Excellence

& Integrity

Excellence

& Integrity

The attorneys of Comiter, Singer, Baseman & Braun, LLP have lectured in programs sponsored by the American Bar Association, The Florida Bar, the Florida Institute of Certified Public Accountants, and other legal and tax associations.

Excellence

& Integrity

Comiter, Singer, Baseman & Braun is a firm consisting of attorneys specializing in tax and transactional issues including estate planning, tax planning, business succession planning, health care law, transactional law, estate, trust and guardianship litigation and all areas of corporate, individual and partnership tax law.

Excellence

& Integrity

Excellence

& Integrity

Excellence

& Integrity

CSBB Blog
  • IRS Gives the Gift of Certainty to Taxpayers: No Clawback on Increased Exemption Amount

    ‘Tis the season of giving, and even the Internal Revenue Service is feeling generous, with proposed regulations that would allow taxpayers to take advantage of the increased exemption amount for estate and gift taxes without fear of retroactive taxation.

    The federal transfer taxation system is based on the fair market value of property transferred, either during lifetime or at death, to others. Two components of this system, the gift tax and the estate tax, are part of a unified method of transfer taxation whereby the aggregate value of both lifetime and testamentary gifts is subject to a single tax. Prior to 2018, a “unified exemption” amount permitted an individual to make taxable transfers by gift during life or at death to the extent of $5,000,000 (as indexed for inflation) in value without having to pay the gift and/or estate tax on such transfers.

    On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (the “TCJA”), which increases the unified estate and gift tax exemption amount to $10,000,000 per person ($11,180,000 in 2018 and $11,400,000 in 2019, as indexed for inflation). However, this increase is currently set to expire at year-end of 2025, when the exemption amount will drop back to the pre-TCJA amount. This looming expiration date caused significant concern among estate planning professionals, who were hesitant to advise clients to make gifts above the pre-TCJA exemption amount for fear that the IRS would retroactively tax such gifts.

    In response to these concerns, the Internal Revenue Service issued proposed regulations which state that there will be no clawback of the increased exemption amount used prior to 2026. So, for example, if an unmarried taxpayer makes a $7 million gift in 2024 and dies in 2027 (after the exemption has returned to $5 million), there will be no tax due on the extra $2 million gift.

    Clients with estimated estates above the pre-TCJA exemption amount, and the estate planning professionals advising them, are likely to take a “wait-and-see” approach – meaning they will wait until it is certain, from Congressional action or inaction, that the increase in the exemption amount will in fact sunset. As such, assuming complete legislative silence on the matter, it is expected that the bulk of the gifts benefitting from the anti-clawback regulations would take place during 2025, when the expiration of the increased exemption amount would be inevitable.

    However, taxpayers should feel fairly confident that any gifts made between now and 2025 will be safe from any clawback.

    The IRS will hold a hearing on the proposed regulations on March 13, 2019.

  • Proposed Regulations Provide Further Clarification About Opportunity Zones

    The Opportunity Zone program presents a unique opportunity for a taxpayer to defer the capital gains tax by investing the proceeds of a realized capital gain in a Qualified Opportunity Fund (“Opportunity Fund”) holding certain property in a Qualified Opportunity Zone (“Opportunity Zone”). The goal of the Opportunity Zone program is to encourage economic growth and investment in Opportunity Zones. Sections 1400Z-1 and 1400Z-2 of the Internal Revenue Code discuss Opportunity Zones. On October 19, 2018, the Treasury Department and the Internal Revenue Service (“IRS”) issued proposed regulations under Section 1400Z-2 (the “Proposed Regulations”). Although the Proposed Regulations are not yet finalized, the Proposed Regulations provide guidance for issues that were unresolved in the text of Section 1400Z-2. In addition to these Proposed Regulations, the Treasury Department and the IRS expect to publish additional proposed regulations in the near future.

     

    I. Realized and Recognized Gains

     

    When property is sold or exchanged, a taxpayer can realize a gain or loss. The realized gain or loss from a sale or exchange of property is usually a recognized gain or loss for tax purposes. A recognized gain must be included in gross income. A taxpayer then pays taxes on the recognized gain. However, a taxpayer is not always required to recognize a gain in the same year that the gain is realized. Under the Opportunity Zone program, a taxpayer who realizes a capital gain on the sale or exchange of a capital asset can defer the gain recognition event by investing the proceeds of the realized capital gain in an Opportunity Fund.

     

    II. Review of Opportunity Zone Program and Tax Consequences

     

    As a refresher, an Opportunity Zone is a nominated population census tract that is considered a low-income community. In Florida, then-Governor Rick Scott designated 427 communities as Opportunity Zones, including 26 communities in Palm Beach County. A taxpayer invests in an Opportunity Zone by purchasing an interest in an Opportunity Fund. An Opportunity Fund is a corporation or a partnership that holds at least 90% of its assets in qualified opportunity zone property. Qualified opportunity zone property includes qualified opportunity zone business property, qualified opportunity zone stock, and a qualified opportunity zone partnership interest. For a more detailed discussion of Opportunity Zones and Opportunity Funds, please review our prior post entitled “New Tax Deferral Possibility by Investing in Qualified Opportunity Zone.”

     

    If a taxpayer realizes a capital gain on the sale or exchange of any capital asset to an unrelated person, the taxpayer can defer the gain recognition event by investing the proceeds in an Opportunity Fund. However, the taxpayer must recognize this realized capital gain at the earlier of (i) the date on which the taxpayer sold or exchanged the Opportunity Fund interest, or (ii) December 31, 2026. Except as provided below, the taxpayer’s basis in an Opportunity Fund interest will be zero. A taxpayer can increase their basis by holding the Opportunity Fund interest for at least five years. If a taxpayer holds the Opportunity Fund interest for five years, the taxpayer’s basis in the Opportunity Fund interest increases from zero to 10% of the deferred capital gain invested in the Opportunity Fund. If a taxpayer holds the Opportunity Fund interest for seven years, the taxpayer’s basis in the Opportunity Fund interest increases to 15% of the deferred capital gain invested in the Opportunity Fund. If a taxpayer holds the Opportunity Fund interest for ten years and sells the interest after December 31, 2026, such taxpayer’s basis in the Opportunity Fund interest will equal the fair market value of the Opportunity Fund interest on the date that such interest is sold or exchanged. In such an instance, a taxpayer will only pay taxes on the original deferred capital gain.

     

    III.       Eligible Types of Gains for Opportunity Zone Program

     

    The wording of Section 1400Z-2(a)(1) made it unclear whether Congress intended for capital gains and ordinary gains to be eligible for the tax deferral benefit under Section 1400Z-2. The Proposed Regulations clarify that only capital gains are eligible for the tax deferral benefit. Under the Opportunity Zone program, a taxpayer may defer the capital gains tax by rolling over the proceeds of a realized capital gain into an Opportunity Fund. A taxpayer can defer the amount of capital gain eligible for the capital gains tax up to the amount of the capital gain proceeds invested in an Opportunity Fund. Regardless of when a taxpayer recognizes the deferred capital gain, the deferred capital gain retains the same tax attributes in the year of inclusion that it would have had if the tax on the capital gain had not been deferred.

     

    IV. Eligible Taxpayers for Opportunity Zone Program

     

    Section 1400Z-2 did not adequately describe what types of taxpayers were eligible to invest in Opportunity Funds. For instance, it was unclear whether a partner or shareholder in a partnership or S corporation could invest in an Opportunity Fund when the partnership or S corporation was the taxpayer that sold a capital asset and generated a capital gain. The Proposed Regulations clarify that taxpayers eligible to invest in an Opportunity Fund include individuals, C corporations, partnerships, S corporations, trusts, and estates. The Proposed Regulations provide special rules for applying Section 1400Z-2 to a partnership, S corporation, trust, or estate. Under the special rules, either a partnership or its partners can take advantage of the tax benefits afforded by the Opportunity Zone program. If a partnership generates the capital gain, the partnership must have the first opportunity to make an election to defer the capital gain by investing in an Opportunity Fund. If the partnership makes this election, the deferred capital gain is not included in the distributive shares of the partners under Section 702 and is not subject to Section 705(a)(1) until the partnership subsequently includes such capital gain in income. If a partnership declines to invest the capital gain in an Opportunity Fund, the individual partners can defer the capital gains tax by investing the capital gain allocated to such partner in an Opportunity Fund. The aforementioned special rules also apply to an S corporation and its shareholders, a trust and its beneficiaries, or an estate and its beneficiaries.

     

    In order to elect to defer the capital gains tax, Section 1400Z-2(a)(1)(A) provides that a taxpayer must invest the capital gain proceeds in an Opportunity Fund within 180 days from the date of the sale or exchange of the capital asset. The Proposed Regulations relax this requirement when a partnership generates the capital gain, elects not to invest in an Opportunity Fund, and then distributes the capital gain to its partners. If, following the distribution of the capital gain proceeds to the partners, a partner elects to invest any portion of the capital gain proceeds in an Opportunity Fund, the Proposed Regulations provide that such individual partner’s 180 day period to invest the capital gain proceeds begins on the last day of the partnership’s tax year.

     

    V. Structure of Opportunity Funds

     

    The Proposed Regulations describe the form in which an Opportunity Fund can be structured. An Opportunity Fund can be any entity classified as a corporation or partnership for federal income tax purposes. Thus, an Opportunity Fund can be structured as a limited liability company. A pre-existing entity may become an Opportunity Fund, but such entity must satisfy all of the requirements of Section 1400Z-2 and the Proposed Regulations. For example, a pre-existing entity must acquire a sufficient percentage of qualified opportunity zone property after December 31, 2017. The Proposed Regulations provide rules describing how an entity can self-certify as an Opportunity Fund without IRS approval. To self-certify as an Opportunity Fund, the corporation or partnership must complete a form and attach it to a timely filed federal income tax return. Simultaneously with the release of the Proposed Regulations, the IRS promulgated Form 8996, which is an early release draft of the self-certification form.

     

    The Proposed Regulations discuss the interests that can be issued by an Opportunity Fund. For purposes of Section 1400Z-2, an eligible interest in an Opportunity Fund includes any equity interest issued by the Opportunity Fund. An equity interest includes preferred stock or a partnership interest with special allocations. However, an eligible interest does not include any debt instrument within the meaning of Section 1275(a)(1) and Treas. Reg. Section 1.1275-1(d). Interestingly, the Proposed Regulations provide that a taxpayer who owns an Opportunity Fund interest can use such interest as collateral for a loan, as long as such taxpayer is the owner of the equity interest for federal income tax purposes.

     

    VI.  90% Asset and Substantial Improvement Requirements

     

    Under Section 1400Z-2(d)(1), an Opportunity Fund must hold at least 90% of its assets in qualified opportunity zone property (“QOZ Property”) located in an Opportunity Zone. This 90% asset test is determined by averaging the percentage of QOZ Property held in the Opportunity Fund as measured on the last day of the first 6-month period of the taxable year of the Opportunity Fund, and on the last day of the taxable year of the Opportunity Fund. If the Opportunity Fund does not meet the 90% threshold at those times, the Opportunity Fund must pay a penalty for each month it fails to meet the 90% threshold. The Proposed Regulations provide some timing relief for eligible entities formed in the first six months of a calendar year. However, the last day of the taxable year will always be a testing date for purposes of the 90% asset test. For example, an Opportunity Fund formed on October 1, 2018 must hold at least 90% of its assets in QOZ Property located in an Opportunity Zone by December 31, 2018. Since December 31 is always a testing date for the 90% test, a taxpayer interested in forming an Opportunity Fund will likely wait until 2019 to form the Opportunity Fund.

     

    Since developing, constructing, and rehabilitating real estate may take longer than six months, real estate commenters believed that Opportunity Funds investing in real estate projects should be afforded additional time to comply with the 90% asset test. Those commenters also recommended that cash should be considered QOZ Property for purposes of the 90% asset test if the cash was held with the intent of investing in QOZ Property. Although the Proposed Regulations do not provide any time extensions for purposes of satisfying the 90% asset test, the Proposed Regulations include a working capital safe harbor for Opportunity Fund investments in a qualified opportunity zone business (“QOZ Business”) that acquires, constructs, or rehabilitates tangible business property, including real property and other tangible property used in a business operating in an Opportunity Zone. If certain requirements are met, a QOZ Business can treat cash held by such business as working capital for up to 30 months.

