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This provision is effective after December 31, 2017, and expires after December 31, 2025.

Estate and Trust Tax Rates and Brackets

Under TCJA, the tax rate for estates and trusts are 10% of taxable income up to $2,550, 24% of the excess over $2,550 but not over $9,150; 35% of the excess over $9,150 but not over $12,500; and 37% of the excess over $12,500.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Simplification of Tax on Unearned Income of Children

TCJA simplifies the "kiddie tax" by effectively applying ordinary and capital gains rates applicable to trusts and estates to the net unearned income of a child. Thus, taxable income attributable to earned income is taxed according to an unmarried taxpayer's brackets and rates. Taxable income attributable to net unearned income is taxed according to the brackets applicable to trusts and estates, with respect to both ordinary income and income taxed at preferential rates. The child's tax is no longer affected by the tax situation of the child's parent or the unearned income of any siblings.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Maximum Rates on Capital Gains and Qualified Dividends

TCJA generally retains the present-law maximum rates on net capital gain and qualified dividends. The breakpoints between the zero- and 15-percent rates ("15-percent breakpoint") and the 15- and 20-percent rates ("20-percent breakpoint") are the same amounts as the breakpoints under current law, except the breakpoints are indexed using the Consumer Price Index for all Urban Consumers (C-CPI-U) in tax years beginning after 2017. Thus, for 2018, the 15-percent breakpoint is $77,200 for joint returns and surviving spouses (one-half of this amount for married taxpayers filing separately), $51,700 for heads of household, $2,600 for estates and trusts, and $38,600 for other unmarried individuals. The 20-percent breakpoint is $479,000 for joint returns and surviving spouses (one-half of this amount for married taxpayers filing separately), $452,400 for heads of household, $12,700 for estates and trusts, and $425,800 for other unmarried individuals.

Observation: Therefore, in the case of an individual (including an estate or trust) with adjusted net capital gain, to the extent the gain would not result in taxable income exceeding the 15-percent breakpoint, such gain is not taxed. Any adjusted net capital gain which would result in taxable income exceeding the 15-percent breakpoint but not exceeding the 20-percent breakpoint is taxed at 15 percent. The remaining adjusted net capital gain is taxed at 20 percent.

As under current law, unrecaptured Code Sec. 1250 gain generally is taxed at a maximum rate of 25 percent, and 28-percent rate gain is taxed at a maximum rate of 28 percent.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Net Investment Income Tax

TJCA retains the 3.8 percent net investment income tax (NIIT) without changes.

Increase in Individual AMT Exemption and Phaseout Amounts

TCJA provides for increased AMT exemptions. For 2018, the exemptions are $109,400 (up from $84,500 in 2017) in the case of a joint return or the return of a surviving spouse; $70,300 (up from $54,300 in 2017) in the case of an individual who is unmarried and not a surviving spouse; $54,700 (up from $39,375 in 2017) in the case of a married individual filing a separate return. Additionally, TCJA increases the alternative minimum taxable income limit where the exemptions begin to phase out. Under TCJA, the exemption amount of any taxpayer is reduced by an amount equal to 25 percent of the amount by which the alternative minimum taxable income of the taxpayer exceeds $1,000,000 (up from $160,900 in 2017) in the case of a joint returns; and $500,000 for all others (up from amounts ranging from $80,450 to $120,700 in 2017).

This provision is effective for tax years beginning after December 31, 2017.

Paid Preparer Due Diligence Requirement for Head of Household Status

TCJA directs the Secretary of the Treasury to issue due diligence requirements for paid preparers in determining eligibility for a taxpayer to file as head of household. A penalty of $500 will be imposed for each failure to meet these requirements.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Increase in Standard Deduction

TCJA increases the basic standard deduction for individuals across all filing statuses. Under the provision, the amount of the standard deduction is increased to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers. The amount of the standard deduction is indexed for inflation using the chained consumer price index for all-urban consumers for tax years beginning after December 31, 2018. The additional standard deduction for the elderly and the blind is not changed by the provision.

Observation: The fact that the standard deduction has nearly doubled may create the misleading impression that taxpayers will reap a large tax benefit from the change. But, because the increase in the standard deduction was coupled with the repeal of the deduction for personal exemption ($4,150, per exemption in 2018), the actual benefit is fairly modest. For example, the overall amount of income that is exempt from tax will increase by $2,700 for joint filers - a nice increase, but nowhere near double the $13,000 standard deduction under prior law.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Repeal of the Deduction for Personal Exemptions

TCJA repeals the deduction for personal exemptions.

In addition, the provision modifies the requirements for those who are required to file a tax return. In the case of an individual who is not married, such individual is required to file a tax return if the taxpayer's gross income for the tax year exceeds the applicable standard deduction. Married individuals are required to file a return if that individual's gross income, when combined with the individual's spouse's gross income for the tax year, is more than the standard deduction applicable to a joint return, provided that: (1) such individual and his spouse, at the close of the tax year, had the same household as their home; (2) the individual's spouse does not make a separate return; and (3) neither the individual nor his spouse is a dependent of another taxpayer who has income (other than earned income) in excess of $500 (indexed for inflation).

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Observation: Withholding rules under present law are based partly on the number of personal exemptions claimed by a taxpayer. Form W-4 and withholding tables will need to be changed to reflect the repeal of personal exemptions. TCJA provides that the Secretary may, at his discretion, administer wage withholding in 2018 without regard to the repeal of the deduction for personal exemptions.

Repeal of Deduction for Alimony Paid

TCJA repeals the deduction for alimony paid and the corresponding inclusion of alimony in income by the recipient. The provision is effective for any divorce or separation instrument executed after December 31, 2018, or for any divorce or separation instrument executed on or before December 31, 2018, and modified after that date, if the modification expressly provides that the amendments made by this provision apply to such modification. Thus, alimony paid under a separation agreement entered into prior to the effective date is generally grandfathered.

Temporary Reduction in Medical Expense Deduction Floor

TCJA provides special rules for medical expense deductions for years 2017 and 2018. For those years, the adjusted-gross-income floor above which a medical expense is deductible is reduced from 10 percent to 7.5 percent.

Observation: The medical expense deduction is one of a few areas where the Senate and House Bills went in opposite directions. Whereas the Senate Bill retained the deduction and enhanced it for certain tax years, the House Bill would have repealed it altogether.

Limitation on Deduction for State and Local Taxes

TCJA limits the deduction for state and local property, income, war profits, and excess profits taxes to $10,000 ($5,000 in the case of a married individual filing a separate return), unless such taxes are paid or accrued in carrying on a trade or business or an activity described in Code Sec. 212 (relating to expenses for the production of income). TCJA also repeals the deduction for foreign property taxes. As under current law, taxpayers may elect to deduct state and local sales taxes in lieu of state and local income taxes.

Observation: An earlier version of this provision that was included in both the House and Senate Bills, would have permitted only the deduction of state, local, and foreign property taxes within the $10,000 limit. TCJA expanded the scope of the deduction to include state and local income taxes (or sales taxes in lieu thereof), as under current law, but eliminated the deduction for foreign property taxes.

Caution: TCJA includes a provision blocking taxpayers from prepaying state and local income taxes relating to the 2018 tax year in 2017 in order to circumvent the new limitation on the deduction. Specifically, in the case of an amount paid in a tax year beginning before January 1, 2018, with respect to a state or local income tax imposed for a tax year beginning after December 31, 2017, the payment will be treated as paid on the last day of the tax year for which such tax is imposed for purposes of applying the provision limiting the dollar amount of the deduction.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Limitation on Mortgage Interest Deduction

TCJA provides that a taxpayer may treat no more than $750,000 as acquisition indebtedness ($375,000 in the case of married taxpayers filing separately) for purposes of the mortgage interest deduction. In the case of acquisition indebtedness incurred before December 15, 2017, the limitation is the same as it is under current law: $1,000,000 ($500,000 in the case of married taxpayers filing separately).

Observation: A provision in the House Bill, that was omitted from TCJA, would have disallowed an interest deduction for debt used to acquire a second home. Thus, interest on such debt remains deductible within the overall limits that apply to the deductibility of acquisition indebtedness.

TCJA repeals the deduction for home equity indebtedness.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Modification to Deduction for Charitable Contributions

TCJA make the following modifications to the deduction for charitable contributions -

(1) increases in the income-based percentage limit described in Code Sec. 170(b)(1)(A) for certain charitable contributions by an individual taxpayer of cash to public charities and certain other organizations from 50 percent to 60 percent;

(2) denies a charitable deduction for payments made in exchange for college athletic event seating rights; and

(3) repeals the substantiation exception in Code Sec. 170(f)(8)(D) for certain contributions reported by the donee organization.

The provisions that increase the charitable contribution percentage limit and deny a deduction for stadium seating payments are effective for contributions made in tax years beginning after December 31, 2017. The provision that repeals the substantiation exception for certain contributions reported by the donee organization is effective for contributions made in tax years beginning after December 31, 2016.

Partial Repeal of Deduction for Casualty and Theft Losses

TCJA temporarily modifies the deduction for personal casualty and theft losses. Under the provision, a taxpayer may claim a personal casualty loss, subject to the applicable limitations in Code Sec. 165(h), only if such loss was attributable to a disaster declared by the President under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

The above-described limitation does not apply with respect to losses incurred after December 31, 2025.

Repeal of Miscellaneous Itemized Deductions Subject to the 2-Percent Floor

TCJA repeals all miscellaneous itemized deductions that are subject to the two-percent of adjusted-gross-income floor.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Repeal of Overall Limitation on Itemized Deductions

TCJA repeals the overall limitation on itemized deductions.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Relief for 2016 and 2017 Disaster Areas - Relaxation of Casualty Loss Deduction Rules

TCJA provides tax relief relating to a "2016 disaster area," which is defined as any area with respect to which a major disaster was declared by the President under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act during calendar year 2016 and 2017. In the case of a personal casualty loss which arose after December 31, 2015, and before January 1, 2018, and was attributable to the events giving rise to the Presidential disaster declaration, such losses are deductible without regard to whether aggregate net losses exceed ten percent of a taxpayer's adjusted gross income. Under the provision, in order to be deductible, the losses must exceed $500 per casualty. Additionally, such losses may be claimed in addition to the standard deduction.

Observation: While the Senate Bill originally applied only to calendar year 2016, TCJA expanded the relief to 2017 without changing the description in the provision as applying to the "2016 disaster area."

The provision is effective on December 22, 2017.

Relief for 2016 Disaster Areas - Relaxation of Retirement Plan Distribution Rules

The Senate Bill provides special rules for using retirement funds and taking a casualty loss deduction with respect to a "2016 disaster area." The term "2016 disaster area" means any area with respect to which a major disaster has been declared by the President under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act during calendar year 2016. The term "qualified 2016 disaster distribution" means any distribution from an eligible retirement plan made on or after January 1, 2016, and before January 1, 2018, to an individual whose principal place of abode at any time during calendar year 2016 was located in a 2016 disaster area and who has sustained an economic loss by reason of the events giving rise to the Presidential declaration which was applicable to such area.

Under the provision, the early withdrawal penalties under Code Sec. 72(t) do not apply to a qualified 2016 disaster distribution to the extent the amount withdrawn does not exceed $100,000 over the aggregate amounts treated as qualified 2016 disaster distributions received by such individual for all prior years. Amounts required to be included in income as a result of such distributions may be included ratably over a three-tax year period. The provision also allows a casualty loss deduction with respect to a loss relating to a 2016 disaster area.

