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The Senate Finance Committee’s proposal for tax reform, and how it compares with the bill passed by the House Committee on Ways & Means

On Thursday, November 9,  the Joint Committee on Taxation (the “JCT”) released a detailed description of the Senate Finance Committee’s version of the Tax Cuts and Jobs Act (the “Senate bill”), and on Friday, November 10, the House Ways & Means approved its version of the tax reform bill and submitted it to the Rules Committee (the “House bill”).

In this post we outline some of the most significant provisions of the Senate bill, list some of the significant changes to the House bill, note some of the most important differences between the House and Senate bills, and then discuss the Senate proposal in detail.  Because the Senate has not yet released legislative text, this summary is based only on the JCT’s description of the Senate Finance Committee’s bill.  (This post does not consider any of the hundreds of amendments to the Senate bill filed with the Senate Finance Committee but not yet voted on.)

The provisions discussed are generally proposed to apply to tax years beginning after December 31, 2017, subject to certain exceptions (only some of which are noted below).  The Senate legislation is likely to evolve significantly as members of the Senate Finance Committee convene to debate the bill this week.  Any differences between the Senate and House bills will have to be reconciled (and the President will have to approve of the final version) before the legislation can pass into law.

Summary of significant provisions and changes

Summary of significant provisions in the Senate bill

  • Businesses
    • Corporate tax rate reduced to 20% beginning in 2019; corporate alternative minimum tax (AMT) eliminated.
    • 4% deduction on qualifying business income earned by owners of pass-through businesses (for effective maximum marginal rate of 31.8%).
    • Net interest expense deductions limited to roughly 30% of earnings before interest and taxes.
    • Net operating loss deductions limited to 90% of taxable income.
    • Like-kind exchange treatment limited to real property.
    • Temporary five-year 100% immediate expensing for certain capital investments.
    • Section 179 expensing expanded.
    • Expanded cash accounting for small businesses.
    • Section 199 domestic production credits repealed.
    • Acceleration of income to date when included in financial reports (other than for certain long-term contracts).
  • Foreign income
    • One-time repatriation tax on untaxed foreign earnings of domestic subsidiaries (10% for cash assets, 5% for noncash assets).
    • Shift from worldwide to territorial taxation.
    • 5% minimum tax on certain global intangible low-taxed income (“GILTI”).
    • 5% “patent box” for deemed foreign-source intangible income of U.S. corporations.
    • 10% base erosion minimum tax on very large corporations with deductible foreign payments.
    • Deductions for disproportionate net interest expense paid to affiliates
    • Expanded definition of intangible property for transfer pricing purposes.
    • Definition of “United States shareholder” of a CFC expanded to include 10% owners of the value of a CFC’s stock.
    • Non-U.S. person selling an interest in a partnership engaged in a U.S. trade or business subject to U.S. tax on effectively connected income.
  • Individuals
    • 7-bracket system retained with adjustments to rates and bracket cut-offs; new maximum individual rate of 38.5%; individual AMT eliminated.
    • Standard deduction increased to $12,000 for single individuals, $18,000 for heads of household, and $24,000 for married individuals filing jointly; personal exemptions repealed.
    • Child tax credit increased from $1,000 to $1,650.
    • Deduction for state and local taxes repealed entirely (other than certain taxes incurred in a trade or business).
    • Cap on charitable contribution deductions increased from 50% to 60% of adjusted gross income (AGI).
    • Repeal of casualty and theft loss deductions except for major disasters.
    • Miscellaneous itemized deductions subject to 2% floor repealed.
    • Estate and generation-skipping transfer tax remains, but exemption amount doubled.
  • Employee benefits and executive compensation
    • Loss of deduction for pay over $1 million to certain employees of public (and possibly some private) companies, even if performance based.
    • Nonqualified deferred compensation taxable once no longer subject to a “substantial risk of forfeiture.”
    • Standardized contribution limits for employer retirement plans.
    • New rules for classification of workers as independent contractors for federal tax purposes.
  • Tax-exempt organizations
    • 4% excise tax on net investment income of certain private colleges and universities.
    • 20% excise tax on compensation over $1 million to five highest paid employees.
    • Additional 10% tax for excess benefit transactions imposed on the organization.
    • Repeal of rebuttable presumption of reasonableness in transactions with disqualified persons.
    • Royalty income from names and logos treated as unrelated business taxable income.