     

    An Opportunity Fund must invest in QOZ Property. Under Section 1400Z-2(d)(2), QOZ Property includes qualified opportunity zone business property (“QOZ Business Property”), qualified opportunity zone stock, and a qualified opportunity zone partnership interest.  Section 1400Z-2(d)(2)(D) discusses the requirements of QOZ Business Property. To be considered QOZ Business Property, the original use of QOZ Business Property must commence with the Opportunity Fund (or QOZ Business) or the Opportunity Fund (or QOZ Business) must substantially improve the property. Under Section 1400Z-2(d)(2)(D)(ii), property is substantially improved only if “during any 30-month period beginning after the date of acquisition of such property, additions to basis with respect to such property in the hands of the [Opportunity Fund] exceed an amount equal to the adjusted basis of such property at the beginning of such 30-month period in the hands of the [Opportunity Fund].” The Proposed Regulations address the substantial improvement requirement with respect to a purchased building located in an Opportunity Zone. Since land can never have its original use commence with an Opportunity Fund, the Proposed Regulations and Revenue Ruling 2018-29 clarify that the basis attributable to the land on which the purchased building sits will not be taken into account in determining whether the building has been substantially improved. In order to satisfy the substantial improvement requirement, an Opportunity Fund only needs to invest an amount exceeding the adjusted basis of the building at the beginning of the 30 month period. An Opportunity Fund is not required to separately substantially improve the land.

     

    VII.      Conclusion

     

    The goal of the Opportunity Zone program is to encourage economic growth and investment in Opportunity Zones. The Proposed Regulations clarified numerous issues that were unresolved by the text of Section 1400Z-2. Beginning in 2019, it is anticipated that an Opportunity Fund will become a viable investment opportunity for taxpayers looking to defer the incurrence of the capital gains tax.

  • New Tax Deferral Possibility by Investing in Qualified Opportunity Zone

     

    Public Law 115-97, more commonly known as The Tax Cuts and Jobs Act, added Sections 1400Z-1 and 1400Z-2 to the Internal Revenue Code (the “Code”). Sections 1400Z-1 and 1400Z-2 allow a taxpayer to defer paying taxes on capital gains by investing such capital gains in a Qualified Opportunity Fund (“Opportunity Fund”) holding certain property in a Qualified Opportunity Zone (“Opportunity Zone”). The Opportunity Zone program should encourage investment in low-income communities.

    An Opportunity Zone is a nominated population census tract that is considered a low-income community. Under Section 45D of the Code, a low-income community includes any population census tract with a poverty rate of at least 20%. The governor of each state can nominate up to 25% of the low-income communities within the state as Opportunity Zones. In June, the Department of the Treasury and the Internal Revenue Service finalized the list of Opportunity Zones. Opportunity Zones are located in all 50 states, the District of Columbia, and five United States territories. In Florida, Governor Rick Scott designated 427 communities as Opportunity Zones, including 26 communities in Palm Beach County. The Opportunity Zone designation remains effective until December 31, 2028.

    A taxpayer invests in an Opportunity Zone by purchasing an interest in an Opportunity Fund. An Opportunity Fund is an investment vehicle organized as a corporation or a partnership that holds at least 90% of its assets in qualified opportunity zone property (defined below) located in an Opportunity Zone. Under Section 1400Z-2(d)(1), this 90 percent threshold is determined by averaging the percentage of qualified opportunity zone property held in the Opportunity Fund as measured on the last day of the first 6-month period of the taxable year of the Opportunity Fund, and on the last day of the taxable year of the Opportunity Fund. If the Opportunity Fund does not meet the 90 percent threshold, Section 1400Z-2(f)(1) states that the Opportunity Fund must pay a penalty for each month it fails to meet the 90 percent threshold in an amount equal to the product of the excess of the amount equal to 90 percent of its aggregate assets, over the aggregate amount of qualified opportunity zone property held by the Opportunity Fund, multiplied by the underpayment rate established under Section 6621(a)(2) for such month. For any Opportunity Fund organized as a partnership, it appears that each partner must pay a proportionate share of this penalty.

    An Opportunity Fund must invest in qualified opportunity zone property. Under Section 1400Z-2(d)(2), qualified opportunity zone property includes qualified opportunity zone business property, qualified opportunity zone stock, and a qualified opportunity zone partnership interest. However, an Opportunity Fund cannot invest in another Opportunity Fund. Section 1400Z-2(d)(2)(D) discusses the requirements of qualified opportunity zone business property (“Opportunity Zone Property”). First, Opportunity Zone Property can be any tangible property used in a trade or business of the Opportunity Fund if the property was acquired by the Opportunity Fund by purchase (as defined in Section 179(d)(2) of the Code) after December 31, 2017. Next, the original use of such property must commence with the Opportunity Fund or the Opportunity Fund must substantially improve the property. Under Section 1400Z-2(d)(2)(D)(ii), property is substantially improved only if “during any 30-month period beginning after the date of acquisition of such property, additions to basis with respect to such property in the hands of the qualified opportunity fund exceed an amount equal to the adjusted basis of such property at the beginning of such 30-month period in the hands of the qualified opportunity fund.” Finally, substantially all of the use of the Opportunity Zone Property must be in an Opportunity Zone during substantially all of the time the Opportunity Fund holds such Opportunity Zone Property.

    Section 1400Z-2(d)(2)(B) and (C) define qualified opportunity zone stock and qualified opportunity zone partnership interest. The definitions are substantially similar. Qualified opportunity zone stock is any stock in a domestic corporation operating as a qualified opportunity zone business if such stock was acquired by the Opportunity Fund after December 31, 2017 at its original issue (directly or through an underwriter) from the corporation solely in exchange for cash. A qualified opportunity zone partnership interest is any capital or profits interest in a domestic partnership operating as a qualified opportunity zone business if such interest was acquired by the Opportunity Fund after December 31, 2017 from the partnership solely in exchange for cash. At the time the qualified opportunity zone stock (or partnership interest) is acquired and during substantially all of the Opportunity Fund’s holding period of such stock (or partnership interest), the corporation (or partnership) must operate as a qualified opportunity zone business. If a corporation (or partnership) is a new entity, such entity must be organized as a qualified opportunity zone business.

    Section 1400Z-2(d)(3) lists the requirements of a qualified opportunity zone business. First, substantially all of the tangible property owned or leased by the entity must be Opportunity Zone Property. A qualified opportunity zone business must also generate at least 50 percent of its total gross income from the active conduct of its business and a substantial portion of its intangible property must be used in the active conduct of its business. Furthermore, less than five percent of the average of such business’s aggregate unadjusted property bases may be attributable to nonqualified financial property. Most trades or businesses can be a qualified opportunity zone business. However, a qualified opportunity zone business does not include a private or commercial golf course, country club, massage parlor, hot tub facility, suntan facility, racetrack or other facility used for gambling, or any store whose principal business is the sale of alcoholic beverages for consumption off premises.

    If a taxpayer realizes a capital gain on the sale or exchange of any capital asset to any unrelated person, the taxpayer can defer the gain recognition event by investing the proceeds in an Opportunity Fund. A taxpayer can defer capital gains up to the amount of the capital gains proceeds invested in an Opportunity Fund. A taxpayer must invest in an Opportunity Fund within 180 days from date of the sale or exchange of the capital asset. The taxpayer who sold the capital asset must be the taxpayer investing in the Opportunity Fund. However, when a partnership or S corporation is the taxpayer selling the capital asset, Sections 1400Z-1 and 1400Z-2 do not clarify whether only the entity itself can invest in an Opportunity Fund.

    Under Section 1400Z-2(b), the deferred capital gains will be recognized at the earlier of December 31, 2026 or the date on which the investment in the Opportunity Fund is sold or exchanged. The deferred gain will be taxed at the rate in effect for the year in which the gain is recognized. Although a taxpayer can hold an Opportunity Fund interest after December 31, 2026, the taxpayer must recognize any deferred gain on that date, which creates a phantom income issue. Except as provided below, the taxpayer’s basis in an Opportunity Fund interest will be zero. A taxpayer can increase their basis by holding the Opportunity Fund interest for at least five years. If a taxpayer holds the Opportunity Fund interest for five years, the taxpayer receives a basis increase from zero to 10% of the deferred gain invested in the Opportunity Fund. Thus, 10% of the deferred gain will be permanently forgiven upon the sale of the Opportunity Fund interest. If a taxpayer holds the Opportunity Fund interest for seven years, the taxpayer receives a basis increase in the Opportunity Fund interest equal to 15% of the deferred gain invested in the Opportunity Fund. A taxpayer must invest in an Opportunity Fund by 2019 in order to take advantage of the 15% basis increase.

    If a taxpayer holds the Opportunity Fund interest for ten years, Section 1400Z-2(c) provides that the taxpayer will be eligible for a basis increase equal to the fair market value of the investment on the date that the investment is sold or exchanged. The complete basis step-up can only be obtained if the taxpayer holds the interest in the Opportunity Fund through December 31, 2026. Although the taxpayer must recognize the deferred gain (as phantom income) on December 31, 2026, it appears the taxpayer will not be taxed on any further appreciation in the Opportunity Fund interest upon the ultimate sale of such interest.

    The new Opportunity Zone program allows a taxpayer to receive preferential tax treatment in exchange for investing in a Qualified Opportunity Fund. A taxpayer can defer paying taxes on capital gains and potentially wipe out any future appreciation on the Qualified Fund interest if the taxpayer holds the interest for ten years. Due to the aforementioned tax benefits, the Opportunity Zone program should encourage investment in low-income communities.

  • 11 Things to Consider When Negotiating a Tax Distribution Provision

     

    The owners of pass-through entities: partnerships (including limited liability companies—LLCs—taxed as partnerships) and S corporations, must pay tax on their share of the entities’ profits, irrespective of whether the pass-through entity distributes any of those profits to the owners. This disconnect creates the possibility of “phantom income”—taxable income without a matching distribution of cash—for the owners. Since pass-through entities have no statutory obligation to make distributions to cover their owners’ tax liabilities, the owners must address this issue when negotiating their partnership, LLC, and shareholders’ agreements.

    Those negotiations often result in a tax distribution provision that requires the pass-through entity to make cash distributions intended to enable the owners to pay their tax liability; however, unless the tax distribution provision is drafted carefully, it may undermine the economics of the deal the parties agreed to. Here is a list of things to things to consider when negotiating a tax distribution provision:

    1. Are the owners able to pay their tax liability without receiving a tax distribution?
    • If any of the owners will be dependent on cash distributions to pay their taxes, then the absence of a tax distribution provision will be a hardship or, even more ominously, a weapon in the hands of the controlling owners, if they can make do without the tax distribution.
    • Are any of the owners employees who have been awarded equity, or sweat equity owners of “carried interests”? If so, the absence of a tax distribution could cause the good feelings from receiving the equity to turn bitter at tax time.
    • Are any of the owners trusts? If so, they may not have any other source of funds from which to pay the tax or make distributions to their beneficiaries who must, in turn, pay tax on the income of the trust (including the income allocated to the trust from the pass-through entity). The result may be that the trustee is caught in the middle between disgruntled beneficiaries and the controllers of the pass-through entity.
    • Are the owners exempt from tax, or do they have tax losses from other investments that can offset the income from the pass-through entity, so that they have no net tax liability? If so, then tax distributions could strip cash from the business unnecessarily.
    1. Will the pass-through entity be able to make tax distributions?
    • Does the business need to retain its profits to fund its growth, or meet its contractual commitments? If so, then the owners must be prepared to fund their tax liabilities from other sources.
    • Will the pass-through entity be leveraged? If so, then the terms of the loans must be negotiated to permit tax distributions before the tax distribution provision can be included in the entity agreement.
    1. The tax distribution provision is a distribution provision.
    • Although the reason for the provision may be to avoid phantom income, it almost always overwrites the distribution waterfall, at least to some degree; and in some cases, it significantly alters the economic arrangement that the parties thought they had agreed to. For example, suppose a partnership has two partners: a sweat-equity partner and a money partner. The sweat-equity partner will operate the business, and the money partner will contribute $500 in capital. The economic arrangement is that the $500 in capital will be returned to the money partner first, before any other distributions are made; then the partners will share cash distributions equally. Nevertheless, applicable tax accounting rules will cause the sweat-equity partner to pay tax on half of the income; but without a tax distribution provision, he will not receive any cash to pay the tax until the money partner receives all of her capital.
    • A typical tax distribution provision would override, at least in part, the money partner’s priority return of capital, and provide the sweat-equity partner with a cash distribution, up to the amount needed to pay his taxes. This override can be significant if a large portion of the profits are reinvested in the business or used to repay debt.
    • Suppose the business earns $100 of profits in year one, $60 of which is retained by the company and reinvested in a capital asset (or used to repay debt); and each partner’s tax rate is 40%. Each partner’s tax liability is $20 ($50 x 40%); however, without the tax distribution provision, the $40 of distributable cash would be distributed entirely to the money partner.
    • A tax distribution provision would override that distribution scheme resulting in a distribution of $20 to each partner, supersede the money partner’s priority return of capital in the first year of the business, and allow the sweat-equity partner to build his equity without a cash outlay. Is that really the deal? Should it be?
    • If the company continues to be profitable, then at some point the money partner’s priority return of capital will result in the return of her capital; however, the tax distribution provision delays this, and thus alters both the timing and the priority of the agreed upon “economics” of the deal.
    1. Are the tax distributions advances against the overall distributions, or in addition to them?
    • If tax distributions will be advances against subsequent distributions, then the next issue to resolve is what future distributions should be offset. Should the tax distributions offset the next distributions that the entity makes or should they come out of some other tier in the distribution waterfall, perhaps even affecting only the liquidating distributions? This can be an important question because delaying the offset will change the timing of future distributions.
    • While it may seem self-evident that a distribution made under a tax distribution provision should be an advance against and offset future distributions, some tax distribution provisions treat the tax distributions as an addition to the other distributions and not advances against them.
    • For example, suppose a private equity firm invests $100 in an LLC (taxed as a partnership) in exchange for a non-participating, preferred interest. The distribution waterfall in the LLC agreement provides that current distributions of free cash flow are to be made first to the private equity firm in the amount of an annual 8% preferred return on its unreturned capital, second to the private equity firm in an amount equal to its unreturned capital, and thereafter to all of the other owners in proportion to their percentage interests in profits. Assume also that the LLC agreement includes a tax distribution provision that covers only the annual 8% preferred return due to the private equity firm. The amount of the tax distribution is 40% of the income allocated to the preferred return.
    • If the tax distribution provision does not specify that the tax distributions will reduce future distributions to the private equity firm, then the private equity firm is likely entitled to the tax distributions in addition to the annual 8% preferred return.[1] Assume that in the first year of operation, the LLC generates $50 in net taxable income and that it also generated $50 in free cash flow that it will distribute. The private equity firm would receive $8 for its preferred return and another $5.33 as a tax distribution, so that it will be allocated $13.33 of income, pay $5.33 of tax on the allocated income, and be left with $8, net. The private equity firm has essentially structured its preferred return as an after-tax return with the other owners paying the private equity firm’s tax liability.
    • The takeaway here is that when negotiating the tax distributions, it is essential to clarify whether the tax distributions are advances against other distributions or are in addition to other distributions.
    1. Is Section 704(c) taken into account?
    • Internal Revenue Code Section 704(c) applies to pass-through entities that are taxed as partnerships. If a partner contributes an asset to a partnership and the fair market value of that asset differs from its income tax basis (“704(c) Property”), then Section 704(c) requires that differential to be taken into account in allocating tax items with respect to the 704(c) Property. Section 704(c) can have a substantial impact on the economic relationship of the parties and, in a forthcoming edition of this newsletter, we will explain its ramifications. For the purposes of this article, however, it is sufficient to know that a partner who contributed 704(c) Property with a value greater than its income tax basis will, ultimately, be taxed on more income than her share of partnership profits, because the profits of the partnership are measured by using the value of the contributed property, rather than its income tax basis.
    • Suppose that A and B form a 50/50 partnership, with A contributing land with an income tax basis of $25 and a value of $100, i.e., 704(c) Property, and B contributing $100 in cash. The partnership holds the land until its value increases to $150, when it is sold, and the proceeds of sale—$150, are then distributed to the partners equally—$75 each. The partnership has realized a profit of $50 ($150 sales price of the land – $100 value at time of contribution); however, it has realized income taxable gain of $125 ($150 sales price – $25 income tax basis).
    • Section 704(c) requires that A be allocated $100 of that gain—$75 of which is the “built-in gain” ($100 value – $25 income tax basis) that was present when A contributed the 704(c) Property to the partnership, and $25 of which is A’s 50% of the gain that arose from the appreciation while the land was held by the partnership.
    • Now suppose that the partnership agreement includes a tax distribution provision, which requires a tax distribution of 23.8% (the capital gain tax at 20% + the net investment income tax at 3.8%) of the gain allocated to each partner. Is A’s tax distribution calculated using the $100 of gain on which he is taxed, or only the $25 of gain that arose after he contributed the property to the partnership?
    • One can see from this simple example that it is essential to specify whether A’s tax distribution includes the tax on the built-in gain. The issues caused by 704(c) Property become far more complex when that property is depreciable or amortizable by the partnership, and can arise in many circumstances. For instance, the admission of a new partner to an existing partnership can cause the property owned by the partnership to become 704(c) Property, whether the new partner contributes only cash, or worse, if the new partner contributes property, when both the existing partnership property and the contributed property have to be accounted for as 704(c) Property.
    1. Are the tax distributions based on yearly or cumulative income?
    • Whether the tax distributions are calculated from annual or cumulative income allocations can have a significant effect on the total amount of tax distributions that are made during the life cycle of the business.
    • The annual method calculates the tax distribution by multiplying the owner’s income allocation for the year, if it is positive, by the tax rate.   The cumulative method, however, takes into account allocations of income and loss from the beginning of the partnership. Sound arguments can be made for using either method; but an informed choice can only be made by considering the specific circumstances of each partnership.
    1. How is the Tax Rate calculated?
    • One of the fundamental elements of a tax distribution provision is the tax rate. Common issues that arise in determining the tax rate are: (1) whether the tax rate will be uniform or determined separately for each owner; (2) whether to include state and local taxes; (3) if state taxes are included should there be an adjustment for the state tax deduction (and what if the deduction affects the alternative minimum tax); (4) should self-employment taxes be included; (5) should the net investment income tax be included; (6) should the application of the alternative minimum tax be considered; and (7) should the tax rate adjust for the character of the income being allocated?
    • The administrative ease of using a stipulated rate for all partners will often prevail over the precision of calculating each partner’s individual rate. To illustrate, simply consider the provisions in the 2017 tax legislation that have created the 20% deduction for certain types of income earned through pass-through entities and reduced the benefit of deducting state taxes, both of which are subject to sunset provisions.
    1. What if the income allocation changes because of an audit or litigation?
    • This is an area that is often not addressed because of the complexity it creates. Also, the IRS has new streamlined audit rules for tax years starting after December 31, 2017, that will result in most tax assessments and subsequent collections occurring at the partnership level. These adjustments and collections will not flow through to the partners unless the partnership is eligible to and opts-out of the new audit rule regime.
    • If the partnership does opt-out and also wants to indemnify its partners for changes on audit or in litigation, then part of the discussion should involve who will control the audit or litigation and who must consent to a settlement.
    1. Final Year and Clawbacks.
    • If the tax distributions are advances and not additive distributions, the parties should resolve whether tax distributions should be made after a liquidity/exit event or in the last year of the business.
    • Owners should discuss whether tax distributions that ultimately exceed all of the distributions due to an owner should be clawed back, and if so, whether a similar principle applies when a partner is bought out of the partnership mid-stream.
    1. How often should tax advances be made?
    • The frequency of tax advances must balance the cash flow needs of the owners against the administrative burden that frequent tax advances impose on the entity. If the owners can finance their own quarterly tax payments, then tax distributions can be made only once a year. Quarterly tax distributions are more likely to result in a tax distribution that exceeds the actual tax distribution that should have been made. Quarterly tax distributions can be coupled with a clawback requiring the return of the excess distribution; however, these are often hard to enforce.
    1. S corporation
    • S corporation shareholders must also consider the desirability of having a shareholders’ agreement that provides for tax distributions; particularly those having trusts as shareholders. While many of the issues discussed above will not apply to shareholders in S corporations, because all distributions to S corporation shareholders must be made ratably, in accordance with their share ownership, consideration must still be given to how tax distributions will be handled when shareholders sell their shares, or have them redeemed by the corporation.

    [1] See Interactivecorp. v. Vivendi Universal, S.A., C.A. No. 20260 (Delaware Chancery Court (July 6, 2004)) , 2004 WL 1573963.

  • The Tax Cuts and Jobs Act: Changes to the Transfer Tax

     

    On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (the “Act”). The Act makes significant changes to federal tax law. As a result of these changes, your estate plan should be examined to determine whether your estate plan remains consistent with your dispositive intent and whether your estate planning documents produce optimal tax results. This is particularly true for married couples with a combined net worth in excess of $5 million. Under the Act, there is no “one size fits all” approach. Rather, the approach needs to be tailored to a client’s individual situation and wishes.

     

    Tax Law Changes

     

    The Act doubles the unified estate and gift tax exemption and GST tax exemption from $5 million to $10 million. This amount is indexed for inflation. Thus for, 2018, this amount is $11.18 million. The increased exemption sunsets (goes away) in 2026 and the prior exemption amounts will be restored. As a result of these increases, fewer taxpayers will be subject to transfer tax.

     

    No change is made to the exemption amounts available to nonresident aliens. Unless a treaty applies, the estate tax exemption available to a nonresident alien is $60,000.

     

    The Act changes the inflation index so that future inflation adjustments will be smaller. Further, this change in the inflation index will not sunset in 2026.

     

    The Act makes no change to the 40% federal estate gift and GST tax rate, the full “step-up” in the basis of a decedent’s assets for income tax purposes or the portability of a married decedent’s unused estate and gift tax exemption[1] amount that was introduced in 2011.

     

    Review Formula Gifts

     

    Many estate plans use formula clauses that are tied to these exemption amounts. These formula clauses should be reviewed to ensure that they remain consistent with intent and are necessary as a result of portability.

     

    For example, a typical estate plan in the past was for married clients to provide in their estate plan that the exemption amount passed to a “family” or “credit shelter” which permitted current distributions to both the surviving spouse and the descendants and the balance of the deceased spouse’s asset to a marital trust which only permitted current distributions to the surviving spouse. With the increase in the exemption, much less or even no assets at all may pass to the marital trust leaving the surviving spouse’s lifestyle in jeopardy.

     

    Further, an estate plan for some clients might leave the GST exemption amount to trusts for grandchildren and the balance to trusts for children. With the increase in exemption, the children may now be disinherited.

     

    These formula clauses should be examined to ensure that a client’s intent is being carried out. Clients may want to consider imposing caps. Alternatively, and perhaps necessitating the greatest number of changes in current estate plans, married clients may decide that achieving a step up in basis on the second death is important and decide to have all assets pass to a marital trust to minimize the imposition of unnecessary federal income tax.

     

    For example, let us assume that Husband dies owning a piece of property that was purchased for $600,000 but is worth $2,000,000 upon Husband’s death. If his surviving spouse sold the property for $2,000,000, because the basis of such property “steps up” to the fair market value at the time of Husband’s death, there would be no income tax gain. However, upon Wife’s death, if the property passed to the Credit Shelter Trust, had not yet been sold and was worth $3,000,000 at her death, there would be a $1,000,000 income tax gain (the difference between $3,000,000 and $2,000,000). If instead the property were placed in the Marital Trust, the property would receive a basis step up for a second time upon the Wife’s death.   For married clients whose assets are worth between $5,000,000 and $20,000,000 attention to this change in the tax law is perhaps most critical.

    Finally, it will be important in the future to build flexibility into estate plans as the transfer tax rules will change in 2026, if not earlier.

     

    Planning with Increased Exemptions

     

                In making planning decisions concerning the increased exemptions, taxpayers need to consider the potential tradeoffs. With gifted assets, the donee takes the donor’s income tax basis, while assets retained until death receive a step-up in income tax basis. Thus, in making gifting decisions, priority should be given to using high basis assets.

     

    If a taxpayer is holding promissory notes from prior estate planning transactions, forgiving these notes should be given consideration as a manner of using this increased basis.

     

    If a trust holds assets that are subject to GST tax, consideration should be given to making a late allocation of GST exemption. Further, if a trust does not provide for generation-skipping, consideration should be given to decanting the assets to a new trust which is a generation-skipping trust.

     

    Selling assets to grantor trusts will continue to be a viable technique as will establishing a grantor retained annuity trust (“GRAT”). With a sale to a grantor trust, a taxpayer sells an interest in a family business entity to a grantor trust in exchange for a promissory note. A grantor trust is a trust where the trust assets are treated for federal income tax purposes as owned by the grantor. Thus, the sale is ignored for federal income tax purposes, as is the payment of interest by the grantor trust to the grantor. A minimum interest rate must be charged based upon treasury obligations. All growth in the value of the sold assets in excess of this minimum interest rate passes tax free.

     

    With a GRAT, a donor makes an immediate gift of an asset to a trust where the donor retains an annuity interest for a term of years. The amount of the gift is the actuarial value of the remainder interest, which can be made very small. The IRS assumes that the assets will grow at a certain rate which varies monthly based upon treasury obligations. The April 2018 assumed rate is 3.2%. Any growth in excess of 3.2% passes tax-free to the remainder beneficiaries.