Observation: Although TCJA's relaxation of retirement plan distribution rules only applies to disasters occurring in 2016 (for which qualified retirement plan distributions can be made in either 2016 or 2017), victims of several major 2017 disasters were granted similar disaster relief by Pub. L. 115-63.

Rules for Exclusion of Gain from the Sale of a Principal Residence Unchanged

Both the House and Senate Bills included similar provisions tightening the rules for the exclusion of gain from the sale of a principal residence. Both bills would have made the exclusion available only if the taxpayer had owned and used the residence as a principal residence for at least five of the eight years (as opposed to two out of five years under current law) prior to selling it, and both would have allowed a taxpayer to benefit from the exclusion only once every five years (as opposed to once every two years under current law).

These provisions were not included in TCJA. Thus, the rules for exclusion of gain from the sale of a principal residence under current law will remain in effect.

Repeal of Exclusion for Qualified Bicycle Commuting Reimbursement

TCJA repeals the exclusion from gross income and wages for qualified bicycle commuting reimbursements.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Repeal of Exclusion for Qualified Moving Expense Reimbursements

TCJA repeals the exclusion from gross income and wages for qualified moving expense reimbursements except in the case of a member of the Armed Forces of the United States on active duty who moves pursuant to a military order.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Repeal of Deduction for Moving Expenses

TCJA repeals the deduction for moving expenses. However, under the provision, rules providing for exclusions of amounts attributable to in-kind moving and storage expenses (and reimbursements or allowances for these expenses) for members of the Armed Forces of the United States (or their spouse or dependents) are not repealed.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Repeal of Certain Deductions Relating to Employee Achievement Awards

TCJA prohibits a deduction for cash, gift cards, and other non-tangible personal property given to an employee as an achievement award, effective for amounts paid or incurred after December 31, 2017.

Repeal of Deductions for Living Expenses of Members of Congress

TCJA repeals a provision which allows members of Congress to deduct up to $3,000 annually for certain living expenses, effective for tax years beginning after December 22, 2017.

Modification to Gambling Losses

TCJA clarifies the scope of "losses from wagering transactions" as that term is used in Code Sec. 165(d). The provision provides that this term includes any deduction otherwise allowable incurred in carrying on any wagering transaction.

The provision is intended to clarify that the limitation on losses from wagering transactions applies not only to the actual costs of wagers incurred by an individual, but to other expenses incurred by the individual in connection with the conduct of that individual's gambling activity. The provision clarifies, for instance, an individual's otherwise deductible expenses in traveling to or from a casino are subject to the limitation under Code Sec. 165(d).

Observation: This provision will reverse the result reached by the Tax Court in Mayo v. Comm'r, 136 T.C. 81 (2011). In that case, the court held that a taxpayer's expenses incurred in the conduct of the trade or business of gambling, other than the cost of wagers, were not limited by Code Sec. 165(d), and were thus deductible under Code Sec. 162(a) as trade or business expenses.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Reform of Child Tax Credit

TCJA increases the child tax credit to $2,000 per qualifying child under the age of 17.

Observation: The Senate Bill would have increased the maximum age of a qualifying child to 17. TCJA retains the current law maximum age of 16 (i.e., "under the age of 17").

The credit is further modified to provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children. The provision generally retains the present-law definition of dependent.

Under TCJA, the modified adjusted gross income threshold at which the credit begins to phase out is increased to $400,000 for joint filers and $200,000 for all other taxpayers. These amounts are not indexed for inflation.

The provision lowers the earned income threshold for the refundable child tax credit to $2,500. The maximum amount refundable may not exceed $1,400 per qualifying child (up from $1,000 under present law). Under the provision, the maximum refundable amount is indexed for inflation with a base year of 2017, rounding up to the nearest $100. In order to receive the refundable portion of the child tax credit, a taxpayer must include a social security number for each qualifying child for whom the credit is claimed on the tax return.

This provision is effective after December 31, 2017, and expires after December 31, 2025.

Increased Contributions to ABLE Accounts and Allowance of Contributions to be Eligible for Saver's Credit

TCJA increases the contribution limitation to ABLE accounts under certain circumstances. While the general overall limitation on contributions (the per-donee annual gift tax exclusion ($14,000 for 2017)) remains the same, the limitation is increased with respect to contributions made by the designated beneficiary of the ABLE account. Under the provision, after the overall limitation on contributions is reached, an ABLE account's designated beneficiary can contribute an additional amount, up to the lesser of (1) the federal poverty line for a one-person household; or (2) the individual's compensation for the tax year. Additionally, the provision allows a designated beneficiary of an ABLE account to claim the saver's credit for contributions made to his or her ABLE account.

The provision is effective for tax years beginning after December 22, 2017 and will sunset after December 31, 2025.

Use of 529 Plan Distributions for Elementary or Secondary Schools

TCJA modifies Section 529 plans to allow such plans to distribute not more than $10,000 in expenses for tuition incurred during the tax year in connection with the enrollment or attendance of the designated beneficiary at a public, private or religious elementary or secondary school. This limitation applies on a per-student basis, rather than a per-account basis. Thus, under the provision, although an individual may be the designated beneficiary of multiple accounts, that individual may receive a maximum of $10,000 in distributions free of tax, regardless of whether the funds are distributed from multiple accounts. Any excess distributions received by the individual will be treated as a distribution subject to tax under the general rules of Code Sec. 529.

The provision applies to distributions made after December 31, 2017.

Rollovers Between 529 Plans and Qualified ABLE Programs

TCJA allows for amounts from qualified tuition programs (also known as Section 529 accounts) to be rolled over to an ABLE account without penalty, provided that the ABLE account is owned by the designated beneficiary of that Section 529 account, or a member of such designated beneficiary's family. Such rolled-over amounts count towards the overall limitation on amounts that can be contributed to an ABLE account within a tax year. Any amount rolled over that is in excess of this limitation will be includible in the gross income of the distributee in a manner provided by Code Sec. 72.

The provision applies to distributions after December 31, 2017, and will sunset after December 31, 2025.

Extension of Time Limit to Contest IRS Levy

TCJA extends from nine months to two years the period for returning the monetary proceeds from the sale of property that has been wrongfully levied upon. The provision also extends from nine months to two years the period for bringing a civil action for wrongful levy.

The provision is effective with respect to: (1) levies made after December 22, 2017; and (2) levies made on or before December 22, 2017 provided that the nine-month period has not expired as of December 22, 2017.

Treatment of Certain Individuals Performing Services in the Sinai Peninsula of Egypt

TCJA grants combat zone tax benefits to the Sinai Peninsula of Egypt, if as of December 22, 2017 of the provision any member of the Armed Forces of the United States is entitled to special pay under Section 310 of title 37, United States Code (relating to special pay; duty subject to hostile fire or imminent danger), for services performed in such location. This benefit lasts only during the period such entitlement is in effect.

The provision is generally effective beginning June 9, 2015. The portion of the provision related to wage withholding applies to remuneration paid after December 22, 2017.

Treatment of Student Loans Discharged on Account of Death or Disability

TCJA modifies the exclusion of student loan discharges from gross income, by including within the exclusion certain discharges on account of death or total and permanent disability of the student. Loans eligible for the exclusion under the provision are loans made by (1) the United States (or an instrumentality or agency thereof), (2) a state (or any political subdivision thereof), (3) certain tax-exempt public benefit corporations that control a state, county, or municipal hospital and whose employees have been deemed to be public employees under state law, (4) an educational organization that originally received the funds from which the loan was made from the United States, a State, or a tax-exempt public benefit corporation, or (5) private education loans (for this purpose, private education loan is defined in Section 140(7) of the Consumer Protection Act).

The provision applies to discharges of loans after December 31, 2017, and before January 1, 2026.

Deduction for Certain Educator Expenses Retained

The House Bill would have repealed the for the deduction of up to $250 for certain expenses of eligible educators. The Senate Bill would have doubled the current law deduction to $500. TCJA adopted neither the House nor Senate Bill and instead keeps the current law $250 deduction.

Deduction for Student Loan Interest and the Exclusion for Graduate Student Tuition Waivers Retained

TCJA omits provisions from the House Bill that would have repealed the above-the-line deduction for student loan interest and the exclusion from income of tuition waivers for graduate students, thereby retaining current rules for both provisions.

Business Loss Limitation Rules Applicable to Individuals

Under TCJA, for tax years beginning after December 31, 2017, and before January 1, 2026, excess business losses of a taxpayer other than a corporation are not allowed for the tax year. Such losses are carried forward and treated as part of the taxpayer's net operating loss ("NOL") carryforward in subsequent tax years. Under this provision, NOL carryovers generally are allowed for a tax year up to the lesser of the carryover amount or 80 percent of taxable income determined without regard to the deduction for NOLs.

An excess business loss for the tax year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer (determined without regard to the limitation of the provision), over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount. The threshold amount for a tax year is $250,000 (or twice the otherwise applicable threshold amount in the case of a joint return). The threshold amount is indexed for inflation after 2018.

In the case of a partnership or S corporation, the provision applies at the partner or shareholder level. Each partner's distributive share and each S corporation shareholder's pro rata share of items of income, gain, deduction, or loss of the partnership or S corporation are taken into account in applying the limitation under the provision for the tax year of the partner or S corporation shareholder. Regulatory authority is provided to apply the provision to any other passthrough entity to the extent necessary to carry out the provision. Regulatory authority is also provided to require any additional reporting as the Secretary determines is appropriate to carry out the purposes of the provision.

The provision applies after the application of the passive loss rules.

For tax years beginning after December 31, 2017, and before January 1, 2026, the present-law limitation relating to excess farm losses does not apply.

The provision is effective for tax years beginning after December 31, 2017.

II. Estate and Gift Tax Changes

Increase in Estate and Gift Tax Exemption

TCJA doubles the estate and gift tax exemption amount. This is accomplished by increasing the basic exclusion amount provided in Code Sec. 2010(c)(3) from $5 million to $10 million. The $10 million amount is indexed for inflation occurring after 2011.

The provision is effective for decedents dying, generation-skipping transfers, and gifts made after December 31, 2017, and expires for years beginning after December 31, 2025.

TCJA omits a provision from the House Bill that would have repealed the estate and generation-skipping transfer tax beginning in 2025.

III. Deduction for Qualified Business Income of an Individual (Passthrough Break)

Under TCJA, sole proprietors, partners in partnerships, members in LLCs taxed as partnerships (hereafter, "partners"), and shareholders in S corporations may qualify for a new deduction for qualified business income for tax years beginning after December 31, 2017, and before January 1, 2026. Trusts and estates are also eligible for this deduction.

The amount of the deduction is generally 20 percent of the taxpayer's qualifying business income.

Example: In 2018, Joe receives a salary of $100,000 from his job at XYZ Corporation and $50,000 of qualified business income from a side business that he runs as a sole proprietorship. Joe's deduction for qualified business income in 2018 is $10,000 (20 percent of $50,000).

Observation: The effective marginal tax rate on qualified business income for individuals in the top 37-percent tax bracket who are able to fully apply the new deduction will be 29.6 percent - fully 10 points lower than the top rate under current law.

