Nelson Mullins - Key Provisions of the 2017 Tax Act for M&A, Private Equity, and Real Estate (2024)

Provision

Prior Law

2017 Tax Act

Individual Income Tax Rates and Brackets

Seven-bracket progressive rate income tax with a top marginal rate of 39.6%.

Retains seven brackets, but at reduced rates, including a top marginal rate of 37%. Rates sunset at the end of 2025.

Charitable Contributions

Charitable contribution deductions for gifts of cash to public charities limited to 50% of AGI.

Retains the charitable contribution and increases the deduction limitation to 60% of AGI for contributions of cash to public charities, denies charitable deduction for payments made in exchange for college athletic event seating rights; and repeals the substantiation exception for certain contributions reported by the donee organization.

State and Local Tax Deductions

Individual taxpayers can deduct state and local income and property taxes as an itemized deduction.

Caps the state and local tax deduction for individual taxpayers at $10,000 (includes property taxes plus income taxes). C corporations are permitted to deduct state and local income and property taxes on business and investment income.

Individual Alternative Minimum Tax

Imposes a two-rate alternative minimum tax (AMT) with an $86,200 exemption and a $164,100 exemption phase out for joint filers. (Other exemptions and phase out thresholds exist for single filers and married filing separately.)

Increases the exemption to $109,400 and raises the phase out threshold to $1 million for joint filers. (Other exemptions and phase out thresholds exist for single filers and married filing separately, and are also adjusted.)

Like-kind Exchanges

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.

Limits the non-recognition of gain for like-kind exchanges to real property that is not held primarily for sale. New limitation applies to exchanges completed after December 31, 2017, with an exception for any exchange if either the property being exchanged or the property received is exchanged or received on or before December 31, 2017 (i.e., the first leg of a deferred exchange transaction).

Corporate Tax
Rate

Multi-bracket corporate income tax structure with a top marginal rate of 35% and a “bubble” rate of 39%.

Single-rate 21% corporate income tax.

Treatment of Pass-Thru Income

Subject to individual income tax rates and brackets.

Adopts a 20% deduction for qualifying business income (QBI) for sole proprietors and interests in pass-thru entities (S corporations, partnerships, and LLCs), limited to the greater of (a) 50% of wage income or (b) 25% of wage income plus 2.5% of the cost of tangible depreciable property for qualifying businesses, including publicly traded partnerships but not including certain service providers (including the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of the owners or employees). QBI is defined as all domestic business income other than investment income (e.g., dividends (other than qualified REIT dividends and cooperative dividends, which are per se QBI), investment interest income, short-term capital gains, long-term capital gains, commodities gains, foreign currency gains, etc. Limitations on the QBI deduction do not apply for individual taxpayers with incomes below $147,600 (separate) and $315,000 (joint), and phase out over a $100,000 range.

Conversion of S Corporation to C Status

Distributions from a terminated S corporation are treated as paid from its accumulated adjustment account if made during the post-termination transition period which ends on the later of one year from the last day the corporation was an S corporation, or the due date for filing the last return of the S corporation (including extensions).

Extends the period for which distributions from a terminated S corporation would be treated as paid from its accumulated adjustment account and from its earnings and profits on a pro-rata basis. Adjustments under §481(a) due to the termination would be accounted for ratably over a 6-year period.

Would be effective for S corporations which revoke their S corporation elections during the 2-year period beginning on the date of enactment and have the same owners on both the date of enactment and the revocation date.

Tax gain on the sale of a partnership interest on look-through basis

In a recent case, Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner of Internal Revenue, the U. S. Tax Court held that a foreign partner’s gain on redemption of a partnership interest was not U.S.-source income and not effectively connected income (ECI), despite the partnership itself being engaged in a U.S. trade or business. The IRS, however, continues to take the position that partners in a partnership are engaged in the conduct of a trade or business within the United States if the partnership is so engaged, and gain or loss from the sale of a partnership interest is effectively connected with a U.S. trade or business.

