. For example, bonus first year depreciation would be 80% for long-production-period property placed in service after Dec. 31, 2023 and before Jan. 1, 2025.
The Act would also provide that qualified property eligible for a 100% first-year depreciation allowance for placed in service after Sept. 27, 2017, and before Jan. 21, 2023, and for the phased-down first year depreciation percentages in subsequent years, includes qualified film, television and live theatrical productions, effective for productions placed in service after Sept. 27, 2017. For this purpose, a production would be considered placed in service at the time of initial release, broadcast, or live staged performance (i.e., at the time of the first commercial exhibition, broadcast, or live staged performance of a production to an audience).
For the first tax year ending after Sept. 27, 2017, a taxpayer could elect to claim 50% bonus first-year depreciation (instead of claiming a 100% first-year depreciation allowance).
Liberalized Depreciation Rules for Luxury Automobiles
Code Sec. 280F limits the annual cost recovery deduction with respect to certain passenger autos (the luxury auto depreciation limit). Under current law, for passenger autos placed in service in 2017, and for which the additional first-year depreciation deduction under Code Sec. 168(k) is not claimed, the maximum amount of allowable depreciation deduction is $3,160 for the year in which the vehicle is placed in service, $5,100 for the second year, $3,050 for the third year, and $1,875 for the fourth and later years in the recovery period. For passenger automobiles eligible for the additional first-year depreciation allowance in 2017, the first-year limitation is increased by an additional $8,000.
Under current law, special rules also apply to listed property, such as any passenger auto; any other property used as a means of transportation; any property of a type generally used for purposes of entertainment, recreation, or amusement; and any computer or peripheral equipment.
The Act would sharply increase the depreciation limitations under Code Sec. 280F that apply to passenger autos. For passenger automobiles placed in service after Dec. 31, 2017, and for which the additional first-year depreciation deduction under Code Sec. 168(k) is not claimed, the maximum amount of allowable depreciation would be: $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period. These dollar limits would be indexed for inflation for passenger automobiles placed in service after 2018. For passengers autos eligible for bonus first year depreciation, the maximum first year depreciation allowance would be increased by $8,000.
The Act would also remove computer or peripheral equipment from the definition of listed property. Such property would therefore not be subject to the heightened substantiation requirements that apply to listed property.
The above changes would apply to property placed in service after Dec. 31, 2017, in tax years ending after that date.
Eased Cost Recovery Rules for Certain Farm Property
The Act would shorten the cost recovery period from seven to five years for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business, the original use of which commences with the taxpayer, and is placed in service after Dec. 31, 2017.
Also, effective for property placed in service after Dec. 31, 2017, in tax years ending after that date, the Act would repeal the required use of the 150% declining balance depreciation method for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property). The 150% declining balance method would continue to apply to any 15-year or 20-year property used in the farming business to which the straight line method does not apply, or to property for which the taxpayer elects the use of the 150% declining balance method.
Shortened Recovery Period for Real Property
Under current law, the cost recovery periods for most real property are 39 years for nonresidential real property and 27.5 years for residential rental property. The straight line depreciation method and mid-month convention are required for such real property. If a taxpayer elects the alternative depreciation system (ADS), residential rental property has a recovery period of 40 years.
For property placed in service after Dec. 31, 2017, the Act would shorten the recovery period for determining the depreciation deduction for nonresidential real and residential rental property to 25 years. It would also eliminate the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, and would provide a general 10-year recovery period and straight line depreciation for qualified improvement property (certain improvements to the interior of nonresidential realty) and a 20-year ADS recovery period for such property. For tax years beginning after Dec. 31, 2017, a real property trade or business electing out of the limitation on the deduction for interest expense would have to use ADS to depreciate any of its nonresidential real property, residential rental property, and qualified improvement property.
For property placed in service after Dec. 31, 2017, the Act also shortens the ADS recovery period for residential rental property from 40 years to 30 years.
Five-Year Writeoff of Specified R&E Expenses
Under current law, taxpayers may elect to deduct currently the amount of certain reasonable research or experimentation (R&E) expenses paid or incurred in connection with a trade or business. Alternatively, taxpayers may forgo a current deduction, capitalize their research expenses, and recover them ratably over the useful life of the research, but in no case over a period of less than 60 months (or, electively, over a period of 10 years).