The deduction for qualified business income is claimed by individual taxpayers on their personal tax returns. The deduction reduces taxable income. The deduction is not used in computing adjusted gross income. Thus, it does not affect limitations based on adjusted gross income.

Observation: The deduction is available to both nonitemizers and itemizers.

The deduction for qualified business income is subject to several restrictions and limitations, discussed below.

Qualified Trade or Business

TCJA provides that qualified business income is determined for each qualified trade or business of the taxpayer. The term "qualified trade or business" means any trade or business other than: (1) a specified service trade or business (defined below); and (2) the trade or business of performing services as an employee.

Specified Service Trade or Business. A specified service trade or business means any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests, or commodities. For this purpose, a security and a commodity have the meanings provided in the rules for the mark-to-market accounting method for dealers in securities (Code Sec. 475(c)(2) and Code Sec. 475(e)(2), respectively).

Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.

Special Rule Where Taxpayer's Income Is Below a Specified Threshold. The rule disqualifying specified service trades or businesses from being considered a qualified trade or business does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the restriction is phased in over a range of $50,000 in taxable income ($100,000 for joint filers).

The threshold amount is indexed for inflation. The exclusion from the definition of a qualified business for specified service trades or businesses is fully phased in for a taxpayer with taxable income in excess of the threshold amount plus $50,000 ($100,000 in the case of a joint return). For a taxpayer with taxable income within the phase-in range, the exclusion applies as follows.

Phase-in of Specified Service Business Limitation. In computing the qualified business income with respect to a specified service trade or business, the taxpayer takes into account only the applicable percentage of qualified items of income, gain, deduction, or loss, and of allocable W-2 wages. The applicable percentage with respect to any tax year is 100 percent reduced by the percentage equal to the ratio of the excess of the taxable income of the taxpayer over the threshold amount bears to $50,000 ($100,000 in the case of a joint return).

Example: Tom, and unmarried taxpayer, has taxable income of $187,500, of which $150,000 is attributable to an accounting sole proprietorship. Assume that the sole proprietorship's W-2 wages are high enough that the W-2 wage limitation (see below) will not affect Tom's deduction. Tom has an applicable percentage of 40 percent [$187,500 - $157,500 (Tom's threshold amount) = $30,000 / $50,000 (phaseout range) = 60 percent; 100 percent - 60 percent = 40 percent]. In determining includible qualified business income, Tom takes into account 40 percent of $150,000, or $60,000. Because we're assuming that the W-2 wage limitation doesn't apply, Tom's deduction for qualified business income is 20 percent of $60,000, or $12,000.

"Domestic" Business Income Requirement

Items are treated as qualified items of income, gain, deduction, and loss only to the extent they are effectively connected with the conduct of a trade or business within the United States. In the case of a taxpayer who is an individual with otherwise qualified business income from sources within the commonwealth of Puerto Rico, if all the income is taxable under Code Sec. 1 (income tax rates for individuals) for the tax year, the "United States" is considered to include Puerto Rico for purposes of determining the individual's qualified business income.

Qualified Business Income

Qualified business income means the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer.

Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer. Similarly, qualified business income does not include any guaranteed payment for services rendered with respect to the trade or business, and to the extent provided in regulations, does not include any amount paid or incurred by a partnership to a partner who is acting other than in his or her capacity as a partner for services.

Example: Charlotte is a partner in, and sales manager for, the XYZ partnership, a domestic business that is not a specified service trade or business. During the tax year, she receives guaranteed payments of $250,000 from XYZ for her services to the partnership as its sales manager. In addition, her distributive share of XYZ's ordinary income (it's only item of income or loss) was $175,000. Charlotte's qualified business income from XYZ is $175,000.

The determination of qualified items of income, gain, deduction, and loss takes into account these items only to the extent included or allowed in the determination of taxable income for the year.

Example: During the tax year, a qualified business has $100,000 of ordinary income from inventory sales, and makes an expenditure of $25,000 that is required to be capitalized and amortized over five years under applicable tax rules. Qualified business income is $100,000 minus $5,000 (current-year ordinary amortization deduction), or $95,000. The qualified business income is not reduced by the entire amount of the capital expenditure, only by the amount deductible in determining tax income for the year.

Calculating the Deduction

The deductible amount for each qualified trade or business is the lesser of -

(1) 20 percent of the taxpayer's qualified business income with respect to the trade or business; or

(2) the greater of 50 percent of the W-2 wages (defined below) with respect to the trade or business or the sum of 25 percent of the W-2 wages with respect to the trade or business and 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.

The amount in "(2)" is referred to hereafter as "the W-2 wage limitation."

W-2 Wage Limitation on the Deduction

The W-2 wage limitation on the deduction for qualified business income is based on either W-2 wages paid, or W-2 wages paid plus a capital element. This limitation is phased in above a threshold amount of taxable income (see below). Specifically, the limitation is the greater of: (1) 50 percent of the W-2 wages paid with respect to the qualified trade or business; or (2) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.

Example: Susan owns and operates a sole proprietorship that sells cupcakes. The business is not a specified service business and Susan's filing status for Form 1040 is single. The cupcake business pays $100,000 in W-2 wages and has $350,000 in qualified business income. For the sake of simplicity, assume the business had no qualified property, and that Susan has no other items of income or loss (putting her taxable income at a level where she's fully subject to the W-2 wage limitation). Susan's deduction for qualified business income is $50,000, which is the lesser of (a) 20 percent of $350,000 in qualified business income ($70,000), or (b) the greater of (i) 50 percent of W-2 wages ($50,000) or (ii) 25 percent of W-2 wages plus 2.5 percent of qualified property ($25,000) ($25,000 ($100,000 x 25 percent) + $0 (2.5 percent x $0)).

Observation: The first of the two ways of calculating the W-2 wage limitation (50 percent of W-2 wages) is the one that will apply to most business that have employees. The second way (25 percent of W-2 wages plus 2.5 percent of qualified property) will mainly apply to real estate activities and other activities that have an unusually high ratio of qualifying property to employees.

W-2 Wages Defined

W-2 wages are the total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the qualified trade or business with respect to employment of its employees during the calendar year ending during the tax year of the taxpayer. W-2 wages do not include any amount which is not properly allocable to the qualified business income as a qualified item of deduction. In addition, W-2 wages do not include any amount which was not properly included in a return filed with the Social Security Administration (SSA) on or before the 60th day after the due date (including extensions) for such return.

Gray Area: The language of new Code Sec. 199A (which provides the rules for the deduction for qualified business income), appears to treat S corporation shareholders and partners in partnerships differently for the narrow purpose of calculating the W-2 wage limitation. Reasonable compensation paid to an S corporation shareholder as wages appear to fall within the definition of W-2 wages for purposes of applying the limitation. By contrast, guaranteed payments to a partner appear not to fall within the definition.

Caution: The text of Code Sec. 199A is convoluted, and other commentators and (and the IRS) may have a different interpretation of how the definition of W-2 wages applies to S corporation shareholders vs. partners and LLC members. Even if our interpretation holds up, there is no indication that Congress intended to treat these types of owners differently with respect to how W-2 wages are calculated. So, for now, practitioners may want to note this as a gray area, and one that will be ripe to be addressed in a future technical corrections bill.

In the case of a taxpayer who is an individual with otherwise qualified business income from sources within the commonwealth of Puerto Rico, if all the income is taxable under Code Sec. 1 (income tax rates for individuals) for the tax year, the determination of W-2 wages with respect to the taxpayer's trade or business conducted in Puerto Rico is made without regard to any exclusion under the wage withholding rules for remuneration paid for services in Puerto Rico.

Qualified Property Defined

For purposes of this provision, qualified property means tangible property of a character subject to depreciation that is held by, and available for use in, the qualified trade or business at the close of the tax year, and which is used in the production of qualified business income, and for which the depreciable period has not ended before the close of the tax year. The depreciable period with respect to qualified property of a taxpayer means the period beginning on the date the property is first placed in service by the taxpayer and ending on the later of (1) the date 10 years after that date, or (2) the last day of the last full year in the applicable recovery period that would apply to the property under Code Sec. 168 (without regard to Code Sec. 168(g)).

Example: Walter (who is subject to the limitation on the deduction for qualified business income) does business as a sole proprietorship conducting a widget-making business. The business buys a widget-making machine for $100,000 and places it in service in 2020. The business has no employees in 2020. The W-2 limitation in 2020 is the greater of (a) 50 percent of W-2 wages, or $0, or (b) the sum of 25 percent of W-2 wages ($0) plus 2.5 percent of the unadjusted basis of the machine immediately after its acquisition: $100,000 x .025 = $2,500. The amount of the limitation on Walter's deduction is $2,500.

In the case of property that is sold, for example, the property is no longer available for use in the trade or business and is not taken into account in determining the limitation. TCJA provides that the IRS must provide rules for applying the limitation in cases of a short tax year in which the taxpayer acquires, or disposes of, the major portion of a trade or business or the major portion of a separate unit of a trade or business during the year. The IRS is required to provide guidance applying rules similar to the rules of Code Sec. 179(d)(2) to address acquisitions of property from a related party, as well as in a sale-leaseback or other transaction as needed to carry out the purposes of the provision and to provide anti-abuse rules, including under the limitation based on W-2 wages and capital. Similarly, the IRS must provide guidance prescribing rules for determining the unadjusted basis immediately after acquisition of qualified property acquired in like-kind exchanges or involuntary conversions as needed to carry out the purposes of the provision and to provide anti-abuse rules, including under the limitation based on W-2 wages and capital.

Phase-in of W-2 Wage Limitation

The application of the W-2 wage limitation phases in for a taxpayer with taxable income in excess of the following threshold amounts: $315,000 for joint filers and $157,500 for all other taxpayers, indexed for inflation. For purposes of phasing in the wage limit, taxable income is computed without regard to the 20 percent deduction.

The W-2 wage limitation applies fully for a taxpayer with taxable income in excess of the threshold amount plus $50,000 ($100,000 in the case of a joint return). For a taxpayer with taxable income within the phase-in range, the wage limit applies as follows. With respect to any qualified trade or business, the taxpayer compares -

(1) 20 percent of the taxpayer's qualified business income with respect to the qualified trade or business; with

(2) the W-2 wage limitation (see above) with respect to the qualified trade or business.

If the amount determined under (2) is less than the amount determined (1), (that is, if the wage limit is binding), the taxpayer's deductible amount is the amount determined under (1) reduced by the same proportion of the difference between the two amounts as the excess of the taxable income of the taxpayer over the threshold amount bears to $50,000 ($100,000 in the case of a joint return).

Carryover Losses

If the net amount of qualified business income from all qualified trades or businesses during the tax year is a loss, it is carried forward as a loss from a qualified trade or business in the next tax year. Similar to a qualified trade or business that has a qualified business loss for the current tax year, any deduction allowed in a subsequent year is reduced (but not below zero) by 20 percent of any carryover qualified business loss.

Example: Sean has qualified business income of $20,000 from qualified business A and a qualified business loss of $50,000 from qualified business B in Year 1. Sean is not permitted a deduction for Year 1 and has a carryover qualified business loss of $30,000 to Year 2. In Year 2, Sean has qualified business income of $20,000 from qualified business A and qualified business income of $50,000 from qualified business B. To determine the deduction for Year 2, Sean reduces the 20 percent deductible amount determined for the qualified business income of $70,000 from qualified businesses A and B by 20 percent of the $30,000 carryover qualified business loss.

