On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (the Act). From a tax perspective, the legislation cut the corporate tax rate from 35 percent to 21 percent beginning this year. The corporate cuts are “permanent,” while the individual changes expire at the end of 2025.
Here’s a summary of how the Act changes income taxes and deductions for businesses.
The Act lowers the maximum corporate tax rate from 35 percent to 21 percent, the lowest since 1939. Technically, the United States has one of the highest rates in the world, but most corporations don’t pay that much. On average, the effective rate is 18 percent.
It raises the standard deduction to 20 percent for pass-through businesses. This deduction ends after 2025. Pass-through businesses include sole proprietorships, partnerships, limited liability companies, and S corporations. They also include real estate companies, hedge funds, and private equity. The deductions phase out for service professionals once their income reaches $157,500 for singles and $315,000 for joint filers.
The Act limits corporations’ ability to deduct interest expense to 30 percent of income. For the first four years, income is EBITDA (earnings before interest, tax, depreciation and amortization), but reverts to earnings before interest and taxes (EBIT) thereafter. This will likely make it more expensive for financial firms to borrow. Therefore, companies would be less likely to issue bonds and buy back their stock. This could have a limiting effect on stock prices; however, limiting this deduction generates revenue to pay for other tax breaks.
The Act will allow businesses to deduct the cost of depreciable assets in one year instead of amortizing them over several years. To qualify, the equipment must be purchased after September 27, 2017, and before January 1, 2023. This however does not apply to structures and buildings.
The Act stiffens the requirements on carried interest profits. Carried interest is taxed at 23.8 percent instead of the top 39.6 percent income rate. Carried interest is a share of any profits the general partners of private equity and hedge funds receive as compensation, regardless of whether or not they contributed any initial funds. Firms must hold assets for a year to qualify for the lower rate. The Act extends that requirement to three years. This may hurt hedge funds which tend to trade frequently. It would not affect private equity funds that generally hold assets for about five years or more. The change in carried interest profits is projected to raise $1.2 billion in revenue.
The Act eliminates the corporate alternative minimum tax (AMT.) The corporate AMT had a 20 percent tax rate that kicked in if tax credits pushed a firm’s effective tax rate below that level.
The Act also advocates a change from the current “worldwide” tax system to a “territorial” system. Under the worldwide system, multinationals are taxed on foreign income earned. They don’t pay the tax until they bring the profits home. As a result, many corporations leave profits parked overseas. Under the territorial system, companies aren’t taxed on foreign profit. They would be more likely to reinvest it in the United States. This may benefit pharmaceutical and high-tech companies the most.
The Act allows companies to repatriate the $2.6 trillion they hold in foreign cash stockpiles. They pay a one-time tax rate of 15.5 percent on cash and 8 percent on equipment.
The Act allows oil drilling in the Arctic National Wildlife Refuge. That’s estimated to add $1.1 billion in revenues over 10 years. However, some experts note that the revenue benefit doesn’t exist as they project that drilling in the refuge won’t be profitable until oil prices are at least $70 a barrel. As of this writing, oil prices currently sit at around $64-65/barrel.
The Act retains tax credits for electric vehicles and wind farms. It cuts the deduction for orphan/rare disease drug research from 50 percent to 25 percent.
The Act also cuts taxes on beer, wine, and liquor.
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material has been prepared for general information purposes only, and is not intended to provide, and
should not be relied on for tax advice, legal advice or accounting advice. You should consult your own
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