Under the Act, effective for amounts paid or incurred in tax years beginning after Dec. 31, 2025, amounts defined as specified R&E expenses would have to be capitalized and amortized ratably over a five-year period (15 years if conducted outside of the U.S.), beginning with the midpoint of the tax year in which the specified R&E expenses were paid or incurred.
Specified R&E expenses subject to capitalization would include expenses for software development, but not expenses for land or for depreciable or depletable property used in connection with the research or experimentation (however, depreciation and depletion allowances of such property would be included). Also excluded would be exploration expenses incurred for ore or other minerals (including oil and gas). In the case of retired, abandoned, or disposed property with respect to which specified R&E expenses are paid or incurred, any remaining basis may not be recovered in the year of retirement, abandonment, or disposal, but instead must continue to be amortized over the remaining amortization period.
The application of the rule would be treated as a change in the taxpayer’s method of accounting for purposes of Code Sec. 481, initiated by the taxpayer, and made with IRS consent. This rule would be applied on a cutoff basis to R&E expenses paid or incurred in tax years beginning after Dec. 31, 2025 (hence there would be no adjustment under Code Sec. 481(a) for R&E expenses paid or incurred in tax years beginning before Jan. 1, 2026).
Expensing of Costs of Replanting Citrus Plants Lost Due to Casualty
Under current law, the uniform capitalization rules of Code Sec. 263A don’t apply to costs incurred in replanting edible crops for human consumption following loss or damage due to freezing temperatures, disease, drought, pests, or casualty. The same type of crop as the lost or damaged crop must be replanted. However, the exception to capitalization still applies if the replanting occurs on a parcel of land other than the land on which the damage occurred provided the acreage of the new land does not exceed that of the land to which the damage occurred and the new land is located in the US.
This exception may also apply to costs incurred by persons other than the taxpayer who incurred the loss or damage, provided (1) the taxpayer who incurred the loss or damage retains an equity interest of more than 50% in the property on which the loss or damage occurred at all times during the tax year in which the replanting costs are paid or incurred, and (2) the person holding a minority equity interest and claiming the deduction materially participates in the planting, maintenance, cultivation, or development of the property during the tax year in which the replanting costs are paid or incurred.
Under the Act, effective for replanting costs paid or incurred after the enactment date, but no later than a date which is ten years after the enactment date, for citrus plants lost or damaged due to casualty, such costs may also be deducted by a person other than the taxpayer if (1) the taxpayer has an equity interest of not less than 50% in the replanted citrus plants at all times during the tax year in which the replanting costs are paid or incurred and such other person holds any part of the remaining equity interest, or (2) such other person acquires all of the taxpayer’s equity interest in the land on which the lost or damaged citrus plants were located at the time of such loss or damage, and the replanting is on such land.
Accounting Method Reforms
The Act provides several provisions reforming and simplifying accounting methods for small businesses:
Cash method of accounting. Under current law, a corporation or partnership with a corporate partner may only use the cash method of accounting if its average gross receipts do not exceed $5 million for all prior years (including the prior tax years of any predecessor of the entity). Under current law, farm corporations and farm partnerships with a corporate partner may only use the cash method of accounting if their gross receipts do not exceed $1 million in any year. An exception allows certain family farm corporations to qualify if its gross receipts do not exceed $25 million.
The Act would increase to $15 million the threshold for small corporations and partnerships with a corporate partner to qualify for the cash accounting method. The Act would also increase the general farm corporation limit to $15 million, but not reduce the limit for family farm corporations.
Accounting for inventories. Under current law, while, businesses that are required to use an inventory method must generally use the accrual accounting method, the cash method can be used for certain small businesses with average gross receipts of not more than $1 million ($10 million businesses in certain industries). Under the cash method, the business could account for inventory as non-incidental materials and supplies.
The Act would exempts certain taxpayers from the requirement to keep inventories. Specifically, taxpayers that meet the $15 million gross receipts test as described above would not be required to account for inventories under Code Sec. 471, but rather could use an accounting method for inventories that either (1) treats inventories as non-incidental materials and supplies, or (2) conforms to the taxpayer’s financial accounting treatment of inventories.