Treatment of Investment Income

Qualified items of income, gain, deduction, and loss do not include specified investment-related income, deductions, or loss. Specifically, qualified items of income, gain, deduction and loss do not include (1) any item taken into account in determining net long-term capital gain or net long-term capital loss, (2) dividends, income equivalent to a dividend, or payments in lieu of dividends, (3) interest income other than that which is properly allocable to a trade or business, (4) the excess of gain over loss from commodities transactions, other than those entered into in the normal course of the trade or business or with respect to stock in trade or property held primarily for sale to customers in the ordinary course of the trade or business, property used in the trade or business, or supplies regularly used or consumed in the trade or business, (5) the excess of foreign currency gains over foreign currency losses from Code Sec. 988 transactions, other than transactions directly related to the business needs of the business activity, (6) net income from notional principal contracts, other than clearly identified hedging transactions that are treated as ordinary (i.e., not treated as capital assets), and (7) any amount received from an annuity that is not used in the trade or business of the business activity. Qualified items under this provision do not include any item of deduction or loss properly allocable to such income.

Special Rules for Partnerships and S Corporations

TCJA provides that, in the case of a partnership or S corporation, the business income deduction applies at the partner or shareholder level. Each partner takes into account the partner's allocable share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the tax year equal to the partner's allocable share of W-2 wages of the partnership. The partner's allocable share of W-2 wages is required to be determined in the same manner as the partner's share of wage expenses. For example, if a partner is allocated a deductible amount of 10 percent of wages paid by the partnership to employees for the tax year, the partner is required to be allocated 10 percent of the W-2 wages of the partnership for purposes of calculating the wage limit under this deduction. Similarly, each shareholder of an S corporation takes into account the shareholder's pro rata share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the tax year equal to the shareholder's pro rata share of W-2 wages of the S corporation.

Qualified REIT Dividends, Cooperative Dividends, and Publicly Traded Partnership Income

A deduction is allowed under the provision for 20 percent of the taxpayer's aggregate amount of qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income for the tax year. Qualified REIT dividends do not include any portion of a dividend received from a REIT that is a capital gain dividend or a qualified dividend. A qualified cooperative dividend means a patronage dividend, per-unit retain allocation, qualified written notice of allocation, or any similar amount, provided it is includible in gross income and is received from either (1) a tax-exempt benevolent life insurance association, mutual ditch or irrigation company, cooperative telephone company, like cooperative organization, or a taxable or tax-exempt cooperative that is described in Code Sec. 1381(a), or (2) a taxable cooperative governed by tax rules applicable to cooperatives before the enactment of subchapter T of the Code in 1962. Qualified publicly traded partnership income means (with respect to any qualified trade or business of the taxpayer), the sum of the (1) the net amount of the taxpayer's allocable share of each qualified item of income, gain, deduction, and loss (that are effectively connected with a U.S. trade or business and are included or allowed in determining taxable income for the tax year and do not constitute excepted enumerated investment-type income, and not including the taxpayer's reasonable compensation, guaranteed payments for services, or (to the extent provided in regulations) Code Sec. 707(a) payments for services) from a publicly traded partnership not treated as a corporation, and (2) gain recognized by the taxpayer on disposition of its interest in the partnership that is treated as ordinary income (for example, by reason of Code Sec. 751).

Determining the Final Amount of the Deduction for Qualified Business Income

An individual taxpayer generally may deduct an amount equal to the sum of -

(1) the lesser of (a) the combined qualified business income amount for the tax year; or (b) an amount equal to 20 percent of the excess (if any) of taxpayer's taxable income for the tax year over the sum of any net capital gain and qualified cooperative dividends, plus

(2) the lesser of 20 percent of qualified cooperative dividends for the tax year or taxable income (reduced by net capital gain).

This sum may not exceed the taxpayer's taxable income for the tax year (reduced by net capital gain).

Treatment of Trusts and Estates

TCJA provides that trusts and estates are eligible for the 20-percent deduction. Rules similar to the rules under present-law Code Sec. 199 (as in effect on December 1, 2017) apply for apportioning between fiduciaries and beneficiaries any W-2 wages and unadjusted basis of qualified property under the limitation based on W-2 wages and capital.

Treatment of Agricultural and Horticultural Cooperatives

For tax years beginning after December 31, 2017, but not after December 31, 2025, a deduction is allowed to any specified agricultural or horticultural cooperative equal to the lesser of (1) 20 percent of the cooperative's taxable income for the tax year or (2) the greater of 50 percent of the W-2 wages paid by the cooperative with respect to its trade or business or the sum of 25 percent of the W-2 wages of the cooperative with respect to its trade or business plus 2.5 percent of the unadjusted basis immediately after acquisition of qualified property of the cooperative. A specified agricultural or horticultural cooperative is an organization to which subchapter T applies that is engaged in (1) the manufacturing, production, growth, or extraction in whole or significant part of any agricultural or horticultural product, (2) the marketing of agricultural or horticultural products that its patrons have so manufactured, produced, grown, or extracted, or (3) the provision of supplies, equipment, or services to farmers or organizations described in the foregoing.

Effective Date

The provision is effective for tax years beginning after December 31, 2017, and does not apply to tax years beginning after December 31, 2025.

IV. Business-Related Changes

Reduction in Corporate Tax Rate

TCJA eliminates the graduated corporate rate structure and instead taxes corporate taxable income at 21 percent. It also eliminates the special tax rate for personal service corporations and repeals the maximum corporate tax rate on net capital gain as obsolete. For taxpayers subject to the normalization method of accounting (e.g., regulated public utilities), TCJA provides for the normalization of excess deferred tax reserves resulting from the reduction of corporate income tax rates (with respect to prior depreciation or recovery allowances taken on assets placed in service before January 1, 2018).

The provision is effective for tax years beginning after December 31, 2017.

Reduction of Dividends Received Deductions to Reflect Lower Corporate Tax Rate

TCJA reduces the 70 percent dividends received deduction available to corporations who receive a dividend from another taxable domestic corporation to 50 percent. It also reduces the 80 percent dividends received deduction for dividends received from a 20-percent owned corporation to 65 percent.

The provision is effective for tax years beginning after December 31, 2018.

Corporate Alternative Minimum Tax

TCJA repeals the corporate alternative minimum tax (AMT).

In the case of a corporation, TCJA allows the AMT credit to offset the regular tax liability for any tax year. In addition, the AMT credit is refundable for any tax year beginning after 2017 and before 2022 in an amount equal to 50 percent (100 percent in the case of tax years beginning in 2021) of the excess of the minimum tax credit for the tax year over the amount of the credit allowable for the year against regular tax liability. Thus, the full amount of the minimum tax credit will be allowed in tax years beginning before 2022.

The provision is effective for tax years beginning after December 31, 2017.

Enhanced Expensing Through Bonus Depreciation

TCJA extends and modifies the additional first-year (i.e., "bonus") depreciation deduction through 2026 (through 2027 for longer production period property and certain aircraft). Under TCJA, the 50-percent additional depreciation allowance is increased to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for longer production period property and certain aircraft), as well as for specified plants planted or grafted after September 27, 2017, and before January 1, 2023.

The 100-percent allowance is phased down by 20 percent per calendar year for property placed in service, and specified plants planted or grafted, in tax years beginning after 2022 (after 2023 for longer production period property and certain aircraft). Thus, for property placed in service after December 31, 2022, and before January 1, 2024 (January 1, 2025, for longer production period property and certain aircraft), the bonus percentage is 80 percent; for property placed in service after December 31, 2023, and before January 1, 2025 (January 1, 2026, for longer production period property and certain aircraft), the bonus percentage is 60 percent; for property placed in service after December 31, 2024, and before January 1, 2026 (January 1, 2027, for longer production period property and certain aircraft), the bonus percentage is 40 percent; for property placed in service after December 31, 2025, and before January 1, 2027 (January 1, 2028, for longer production period property and certain aircraft), the bonus percentage is 20 percent. The general bonus depreciation percentages also apply to certain specified plants bearing fruits or nuts.

Observation: Under current law, the bonus depreciation is scheduled to end for qualified property acquired and placed in service before January 1, 2020 (January 1, 2021, for longer production period property and certain aircraft) and the 50-percent bonus depreciation amount is scheduled to be phased down for property placed in service after December 31, 2017, including certain specified plants bearing fruits or nuts planted or grafted after such date. Thus, TCJA repeals the current-law phase-down of the additional first-year depreciation deduction for property placed in service after December 31, 2017, as well as the phase down also scheduled for certain specified plants bearing fruits or nuts planted or grafted after such date.

TCJA also provides that the present-law phase-down of bonus depreciation is maintained for property acquired before September 28, 2017, and placed in service after September 27, 2017. Under the provision, in the case of property acquired and adjusted basis incurred before September 28, 2017, the bonus depreciation rates are as follows: 50 percent if placed in service in 2017 (2018 for longer production period property and certain aircraft), 40 percent if placed in service in 2018 (2019 for longer production period property and certain aircraft), 30 percent if placed in service in 2019 (2020 for longer production period property and certain aircraft), and zero percent if placed in service in 2020 (2021 for longer production period property and certain aircraft).

TCJA maintains the bonus depreciation increase amount of $8,000 for luxury passenger automobiles placed in service after December 31, 2017.

Observation: Under current law, the $8,000 increase in depreciation for luxury passenger automobiles (as defined in Code Sec. 280F(d)(5)) was scheduled to be phased down to $6,400 and $4,800 for property placed in service in 2018 and 2019, respectively.

As a conforming amendment to the repeal of the corporate AMT, TCJA repeals the election to accelerate corporate AMT credits in lieu of bonus depreciation.

TCJA extends the special rule under the percentage-of-completion method for the allocation of bonus depreciation to a long-term contract for property placed in service before January 1, 2027 (January 1, 2028, in the case of longer production period property).

Qualified Property. TCJA removes the requirement that, in order to qualify for bonus depreciation, the original use of qualified property must begin with the taxpayer. Thus, the provision applies to purchases of used as well as new items. To prevent abuses, the additional first-year depreciation deduction applies only to property purchased in an arm's-length transaction. It does not apply to property received as a gift or from a decedent. In the case of trade-ins, like-kind exchanges, or involuntary conversions, it applies only to any money paid in addition to the traded-in property or in excess of the adjusted basis of the replaced property. It does not apply to property acquired in a nontaxable exchange such as a reorganization, to property acquired from a member of the taxpayer's family, including a spouse, ancestors, and lineal descendants, or from another related entity as defined in Code Sec. 267, nor to property acquired from a person who controls, is controlled by, or is under common control with, the taxpayer. Thus, it does not apply, for example, if one member of an affiliated group of corporations purchases property from another member, or if an individual who controls a corporation purchases property from that corporation. TCJA also removes computer equipment from the category of listed property (as defined in Code Sec. 280F(b)(2)), thus eliminating the depreciation limitation on such property.

TCJA also expands the definition of qualified property eligible for the additional first-year depreciation allowance to include qualified film, television and live theatrical productions, effective for productions placed in service after September 27, 2017, and before January 1, 2023. For this purpose, a production is 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).