     

    Finally, making gifts will remain an option. While taxpayers may not want immediately to make gifts, if the law has not changed by 2025, then taxpayers who will be affected by a decline in the exemption will need to consider whether gifting is appropriate in order to be able to lock in the benefit of the increased exemption before the exemption returns to pre-Act levels. This will be similar to the situation that taxpayers faced in 2012 when the $5 million transfer tax exemption was scheduled to fall to $1 million. Congress did not act to retain the $5 million exemption until January 1, 2013.

     

    529 Plans

     

    The Act expands the benefits of 529 plans. For distributions after December 31, 2017, the definition of “qualified higher education expenses” has been expanded to include tuition at an elementary or secondary public, private, or religious school, and various expenses associated with home school, up to a $10,000 limit per tax year.

     

     

    [1]                 With portability, the surviving spouse’s exemption is increased by the unused portion of the deceased spouse’s exemption.

  • 10 Potentially Overlooked Aspects of the New Tax Bill

     

    The passage of the new tax bill was highly publicized. This post focuses on ten potentially overlooked aspects of the new tax bill that may impact an individual’s 2018 income tax return. Remember, these new laws do not affect the 2017 individual income tax return.

     

    1. All miscellaneous itemized deductions subject to the 2% of adjusted gross income floor are now suspended until 2026. For example, an individual cannot claim a deduction for investment management and consulting expenses or tax preparation expenses.

    2. Beginning in 2018, an individual cannot claim a deduction for personal casualty and theft losses unless such losses occur in a presidentially-declared disaster. The personal casualty and theft loss deduction will be reinstated in 2026.

    3. For any divorce or separation instrument executed after December 31, 2018, the payor-spouse will not be able to deduct alimony payments, which means the recipient will not include alimony payments in gross income. This new law does not retroactively apply to any divorce or separation instrument currently in existence. If a divorce or separation instrument is executed on or before December 31, 2018 but is modified after that date, the payor-spouse cannot claim the alimony payment deduction if the modification expressly provides that this new law applies to the modified instrument.

    4. Beginning in 2018, an individual cannot deduct any business-related expenses for entertainment, amusement, or recreation. Previously, an individual could deduct 50% of such business-related entertainment expenses. It should be noted that commentators have disagreed about whether an individual who pays for a client meal at a restaurant is still entitled to a 50% deduction. Ideally, the Internal Revenue Service will provide more guidance on this issue in the upcoming months.

    5. Beginning in 2018, there is a 50% limitation on an employer’s deduction for food and beverage expenses provided to employees that can be excluded from an employee’s income as a de minimis fringe benefit. Previously, an employer could deduct 100% of such expenses. After December 31, 2025, an employer will not be allowed to deduct such expenses.

    6. Beginning in 2018, a married joint filing individual can claim an itemized deduction of up to $10,000 for state and local property taxes and either state and local income or sales taxes. The individual can elect any combination of those taxes to reach the $10,000 limit. Previously, there was no limit on the state and local tax deduction. The new limit on the state and local tax deduction sunsets after 2025. Unless Congress approves an extension of this law, the unlimited state and local tax deduction will be reinstated in 2026.

    7. For the 2017 and 2018 tax years, an individual may claim an itemized deduction for unreimbursed medical expenses only to the extent that such expenses exceed 7.5% of adjusted gross income. Previously, an individual under the age of 65 could take this deduction only to the extent that such expenses exceeded 10% of adjusted gross income. Starting in 2019, the 10% threshold will be reinstated for such individuals.

    8. Beginning in 2018, an individual can take a deduction of up to 60% of the individual’s adjusted gross income for cash contributions made to public charities. Previously, an individual could take a deduction of up to 50% of the individual’s adjusted gross income for cash contributions made to public charities.

    9. Beginning in 2018, an individual will not get a charitable deduction for any payments to a college in exchange for the right to purchase tickets for collegiate athletic events.

    10. Beginning in 2018, a Section 529 plan can distribute up to $10,000 per year in expenses for tuition incurred in connection with the enrollment or attendance at a public, private, or religious elementary or secondary school. These expenses may be distributed from kindergarten through the 12th grade. Previously, a Section 529 plan could only be used for qualified higher education expenses.

  • Health Care Surrogates vs. Living Wills

    Some people assume that if they are unable to make decisions or if a decision relates to “end of life,” that those closest to them, most often immediate family members, automatically make these decisions on their behalf. Others are aware that to carry out their directives that they need to sign documents generally known as Health Care Surrogates and Living Wills but aren’t quite sure of the difference between the two documents. Clients regularly ask – “what is the difference between a Health Care Surrogate and a Living Will, and why do I need both of these documents?”

    Every competent adult in Florida has the fundamental right to make decisions pertaining to his or her own health, including the right to choose or refuse medical treatment. In order to ensure that this right is not diminished or even lost as a result of a person’s incapacity, the Florida legislature has codified the requirements for the creation of two different documents to facilitate medical decisions – the Health Care Surrogate and the Living Will. The Florida legislature has prescribed specific requirements for both the content and execution of these documents to be accepted by hospitals and physicians, and enforceable under the law.

    The document which nominates a person to make medical decisions for you is called your Designation of Health Care Surrogate. This person(s), known as your Health Care Surrogate, is permitted to receive all of your health information relating to past, present or future physical or mental health as well as make health care decisions, give consent on your behalf for medical treatment, make anatomical gifts, etc. Your designation of health care surrogate needs to be signed by you in the presence of two witnesses (who also sign the document), who ideally are not related to you. Additionally, you should also designate an alternative surrogate if the original surrogate is not willing, not able or unavailable to perform the required duties.

    The Living Will is a document generally used only to direct the providing, withholding or withdrawal of life-prolonging procedures in the event that such person has an end-stage condition or is in a persistent vegetative state. Two physicians, one being the patient’s primary physician, must separately examine the patient and conclude that death is clearly imminent before life-prolonging procedures may be withheld or withdrawn. In order to be effective, Florida law dictates that a living will be signed in the presence of two witnesses (who also sign the document) and again, ideally, these witnesses should, although one does not have to, be unrelated to the person signing the living will. In the absence of a living will, the designated health care surrogate will generally be entitled to make end of life decisions.

    You may also hear the term “advance directive” in association with a living will or a designation of health care surrogate. Both the living will and the health care surrogate are themselves types of advance directives under Florida law. (Florida Statutes § 765.101(1)).

    It is important to note that if an advance directive is executed in another state and is in compliance with the laws of that state, Florida physicians will generally be required to follow such directive. For example, if you executed a living will in New York that follows New York law, Florida physicians should honor your New York living will.

    Most importantly, if you want your health care and end of life wishes carried out, it is imperative that you have both the Health Care Surrogate, and if appropriate, a separate Living Will.

    We hope this discussion has been helpful. We encourage you to contact us for any clarification.

  • Tax Reform Now: Part 11

    On December 20, 2017, the Senate and House of Representatives passed the same tax bill, which opened the door for President Trump to deliver significant changes to the United States tax code. The Senate passed the tax bill by a vote of 51-48. The House of Representatives passed the tax bill by a vote of 224-201. No Congressional Democrats voted in favor of this partisan tax bill. On December 22, 2017, President Trump officially signed the tax bill into law. Most of the changes will be implemented starting in 2018.

     

    At the outset, it should be noted that the tax bill makes certain changes temporary for individuals in order to comply with the budget reconciliation rules. President Bush passed tax cuts in 2001 and 2003 using budget reconciliation. The budget reconciliation rules allowed the Senate Republicans to pass this tax bill by a simple majority vote. A tax bill passed by the Senate through budget reconciliation must satisfy the Byrd Rule, which requires that the tax bill cannot increase the federal deficit after ten years. Therefore many of the provisions affecting individual and estate and gift taxation will “sunset” (in essence, expire) after 2025. This newsletter will focus on certain provisions in the tax bill that significantly affect individuals, corporations, pass-through businesses, estates, and trusts.

     

    Individuals

    The new tax bill retains seven income tax brackets for individuals, but it will change the income tax rates. Starting on January 1, 2018, the seven income tax brackets will be 10%, 12%, 22%, 24%, 32%, 35%, and 37%. To comply with the budget reconciliation rules, these new income tax rates will sunset after 2025. Under the new tax bill, the personal exemption is repealed, and the standard deduction increases to $12,000 for single individuals and $24,000 for joint filers.

     

    Single Individuals

    If taxable income is The income tax is equal to
    Not over $9,525 10% of taxable income
    Over $9,525 but not over $38,700 $952.50 plus 12% of the excess over $9,525
    Over $38,700 but not over $82,500 $4,453.50 plus 22% of the excess over $38,700
    Over $82,500 but not over $157,500 $14,089.50 plus 24% of the excess over $82,500
    Over $157,500 but not over $200,000 $32,089.50 plus 32% of the excess over $157,500
    Over $200,000 but not over $500,000 $45,689.50 plus 35% of the excess over $200,000
    Over $500,000 $150,689.50 plus 37% of the excess over $500,000

     

    Heads of Households

    If taxable income is The income tax is equal to
    Not over $13,600 10% of taxable income
    Over $13,600 but not over $51,800 $1,360 plus 12% of the excess over $13,600
    Over $51,800 but not over $82,500 $5,944 plus 22% of the excess over $51,800
    Over $82,500 but not over $157,500 $12,698 plus 24% of the excess over $82,500
    Over $157,500 but not over $200,000 $30,698 plus 32% of the excess over $157,500
    Over $200,000 but not over $500,000 $44,298 plus 35% of the excess over $200,000
    Over $500,000 $149,298 plus 37% of the excess over $500,000

     

    Married Individuals Filing Joint Returns and Surviving Spouses

    If taxable income is The income tax is equal to
    Not over $19,050 10% of taxable income
    Over $19,050 but not over $77,400 $1,905 plus 12% of the excess over $19,050
    Over $77,400 but not over $165,000 $8,907 plus 22% of the excess over $77,400
    Over $165,000 but not over $315,000 $28,179 plus 24% of the excess over $165,000
    Over $315,000 but not over $400,000 $64,179 plus 32% of the excess over $315,000
    Over $400,000 but not over $600,000 $91,379 plus 35% of the excess over $400,000
    Over $600,000 $161,379 plus 37% of the excess over $600,000

     

    Estates and Trusts

    If taxable income is The income tax is equal to
    Not over $2,550 10% of taxable income
    Over $2,550 but not over $9,150 $255 plus 24% of the excess over $2,550
    Over $9,150 but not over $12,500 $1,839 plus 35% of the excess over $9,150
    Over $12,500 $3,011.50 plus 37% of the excess over $12,500

     

    Although most itemized deductions are now eliminated, the status of certain itemized deductions are worth mentioning. Beginning in 2018, an individual can take a deduction of up to 60% of the individual’s adjusted gross income for cash contributions made to public charities or certain private foundations if the individual itemizes his or her deductions. This new increase is only beneficial to those individuals who will itemize their deductions under the new tax bill. The increased charitable deduction sunsets after 2025. That is, after 2025, an individual can take a deduction of up to 50% of the individual’s adjusted gross income for cash contributions made to public charities or certain private foundations.

     

    The tax bill repeals the alimony payment deduction. As a result, alimony payments will no longer be included in gross income by the recipient, nor will the payments be deductible by the payor. The effective date of the repeal is delayed by one year. Thus, the new tax treatment for alimony payments will apply to 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 new rule created by the tax bill applies to the divorce or separation instrument.

     

    Some itemized deductions will be scaled back. A married joint filing taxpayer can now claim an itemized deduction of up to $10,000 for state and local property taxes and either state and local income or sales taxes. The taxpayer can elect any combination of those taxes to reach the $10,000 cap. The tax bill prohibits a taxpayer from taking a deduction resulting from prepaying state and local income taxes for taxable years beginning in 2018. The new state and local tax deduction rules sunset after 2025.

     

    Many taxpayers deduct the mortgage interest on their homes. Under the current law, interest incurred on up to $1 million of mortgage debt is deductible. The current home mortgage interest deduction rules will apply to all mortgages entered into before December 15, 2017.  However, the home mortgage interest deduction will be scaled back for home mortgages entered into after that date. Under the tax bill, a taxpayer can deduct interest incurred on up to $750,000 of mortgage debt on a home purchased after December 15, 2017. Furthermore, a taxpayer can no longer take a deduction for interest on home equity indebtedness.

     

    There are a few other items affecting individuals which are noteworthy. Under the Affordable Care Act, individual taxpayers have been required to purchase a health plan that provides minimum essential coverage or be subject to a penalty tax for failing to maintain suitable coverage. This penalty tax is imposed on a taxpayer for any month he or she does not have minimum essential coverage unless he or she qualified for an exemption. The tax bill eliminates the penalty tax for taxpayers who fail to buy health insurance beginning in 2019. Additionally, although discussed and contained in several of the proposed versions, the tax bill did not end up including a provision requiring the first-in-first-out method for determining the cost basis of securities, which would have eliminated a taxpayer’s ability to specifically identify which securities were sold.