Capitalization and inclusion of certain expenses in inventory costs. Under current law, the uniform capitalization (UNICAP) rules generally require certain direct and indirect costs associated with real or tangible personal property manufactured by a business to be included in either inventory or capitalized into the basis of such property. A business with average annual gross receipts of $10 million or less in the preceding three years is not subject to the UNICAP rules for personal property acquired for resale. The exemption does not apply to real property (e.g., buildings) or personal property that is manufactured by the business.
The Act would provide a comprehensive exemption from the UNICAP rules for businesses meeting the $15 million threshold proposed for the cash method of accounting described above. The Act would also expand the exemption to apply to real or personal property acquired for resale or manufactured by the business, provided it meets the $15 million threshold.
Accounting for long-term contracts. Under current law, an exception from the requirement to use the percentage-of-completion method (PCM) for long-term contracts is provided for construction companies with average annual gross receipts of $10 million or less in the preceding three years (i.e., they are allowed to instead deduct costs associated with construction when they are paid and recognize income when the building is completed).
The Act would increase the threshold to $15 million for the completed-contract method, which is used primarily to account for small construction contracts.
Taxable year of inclusion. The Act would require a taxpayer to recognize income no later than the tax year in which such income is taken into account as income on an applicable financial statement (AFS) or another financial statement under rules specified by IRS (subject to an exception for long-term contract income under Code Sec. 460).
The Act would also codify the current deferral method of accounting for advance payments for goods and services provided by Rev Proc 2004-34 to allow taxpayers to defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt if such income also is deferred for financial statement purposes. In addition, it would also direct taxpayers to apply the revenue recognition rules under Code Sec. 452before applying the original issue discount (OID) rules under Code Sec. 1272.
In the case of any taxpayer that would be required by this provision to change its accounting method for its first tax year beginning after Dec. 31, 2017, such change would be treated as initiated by the taxpayer and made with IRS’s consent.
Effective date. The above changes would be effective for tax years beginning after Dec. 31, 2017, except that the PCM change would apply to contracts entered into after Dec. 31, 2017 in tax years ending after that date, and the AFS conformity rule would apply for OID for tax years beginning after Dec. 31, 2018, and the adjustment period would be six years.
Limits on Deduction of Business Interest
Under the Act, every business, regardless of its form, would generally be subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. The net interest expense disallowance would be determined at the tax filer level. However, a special rule would apply to pass-through entitles, which requires the determination to be made at the entity level, for example, at the partnership level instead of the partner level. Adjusted taxable income is a business’s taxable income computed without regard to business interest expense, business interest income, the deduction for certain pass-through income, net operating losses (NOLs), and depreciation, and other adjustments as provided by IRS. Any interest amounts so disallowed would be carried forward to the succeeding five tax years.
The Act would provide an exemption from these rules for taxpayers (other than a tax shelter) with average annual gross receipts under $15 million during the three preceding years, indexed for inflation. The business-interest-limit provision would not apply to certain regulated public utilities and electric cooperatives. Real property trades or businesses could elect out of the provision if they use the alternative depreciation system (ADS) to depreciate applicable real property used in the trade or business. Farming businesses could also elect out if they use ADS to depreciate any property used in the farming business with a recovery period of ten years or more. An exception from the limitation on the business interest deduction would also be provided for floor plan financing (i.e., used to finance the acquisition of motor vehicles for sale or lease and secured by such inventory).
These changes would be effective for tax years beginning after Dec. 31, 2017.
Modification of Net Operating Loss Deduction
Under current law, a net operating loss (NOL” may be carried back two years and carried over 20 years to offset taxable income in such years. Different carryback periods apply with respect to NOLs arising in different circumstances. For example, extended carryback periods are allowed for NOLs attributable to specified liability losses and certain casualty and disaster losses.
Effective for NOLs arising in tax years ending after Dec. 31, 2017, the Act would repeal the two-year carryback and the special carryback provisions, but would provide a two-year carryback in the case of certain losses incurred in the trade or business of farming. Effective for losses arising in tax years beginning after Dec. 31, 2017, the Act would limit the NOL deduction to 90% (80% in tax years beginning after Dec. 31, 2022) of taxable income (determined without regard to the deduction). Carryovers to other years would be adjusted to take account of this limitation and would be able to be carried forward indefinitely.
