On December 22, President Donald Trump signed the most sweeping tax reform bills in over 30 years, which impacts every US taxpayer and industry. Non-US investors should also take note. The following are some of the main changes.
Individual income tax changes:
For individuals, the top rate is reduced slightly to 37% with the top bracket for married couples filing joint set at $600,000 ($500,000 for single taxpayers). Despite campaign promises, Alternative Minimum Tax remains for individuals, though the exemption amounts are increased slightly.
Estate and gift taxes:
The estate and gift tax exclusion has been doubled so that US individuals can now exclude roughly $11.2 million in value from estate tax ($22.4m. combined for married US couples). The increased exemption applies through 2025.
As for noncitizen nonresidents from countries with which the US has no estate or gift tax treaty, such as Israel, the US exemption remains at $60,000 for US-sourced property subject to transfer tax. This may be avoidable with an appropriate structure.
Business Tax Changes:
The largest favorable tax change is that the corporate tax rate is reduced to a flat 21%, along with a repeal of corporate Alternative Minimum Tax. This is for “C” corporations.
Congress also sought to reduce the effective rate for passthrough businesses by promulgating a passthrough income deduction known as the “qualified income (qualified business income) deduction” of 20% for partnerships, sole proprietorships and “S” corporations. However, Congress made it so complex that some taxpayers will find themselves unable to claim it. Various accelerated depreciation improvements were also enacted.
“Carried interests” in the area of partnership profits must held for three years, whereas it was previously two years.
Interest expense limitation:
There will be an onerous and limited interest limitation of basically 30% of EBITDA (earnings before interest, taxes, depreciation and amortization) for commonly held entities (including now not just corporations but also partnerships and sole proprietorships) where gross receipts exceed $25m.
Turning to international taxes, if US taxpayers are (1) “controlled foreign corporation” (CFC) owners (10% or more) or (2) have ownership in a foreign corporation that is also held by another domestic corporation and the foreign corporation has offshore profits, they face a deemed dividend repatriation tax to be paid over an eight-year period. US taxpayers that could fall into this liability include US individuals, partnerships and trusts.
The rate imposed is 15.5% on earnings attributable to cash and cash equivalents; 8% on the balance. After this, inbound dividends are tax free through no foreign tax credits are available.
Various strategies may mitigate this.
To preclude continued offshore revenue generation where the income ultimately flows into low or no tax jurisdictions, a “Global Intangible Low Tax Income” category was added to the Subpart F income anti-deferral regime. Such income is therefore deemed subject to US taxation immediately.
GILTI is the excess (if any) of (A) the shareholder’s net controlled foreign corporation (CFC) tested income for the tax year, over (B) the shareholder’s net deemed tangible income return for the tax year. A taxpayer’s “net deemed tangible income return” looks to a deemed return on tangible assets, and amounts to essentially 10% of the shareholder’s pro rata share of qualified business asset investment over certain specified interest expense.
Prospectively, corporate US shareholders of a controlled foreign corporation with applicable GILTI are subject to taxation to a net effective tax rate of 10.5% on the income, with the income and any taxes paid calculated in a separate foreign tax credit “basket” with any foreign tax credit limited to 80% of taxes paid.
The 2017 Tax Cuts and Jobs Act also contains a new 10% withholding requirement on the gross proceeds upon disposition of any interest in any entity viewed as a partnership under US tax rules and held by a foreign partner where the underlying partnership has US effectively connected taxable income.
A new royalty export incentive was promulgated to incentivize outbound US licensing or leasing to foreign persons or the performance of services for foreign persons or relative to property outside the US.
While the underlying rules are very complex, fundamentally a new deduction for “foreign derived intangible income” (FDII) in the amount of 37.5% was created.
There is a new tax to prevent companies from stripping income out of the US by means of deductible related party payments such as licenses and interest. The tax is called BEAT (Base Erosion Avoidance Tax) and applies only to very large US corporations with average gross receipts of at least $500m. per year.
The tax works similarly to an alternative minimum tax. US taxpayers are required to pay a tax at a rate equal to the excess of 10% of modified taxable income over their regular tax liability over certain specified tax credits.
Summary: Overall, the US tax reform creates a very favorable inbound investment environment for foreign investors utilizing a corporate tax structure. Check out the benefits and issues.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Magda Szabo, CPA, JD, LL.M is a tax partner at Janover LLC in the US.