TCJA excludes from the definition of qualified property certain public utility property, i.e., property used predominantly in the trade or business of the furnishing or sale of:

(1) electrical energy, water, or sewage disposal services;

(2) gas or steam through a local distribution system; or

(3) transportation of gas or steam by pipeline, if the rates for such furnishing or sale, as the case may be, have been established or approved by a state or political subdivision thereof, by any agency or instrumentality of the United States, or by a public service or public utility commission or other similar body of any state or political subdivision thereof.

TCJA also excludes from the definition of qualified property any property used in a trade or business that has had floor plan financing indebtedness, unless the taxpayer which has such trade or business is not a tax shelter prohibited from using the cash method and is exempt from the interest limitation rules by meeting the small business gross receipts test of Code Sec. 448(c).

The provision generally applies to property placed in service after September 27, 2017, in tax years ending after such date, and to specified plants planted or grafted after such date. A transition rule provides that, for a taxpayer's first tax year ending after September 27, 2017, the taxpayer may elect to apply a 50-percent allowance.

Enhanced Expensing Through Section 179 Expense Deductions

TCJA increases the maximum amount a taxpayer may expense under Code Sec. 179 to $1,000,000, and increases the phase-out threshold amount to $2,500,000. Thus, the provision provides that the maximum amount a taxpayer may expense, for tax years beginning after 2017, is $1,000,000 of the cost of qualifying property placed in service for the tax year. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $2,500,000. The $1,000,000 and $2,500,000 amounts, as well as the $25,000 sport utility vehicle limitation, are indexed for inflation for tax years beginning after 2018.

TCJA expands the definition of Code Sec. 179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging.

Observation: Property used predominantly to furnish lodging or in connection with furnishing lodging generally includes, for example, beds and other furniture, refrigerators, ranges, and other equipment used in the living quarters of a lodging facility such as an apartment house, dormitory, or any other facility (or part of a facility) where sleeping accommodations are provided.

TCJA also expands 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 provision applies to property placed in service in tax years beginning after December 31, 2017.

Modifications to Depreciation Limitations on Luxury Automobiles and Personal Use Property

TCJA increases the depreciation limitations under Code Sec. 280F that apply to listed property. For passenger automobiles that qualify as luxury automobiles (i.e., gross unloaded weight of 6,000 lbs or more) placed in service after December 31, 2017, and for which the additional first-year depreciation deduction is not claimed, the maximum amount of allowable depreciation is $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. The limitations are indexed for inflation for luxury passenger automobiles placed in service after 2018.

TCJA removes computer or peripheral equipment from the definition of listed property. Such property is therefore not subject to the heightened substantiation requirements that apply to listed property.

The provision is effective for property placed in service after December 31, 2017.

Modifications of Treatment of Certain Farm Property

TCJA shortens the recovery period from 7 to 5 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 begins with the taxpayer and is placed in service after December 31, 2017.

TCJA also repeals the required use of the 150-percent declining balance method for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property). The 150-percent declining balance method will 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-percent declining balance method.

The provision is effective for property placed in service after December 31, 2017.

Modification of Net Operating Loss (NOL) Deduction

TCJA limits the NOL deduction to 80 percent of taxable income (determined without regard to the deduction). Carryovers to other years are adjusted to take account of this limitation, and may be carried forward indefinitely.

The provision repeals the two-year carryback and the special carryback provisions in current law, but provides a two-year carryback in the case of certain losses incurred in the trade or business of farming. In addition, TCJA provides a two-year carryback and 20-year carryforward for NOLs of a property and casualty insurance company.

The provision applies to losses arising in tax years beginning after December 31, 2017.

Modification of Like-Kind Exchange Rules

TCJA modifies the provision providing for nonrecognition of gain in the case of like-kind exchanges by limiting its application to real property that is not held primarily for sale.

The provision generally applies to exchanges completed after December 31, 2017. However, an exception is provided for any exchange if the property disposed of by the taxpayer in the exchange is disposed of on or before December 31, 2017, or the property received by the taxpayer in the exchange is received on or before such date.

Modification of Alternative Depreciation System Recovery Period for Residential Rental Property

TCJA shortens the alternative depreciation system (ADS) recovery period for residential rental property from 40 to 30 years. It also allows an electing real property trade or business to use the ADS recovery period in depreciating real and qualified improvement property.

Observation: The Senate Bill had shortened the recovery period for determining the depreciation deduction with respect to nonresidential real property from 39 years to 25 years and for residential rental property from 27.5 years to 25 years. Under the Senate Bill, such property placed in service before 2018 would have been treated as having a new placed-in-service date of January 1, 2018, if it resulted in more advantageous deductions. However, this provision was eliminated in TCJA.

Elimination of Separate Definitions Relating to Qualified Leasehold Improvements, Qualified Restaurant, and Qualified Retail Improvement Property

TCJA eliminates the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, and provides a general 15-year recovery period for qualified improvement property, and a 20-year ADS recovery period for such property. Thus, for example, qualified improvement property placed in service after December 31, 2017, is generally depreciable over 15 years using the straight line method and half-year convention, without regard to whether the improvements are property subject to a lease, placed in service more than three years after the date the building was first placed in service, or made to a restaurant building. Restaurant building property placed in service after December 31, 2017, that does not meet the definition of qualified improvement property is depreciable over 39 years as nonresidential real property, using the straight line method and the mid-month convention.

As a conforming amendment, TCJA replaces the references in Code Sec. 179(f) to qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property with a reference to qualified improvement property.

TCJA also requires a real property trade or business electing out of the limitation on the deduction for interest to use ADS to depreciate any of its nonresidential real property, residential rental property, and qualified improvement property.

The provision is effective for property placed in service after December 31, 2017.

Modification of Treatment of S Corporation Conversions to C Corporations

TCJA provides that any Code Sec. 481(a) adjustment of an eligible terminated S corporation attributable to the revocation of its S corporation election (i.e., a change from the cash method to an accrual method) is taken into account ratably during the six-taxable-year period beginning with the year of change. An eligible terminated S corporation is any C corporation which (1) is an S corporation the day before the enactment of TCJA, (2) during the two-year period beginning on the date of such enactment revokes its S corporation election under Code Sec. 1362(a), and (3) all of the owners of which on the date the S corporation election is revoked are the same owners (and in identical proportions) as the owners on the date of such enactment.

Under the provision, in the case of a distribution of money by an eligible terminated S corporation, the accumulated adjustments account shall be allocated to such distribution, and the distribution shall be chargeable to accumulated earnings and profits, in the same ratio as the amount of the accumulated adjustments account bears to the amount the accumulated earnings and profits.

The provision is effective upon enactment.

Modification of Orphan Drug Credit

TCJA reduces the Orphan Drug Credit rate to 25 percent (instead of current law's 50 percent rate) of qualified clinical testing expenses. The new law also has reporting requirements similar to those required in Code Sec. 48C and Code Sec. 48D. In addition, TCJA strikes any base amount calculation and also the limitation regarding qualified clinical testing expenses to the extent such testing relates to a drug which has previously been approved under Section 505 of the Federal Food, Drug, and Cosmetic Act.

The provision applies to amounts paid or incurred in tax years beginning after December 31, 2017.

Small Business Cash Accounting Method Reform and Simplification

TCJA expands the universe of taxpayers that may use the cash method of accounting. Under the provision, the cash method of accounting may be used by taxpayers, other than tax shelters, that satisfy a gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25 million for the three prior taxable-year period (the "$25 million gross receipts test") to use the cash method. The $25 million amount is indexed for inflation for tax years beginning after 2018.

The provision expands the universe of farming C corporations (and farming partnerships with a C corporation partner) that may use the cash method to include any farming C corporation (or farming partnership with a C corporation partner) that meets the $25 million gross receipts test.

TCJA retains the exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations. Thus, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other passthrough entities are allowed to use the cash method without regard to whether they meet the $25 million gross receipts test, so long as the use of such method clearly reflects income.

The provisions to expand the universe of taxpayers eligible to use the cash method apply to tax years beginning after December 31, 2017. The change to the cash method is a change in the taxpayer's method of accounting for purposes of Code Sec. 481

Modification of Inventory Classification Rules for Small Businesses

TCJA exempts certain taxpayers from the requirement to keep inventories. Specifically, taxpayers that meet the $25 million gross receipts test are not required to account for inventories under Code Sec. 471, but rather may use a method of accounting 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.

TCJA expands the exception for small taxpayers from the uniform capitalization rules. Under the provision, any producer or reseller that meets the $25 million gross receipts test is exempted from the application of Code Sec. 263A. The provision retains the exemptions from the uniform capitalization rules that are not based on a taxpayer's gross receipts. Finally, the provision expands the exception for small construction contracts from the requirement to use the percentage-of-completion method. Under the provision, contracts within this exception are those contracts for the construction or improvement of real property if the contract: (1) is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract, and (2) is performed by a taxpayer that (for the tax year in which the contract was entered into) meets the $25 million gross receipts test.

Under TCJA, a taxpayer who fails the $25 million gross receipts test is not eligible for any of the aforementioned exceptions (i.e., from the accrual method, from keeping inventories, from applying the uniform capitalization rules, or from using the percentage-of completion method) for such tax year.

The provisions to exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the uniform capitalization rules are changes in the taxpayer's method of accounting for purposes of Code Sec. 481. Application of the exception for small construction contracts from the requirement to use the percentage-of-completion method is applied on a cutoff basis for all similarly classified contracts (hence there is no adjustment under Code Sec. 481(a) for contracts entered into before January 1, 2018).

The provisions to expand the universe of taxpayers eligible to use the cash method, exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the uniform capitalization rules apply to tax years beginning after December 31, 2017. The provision to expand the exception for small construction contracts from the requirement to use the percentage-of-completion method applies to contracts entered into after December 31, 2017, in tax years ending after such date.

Exceptions to Using Uniform Capitalization Rules Expanded

TCJA expands the exception for small taxpayers being subject to the uniform capitalization accounting method rules. Under the provision, any producer or reseller that meets a $25 million gross receipts test is exempted from the application of Code Sec. 263A. In the case of a sole proprietorship, the $25 million gross receipts test is applied as if the sole proprietorship is a corporation or partnership. The provision retains the exemptions from the uniform capitalization rules that are not based on a taxpayer's gross receipts.

If a taxpayer changes its method of accounting because it is either no longer required or is required to apply Code Sec. 263A by reason of this provision, such change is treated as initiated by the taxpayer and made with the consent of the Secretary.

The provision apples to tax years beginning after December 31, 2017. Application of these rules would be a change in the taxpayer's method of accounting for purposes of Code Sec. 481.

Increase in Gross Receipts Test for Construction Contract Exception to Percentage of Completion Accounting Method

TCJA expands the exception for small construction contracts from the requirement to use the percentage-of-completion accounting method. Under the provision, contracts within this exception are those contracts for the construction or improvement of real property if the contract:

(1) is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract; and

(2) is performed by a taxpayer that (for the tax year in which the contract was entered into) meets the $25 million gross receipts test.

In the case of a sole proprietorship, the $25 million gross receipts test is applied as if the sole proprietorship is a corporation or partnership. The provision applies to contracts entered into after December 31, 2017, in tax years ending after such date. Application of this rule would be a change in the taxpayer's method of accounting for purposes of Code Sec. 481, but is applied on a cutoff basis for all similarly classified contracts (hence there is no adjustment under Code Sec. 481(a) for contracts entered into before January 1, 2018).