Under the Act, NOLs of property and casualty insurance companies may be carried back two years and carried over 20 years to offset 100% of taxable income in such years.
Like-Kind Exchange Treatment Limited
Under current law, the like-kind exchange rule provides that no gain or loss is recognized to the extent that property—which includes a wide range of property from real estate to tangible personal property—held for productive use in the taxpayer’s trade or business, or property held for investment purposes, is exchanged for property of a like-kind that also is held for productive use in a trade or business or for investment.
Under the Act, the rule allowing the deferral of gain on like-kind exchanges would be modified to allow for like-kind exchanges only with respect to real property, generally effective for transfers after Dec. 31, 2017. However, a transition rule would allow like-kind exchanges of personal property to be completed if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017.
Employer’s Deduction for Fringe Benefit Expenses Limited
Under current law, a taxpayer may deduct up to 50% of expenses relating to meals and entertainment. Housing and meals provided for the convenience of the employer on the business premises of the employer are excluded from the employee’s gross income. Various other fringe benefits provided by employers are not included in an employee’s gross income, such as qualified transportation fringe benefits
The Act would bar deductions for entertainment expenses, and eliminate the subjective determination of whether such expenses are sufficiently business related; expand the current 50% limit on the deductibility of business meals to meals provided through an inhouse cafeteria or otherwise on the premises of the employer; deny deductions for employee transportation fringe benefits (e.g., parking and mass transit) but retain the exclusion from income for such benefits received by an employee. In addition, the Act would also preclude deductions for transportation expenses that are the equivalent of commuting for employees (e.g., between the employee’s home and the workplace), except as provided for the safety of the employee.
For tax years beginning after Dec. 31, 2025, the Act would disallow an employer’s deduction for expenses associated with meals provided for the convenience of the employer on the employer’s business premises, or provided on or near the employer’s business premises through an employer-operated facility that meets certain requirements.
Deductible Penalties and Fines
Currently, there’s no deduction for fines or penalties paid to a government for the violation of any law.
The Act would deny deductibility for any otherwise deductible amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or specified nongovernmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law. An exception would apply to payments that the taxpayer establishes are either restitution (including remediation of property) or amounts required to come into compliance with any law that was violated or involved in the investigation or inquiry, that are identified in the court order or settlement agreement as restitution, remediation, or required to come into compliance.
Restitution for failure to pay any tax and assessed as restitution under the Code would be deductible only to the extent it would have been allowed as a deduction if it had been timely paid. IRS would remain free to challenge the characterization of an amount so identified; however, no deduction would be allowed unless the identification is made.
The change would apply for amounts paid or incurred after the date of enactment, except that it would not apply to amounts paid or incurred under any binding order or agreement entered into before that date. But the exception would not apply to an order or agreement requiring court approval unless the approval was obtained before the enactment date.
Nondisclosure Agreements Paid in Connection With Sexual Harassment or Abuse.
Under current law, a taxpayer generally is allowed a deduction for ordinary and necessary expenses paid or incurred in carrying on any trade or business. However, among other exceptions, there’s no deduction for: any illegal bribe, illegal kickback, or other illegal payment; certain lobbying and political expenses; any fine or similar penalty paid to a government for the violation of any law; and two-thirds of treble damage payments under the antitrust laws.
Under the Act, effective for amounts paid or incurred after the enactment date, no deduction would be allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.
Employee Achievement Awards
The Act would prohibit “tangible personal property” as deductible employee achievement awards. Tangible personal property would be defined as cash, cash equivalents, gifts cards, gift coupons, gift certificates (other than where from the employer pre-selected or pre-approved limited selection) vacations, meals, lodging, tickets for theatre or sporting events, stock, bonds or similar items. and other non-tangible personal property. This change would apply for amounts paid or incurred after Dec. 31, 2017.
Orphan Drug Credit Modified
For amounts paid or incurred after Dec. 31, 2017, the Code Sec. 45C orphan drug credit would be limited by the Act to 27.5% (instead of current law’s 50%) of so much of qualified clinical testing expenses for the tax year. In the case where there are no qualified clinical expenses, the credit would be equal to 17.5% of qualified expenses. Taxpayers would be able to elect a reduced credit in lieu of reducing otherwise allowable deductions in a manner similar to the research credit under Code Sec. 280C.