The Act clarifies that gain or loss from the sale or exchange of a partnership interest is effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. Any gain or loss from the hypothetical asset sale by the partnership would be allocated to partnership interests in the same manner as non-separately stated income and loss.

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

Executive Compensation

$1 million limitation on deductibility of executive compensation for employees of public corporations subject to performance based exception.

Eliminates the performance based exception to the $1 million limitation on executive compensation for publicly held corporations, and expands the coverage of the provision to SEC reporting companies regardless of whether the stock is public.

Carried
Interest

The receipt of a profits interest in a partnership (a “carried interest”) in exchange for the performance of services is not taxed to the recipient. The partner thereafter includes in income the partner’s distributive share (whether or not actually distributed) of partnership items of income and gain, including capital gain eligible for the lower tax rates.

Transfers of applicable partnership interests held for less than three years would be treated as short-term capital gain. This treatment would affect partnership interests issued to partners in connection with the performance of substantial services to businesses that consist of engaging in capital market transactions or other specified investments. Certain equity interests and interests held by corporations would be exempt. The extended holding period does not apply to pass-thru gain from the disposition of partnership assets. The application of these rules will be subject to regulations.

Capital Investment and Expensing

In relevant part, allows 50% bonus depreciation of short-lived capital investment, such as machinery and equipment, and offers Section 179 small business expensing with a cap of $500,000 and a phase out beginning at $2 million. Other tangible assets are subject to allowance for depreciation over useful lives.

Allows full (100%) expensing of cost of depreciable tangible assets, such as machinery and equipment, for five years, then phases out the provision over the subsequent five years, as follows:

For property placed in service after September 27, 2017, and before January 1, 2023, 100%.

For property placed in service after December 31, 2022, and before January 1, 2024, 80%.

For property placed in service after December 31, 2023, and before January 1, 2025, 60%.

For property placed in service after December 31, 2024, and before January 1, 2026, 40%.

For property placed in service after December 31, 2025, and before January 1, 2027, 20%.

For property with longer production periods placed in service after Sept. 27, 2017, and before January 1, 2024, 100%.

For property place in service after December 31, 2023, and before January 1, 2025, 80%.

For property place in service after December 31, 2024, and before January 1, 2026, 60%.

For property placed in service after December 31, 2025, and before January 1, 2027, 40%.

For property placed in service after December 31, 2026, and before January 1, 2028, 20%.

Alternatively, taxpayers may elect 50% in lieu of 100% expensing for qualified property placed in service during the first tax year beginning after September 27, 2017.

The definition of qualified property is expanded to allow used property acquired by the taxpayer to be eligible for bonus depreciation, provided the property was not used by the taxpayer before the taxpayer acquired it. The definition of qualified property is also amended to exclude property used in a real estate trade or business and certain regulated public utility property.

Corporate Alternative Minimum Tax

Applies a 20% tax rate to a broadly defined alternative definition of income.

Corporate AMT is repealed.

Tax Treatment of
Business Interest

Allows a full deduction for business interest paid (with no cap).

Caps net interest deduction at the sum of business interest income, (i) 30% of earnings before interest, taxes, depreciation, and amortization (EBITDA) for four years, and (ii) 30% of earnings before interest and taxes (EBIT) thereafter, and any floor plan financing interest. Any interest disallowed as a deduction may be carried forward indefinitely. Exemption for certain taxpayers that meet a $25 million gross receipts test - allows taxpayers with annual gross receipts that do not exceed $25 million for the three prior taxable year period to be exempt from the limitation on interest deductibility.

Net Operating Loss (NOL) Provisions

Generally, net operating losses can be carried back two years or forward twenty years, with no limits with regard to taxable income.

Eliminates net operating loss carrybacks while providing indefinite net operating loss carryforwards, limited to 80% of taxable income.

Cash Accounting

Businesses with less than $5 million in income may elect to use the cash method of accounting.

Increases eligibility to businesses with up to $25 million in income.

Deduction of settlement payments

Generally deductible as ordinary and necessary business expense, except where specifically denied, as in the case of fines, penalties, and trebled damages under anti-trust laws involving plea of guilty or nolo contendere.