Modification of Accounting Method Rules Relating to Income Recognition

TCJA revises the rules associated with the recognition of income. Specifically, the provision requires 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 or another financial statement under rules specified by the Secretary, but provides an exception for long-term contract income to which Code Sec. 460 applies.

The provision also codifies the current deferral method of accounting for advance payments for goods and services provided by the IRS under Rev. Proc. 2004-34. That is, the provision allows 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, the provision directs taxpayers to apply the revenue recognition rules under Code Sec. 451 before applying the OID rules under Code Sec.1272.

Observation: Thus, for example, to the extent amounts are included in income for financial statement purposes when received (e.g., late payment fees, cash-advance fees, or interchange fees), such amounts generally are includable in income at such time in accordance with the general recognition principles under Code Sec. 451.

In the case of any taxpayer required by this provision to change its method of accounting for its first tax year beginning after December 31, 2017, such change is treated as initiated by the taxpayer and made with the consent of the Secretary.

The provision applies to tax years beginning after December 31, 2017, and application of these rules would be a change in the taxpayer's method of accounting for purposes of Code Sec. 481.

Changes to Interest Deduction Rules

Under TCJA, in the case of any taxpayer for any tax year, the deduction for business interest is limited to the sum of business interest income plus 30 percent of the adjusted taxable income of the taxpayer for the tax year. There is an exception to this limitation, however, for floor plan financing, which is a specialized type of financing used by car dealerships and certain regulated utilities.

TCJA also exempts from the limitation taxpayers with average annual gross receipts for the three-tax year period ending with the prior tax year that do not exceed $25 million. In addition, for purposes of defining floor plan financing, TCJA modifies the definition of motor vehicle by deleting the specific references to an automobile, a truck, a recreational vehicle, and a motorcycle because those terms are encompassed in the phrase, "any self-propelled vehicle designed for transporting persons or property on a public street, highway, or road."

At the taxpayer's election, any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business is not treated as a trade or business for purposes of the limitation, and therefore the limitation does not apply to such trades or businesses. The limitation also does not apply to certain regulated public utilities. Specifically, the trade or business of the furnishing or sale of (1) electrical energy, water, or sewage disposal services, (2) gas or steam through a local distribution system, or (3) transportation of gas or steam by pipeline, if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof, by any agency or instrumentality of the United States, or by a public service or public utility commission or other similar body of any State or political subdivision thereof is not treated as a trade or business for purposes of the limitation.

The amount of any interest not allowed as a deduction for any tax year may be carried forward indefinitely. The limitation applies at the taxpayer level. In the case of a group of affiliated corporations that file a consolidated return, it applies at the consolidated tax return filing level. A farming business, including agricultural and horticultural cooperatives, may elect not to be subject to this limitation if the business uses the alternative depreciation system to depreciate any property used in the farming business with a recovery period of 10 years or more. An electing real property trade or business may also elect out of the interest deduction limitation if the business also uses the alternative depreciation system to depreciate its property.

Business interest means any interest paid or accrued on indebtedness properly allocable to a trade or business. Any amount treated as interest for purposes of the Internal Revenue Code is interest for purposes of the provision. Business interest income means the amount of interest includible in the gross income of the taxpayer for the tax year which is properly allocable to a trade or business. Business interest does not include investment interest, and business interest income does not include investment income, within the meaning of Code Sec. 163(d).

By including business interest income in the limitation, the rule operates to limit the deduction for net interest expense to 30 percent of adjusted taxable income. That is, a deduction for business interest is permitted to the full extent of business interest income. To the extent that business interest expense exceeds business interest income, the deduction for the net interest expense is limited to 30 percent of adjusted taxable income.

Generally, adjusted taxable income means the taxable income of the taxpayer computed without regard to:

(1) any item of income, gain, deduction, or loss which is not properly allocable to a trade or business (but see below for special rules for tax years beginning after 2017 and before 2022);

(2) any business interest or business interest income;

(3) the 20 percent deduction for certain pass-through income; and

(4) the amount of any net operating loss deduction.

However, under TCJA, for tax years beginning after December 31, 2017, and before January 1, 2022, adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion. Additionally, because TCJA repeals Code Sec. 199 effective December 31, 2017 (see discussion below), adjusted taxable income is computed without regard to such deduction.

TCJA authorizes the IRS to provide other adjustments to the computation of adjusted taxable income.

Application to pass-through entities: In the case of any partnership, the limitation is applied at the partnership level. Any deduction for business interest is taken into account in determining the nonseparately stated taxable income or loss of the partnership. To prevent double counting, special rules are provided for the determination of the adjusted taxable income of each partner of the partnership. Similarly, to allow for additional interest deduction by a partner in the case of an excess amount of unused adjusted taxable income limitation of the partnership, special rules apply. Similar rules apply with respect to any S corporation and its shareholders.

Double counting rule: The adjusted taxable income of each partner (or shareholder, as the case may be) is determined without regard to such partner's distributive share of the nonseparately stated income or loss of such partnership. In the absence of such a rule, the same dollars of adjusted taxable income of a partnership could generate additional interest deductions as the income is passed through to the partners.

Additional deduction limit: The limit on the amount allowed as a deduction for business interest is increased by a partner's distributive share of the partnership's excess taxable income. The excess taxable income with respect to any partnership is the amount which bears the same ratio to the partnership's adjusted taxable income as the excess (if any) of 30 percent of the adjusted taxable income of the partnership over the amount (if any) by which the business interest of the partnership exceeds the business interest income of the partnership bears to 30 percent of the adjusted taxable income of the partnership. This allows a partner of a partnership to deduct additional interest expense the partner may have paid or incurred to the extent the partnership could have deducted more business interest. TCJA requires that excess taxable income be allocated in the same manner as nonseparately stated income and loss.

Carryforward of disallowed business interest: The amount of any business interest not allowed as a deduction for any tax year is treated as business interest paid or accrued in the succeeding tax year. Business interest may be carried forward indefinitely. With respect to the limitation on deduction of interest by domestic corporations which are United States shareholders that are members of worldwide affiliated groups with excess domestic indebtedness, whichever rule imposes the lower limitation on the deduction of interest with respect to the tax year (and therefore the greatest amount of interest to be carried forward) governs.

The trade or business of performing services as an employee is not treated as a trade or business for purposes of the limitation. As a result, for example, the wages of an employee are not counted in the adjusted taxable income of the taxpayer for purposes of determining the limitation.

The provision applies to tax years beginning after December 31, 2017.

Repeal of Domestic Activities Production Deduction

Under TCJA, the deduction in Code Sec. 199 for domestic production activities is repealed.

The provision applies to tax years beginning after December 31, 2017.

Limitation on Deduction by Employers of Expenses for Fringe Benefits

TCJA provides that no deduction is allowed with respect to -

(1) an activity generally considered to be entertainment, amusement or recreation;

(2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes; or

(3) a facility or portion thereof used in connection with any of the above items.

Thus, the provision repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer's trade or business (and the related rule applying a 50 percent limit to such deductions). TCJA also disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, and except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee's residence and place of employment.

Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel). For amounts incurred and paid after December 31, 2017, and until December 31, 2025, the provision expands this 50 percent limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer. Such amounts incurred and paid after December 31, 2025, are not deductible.

The provision generally applies to amounts paid or incurred after December 31, 2017. However, for expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer, amounts paid or incurred after December 31, 2025, are not deductible.

Repeal of Deduction for Local Lobbying Expenses

TCJA disallows deductions for lobbying expenses with respect to legislation before local government bodies (including Indian tribal governments), effective for amounts paid or incurred on or after December 22, 2017.

Limitation on Deduction Relating to FDIC Premiums

Under TCJA, no deduction is allowed for the applicable percentage of any FDIC premium paid or incurred by certain large financial institutions. For taxpayers with total consolidated assets of $50 billion or more, the applicable percentage is 100 percent. Otherwise, the applicable percentage is the ratio of the excess of total consolidated assets over $10 billion to $40 billion. The provision does not apply to taxpayers with total consolidated assets (as of the close of the tax year) that do not exceed $10 billion. The provision applies to tax years beginning after December 31, 2017.

Contributions to Capital

While TCJA retains Code Sec. 118, a provision the House Bill had sought to repeal, it provides that the term "contributions to capital" does not include -

(1) any contribution in aid of construction or any other contribution as a customer or potential customer, and

(2) any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such).

The Conference Report states that the conferees intended that, as modified, Code Sec. 118, which under current law provides that the gross income of a corporation does not include any contributions to capital, will continue to apply only to corporations.

The provision applies to contributions made after December 22, 2017. However, the provision will not apply to any contribution made after December 22, 2017, by a governmental entity pursuant to a master development plan that has been approved prior to such date by a governmental entity.

Tax Credits

TCJA modifies the rehabilitation credit in Code Sec. 47.

Observation: While both the House Bill and the Senate Bill would have repealed the deduction in Code Sec. 196 for certain unused business credits, the repeal of that provision did not make it into TCJA.

Change in Determination of Cost Basis of Specified Securities

TCJA does not include a controversial provision in the Senate Bill which would have required that the cost of any specified security sold, exchanged, or otherwise disposed of on or after January 1, 2018, generally be determined on a first-in first-out basis except to the extent the average basis method is otherwise allowed (as in the case of stock of a regulated investment company). The Senate's proposal had included several conforming amendments, including a rule restricting a broker's basis reporting method to the first-in first-out method in the case of the sale of any stock for which the average basis method was not permitted.

Repeal of Rollover of Publicly Traded Securities Gain into Specialized Small Business Investment Companies

TCJA repeals the election that could be made by a corporation or individual to roll over tax-free any capital gain realized on the sale of publicly-traded securities to the extent of the taxpayer's cost of purchasing common stock or a partnership interest in a specialized small business investment company within 60 days of the sale. The amount of gain that an individual could elect to roll over under this provision for a tax year was limited to (1) $50,000 or (2) $500,000 reduced by the gain previously excluded under this provision. For corporations, these limits were $250,000 and $1 million, respectively.

The provision applies to sales after December 31, 2017.

Certain Self-Created Property Not Treated as a Capital Asset

TCJA amends Code Sec. 1221(a)(3), resulting in the exclusion of a patent, invention, model or design (whether or not patented), and a secret formula or process which is held either by the taxpayer who created the property or a taxpayer with a substituted or transferred basis from the taxpayer who created the property (or for whom the property was created) from the definition of a "capital asset." Thus, gains or losses from the sale or exchange of a patent, invention, model or design (whether or not patented), or a secret formula or process which is held either by the taxpayer who created the property or a taxpayer with a substituted or transferred basis from the taxpayer who created the property (or for whom the property was created) will not receive capital gain treatment.

The provision applies to dispositions after December 31, 2017.

Repeal of Technical Termination of Partnerships

TCJA repeals the Code Sec. 708(b)(1)(B) rule providing for technical terminations of partnerships in certain situations. The provision does not change the present-law rule of Code Sec. 708(b)(1)(A) that a partnership is considered as terminated if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.