Rehabilitation Credit Limited
The Act would repeal the 10% credit for qualified rehabilitation expenditures with respect to a pre-’36 building. For amounts paid or incurred after Dec. 31, 2017, the Act would provide a 20% credit for qualified rehabilitation expenditures with respect to a certified historic structure which would be claimed ratably over a five-year period beginning in the tax year in which a qualified rehabilitated structure is placed in service. A transition rule would provide that current law and not the Act provision would remain in effect for projects where the building was owned or leased by the taxpayer at all times on or after Jan. 1, 2018, and where the 24-month period selected by the taxpayer for claiming the credit begins not later than 180 days of enactment.
Veteran’s Preference for Low-Income Housing Credit
Under current law, if a residential rental unit in a building is not for use by the general public, the unit is not eligible for a low-income housing credit. The Act would provide that a project would not fail to meet the general public use requirement solely because of occupancy restrictions or preferences that favor veterans of the Armed Forces, effective for buildings placed in service before, on, or after the date of enactment.
New Credit for Employer-Paid Family and Medical Leave
The Act would allow businesses to claim a general business credit equal to 12.5% of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave (FMLA) if the rate of payment is 50% of the wages normally paid to an employee. The credit would be increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%. All qualifying full-time employees would have to be given at least two weeks of annual paid family and medical leave (all less-than-full-time qualifying employees would have to be given a commensurate amount of leave on a pro rata basis).
The change would generally be effective for wages paid in tax years beginning after Dec. 31, 2017, but would not apply to wages paid in tax years beginning after Dec. 31, 2019. A Government Accountability Office Study would determine the effectiveness of the credit.
Limitation on Excessive Employee Compensation
Under current law, the deduction for compensation paid or accrued with respect to a covered employee of a publicly traded corporation is limited to no more than $1 million per year. However, exceptions apply for: (1) commissions; (2) performance-based remuneration, including stock options; (3) payments to a tax-qualified retirement plan; and (4) amounts that are excludable from the executive’s gross income.
Under the Act, the exceptions to the $1 million deduction limitation for commissions and performance-based compensation would be repealed. The Act would also revise the definition of “covered employee” to include the principal executive officer, the principal financial officer, and the three (rather than four) other highest paid officers. Under this definition, if an individual is a covered employee with respect to a corporation for a tax year beginning after Dec. 31, 2016, the individual would remain a covered employee for all future years.
Under a transition rule, the changes would not apply to any remuneration under a written binding contract which was in effect on Nov. 2, 2017 and which was not modified after that date in any material respect after that date.
The changes described above would be effective for tax years beginning after Dec. 31, 2017.
Treatment of S Corporation Converted to C Corporation
The Act would provide that distributions from an “eligible terminated S corporation” would be treated as paid from its accumulated adjustments account and from its earnings and profits on a pro rata basis. Resulting adjustments would be taken into account ratably over a 6-year period. An eligible terminated S corporation would be any C corporation which (i) was an S corporation on the date before the enactment date, (ii) revoked its S corporation election during the 2-year period beginning on the enactment date, and (iii) had the same owners on the enactment date and on the revocation date (in the same proportion). These changes would apply to distributions after the date of enactment.
Look-through rule applied to gain on the sale of a partnership interest. The Act would provide that gain or loss from the sale or exchange of a partnership interest is effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. The Act would require that any gain or loss from the hypothetical asset sale by the partnership be allocated to interests in the partnership in the same manner as non-separately stated income and loss.
The provision would apply to sales and exchanges on or after Nov. 27, 2017.
Definition of “substantial built-in loss.” The Act would modify the definition of a substantial built-in loss for purposes of Code Sec. 743(d), affecting transfers of partnership interests. Under the Act, in addition to the present-law definition, a substantial built-in loss also exists if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership’s assets in a fully taxable transaction for cash equal to the assets’ fair market value, immediately after the transfer of the partnership interest.
The provision would apply to transfers of partnership interests after Dec. 31, 2017.