Deduction is denied for certain sexual harassment and discrimination settlements if non-disclosure is required - this will affect all severance agreements where a general waiver/release is involved.

Deduction of Local Lobbying Expenses

Businesses are not allowed to deduct expenses related to lobbying and political expenditures with respect to legislation and candidates for public office. An exception to this rule allows for the deduction of lobbying expenses with respect to legislation before local government bodies, including Indian tribal governments.

Eliminates the exception for lobbying expenses with respect to legislation before local government bodies and Indian tribal governments, so they are no longer deductible.

Deduction of Entertainment Expenses

Employers can only deduct expenses associated with entertainment, amusem*nt, or recreational activities if they establish that the activity was directly related to the active conduct of the employer's trade or business or a facility used in connection with such activity. If an employer is entitled to deduct entertainment expenses, there generally is a 50% cap of the amount otherwise deductible. No deduction is allowed for membership dues with respect to any club organized for entertainment purposes. Gross income generally includes the value of employer-provided fringe benefits, except as discussed below. In general, a service provider includes in gross income the amount by which the fair market value of a fringe benefit exceeds the sum of the amount paid by the service provider and the amount that is specifically excluded from gross income.

Repeals the present-law exception to the deduction disallowance for entertainment expenses that are directly related to a taxpayer's trade or business. Allows taxpayers to continue to deduct 50% of food and beverage expenses associated with operating their trade or business, but would expand this 50% limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes. Disallows deduction for (1) expenses associated with providing any qualified transportation fringe benefit to employees, as well as (2) any expenses incurred for providing transportation for commuting between an employee's residence and place of employment, except as necessary to ensure the safety of an employee. Disallows an employer's deduction for expenses associated with meals provided for the convenience of the employer on the employer's business premises or provided on or near such premises through an employer-operated facility that meets certain requirements.

Business Credits and Deductions

Provides a range of business credits and deductions.

Modifies, but does not eliminate, the rehabilitation credit and the orphan drug credit, while limiting the deduction for FDIC premiums. Amortizes the Research & Experimentation Credit after 2021.

Taxation of Foreign Income

Imposes a worldwide system of taxation.

Moves to a territorial system with anti-abuse rules and a base erosion anti-abuse tax (BEAT) to target earnings stripping to avoid U.S. income taxes. The BEAT applies to large domestic corporations before any deductions to foreign related partners, by imposing tax at a standard rate of 5% of modified taxable income over an amount equal to regular tax liability for 2018, then 10% through 2025 and 12.5% thereafter, with higher rates for banks.

The new law transitions to territoriality by requiring a one-time income inclusion by 10% U. S. shareholders of historic earnings of a foreign subsidiary at a tax rate of 15.5% or 8%, depending on whether the foreign subsidiary’s earnings are invested in cash or business assets, respectively. The transition tax may be paid in installments over a period of 8 years.

Inversion Transactions

Various disincentives to inversion transactions, where a foreign corporation acquires a domestic corporation and U. S. shareholders own 60-80% of the combined entity.

The benefits of the reduced rates on the mandatory deemed repatriation of offshore earnings and profits will be recaptured if a U.S. corporation engages in an inversion transaction within 10 years of enactment (December 22, 2017), dividends will not qualify for the 20% rate applicable to qualified dividends, and the cost of goods sold to a related party will not be excepted when calculating the BEAT.

Estate, Gift, and Generation Skipping Tax

$5.6 million estate, gift, and generation skipping tax exemption ($11.2 million for married couples, adjusted annually for inflation.

Doubles the estate, gift, and generation skipping tax exemption in 2018 to $11.2 million ($22.4 million for married couples, adjusted for inflation, now Chained CPI.

Electing Small Business Trusts as Permitted S Corporation Shareholders

An electing small business trust (ESBT) is an eligible shareholder of an S corporation. Nonresident alien individuals may not be S corporation shareholders or potential current beneficiaries of an ESBT.

A nonresident alien individual may be a potential current beneficiary of an ESBT. The provision would not permit a nonresident alien individual to be an S corporation shareholder.