The provision applies to partnership tax years beginning after December 31, 2017

Recharacterization of Certain Gains in the Case of Partnership Profits Interests Held in Connection with Performance of Investment Services

TCJA provides for a three-year holding period in the case of certain net long-term capital gain generated as the result of the receipt of a profits interest in a partnership (sometimes referred to as a carried interest). TCJA clarifies the interaction of Code Sec. 83 with the provision's three-year holding requirement, which applies notwithstanding the rules of Code Sec. 83 or any election in effect under Code Sec. 83(b). Under the provision, the fact that an individual may have included an amount in income upon acquisition of the applicable partnership interest, or that an individual may have made a Code Sec. 83(b) election with respect to an applicable partnership interest, does not change the three-year holding period requirement for long-term capital gain treatment with respect to the applicable partnership interest. Thus, the provision treats as short-term capital gain taxed at ordinary income rates the amount of the taxpayer's net long-term capital gain with respect to an applicable partnership interest for the tax year that exceeds the amount of such gain calculated as if a three-year (not one-year) holding period applies. In making this calculation, the provision takes account of long-term capital losses calculated as if a three-year holding period applies.

The provision applies to tax years beginning after December 31, 2017.

Compensation and Benefits

Modification of Limitation on Excessive Employee Remuneration. TCJA revises the definition of covered employee to include both the principal executive officer and the principal financial officer. Further, an individual is a covered employee if the individual holds one of these positions at any time during the tax year. The provision also defines as a covered employee the three (rather than four) most highly compensated officers for the tax year (other than the principal executive officer or principal financial officer) who are required to be reported on the company's proxy statement for the tax year (or who would be required to be reported on such a statement for a company not required to make such a report to shareholders). The provision applies to tax years beginning after December 31, 2017. However, there is a transition rule which provides that the proposed changes do not apply to any remuneration under a written binding contract which was in effect on November 2, 2017, and which was not modified after this date in any material respect, and to which the right of the covered employee was no longer subject to a substantial risk of forfeiture on or before December 31, 2016.

Excise Tax on Excess Tax-Exempt Organization Executive Compensation. Under TCJA, an employer is liable for an excise tax equal to 21 percent of the sum of the (1) remuneration (other than an excess parachute payment) in excess of $1 million paid to a covered employee by an applicable tax-exempt organization for a tax year, and (2) any excess parachute payment (under a new definition for this purpose that relates solely to separation pay) paid by the applicable tax-exempt organization to a covered employee. Accordingly, the excise tax applies as a result of an excess parachute payment, even if the covered employee's remuneration does not exceed $1 million. The provision applies to tax years beginning after December 31, 2017.

Treatment of Qualified Equity Grants. Under TCJA, a qualified employee can 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. An election to defer income inclusion (inclusion deferral election) with respect to qualified stock must 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 an employee elects to defer income inclusion under the provision, the income must 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 (as described below); (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 her inclusion deferral election. Deferred income inclusion applies also for purposes of the employer's deduction of the amount of income attributable to the qualified stock. The provision generally applies with respect to stock attributable to options exercised or RSUs settled after December 31, 2017.

Excise Tax on Stock Compensation in an Inversion Transaction. TCJA increases the excise tax on stock compensation in an inversion transaction from 15 percent to 20 percent. The provision applies to corporations first becoming expatriated corporations after December 22, 2017.

Partnerships

Tax Gain on the Sale of a Partnership Interest on a Look-through Basis. Under TCJA, 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 provision requires 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 nonseparately stated income and loss.

TCJA also requires the transferee of a partnership interest to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation. If the transferee fails to withhold the correct amount, the partnership is required to deduct and withhold from distributions to the transferee partner an amount equal to the amount the transferee failed to withhold.

The provision treating gain or loss on sale of a partnership interest as effectively connected income is effective for sales, exchanges, and dispositions on or after November 27, 2017. The portion of the provision requiring withholding on sales or exchanges of partnership interests is effective for sales, exchanges, and dispositions after December 31, 2017.

Modification of the Definition of Substantial Built-in Loss on Transfers of a Partnership Interest. TCJA modifies the definition of a substantial built-in loss for purposes of Code Sec. 743(d), affecting transfers of partnership interests. Under the provision, 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.

Example: ABC Partnership has three taxable partners (partners A, B, and C). ABC has not made an election pursuant to Code Sec. 754. The partnership has two assets, one of which, Asset X, has a built-in gain of $1 million, while the other asset, Asset Y, has a built-in loss of $900,000. Pursuant to the ABC partnership agreement, any gain on the sale or exchange of Asset X is specially allocated to partner A. The three partners share equally in all other partnership items, including in the built-in loss in Asset Y. In this case, partner B and partner C each have a net built-in loss of $300,000 (one third of the loss attributable to asset Y) allocable to his partnership interest. Nevertheless, the partnership does not have an overall built-in loss, but a net built-in gain of $100,000 ($1 million minus $900,000). Partner C sells his partnership interest to another person, D, for $33,333. Under the provision, the test for a substantial built-in loss applies both at the partnership level and at the transferee partner level. If the partnership were to sell all its assets for cash at their fair market value immediately after the transfer to D, D would be allocated a loss of $300,000 (one third of the built-in loss of $900,000 in Asset Y). The partnership does not have a substantial built-in loss, but a substantial built-in loss exists under the partner-level test, and the partnership adjusts the basis of its assets accordingly with respect to D.

The provision applies to transfers of partnership interests after December 31, 2017.

Charitable Contributions and Foreign Taxes Taken into Account in Determining Limitation on Allowance of Partner's Share of Loss. TCJA modifies the basis limitation on partner losses 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 basis limitation on partner losses 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 applies to partnership tax years beginning after December 31, 2017.

Amortization of Research and Experimental Expenditures

Under TCJA, amounts defined as specified research or experimental expenditures are required to be capitalized and amortized ratably over a five-year period, beginning with the midpoint of the tax year in which the specified research or experimental expenditures were paid or incurred. Specified research or experimental expenditures which are attributable to research that is conducted outside of the United States are required to be capitalized and amortized ratably over a period of 15 years, beginning with the midpoint of the tax year in which such expenditures were paid or incurred. Specified research or experimental expenditures subject to capitalization include expenditures for software development. Specified research or experimental expenditures do not include expenditures for land or for depreciable or depletable property used in connection with the research or experimentation, but do include the depreciation and depletion allowances of such property. Also excluded are exploration expenditures incurred for ore or other minerals (including oil and gas).

This rule will be applied on a cutoff basis to research or experimental expenditures paid or incurred in tax years beginning after December 31, 2025 (hence there is no adjustment under Code Sec. 481(a) for research or experimental expenditures paid or incurred in tax years beginning before January 1, 2026).

The provision applies to amounts paid or incurred in tax years beginning after December 31, 2025.

Employer Credit for Paid Family and Medical Leave

For 2018 and 2019, TCJA allows eligible employers to claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is 50 percent of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent.

Observation: An employer must have a written policy in place that provides family and medical leave to all employees on a non-discriminatory basis in order to qualify for the credit. Given the cost of implementing such a policy and complying with yet-to-be-announced reporting requirements, the credit may be impractical for many employers to pursue during the short period it's available. For companies that already have a qualifying family and medical leave plan in place, however, the credit may provide a nice windfall.

Modify Tax Treatment of Alaska Native Corporations and Settlement Trusts

TCJA addresses the tax treatment of Alaska Native Corporations and settlement trusts in three separate but related sections. The first section allows a Native Corporation to assign certain payments described in the Alaska Native Claims Settlement Act (ANCSA) to a Settlement Trust without having to recognize gross income from those payments, provided the assignment is in writing and the Native Corporation has not received the payment prior to assignment. The Settlement Trust is required to include the assigned payment in gross income when received. The second section allows a Native Corporation to elect annually to deduct contributions made to a Settlement Trust. The third section of the provision requires any Native Corporation which has made an election to deduct contributions to a Settlement Trust as described above to furnish a statement to the Settlement Trust containing: (1) the total amount of contributions; (2) whether such contribution was in cash; (3) for non-cash contributions, the date that such property was acquired by the Native Corporation and the adjusted basis of such property on the contribution date; (4) the date on which each contribution was made to the Settlement Trust; and (5) such information as the Secretary determines is necessary for the accurate reporting of income relating to such contributions.

The provision relating to the exclusion for ANCSA payments assigned to Settlement Trusts is effective to tax years beginning after December 31, 2016. The provision relating to the reporting requirement applies to tax years beginning after December 31, 2016.

Expansion of Qualifying Beneficiaries of an Electing Small Business Trust (ESBT)

TCJA allows a nonresident alien individual to be a potential current beneficiary of an ESBT. The provision takes effect on January 1, 2018.

Charitable Contribution Deduction for ESBTs

TCJA provides that the charitable contribution deduction of an ESBT is not determined by the rules generally applicable to trusts but rather by the rules applicable to individuals. Thus, the percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.

The provision applies to tax years beginning after December 31, 2017.

Deductibility of Penalties and Fines for Federal Income Tax Purposes

TCJA denies 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 applies 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. In the case of any amount of restitution for failure to pay any tax and assessed as restitution under the Code, such restitution is deductible only to the extent it would have been allowed as a deduction if it had been timely paid. Restitution or included remediation of property does not include reimbursement of government investigative or litigation costs.

The provision applies only where a government (or other entity treated in a manner similar to a government under the provision) is a complainant or investigator with respect to the violation or potential violation of any law. An exception also applies to any amount paid or incurred as taxes due.

The provision is effective for amounts paid or incurred after December 22, 2017, except that it does not apply to amounts paid or incurred under any binding order or agreement entered into before such date. Such exception does not apply to an order or agreement requiring court approval unless the approval was obtained before such date.

Aircraft Management Services

TCJA exempts certain payments related to the management of private aircraft from the excise taxes imposed on taxable transportation by air, effective for amounts paid after December 22, 2017.

Qualified Opportunity Zones

TCJA provides for the temporary deferral of inclusion in gross income for capital gains reinvested in a qualified opportunity fund and the permanent exclusion of capital gains from the sale or exchange of an investment in the qualified opportunity fund. The provision allows for the designation of certain low-income community population census tracts as qualified opportunity zones, where low-income communities are defined in Code Sec. 45D(e). The designation of a population census tract as a qualified opportunity zone remains in effect for the period beginning on the date of the designation and ending at the close of the tenth calendar year beginning on or after the date of designation. The provision is effective on December 22, 2017.

Expensing of Certain Costs of Replanting Citrus Plants Lost by Reason of Casualty

TCJA modifies the special rule for costs incurred by persons other than the taxpayer in connection with replanting an edible crop for human consumption following loss or damage due to casualty. Under the provision, with respect to replanting costs paid or incurred after December 22, 2017, but no later than a date which is ten years after such date of enactment, 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 percent 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.

Denial of Deduction for Settlements Subject to a Nondisclosure Agreement Paid in Connection with Sexual Harassment or Sexual Abuse

Under TCJA, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement. The provision is effective for amounts paid or incurred after December 22, 2017.

Repeal of Tax Credit Bonds

TCJA prospectively repeals the authority to issue tax-credit bonds and direct-pay bonds. The provision applies to bonds issued after December 31, 2017.

V. Foreign-Related Changes

Deduction for Foreign-Source Portion of Dividends Received by Domestic Corporations from Specified 10-Percent Owned Foreign Corporations

TCJA enacts new Code Sec. 245A, which provides for an exemption for certain foreign income. This exemption is provided for by means of a 100-percent deduction for the foreign-source portion of dividends received from specified 10-percent owned foreign corporations by domestic corporations that are United States shareholders of those foreign corporations within the meaning of Code Sec. 951(b) (referred to as "DRD"). The provision is effective for distributions made (and, for purposes of determining a taxpayer's foreign tax credit limitation under Code Sec. 904, deductions in tax years beginning) after December 31, 2017.