Charitable contributions and foreign taxes taken into account for partner’s share of loss. The Act would modify the Code Sec. 704(d) loss limitation rule to provide that a partner’s distributive share of items that are not deductible in computing the partnership’s taxable income, and not properly chargeable to capital account, are allowed only to the extent of the partner’s adjusted basis in its partnership interest at the end of the partnership tax year in which the expenditure occurs. Thus, the Code Sec. 704(d) loss limitation applies to a partner’s distributive share of charitable contributions and foreign taxes.
A partner’s distributive share of loss takes into account the partner’s distributive share of charitable contributions and foreign taxes for purposes of the basis limitation on partner losses. In the case of a charitable contribution of property whose fair market value exceeds its adjusted basis, the basis limitation on partner losses does not apply to the extent of the partner’s distributive share of such excess.
The provision would apply to partnership tax years beginning after Dec. 31, 2017.
New Rules for Qualified Equity Grants
Under the Act, a qualified employee could elect to defer, for income tax purposes, the inclusion in income of the amount of income attributable to qualified stock transferred to the employee by the employer. The election would apply only for income tax purposes; the application of FICA and FUTA would not be affected.
An inclusion deferral election would have to be made no later than 30 days after the first time the employee’s right to the stock is substantially vested or is transferable, whichever occurs earlier. If the election is made, the income would have to be included in the employee’s income for the tax year that includes the earliest of:
- (1) The first date the qualified stock becomes transferable, including, solely for this purpose, transferable to the employer.
- (2) The date the employee first becomes an “excluded employee” (i.e., an individual: (a) who is one-percent owner of the corporation at any time during the 10 preceding calendar years; (b) who is, or has been at any prior time, the chief executive officer or chief financial officer of the corporation or an individual acting in either capacity; (c) who is a family member of an individual described in (a) or (b); or (d) who has been one of the four highest compensated officers of the corporation for any of the 10 preceding tax years.
- (3) the first date on which any stock of the employer becomes readily tradable on an established securities market;
- (4) the date five years after the first date the employee’s right to the stock becomes substantially vested; or
- (5) the date on which the employee revokes his or her inclusion deferral election.
The inclusion deferral election would be available for qualified stock attributable to a statutory option. In such a case, the option would not treated as a statutory option and the rules relating to statutory options and related stock would not apply. In addition, an arrangement under which an employee may receive qualified stock would not be treated as a nonqualified deferred compensation plan solely because of an employee’s inclusion deferral election or ability to make an election.
Deferred income inclusion would apply also for purposes of the employer’s deduction of the amount of income attributable to the qualified stock. That is, if an employee makes an inclusion deferral election, the employer’s deduction is deferred until the employer’s tax year in which or with which ends the tax year of the employee for which the amount is included in the employee’s income as described in (1) – (5) above.
The new election would apply for qualified stock of an eligible corporation. An corporation would be treated as such for a tax year if: (1) no stock of the employer corporation (or any predecessor) is readily tradable on an established securities market during any preceding calendar year, and (2) the corporation has a written plan under which, in the calendar year, not less than 80% of all employees who provide services to the corporation in the US (or any US possession) are granted stock options, or restricted stock units (RSUs), with the same rights and privileges to receive qualified stock.
The inclusion deferral election would be subject to detailed conditions as well as employer notice, withholding, and reporting requirements.
The income deferral election would generally apply with respect to stock attributable to options exercised or RSUs settled after Dec. 31, 2017. Under a transition rule, until IRS issues regs or other guidance implementing the 80% and employer notice requirements under the provision, a corporation would be treated as complying with those requirements (respectively) if it complies with a reasonable good faith interpretation of the requirements. The penalty for a failure to provide the notice required under the provision would apply to failures after Dec. 31, 2017.
The Act would repeal/eliminate the following:
- . . . the domestic production activities deduction (DPAD) under Code Sec. 199 for non-corporate taxpayers, for tax years beginning after Dec. 31, 2017.
- . . . the Code Sec. 162(e) deduction for lobbying expenses with respect to legislation before local government bodies (including Indian tribal governments), for amounts paid or incurred on or after the date of enactment.
- . . . the Code Sec. 162(a)(3) deduction for living expenses incurred by members of Congress.