     

    Corporations

    Corporations are the biggest beneficiaries under the new tax bill. The corporate tax rate will be lowered from 35% to a flat 21% rate starting in 2018. Unlike the new individual income tax rates, the corporate income tax rate change is permanent. Additionally, the corporate alternative minimum tax is repealed. The tax bill scales back a corporation’s dividend received deduction. If a corporation owns more than 20% of the distributing corporation’s stock, the corporation can deduct 65% of the dividends received. If a corporation owns less than 20% of the distributing corporation’s stock, the corporation can deduct 50% of the dividends received.

     

    Provisions Applying to All Business Entities

    All businesses will be allowed to immediately deduct the entire cost of investment in “qualified property” acquired and placed in service after September 27, 2017 and before January 1, 2023. This 100% deduction phases out between 2023 and 2026. Unlike the existing law, a business will be able to deduct the entire cost of newly purchased used property. “Qualified property” includes all depreciable property and certain qualified film, television, and live theatrical productions (as defined in Section 181(d) and (e)). However, “qualified property” does not include any property used in a real property trade or business.

     

    Under the current Section 1031, no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged for property of a “like kind” which is to be held for productive use in a trade or business or for investment. Section 1031 will be modified to only allow nontaxable like-kind exchanges of real property not held primarily for sale. The new rule will apply to exchanges completed after December 31, 2017. After that date, a taxpayer can no longer defer gain recognition on non-real property by engaging in a like-kind exchange.

     

    Pass-Through Business Deduction

    Sole proprietorships, partnerships, limited liability companies, and S corporations are generally treated as pass-through entities that are not subject to tax at the entity level. Instead, an individual owning an interest in a pass-through business is taxed on any pass-through income at their own individual income tax rate. The tax bill does not create a new maximum tax rate for pass-through business owners. However, many pass-through business owners will be able to deduct a portion of their pass-through income, which will reduce the taxpayer’s taxable income. After this deduction is taken, the individual owner will pay income taxes at the new individual income tax rates.

     

    The tax bill adds Code Section 199A, which will allow an individual (or trust / estate) with an ownership interest in a pass-through business to potentially deduct 20% of the non-wage portion of pass-through income. The new pass-through deduction will be available starting on January 1, 2018 and sunsets after December 31, 2025. Under Section 199A(a)(1), the deduction for qualified business income is equal to the sum of

     

    • the lesser of the combined qualified business income amount for the taxable year or an amount equal to 20 percent of the excess of taxpayer’s taxable income over any net capital gain and qualified cooperative dividends, plus
    • the lesser of 20 percent of qualified cooperative dividends or taxable income (reduced by net capital gain).

     

    The “combined qualified business income amount” (referred to as the “combined QBI amount” in the rest of the newsletter) consists of the deduction for each qualified trade or business plus 20% of taxpayer’s REIT dividends and qualified publicly traded partnership income (“qualified PTP income”). For simplicity’s sake, the computation for “combined QBI amount” in the newsletter will not include REIT dividends and qualified PTP income.

     

    While reviewing this section, the reader should remember that the final “combined QBI amount” represents the amount of the potential pass-through deduction. Since this newsletter is ignoring REIT dividends and qualified PTP income, a taxpayer’s “combined QBI amount” (or potential pass-through deduction) will be the lesser of

     

    (a) 20 percent of the taxpayer’s qualified business income with respect to the trade or business, or

     

    (b) The greater of

     

    (i) 50 percent of the W-2 wages with respect to the trade or business, or

     

    (ii) 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 taxpayer must initially determine the amount of “qualified business income,” which consists of the “net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business.” There are certain items which are not included in this calculation, including reasonable compensation to the taxpayer and any guaranteed payments made to the taxpayer.

     

    After your eyes have recovered from reading the previous three paragraphs, this newsletter will attempt to describe the mechanics of the pass-through deduction in a simpler manner. Essentially, Section 199A(a)(1) allows a taxpayer to deduct the lesser of the “combined QBI amount” or 20% of the excess of taxpayer’s taxable income over net capital gain. The pass-through deduction can be confusing because a taxpayer may need to calculate their “combined QBI amount” three times using three different tests. Conquering the concept of the “combined QBI amount” is critical to understanding the pass-through deduction. This newsletter will clarify (to the best of our ability) how a taxpayer calculates the “combined QBI amount.”

     

    Let’s start with the easiest scenarios. If a single taxpayer earns $157,500 or less of qualified business income and files a return, that taxpayer multiplies 20% by $157,500 (or less) of qualified business income. This amount represents the taxpayer’s “combined QBI amount” (unless the taxpayer also has REIT dividends and qualified PTP income). If a married joint filer earns $315,000 or less of qualified business income, that taxpayer multiples 20% by $315,000 (or less) of qualified business income. This amount represents the married joint filer’s “combined QBI amount.” Taxpayers in these income thresholds do not need to worry about the three tests described later in the newsletter. With the taxpayer’s “combined QBI amount” now calculated, the taxpayer’s actual pass-through deduction will be the lesser of this “combined QBI amount” or 20% of the excess of taxpayer’s taxable income over net capital gain. Once the pass-through deduction is taken, the taxpayer will pay income taxes on their taxable income at the new income tax rates.

     

    A taxpayer with qualified business income between certain income levels will be entitled to a reduced pass-through deduction. The wording of the statute is confusing, but it can be synthesized into two points. A single taxpayer can take a reduced pass-through deduction if the taxpayer’s qualified business income is between $157,500 and $207,500. A married joint filer can take a reduced pass-through deduction if the taxpayer’s qualified business income is between $315,000 and $415,000.

     

    When a taxpayer’s qualified business income exceeds the income thresholds ($157,500 for individual taxpayers and $315,000 for married joint filers) and the phase-in amounts (over the next $50,000 for individual taxpayers and $100,000 for married joint filers), Section 199A becomes difficult to follow. However, keep in mind that the rules described below only apply to a single individual taxpayer who earns more than $207,500 of qualified business income (or to a married joint filer who earns more than $415,000 of qualified business income).

     

    For a single individual taxpayer earning more than $207,500 of qualified business income (or a married joint filing taxpayer earning more than $415,000 of qualified business income), the taxpayer must calculate the “combined QBI amount” under three tests. After a taxpayer computes the “combined QBI amount” under the three tests, the taxpayer chooses the larger “combined QBI amount” between the second and third tests. The taxpayer must then compare such “combined QBI amount” to the amount calculated under the first test. The lower amount between the first test and second (or third) test will represent the taxpayer’s “combined QBI amount.”

     

    First Test – 20% Test

    The first test can be referred to as the “20%” Test. The “20%” Test is the same test discussed above in the easiest scenarios. The taxpayer calculates their “combined QBI amount” by multiplying 20% by the amount of qualified business income. However, the taxpayer is subject to a wage limitation threshold. This threshold is intended to deter taxpayers from attempting to convert wages (or other reasonable compensation) to qualified business income eligible for the deduction. Thus, the taxpayer must now calculate the “combined QBI amount” under two other tests.

     

    Second Test – W-2 Wages Test

    The second test can be referred to as the “W-2 Wages” Test. Under the second test, the taxpayer calculates their “combined QBI amount” by multiplying 50% by the amount of the W-2 wages. Understanding this calculation is difficult without knowing the definition of W-2 wages. Under Section 199A, W-2 wages “means, with respect to any person for any taxable year of such person, the amounts described in paragraphs (3) and (8) of section 6051(a) paid by such person with respect to employment of employees by such person during the calendar year ending during such taxable year.” The “amounts described in paragraphs (3) and (8) of section 6051(a)” refers to the total amount of wages defined in Section 3401(a), elective deferrals, and compensation deferred under Section 457, including the amount of designated Roth Contributions. Under Section 3401(a), wages refers to “all remuneration . . . for services performed by an employee for his employer, including the cash value of all remuneration (including benefits) paid in any medium other than cash . . . .” There are twenty-three exceptions to this wages definition, which this newsletter will not discuss. Once the total amount of W-2 wages are determined, the taxpayer multiples 50% by the W-2 wages to calculate the “combined QBI amount” under the second test.

     

    Third Test – “W-2 Wages and Basis Test”

    The third test can be referred to as the “W-2 Wages and Basis” Test. Under the third test, the taxpayer initially multiplies 25% by the amount of W-2 wages. The taxpayer then computes 2.5% of the unadjusted basis immediately after acquisition of all qualified property. The taxpayer adds these two amounts together to arrive at the taxpayer’s “combined QBI amount” under the third test.

     

    Understanding this calculation is difficult without knowing the definitions of key terms, such as W-2 wages and qualified property. W-2 wages is defined in the same manner as discussed in the second test. “Qualified property” refers to depreciable tangible property that satisfies three requirements. The depreciable tangible property must be held for use in the qualified trade or business at the close of the taxable year, was used at any point in producing qualified business income, and the depreciable period has not ended before the close of the taxable year. Each taxpayer has an “unadjusted basis immediately after acquisition of qualified property” equal to such taxpayer’s allocable share of the unadjusted basis immediately after acquisition of the qualified property.

     

    Final Pass-Through Deduction

    The reader has almost conquered the pass-through deduction. As a reminder, the “combined QBI amount” (potential pass-through deduction) is the lesser of (a) 20 percent of the taxpayer’s qualified business income with respect to the trade or business (the “20% Test”), or (b) the greater of (i) 50 percent of the W-2 wages with respect to the trade or business (the “W-2 Wages Test”) or (ii) 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 “W-2 Wages and Basis Test”). If a reader understands the previous sentence, then the reader has conquered the pass-through deduction.

     

    This table may be helpful in visualizing how to determine the final “combined QBI amount.”

    The final “combined QBI amount” is the LESSER of

    ·      20% x QBI (First test – “20% Test”) or

    ·      The greater of

    o   W-2 wages x 50% (Second test – “W-2 Wages Test”)

    o   W-2 wages x 25% + 2.5% of unadjusted basis of qualified property (Third test – “W-2 Wages and Basis Test”)

     

    For a single individual taxpayer earning $207,500 or more of qualified business income (or $415,000 for a married joint filing taxpayer), such taxpayer’s “combined QBI amount” typically will be the largest under the first test. However, the wage limitation threshold will prevent the taxpayer from taking a deduction for this amount.[1] Instead, the taxpayer compares the “combined QBI amounts” calculated using the second and third tests. Whichever test generates the larger amount will be the taxpayer’s final “combined QBI amount.” Example 2 describes the pass-through deduction mechanics for this scenario.

     

    At this point, the taxpayer has reached the last step of the pass-through deduction. The taxpayer’s permitted pass-through deduction will be the lesser of the final “combined QBI amount” or 20% of the excess of taxpayer’s taxable income over net capital gain. The pass-through deduction reduces the taxpayer’s taxable income, and the taxpayer will pay income taxes at the new income tax rates.

     

    This newsletter will now discuss two simple examples applying the new pass-through deduction rules.

     

    Example 1 – Single Individual Earning Less than $157,500 of Qualified Business Income

    In 2018, a taxpayer earns $100,000 of qualified business income in a sole proprietorship. The taxpayer has $24,000 of other income. The taxpayer will take the new $12,000 standard deduction in 2018. The taxpayer’s adjusted gross income is $124,000 ($100,000 qualified business income + $24,000 other income). The taxpayer’s taxable income is $112,000 ($124,000 adjusted gross income – $12,000 standard deduction). The taxpayer’s pass-through deduction will be the lesser of the combined QBI amount calculated under the 20% Test or 20% of the taxpayer’s taxable income. Under the 20% Test, this taxpayer’s “combined QBI amount” is $20,000 (20% x $100,000 of qualified business income). Twenty percent of the taxpayer’s $112,000 of taxable income is $22,400. Since the “combined QBI amount” is less than 20% of the taxpayer’s taxable income, the taxpayer is entitled to a $20,000 pass-through deduction. This $20,000 pass-through deduction reduces the taxpayer’s taxable income to $92,000 ($112,000 taxable income – $20,000 pass-through deduction).

     

     

    Example 2 – Married Individual Earning More than $415,000 of Qualified Business Income

    In 2018, a married taxpayer who files a joint return earned $600,000 of qualified business income in a sole proprietorship. The taxpayer and her spouse have $44,000 of other income and $74,000 of itemized deductions in 2018. The sole proprietorship has $150,000 of W-2 wages and $1,000,000 of assets (unadjusted cost basis). The taxpayer’s adjusted gross income is $644,000 ($600,000 qualified business income + $44,000 other income). The taxpayer’s taxable income is $570,000 ($644,000 adjusted gross income – $74,000 itemized deductions). Because this taxpayer earned more than $415,000 of qualified business income, the taxpayer must calculate her “combined QBI amount” under the three tests.