Special Rules Relating to Sales or Transfers Involving Specified 10-Percent Owned Foreign Corporations

TCJA provides that, in the case of the sale or exchange by a domestic corporation of stock in a foreign corporation held for one year or more, any amount received by the domestic corporation which is treated as a dividend for purposes of Code Sec. 1248, is treated as a dividend for purposes of applying the provision.

Solely for the purpose of determining a loss, TCJA provides that a domestic corporate shareholder's adjusted basis in the stock of a specified 10-percent owned foreign corporation (as defined in this provision) is reduced by an amount equal to the portion of any dividend received with respect to such stock from such foreign corporation that was not taxed by reason of a dividends received deduction allowable under Code Sec. 245A in any tax year of such domestic corporation. This rule applies in coordination with Code Sec. 1059, such that any reduction in basis required pursuant to this provision will be disregarded, to the extent the basis in the specified 10-percent owned foreign corporation's stock has already been reduced pursuant to Code Sec. 1059.

TCJA also provides that, if for any tax year of a controlled foreign corporation (CFC) beginning after December 31, 2017, an amount is treated as a dividend under Code Sec. 964(e)(1) because of a sale or exchange by the CFC of stock in another foreign corporation held for a year or more, then: (1) the foreign-source portion of the dividend is treated as subpart F income of the selling CFC for purposes of Code Sec. 951(a)(1)(A), (2) a United States shareholder with respect to the selling CFC includes in gross income for the tax year of the shareholder with or within the tax year of the CFC ends, an amount equal to the shareholder's pro rata share (determined in the same manner as under Code Sec. 951(a)(2)) of the amount treated as subpart F income under (1), and (3) the deduction under Code Sec. 245A(a) is allowable to the U.S. shareholder with respect to the subpart F income included in gross income under (2) in the same manner as if the subpart F income were a dividend received by the shareholder from the selling CFC.

In the case of a sale or exchange by a CFC of stock in another corporation in a tax year of the selling CFC beginning after December 31, 2017, to which this provision applies if gain were recognized, rules similar to Code Sec. 961(d) apply.

Code Sec. 367 is amended to provide that in connection with any exchange described in Code Secs. 332, 351, 354, 356, or 361, if a U.S. person transfers property used in the active conduct of a trade or business to a foreign corporation, such foreign corporation is not, for purposes of determining the extent to which gain is recognized on such transfer, be considered to be a corporation.

Under TCJA, if a domestic corporation transfers substantially all of the assets of a foreign branch (within the meaning of Code Sec. 367(a)(3)(C), as in effect before the date of enactment of TCJA) to a specified 10-percent owned foreign corporation with respect to which it is a U.S. shareholder after the transfer, the domestic corporation includes in gross income an amount equal to the transferred loss amount, subject to certain limitations.

The provisions relating to sales or exchanges of stock apply to sales or exchanges after December 31, 2017. The provision relating to reduction of basis in certain foreign stock for the purposes of determining a loss is effective for distributions made after December 31, 2017. The provisions relating to transfer of loss amounts from foreign branches to certain foreign corporations and to the repeal of the active trade or business is effective for transfers after December 31, 2017.

Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation

TCJA generally requires that, for the last tax year beginning before January 1, 2018, any U.S. shareholder of a controlled foreign corporation, as well as all foreign corporations (other than PFICs) in which a U.S. person owns a 10-percent voting interest, must include in income its pro rata share of the undistributed, non-previously-taxed post-1986 foreign earnings of the corporation ("mandatory inclusion"). A special rule permits deferral of the transition net tax liability for shareholders of a U.S. shareholder that are an S corporation. The provision is effective for the last tax year of a foreign corporation that begins before January 1, 2018, and with respect to U.S. shareholders, for the tax years in which or with which such tax years of the foreign corporations end.

Current Year Inclusion of Global Intangible Low-Taxed Income by U.S. Shareholders

Under TCJA, a U.S. shareholder of any CFC must include in gross income for a tax year its global intangible low-taxed income (GILTI) in a manner generally similar to inclusions of subpart F income. GILTI, which is defined in new Code Sec. 951A, means, with respect to any U.S. shareholder for the shareholder's tax year, the excess (if any) of the shareholder's net CFC tested income over the shareholder's net deemed tangible income return. The shareholder's net deemed tangible income return is an amount equal to 10 percent of the aggregate of the shareholder's pro rata share of the qualified business asset investment (QBAI) of each CFC with respect to which it is a U.S. shareholder. The provision is effective for tax years of foreign corporations beginning after December 31, 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign corporations end.

Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income

TCJA provides domestic corporations with reduced rates of U.S. tax on their foreign-derived intangible income ("FDII") and GILTI (defined above). A domestic corporation's FDII is the portion of its intangible income, determined on a formulaic basis that is derived from serving foreign markets. For tax years beginning after December 31, 2017, and before January 1, 2019, the effective tax rate on FDII is 21.875 percent and the effective U.S. tax rate on GILTI is 17.5 percent. For tax years beginning after December 31, 2018, and before January 1, 2026, the effective tax rate on FDII is 12.5 percent and the effective U.S. tax rate on GILTI is 10 percent. For tax years beginning after December 31, 2025, the effective tax rate on FDII is 15.625 percent and the effective U.S. tax rate on GILTI is 12.5 percent. The provision is effective for tax years beginning after December 31, 2017.

Modifications of Subpart F Provisions

TCJA makes the following modifications -

(1) eliminates the inclusion of foreign base company oil related income as a category of foreign base company income;

(2) repeals Code Sec. 955;

(3) amends the ownership attribution rules of Code Sec. 958(b);

(4) modifies the definition of U.S. shareholder;

(5) eliminates the requirement that a corporation must be controlled for 30 days before subpart F inclusions apply;

(6) makes permanent the exclusion from foreign personal holding company income for certain dividends, interest (including factoring income that is treated as equivalent to interest under Code Sec. 954(c)(1)(E)), rents, and royalties received or accrued by one CFC from a related CFC; and

(7) amends the requirement in subpart F that U.S. shareholders recognize income when earnings are repatriated in the form of increases in investment by a CFC in U.S. property to provide an exception for domestic corporations that are U.S. shareholders in the CFC either directly or through a domestic partnership.

Prevention of Base Erosion

TCJA makes the following modifications -

(1) places limitations on income shifting through intangible property transfers;

(2) denies a deduction for any disqualified related party amount paid or accrued pursuant to a hybrid transaction or by, or to, a hybrid entity;

(3) provides rules that surrogate foreign corporations are not eligible for reduced rate on dividends; and

(4) modifies the tax rate on base erosion payments of taxpayers with substantial gross receipts.

Modifications Related to Foreign Tax Credit System

TCJA makes the following modifications: (1) repeals the Code Sec. 902 indirect foreign tax credits and provide for the determination of Code Sec. 960 credit on current year basis; (2) requires foreign branch income to be allocated to a specific foreign tax credit basket; (3) accelerates the effective date of the worldwide interest allocation rules to apply to tax years beginning after December 31, 2017, rather than to tax years beginning after December 31, 2020; and (4) allocates and apportion gains, profits, and income from the sale or exchange of inventory property produced partly in, and partly outside, the United States on the basis of the location of production with respect to the property.

Inbound Provisions

Under TCJA, an applicable taxpayer is required to pay a tax equal to the base erosion minimum tax amount for the tax year. The base erosion minimum tax amount means, with respect to an applicable taxpayer for any tax year, the excess of 10-percent of the modified taxable income of the taxpayer for the tax year over an amount equal to the regular tax liability of the taxpayer for the tax year reduced (but not below zero) by the excess (if any) of credits allowed under Chapter 1 against such regular tax liability over the sum of: (1) the credit allowed under Code Sec. 38 for the tax year which is properly allocable to the research credit determined under Code Sec. 41(a), plus (2) the portion of the applicable Code Sec. 38 credits not in excess of 80 percent of the lesser of the amount of such credits or the base erosion minimum tax amount (determined without regard to this clause (2)).

For tax years beginning after December 31, 2025, two changes have been made, (i) the 10-percent provided for above is changed to 12.5-percent, and (ii) the regular tax liability is reduced by the aggregate amount of the credits allowed under Chapter 1 (and no other adjustment made).

Modification of Insurance Exception to the Passive Foreign Investment Company Rules

TCJA modifies the requirements for a corporation the income of which is not included in passive income for purposes of the PFIC rules. The provision replaces the test based on whether a corporation is predominantly engaged in an insurance business with a test based on the corporation's insurance liabilities. The requirement that the foreign corporation is subject to tax under subchapter L if it were a domestic corporation is retained.

Repeal of Fair Market Value of Interest Expense Apportionment

TCJA prohibits members of a U.S. affiliated group from allocating interest expense on the basis of the fair market value of assets for purposes of Code Sec. 864(e). Instead, the members must allocate interest expense based on the adjusted tax basis of assets. The provision is effective for tax years beginning after December 31, 2017.

VI. Retirement Plan-Related Changes

Partial Repeal of Special Rule Permitting Recharacterization of IRA Contributions

Under TCJA, the special rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA does not apply to a conversion contribution to a Roth IRA. Thus, recharacterization cannot be used to unwind a Roth conversion. However, recharacterization is still permitted with respect to other contributions. For example, an individual may make a contribution for a year to a Roth IRA and, before the due date for the individual's income tax return for that year, recharacterize it as a contribution to a traditional IRA

The provision is effective for tax years beginning after December 31, 2017.

Extended Rollover Period for the Rollover of Plan Loan Offset Amounts in Certain Cases

Under TCJA, the period during which a qualified plan loan offset amount may be contributed to an eligible retirement plan as a rollover contribution is extended from 60 days after the date of the offset to the due date (including extensions) for filing the federal income tax return for the tax year in which the plan loan offset occurs, that is, the tax year in which the amount is treated as distributed from the plan. Under the provision, a qualified plan loan offset amount is a plan loan offset amount that is treated as distributed from a qualified retirement plan, a Code Sec. 403(b) plan or a governmental Code Sec. 457(b) plan solely by reason of the termination of the plan or the failure to meet the repayment terms of the loan because of the employee's separation from service, whether due to layoff, cessation of business, termination of employment, or otherwise. As under present law, a loan offset amount under the provision is the amount by which an employee's account balance under the plan is reduced to repay a loan from the plan. The provision applies to tax years beginning after December 31, 2017.

Length of Service Award Programs for Bona Fide Public Safety Volunteers

TCJA increases the aggregate amount of length of service awards that may accrue for a bona fide volunteer with respect to any year of service to $6,000 and adjusts that amount to reflect changes in cost-of-living for years after the first year the provision is effective. In addition, under the provision, if the plan is a defined benefit plan, the limit applies to the actuarial present value of the aggregate amount of length of service awards accruing with respect to any year of service. Actuarial present value is to be calculated using reasonable actuarial assumptions and methods, assuming payment will be made under the most valuable form of payment under the plan with payment commencing at the later of the earliest age at which unreduced benefits are payable under the plan or the participant's age at the time of the calculation. The provision is effective for tax years beginning after December 31, 2017.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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