     

    1. Under the “20%” Test, the taxpayer calculates her “combined QBI amount” by multiplying 20% by the $600,000 of qualified business income. Under the first test, the taxpayer’s “combined QBI amount” is $120,000.

     

    1. Under the “W-2 Wages” Test, the taxpayer calculates her “combined QBI amount” by multiplying 50% by the $150,000 of W-2 wages. Under the second test, the taxpayer’s “combined QBI amount” is $75,000.
    2. Under the “W-2 Wages and Basis” Test, the taxpayer calculates her “combined QBI amount” by first multiplying 25% by the $150,000 of W-2 wages, which equals $37,500. Next, the taxpayer multiples 2.5% by the $1,000,000 of unadjusted basis immediately after acquisition of all “qualified property,” which equals $25,000. Under the third test, the taxpayer’s “combined QBI amount” is $62,500 ($37,500 + $25,000).

     

    The taxpayer’s final “combined QBI amount” is $75,000, which was calculated under the “W-2 Wages” Test. Although the taxpayer would have been entitled to a larger pass-through deduction under the “20%” Test, the taxpayer is subject to the wage limitation threshold. Thus, the taxpayer can only take a deduction on the larger amount calculated under the second and third tests. When comparing the second and third tests, the taxpayer receives a larger deduction under the second test. The taxpayer’s final “combined QBI amount” is $75,000.

     

    The final “combined QBI amount” is the LESSER of

    ·      $120,000 – 20% x $600,000 QBI (First test – “20% Test”) or

    ·      The greater of

    o   $75,000 – 50% x $150,000 W-2 wages (Second test – “W-2 Wages Test”)

    o   $62,500 – 25% x $150,000 W-2 wages + 2.5% of $1,000,000 unadjusted basis of qualified property (Third test – “W-2 Wages and Basis Test”)

     

    The taxpayer’s permitted pass-through deduction will be the lesser of the $75,000 final “combined QBI amount” or $114,000 (20% of the $570,000 excess of taxpayer’s taxable income over net capital gain). As a result, the taxpayer can take a $75,000 pass-through deduction. This deduction reduces the taxpayer’s taxable income to $495,000 ($570,000 taxable income – $75,000 pass-through deduction).

     

    Certain Service Professionals Not Entitled to Pass-Through Deduction

    This new pass-through deduction is not available to all pass-through business owners. A taxpayer participating in a “specified service trade or business” will generally not be able to take the pass-through deduction. A “specified service trade or business” includes a trade or business that performs services in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, trading or dealing in securities, partnership interests, or commodities, 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. Engineers and architects can breathe a sigh of relief. Unlike business owners involved in the professions listed above, engineers and architects will be entitled to take the pass-through deduction.

     

    Even if a taxpayer is engaged in a prohibited “specified service trade or business,” that taxpayer can take the pass-through deduction if the taxpayer’s qualified business income is less than $157,500 for single filers and $315,000 for married joint filers. The pass-through deduction is calculated in the same manner as the previous section. A reduced deduction will be available if a single filer’s taxable income is between $157,500 and $207,500 and when a married joint filer’s taxable income is between $315,000 and $415,000. Once these income thresholds are surpassed, a taxpayer participating in a “specified service trade or business” is not entitled to any pass-through deduction.

     

    Estate Tax

    The tax bill does not repeal the estate tax as was discussed in the past months. Instead, the estate, gift and generation skipping transfer tax exemption amounts will double as indexed for inflation. In 2017, an individual has an estate, gift and generation skipping transfer tax exemption amount of $5,490,000. As indexed for inflation, in 2018, an individual can leave up to $11,200,000 to heirs and pay no federal estate or gift tax. A married couple will therefore be able to shelter $22,400,000 in assets. That is, couples will be able to give up to $22,400,000 during life or at death (not including annual exclusion amounts) to beneficiaries without incurring any transfer tax.

     

    The increase in the estate, gift and generation skipping transfer tax exemption will sunset after 2025. After December 31, 2025, the estate, gift and generation-skipping transfer tax exemption will return to the current amount, as indexed for inflation [i.e., a married couple will only be able to shelter $11,200,000 in taxes as indexed for inflation]. The return of the lower exclusion amount in 2026 will have critical estate planning effects as described below.

     

    The portability of a deceased spouse’s unused exemption is retained under the Act. Therefore, if a spouse dies before using all of his or her exemption, the surviving spouse can elect to retain his or her spouse’s remaining exemption. The higher exemption amount should not deter surviving spouses from filing a federal estate tax return as detailed below.

     

    Planning Techniques

     

    Estate Planning

    Beginning in 2018, you should consider making gifts to or using trusts for the benefit of other family members up to the new gift tax exclusion amount.

     

    As there are no assurances that a future administration will not lower the exemption amounts, moderately wealthy taxpayers who would benefit from the higher exemption should not defer estate planning. In particular, if your net worth is between the current exclusion amount and that which will be effective next year, you should consider seizing on what may be only a temporary increase in exemption amounts. For instance, if you are married and your net worth is $18,000,000, you should consider estate planning techniques to assure your use of the higher exclusion. Although overly simplified, if you did not take any action to use the additional credit, when the transfer tax exemptions return in 2026 to the current amount, as indexed for inflation, your estate will pay up to $2,720,000 in tax that could have been avoided. [$18,000,000 – $11,200,000 [the exemption for 2018 as indexed for inflation, before the act passed] = $6,800,000; $6,800,000 x 40% [the current estate tax rate] = $2,720,000.

     

    Individuals with a net worth higher than the 2018 exclusion amount should also consider planning in order to take advantage of the new exemption amount to leverage larger wealth transfers.

     

    Income Tax Planning

    Income tax planning will be increasingly popular with respect to generational wealth shifting for the next eight years. Take the following scenario as an example. A husband dies in 2004 owning a piece of property with a value of $200,000. Pursuant to the husband’s estate planning documents, the property is devised to a credit shelter trust for the benefit of husband’s wife. The new basis of the property is $200,000 (the value of the property at husband’s death). By 2018, when the wife dies, the property is worth $1,000,000. The property in the family trust would still have a basis of $200,000. Therefore, if the property is sold following the wife’s death, gain would be $800,000 ($1,000,000-200,000). However, if prior to the wife’s death, the trust is decanted into a new trust giving the wife a general power of appointment, the trust would be included in the wife’s estate. Therefore, the property would receive a step-up in basis to $1,000,000. Decanting the property into a trust over which the wife has a general power of appointment could save $160,000 of income tax ($800,000 x 20% capital gain tax).

     

    Portability

    If your net worth now does not exceed the new exemption amounts, you should not disregard filing a federal estate tax return. If the estate tax returns as expected in 2026, loss of portability due to failure to file an estate tax return could create a greater estate tax on the death of the survivor. For example, under current law, if you and your spouse have a gross estate over the exemption amount and do not use the full exemption during your lifetime, the surviving spouse (upon the first spouse’s death) can file a tax return electing to use the deceased spouse unused exemption.

     

    You should not solely rely on the doubled exemption remaining permanent. For example, Husband passes in 2019 and has not used any of his estate tax exemption. If Wife does not file a federal estate tax return electing portability and dies in 2026 and the estate tax exemption has returned to the lower amount, she will have lost the ability to transfer over $5.5 million tax free. Filing for portability during the higher exemption period locks in the higher exemption amount if the estate tax returns to the current amount in 2026.

     

    Non-Tax Estate Planning

    Individuals might find themselves wanting a simpler estate plan that, for example, utilizes outright bequests rather than holding assets for children and grandchildren (for example) in trust.   However, trusts will still be important for many purposes such as dealing with children with special needs, assuring longevity of family wealth and for asset protection of the beneficiaries from outside creditors including, potentially, ex and future spouses.

     

    Other Year End Considerations!

    • With most itemized deductions disappearing in 2018, a taxpayer should attempt to accelerate certain deductions in 2017.
    • In 2016, unreimbursed medical and dental expenses were deductible if they exceeded 10% of your adjusted gross income. Although the floor is lowered for unreimbursed medical and dental expenses to 7.5% in 2017 and 2018, taxpayers have to itemize their deductions in order for this lowered rate to benefit them. It is expected that most taxpayers will use the doubled standard deduction beginning in 2018. Therefore, if you do not anticipate itemizing your deductions next year, you should accelerate any medical or dental expenses into this year such as filling prescriptions, paying any outstanding bills, scheduling appointments and paying at the time of service, bills and if possible, accelerate any expenses that you have been postponing such as orthodontia, a hearing aid or laser eye surgery.
    • Because the state and local deduction will be limited to $10,000 starting in 2018, a taxpayer should pay off the outstanding balance of state and local income, property, or sales taxes in 2017 and prepay your 2018 real estate taxes before the new law takes effect.
    • Additionally, because the law states that you cannot deduct 2018 state and local income taxes that you prepay in 2017, you should pay all state and local taxes that you owe for 2017 by December 31 (even though your fourth quarter federal income tax estimated payment may not be due until January 16, 2018). If you wait to pay the state and local income taxes in 2018, you will not be able to deduct the expense on your 2017 tax return.
    • 2017 is the last year that you can take deductions on “miscellaneous expenses”. This deduction allows you to deduct certain expenses if they total more than two percent of your adjusted gross income. For employees, these expenses include union dues, uniforms, unreimbursed job travel and training. Additionally, fees associated with your investments such as those charged by accountants, financial advisers and lawyers are included as a miscellaneous expense. If you have any outstanding bills for investment expenses, you should pay them in 2017 in order to deduct the expenses on your 2017 tax return.
    • If you itemize your tax return and make charitable contributions, you should consider making your planned 2018 contributions in 2017 because you might lose the deduction if you wait until 2018 to make the contribution. If you take the standard deduction in 2018, you will not get any tax savings from your charitable contribution.
    • Due to the new individual income tax rates, a taxpayer will likely benefit from recognizing more income in 2018 (than 2017).

     

     

    [1] This may not always be the case. There may be circumstances where the “combined QBI amount” calculated under the first test is less than “combined QBI amounts” calculated under the second or third tests. If that scenario arises, the “combined QBI amount” will be the amount calculated under the first test.

     

  • Tax Reform Now: Part 10

    12/20/2017

    After the House of Representatives and Senate passed different versions of the “Tax Cuts and Jobs Act,” a conference committee was appointed to reconcile the two tax bills. On December 13, 2017, the conference committee reached a consensus on a revised “Tax Cuts and Jobs Act.” Both chambers must pass the “Tax Cuts and Jobs Act” by a majority vote before President Trump can sign it into law. On December 20, 2017, the Senate passed the bill by a vote of 51-49. The House is expected to pass the tax bill later this week. “Tax Reform Now” will highlight the relevant changes for individuals, corporations, pass-through businesses, and estates.

    Individuals

    The “Tax Cuts and Jobs Act” retains seven income tax brackets, but it will change the income tax rates. The seven income tax brackets will be 10%, 12%, 22%, 24%, 32%, 35%, and 37%. To comply with the budget reconciliation rules, the lower income tax rates will begin in 2018 and sunset after 2025. Due to the changes made by Congress, many taxpayers will no longer itemize their deductions. The alimony payment deduction will be repealed. As a result, an ex-spouse will not include alimony payments in gross income. This law will apply to any divorce or separation instrument executed after December 31, 2018. Under the tax bill, a taxpayer will be able to take a maximum $750,000 deduction for home mortgage interest on a newly purchased home. This maximum deduction is lower than the currently allowable $1 million deduction for home mortgage interest. A taxpayer will be allowed to deduct up to $10,000 for state and local property taxes and either state income or sales taxes. This tax bill will also repeal the Obamacare penalty tax for taxpayers who fail to buy health insurance beginning in 2019.

    Corporations

    Corporations receive favorable treatment under the tax bill. The corporate income tax rate will be cut from 35% to 21% for tax years beginning in 2018. The corporate income tax rate change will be permanent. The corporate alternative minimum tax will be repealed.

    Pass-Through Business

    The “Tax Cuts and Jobs Act” will not create a new maximum tax rate for pass-through business owners. However, most pass-through business owners will be able to deduct 20% of their non-wage portion of business income. After this deduction is taken, the pass-through owner will pay income taxes at the new individual income tax rates. Trusts or estates with ownership interests in pass-through businesses will be entitled to take this deduction. However, this deduction is generally not available for pass-through business income from a “specified service trade or business.” A “specified service trade or business” includes a trade or business “involving the performance of services in the fields of health, law, actuarial science, performing arts, 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 1 or more of its employees.” For pass-through business owners in a “specified service trade or business,” this deduction is available only if the pass-through business owner’s taxable income is not more than $157,500 for single filers and $315,000 for married joint filers. A reduced deduction will be available if a single filer’s taxable income is between $157,500 and $207,500 and when a married joint filer’s taxable income is between $315,000 and $415,000.

    Estates

    Although the estate tax will not be eliminated, almost all estates will no longer pay the federal estate tax. Beginning in 2018, an unmarried individual’s estate, gift, and generation-skipping transfer tax exclusions will be doubled to almost $11 million. The exclusions for married couples will approach $22 million. The doubling of the exclusions will sunset after 2025.

    We hope this update has been helpful. As always, please let us know if you have any questions.

  • Tax Reform Now: Part 9

    11/17/2017

    On November 16, 2017, the House of Representatives approved its version of the “Tax Cuts and Jobs Act” (the “Act”) by a vote of 227-205. All Democrats and 13 Republicans voted against the tax bill. Although potential obstacles still exist, Republicans are one step closer towards enacting comprehensive tax reform. The Senate Finance Committee is currently working on its tax reform bill. If the Senate passes this bill, a conference committee will be held to resolve the differences between the two versions. “Tax Reform Now” will highlight the significant changes included in the House’s tax bill for estates, individuals, pass-through businesses, and corporations.

    Estates

    The Act defangs the estate tax. Beginning in 2018, an unmarried individual’s estate, gift, and generation-skipping transfer tax exclusions will be doubled to almost $11 million. Thus, an unmarried individual can pass up to $11 million to his or her heirs without paying federal estate tax. A married couple can pass up to $22 million without paying federal estate tax. Furthermore, the House’s tax bill completely phases out the estate tax following the 2024 tax year.

    Individuals

    The Act seeks to streamline the individual income tax code and encourage more taxpayers to use the standard deduction. Under the Act, there will be four income tax brackets. These brackets will be 12%, 25%, 35%, and 39.6%. The alternative minimum tax will be repealed. The standard deduction will double to around $12,000 for unmarried individuals and $24,000 for married couples.

    The Act eliminates nearly all itemized deductions. The status of some itemized deductions are worth mentioning. The charitable contribution deduction will be expanded under the Act. An individual will be able to take a deduction of up to 60% of the individual’s adjusted gross income for cash contributions to public charities or certain public foundations. Other itemized deductions will be eliminated or scaled back. For example, the alimony payment deduction will be repealed. As a result, an ex-spouse will not have to include alimony payments in gross income. This law will apply to any divorce or separation instrument executed after December 31, 2017. In the House, the status of the state and local tax deduction has been a divisive issue. The House’s tax bill allows an individual to deduct up to $10,000 of state and local property taxes. However, the deduction for state and local income taxes or sales taxes will be repealed. Many individuals currently take the home mortgage interest deduction. This deduction will be scaled back under the Act. The current home mortgage interest deduction rules will apply to all mortgages incurred on or before November 2, 2017. However, the home mortgage interest deduction rules will change for all mortgages incurred after that date. A married couple who purchases a home after November 2, 2017 will be entitled to take a maximum $500,000 home mortgage interest deduction. A married couple currently can take a $1 million home mortgage interest deduction on a principal residence and one other residence. Under the new rules, the home mortgage interest deduction can only be taken for mortgage interest paid on the individual’s principal residence.

    The Act contains other interesting provisions. The Act changes the requirements that an individual must satisfy before he or she can exclude a portion of the gain from the sale of a principal residence from gross income. In order to exclude the gain, an individual must own and use the residence as a principal residence for five of the previous eight years. This exclusion can apply to one sale or exchange every five years. The Act restricts who can utilize this exclusion. A married couple with adjusted gross income greater than $500,000 will not be able to use this exclusion. Additionally, an individual will no longer be allowed to recharacterize a contribution to a traditional IRA as a contribution to a Roth IRA (or vice versa). Finally, the like-kind exchange rules will be altered. The gain or loss deferral on like-kind exchanges will only apply to like-kind exchanges of real property.

    Pass-through Businesses

    Under the Act, an individual owning a pass-through business will benefit if his or her pass-through business has net income above the 25% tax bracket threshold. When such a pass-through business distributes its net income to that individual, 30% of the distributed income will be treated as “business income” taxed at a maximum 25% rate. The remaining 70% of the distributed net income will be taxed at the individual’s personal income tax rate.

    The amount of “business income” depends on whether the income derives from an active or passive business activity. The current material participation and activity rules will determine whether a business is considered an active or passive business activity. This distinction is important. All net income derived from a passive business activity will be treated as “business income.” For example, a limited partner is engaged in a passive business activity. Since passive investors are entitled to this preferential rate, individuals may be more inclined to be treated as passive investors.

    The calculation of an individual’s “business income” derived from an active business activity is more complicated. First, an individual determines his or her net income derived from the active business activity. An individual’s wages would be included in net income. After calculating the net income, that individual determines the amount of “business income” eligible for the 25% rate. The amount of “business income” is 30% of the net income derived from the active business activity. The House refers to this 30% rate as a “capital percentage.” The resulting dollar amount is the amount of “business income” eligible for the preferential 25% rate. The remaining 70% of the net income passed through to the individual would be taxed at the individual’s income tax rate. An individual can choose to apply a different formula in order to get a “capital percentage” of greater than 30%. However, the facts and circumstances of the business will determine whether the individual can receive a larger rate. The election to use this formula will be binding for five years.

    An individual working in a personal service business will have a capital percentage of 0%. A personal service business includes any business engaged in services related to law, accounting, consulting, engineering, financial services, or performing arts. As a result, an individual actively participating in a personal service business generally will not be eligible for the 25% rate on “business income.” That individual will continue to be taxed at their own individual income tax rate.

    Corporations

    Corporations are the biggest beneficiaries under the Act. The corporate tax rate will be lowered from 35% to a flat 20% rate starting in 2018. This rate reduction is the biggest one-time drop in the maximum corporate tax rate in United States history. To encourage more investment in businesses, the Act will allow businesses to immediately deduct the entire cost of investment in “qualified property” acquired and placed in service after September 27, 2017. This immediate deduction will be available for five years. However, “qualified property” does not include any property used in a real property trade or business. Like the House’s treatment of most deductions, a corporation’s dividend received deduction will be scaled back. If a corporation owns more than 20% of the distributing corporation’s stock, the corporation can deduct 65% of the dividends received. If a corporation owns less than 20% of the distributing corporation’s stock, the corporation can deduct 50% of the dividends received.

    We hope this update has been helpful. As always, please let us know if you have any questions.

  • Tax Reform Now: Part 8

    11/3/2017

    On November 2nd, the House Ways and Means Committee unveiled the first draft of the “Tax Cuts and Jobs Act.” The House Ways and Means Committee will revise the “Tax Cuts and Jobs Act” during its mark-up session beginning on November 6th. However, the initial draft of the “Tax Cuts and Jobs Act” includes impactful changes to the Internal Revenue Code. “Tax Reform Now” will briefly highlight some relevant changes.

    Corporate Income Tax Brackets
    Current Law – There are seven income tax brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%.

    Proposed Law – There will be four income tax brackets: 12%, 25%, 35% and 39.6%.

    Estate and Gift Tax
    Current Law – A taxpayer can pass (during life or upon death) up to $5.49 million to his or her heirs without paying any federal estate tax (married couples can pass up to $10.98 million). If a taxpayer owns more than that, upon his or her death, the estate must pay a federal estate tax of 40%.

    Proposed Law – The estate, gift and generation – skipping transfer tax exclusions doubles to almost $11 million beginning in 2018. That is, a taxpayer can pass up to $11 million to his or her heirs without paying federal estate tax and married couples will be able to pass up to $22 million. Please note that the estate tax will be phased out beginning in the 2024 tax year. Additionally, beginning in 2024, the top gift tax rate would be lowered to 35%.

    Pass-through Businesses 
    Current Law – Sole proprietorships, partnerships, limited liability companies, and S corporations are generally treated as pass-through businesses subject to tax at the individual owner or shareholder level. Thus, an individual owning an interest in a pass-through business is taxed on any business profits at their own individual income tax rate. The maximum individual income tax rate is 39.6%.

    Proposed Law – For a pass-through business that distributes net income to an individual, a portion of the distributed net income will be treated as “business income.” The maximum tax rate on this portion of “business income” will be 25%. The remaining portion of net income distributed to an individual will be compensation subject to the individual income tax rates.

    Corporate Income Tax Brackets

    Current Law – The maximum corporate tax rate is 35%.

    Proposed Law – Starting in 2018, the corporate tax rate will be a flat 20% rate.  However, personal service corporations will be subject to a 25% corporate tax rate.

    State and Local Tax (“SALT”) Deduction
    Current Law – An individual must itemize their deductions in order to take the SALT deduction. The SALT deduction allows an individual to deduct state and local property taxes along with state and local income taxes or sales taxes from their federal income tax bill.

    Proposed Law – An individual can deduct state and local real property taxes up to $10,000. An individual will not be allowed to deduct state and local income taxes or sales taxes. By capping the amount of the SALT deduction, more individuals will switch from itemizing their deductions to utilizing the larger standard deduction.

    401(k) Plans and Individual Retirement Accounts
    The “Tax Cuts and Jobs Act” will not substantively alter the tax treatment of 401(k) plans and Individual Retirement Accounts.

    We hope this update has been helpful. As always, please let us know if you have any questions.

  • Tax Reform Now: Part 7

    10/30/2017

    As explained in Part 2 of “Tax Reform Now”, Republican lawmakers sought an outright repeal of the state and local tax deduction (“SALT deduction”) in order to offset tax cuts.  After encountering criticism from both political parties and lobbyists, Republican lawmakers have renounced this position.  Although the new tax reform bill has not been released, Kevin Brady, the Chairman of the House Ways and Means Committee, announced that the SALT deduction will be included in the tax reform bill.  A taxpayer who itemizes their deductions can currently take the SALT deduction.  The SALT deduction allows a taxpayer to deduct state and local property taxes along with state and local income taxes or sales taxes.  It is unclear how the SALT deduction will change in the new tax reform bill.  The details of the new tax reform bill will be announced this week.  Following this announcement, “Tax Reform Now” will explain the new SALT deduction and its effect on taxpayers.

    We hope this update has been helpful. As always, please let us know if you have any questions.

  • Tax Reform Now: Part 6

    10/27/2017

    On October 26th, the House of Representatives approved the budget resolution previously passed by the Senate. Because the House approved the Senate’s budget resolution without making any changes, a conference committee will not be necessary. Avoiding a conference committee speeds up the timeline for tax reform. The budget resolution passed 216-212 in the House. All Democrats and 20 Republicans voted against the budget resolution. As expected, most Republicans who voted against the budget resolution were those who do not want the state and local tax deduction (“SALT deduction”) to be eliminated or scaled back. Repealing the SALT deduction in its entirety could generate more than $1 trillion in revenue that would help offset the proposed tax cuts. Part 2 of “Tax Reform Now” describes why repealing the SALT deduction is a contentious issue. Since the budget resolution included the budget reconciliation instructions, a tax reform bill can now be approved by a majority vote in the Senate. Part 5 of “Tax Reform Now” explains in greater detail how the budget reconciliation instructions impact long-term tax reform.

    Republican leaders want to pass a tax reform bill through Congress before Thanksgiving. Thus, Republicans have approximately three weeks to achieve this goal. Because the Senate’s budget resolution was passed by the House, the House and Ways Means Committee is now tasked with drafting the tax reform bill. Kevin Brady, the House Ways and Means Committee Chairman, announced that a draft of the tax reform bill should be released on November 1st. After this draft is released, the House Ways and Means Committee will hold a mark-up session starting on November 6th. In a mark-up session, the House Ways and Means Committee members will debate, propose amendments, and rewrite the proposed tax reform bill. While this mark-up session is going on, the Senate Finance Committee will be gearing up for its own mark-up session.

    Since the release of President Trump’s framework for tax policy reform in late September, the details of any tax reform legislation have been shrouded in mystery. Republican leaders have not yet reached a consensus on thorny issues. Nevertheless, the House Ways and Means Committee’s draft of the tax reform bill will provide answers for individuals and businesses anticipating significant tax changes. When the draft of this tax reform bill is released, “Tax Reform Now” will provide a summary of the proposed changes.

    We hope this update has been helpful. As always, please let us know if you have any questions.

  • Tax Reform Now: Part 5

    10/25/2017

    On October 19th, the Senate approved a $4 billion budget resolution, which now paves the way for passage of a tax bill using the budget reconciliation rules. This budget resolution passed 51-49 in the Senate, with Rand Paul being the lone Republican Senator to vote against it. As mentioned in Part 3 of “Tax Reform Now,” the House of Representatives previously passed a budget resolution with budget reconciliation instructions. The House’s budget resolution stated that any tax cuts must be offset by tax increases or spending cuts. The Senate’s budget resolution did not follow the House’s philosophy. Instead, the Senate’s budget resolution would add $1.5 trillion to the federal deficit over the next ten years.

    The most important aspect of the Senate’s budget resolution is its inclusion of budget reconciliation instructions. These instructions allow a future tax bill to pass by a simple majority vote in the Senate. Typically, the political party in the Senate minority can filibuster a bill unless there are 60 votes to break the filibuster. By including the budget reconciliation instructions in the budget resolution, a future tax bill cannot be filibustered by Democrats if the tax bill adds $1.5 trillion or less to the federal deficit. There is a drawback to enacting tax reform using budget reconciliation. If a tax bill is passed using budget reconciliation, the Senate rules do not allow the tax bill to increase the federal deficit beyond the first ten years after its enactment. Like the Bush administration’s tax cuts enacted using budget reconciliation in the early 2000s, any tax cuts would be temporary and “sunset” after ten years.

    Before the budget reconciliation instructions take effect, the House and Senate must pass identical budgets. Interestingly, the Senate’s budget resolution includes an amendment that allows the House to adopt the Senate’s version of the budget. Either the House will pass the Senate’s budget resolution without making any changes, or the budget resolution will go to a conference committee between the two chambers. It is common for a budget resolution to go to a conference committee. A conference committee usually takes a week or two to resolve any differences. However, the Senate’s budget resolution is expected to pass the House without the need for a conference committee because the Senate’s budget resolution included amendments that appeased House Republicans. Avoiding a conference committee speeds up the timeline for tax reform. If the Senate’s budget is passed by the House, the House Ways and Means Committee will draft the tax reform legislation. Republican leaders hope that the tax bill will be ready to be presented to the House by early November.

    We hope this update has been helpful. As always, please let us know if you have any questions.

  • Tax Reform Now: Part 4

    10/18/2017

    A Compromise on the State and Local Tax Deduction?

    There has not been much progress in the last week with respect to President Trump’s plan for tax reform, except with respect to the state and local tax deduction (“SALT deduction”). The debate over the future availability of the SALT deduction has been an initial obstacle for Republican lawmakers attempting to reach an agreement on tax reform. Part 2 of “Tax Reform Now” discussed why potentially repealing the SALT deduction is a contentious issue. Instead of an outright repeal of the SALT deduction, Republican lawmakers are now exploring other options. One option gaining traction is making the SALT deduction available to taxpayers earning less than a specified amount of income. Taxpayers earning more than this income threshold would no longer be able to take the SALT deduction. Although an exact amount has not been specified, recent discussions have an amount somewhere between $200,000 and $400,000 as the income threshold. However, the final decision regarding the SALT deduction will not be known until the House of Representatives introduces its tax bill.

    2704 Proposed Regulation

    Although not related to the current tax reform initiative in Washington, we wanted to let you know that on October 3, 2017, the Treasury Department withdrew Proposed Treasury Regulations to Section 2704 of the Internal Revenue Code issued last year. Had they been finalized, the Proposed Regulation would have reduced or eliminated the ability to use minority-interest and marketability discounts for transfers of interests in family controlled entities. The Treasury Department withdrew the Proposed Regulation citing, “the Proposed Regulation’s approach to the problem of artificial valuation discounts is unworkable.”

     

    We hope this update has been helpful. As always, please let us know if you have any questions.

  • Tax Reform Now: Part 3

    10/11/2017

    On October 5, the House of Representatives took the first step in overhauling the United States tax code when it passed a budget resolution. This budget resolution would allow a future tax bill to pass in the House and the Senate without the support of any Democrats. In a 219 to 206 vote, 18 Republicans and all Democrats voted against the House’s budget resolution. As discussed in last week’s edition of “Tax Reform Now”, some Republican Representatives voted against the budget resolution because of the potential repeal of the state and local tax deduction. The House’s budget resolution now serves as a blueprint for federal spending during the 2018 fiscal year. This week’s edition of “Tax Reform Now” will discuss the reconciliation language in the House’s budget resolution along with the next steps that legislators will take.

    The House’s budget resolution includes language for a procedure called reconciliation, which will allow a future tax bill to avoid a filibuster in the Senate. Instead of needing 60 votes to overcome a filibuster, Republicans can pass a tax bill in the Senate with 51 votes. If there is a tie, Vice President Pence would then cast the deciding vote. This parliamentary language was added because the Republicans only hold 52 seats in the Senate. However, in order to use reconciliation and avoid a filibuster, the House and Senate must first agree on an identical budget resolution for the 2018 fiscal year. If the House and Senate can decide on an identical budget resolution, a tax bill that satisfies the approved budget conditions will avoid a filibuster.

    The House’s budget resolution discusses how to eliminate annual budget deficits by the end of the decade. The House assumes its proposed budget resolution will not add to the federal deficit by providing $203 billion in spending cuts. The Senate Budget Committee has advanced its own budget resolution, which would allow legislators to add up to $1.5 trillion to the budget deficit. The Senate Budget Committee’s resolution must be approved by the Senate. The Senate will vote on this budget resolution next week. If the Senate passes this budget resolution, the House would need to pass the Senate’s version of the budget without making any changes, or else the budget must go to a conference committee to resolve any differences. The House and Senate would vote again on the budget resolution offered by the conference committee. If the budget resolution is approved by the House and Senate, the House Ways and Means Committee would then meet to draft a tax bill.

    We hope this update has been helpful. As always, please let us know if you have any questions.

     

  • Tax Reform Now: Part 2

    10/4/2017 
    “Repeal of the State and Local Tax Deduction?”

    As mentioned in last week’s edition of “Tax Reform Now,” President Trump’s “Unified Framework for Fixing Our Broken Tax Code” would eliminate most itemized deductions. Although the home mortgage interest and charitable contribution deductions would be retained, this framework would eliminate the widely used state and local tax deduction (“SALT deduction”). The Trump administration believes the revenue generated from eliminating the SALT deduction would help defray the costs of other proposed tax cuts in the framework. Proponents of eliminating the SALT deduction argue that taxpayers living in states that impose less state and local taxes currently subsidize taxpayers living in states that impose more state and local taxes. Merely talking about eliminating the SALT deduction has triggered backlash from both political parties. As a result, the SALT deduction may be used as a potential bargaining chip in ongoing discussions between Republicans and Democrats.

    The SALT deduction can be taken by a taxpayer who itemizes their deductions. The SALT deduction allows a taxpayer to deduct property taxes along with state and local income taxes or sales taxes. Due to the availability of this deduction, some states and local governments have imposed more onerous taxes on taxpayers. Wealthy taxpayers living in states that impose more state and local taxes, such as California and New York, can utilize the SALT deduction to reduce their federal income tax bill by the amount paid to their state and local governments. This deduction is typically one of the largest itemized deductions taken by taxpayers. By eliminating the SALT deduction, wealthy taxpayers living in states that impose more state and local taxes would pay more taxes. Less affluent taxpayers living in these states are likely to switch from itemizing their deductions to utilizing the larger standard deduction offered in Trump’s framework. If the SALT deduction is repealed, states and local governments may feel pressure from their constituents to lower state and local taxes.

    The states that would be most affected by the elimination of the SALT deduction are traditionally “blue” states. However, Republican politicians from California, New York, New Jersey, and Illinois have spoken out against eliminating the SALT deduction. These politicians do not want their constituents to pay more taxes. They are also apprehensive about not being reelected, which could result in the Republicans losing control over the House of Representatives in 2018. Their resistance has produced immediate results. During this past week, the Trump administration mentioned that eliminating the SALT deduction is a position up for negotiation.

    The fate of the SALT deduction may decide whether President Trump has enough clout to enact his proposed tax framework. If the SALT deduction is not completely eliminated, the Trump administration must find other revenue streams to defray their proposed tax cuts. “Tax Reform Now” will provide updates about this contentious deduction when more information is disseminated.

    And what happens to basis?

    Under the current tax regime, taxpayers receive a step-up in basis when they inherit property. For example, imagine that you inherit a painting today that your mother purchased for $2 million. Now, that painting is worth $20 million. Upon your mother’s death, you receive a step-up in basis to the current fair market value: $20 million. That is, you receive the painting with a basis of $20 million. You avoid recognizing any gain that accrued during the time your mother owned it ($18 million) when you ultimately sell the property. This has been the law for some time.

    However, in his campaign, President Trump proposed eliminating the basis step-up for assets exceeding $10 million. At this point, it is not clear whether the proposed framework supports (with respect to the above scenario) (1) an income tax recognition event at death, whereby your mother’s estate would recognize $18 million of gain at her death; or (2) a carry-over of the basis, whereby you would receive the painting with a basis of $2 million (the basis in which your mother had) and when you chose to sell the painting, would recognize whatever the gain is at that time (at its sale price). Clause (1) proposes a deemed recognition event at death for assets exceeding $10 million – this has never been seen before in our tax law. A forced recognition event, as described in clause (1) above would be problematic if the decedent did not have sufficient liquid assets to pay the tax. If that is the case, it will be crucial for individuals who have assets in their estate that have appreciated greatly, along with individuals who have few liquid assets, to plan in advance for more liquidity. A typical planning tool would be to purchase a life insurance policy in an amount sufficient to pay such taxes, whether income or estate (or to continue holding an existing life insurance policy).

    Where do we go from here?

    A bill regarding tax reform is expected to be introduced in early November. Before the bill can be written, a 2018 budget resolution must be adopted in order for the tax-writing committees to know the financial parameters of the bill. If the House and Senate fail to adopt a budget resolution that is filibuster proof, there will likely be no significant tax reform this year. Additionally, Republican House members have already shown dissidence with the elimination of the state and local tax deduction. A split Republican Party will make it more difficult for any tax legislation to be passed.

    We hope this update has been helpful. As always, please let us know if you have any questions.

  • Tax Reform Now: Part 1

    9/27/2017

    “Unified Framework for Fixing Our Broken Tax Code”
    On Wednesday September 29, 2017, President Trump unveiled a framework for his tax policy reform, entitled the “Unified Framework for Fixing Our Broken Tax Code”. If the tax overhaul takes place as planned, this will be the country’s largest tax reform since 1986. A summary of the proposed major changes follows:

    Income Tax Brackets. The framework collapses the seven current individual income tax brackets into three brackets at 12%, 25% and 35%.

    Deductions. The framework proposes doubling the standard deduction to $24,000 for married taxpayers filing jointly and $12,000 for single filers.   President Trump’s plan additionally eliminates most itemized tax deductions, except for the deduction for mortgage interest payments and charitable deductions.

    Estate/Generating Skipping Tax. The framework proposes repealing the estate tax and generation-skipping tax, but does not give any further details of how that will be accomplished.

    Alternative Minimum Tax. The framework also proposes repealing the individual alternative minimum tax.

    New Tax Structure for Small Businesses. The framework creates a new tax rate structure for small businesses. For small businesses organized as sole proprietorships, partnerships, or S corporations, the maximum tax rate on any business income will be 25%. Individuals owning interests in these pass-through businesses are currently taxed on any business profits at their own individual income tax rates.

    Corporations. The framework proposes to lower the top federal tax rate for corporations from 35% to 20%. The corporate alternative minimum tax will also be eliminated. Although no details were provided, the framework suggests that future efforts may be made to reduce the double taxation of corporate earnings.

    Elimination of Certain Business Deductions and Credits. The framework expresses the goal of limiting the number of business deductions and credits. The domestic production deduction will be eliminated. The net interest expense deduction taken by C corporations will be partially limited. Although the framework discusses the goal of limiting business credits, the business credits for research and development and low-income housing will be retained.

    Immediate Deduction for Purchased Depreciable Assets. Under the framework, companies will be able to immediately write off the entire cost of investments in depreciable assets purchased after September 27, 2017. Companies will be able to take advantage of this immediate deduction for at least the next five years. Companies can currently deduct the cost of depreciable assets over a period of years.

    Repatriation of Foreign Profits. To avoid paying the corporate tax on profits earned outside of the United States, United States-owned multinational companies have opted to keep these foreign earnings in overseas tax havens. This framework encourages these multinational companies to return foreign earnings and illiquid assets to the United States. The framework proposes that the United States switch to a territorial tax system, meaning that multinational companies would no longer pay taxes in the United States on any foreign earnings. These multinational companies will only pay taxes to the government of the country where the money was earned. However, multinational companies would be required to pay a one-time repatriation tax on their existing foreign earnings. All foreign earnings will then be treated as repatriated (or returned) to the United States. Foreign earnings will be taxed at different tax rates depending on if the foreign earnings are in cash or illiquid assets. If a company has earnings invested in illiquid assets, the repatriated illiquid assets will be taxed at a lower rate than cash or cash equivalents. Companies will be able to pay this proposed repatriation tax over an unspecified number of years. The framework does not specify the proposed repatriation tax rate.