Summary of significant changes to the House bill since its proposal on November 2

  • Businesses
    • Corporate dividends received deduction reduced to 65% for 80%-deductible dividends and 50% for 70%-deductible dividends.
    • New 9% tax rate on an individual owner’s first $37,500 of qualified business income earned through a pass-through (lower rate phased in over 3 years) if below an AGI threshold.
    • Removed proposal to subject limited partners to self-employment tax on a percentage of their pass-through income.
    • Added 3-year holding period requirement for certain partners receiving profits interests in exchange for services (i.e., carried interests) to qualify for long-term capital gains rates.
  • Foreign income
    • Tax rate on deemed repatriation of foreign untaxed earnings increased to 7% on illiquid assets and 14% on cash-equivalent assets from 5% and 12%, respectively.
    • Changes to 20% excise tax on deductible payments to related foreign corporations:
      • Amount of tax allowed to be offset by foreign tax credits increased to 80%.
      • All amounts paid to acquire securities or commodities are excluded from the tax.
  • Individuals
    • Delayed proposed total repeal of estate tax by one year from 2023 to 2024.
    • Restored certain specialized itemized deductions and credits.
  • Employee benefits and executive compensation
    • Removed proposal to immediately tax non-qualified deferred compensation when no longer subject to a substantial risk of forfeiture.
    • Added election for employees receiving compensation in the form of stock options or restricted stock units to defer recognition for up to 5 years.
  • Tax-exempt organizations
    • Provision to allow limited political speech during religious services of 501(c)(3) churches expanded to apply to all 501(c)(3) charities.
    • Total gross assets threshold for application of the 1.4% net investment tax on private colleges and universities increased from $100,000 per student to $250,000 per student.

 Summary of major differences between the Senate bill and the modified House bill

  • Businesses
    • The House bill would cut the corporate rate to 20% for tax years beginning after December 31, 2017; the Senate bill delays this reduction one year to 2019.
    • The Senate bill reduces the tax rate on pass-through business income with an individual above-the-line deduction, whereas the House bill provides for a maximum 25% rate for this type of income (or 9% for certain taxpayers below an income threshold).
  • Foreign income
    • The Senate and House bills propose different rates for the one-time tax on deemed repatriated earnings: 5% (non-cash) and 10% (cash) under the Senate bill compared to 7% and 14% under the House bill.
    • The House bill would impose a 10% tax on the foreign high returns of U.S. corporations’ foreign subsidiaries; the Senate bill would impose a 12.5% GILTI tax.  (The amount of income subject to each tax is calculated using a similar formula.)
    • The Senate bill would introduce a 12.5% partial patent box regime for the deemed foreign intangible income of U.S. corporations, determined by reference to foreign sales and services.
    • The Senate bill would impose a 10% base erosion minimum tax on very large corporations with disproportionate foreign deductible payments to related parties, whereas the House bill would impose a 20% excise tax on disproportionate deductible payments to related foreign parties.
  • Individuals
    • The Senate bill eliminates the deduction for state and local taxes in its entirety; the House bill retains a deduction up to $10,000 for state or local property taxes.
    • The Senate bill would retain the current law cap on mortgage indebtedness eligible for an interest exemption at $1,000,000 while the House bill would reduce the cap to $500,000.
    • Only the Senate bill would limit catch-up contributions to 401(k) accounts for taxpayers with high incomes.
    • Only the House bill would repeal the estate tax entirely (beginning in 2024).
    • The Senate bill increases the period for exclusion of gain from the sale of a personal residence from two years to five of the eight preceding years; the House bill would retain the two-year holding period but phase out the exclusion for incomes beginning at $250,000 (for a single individual) or $500,000 for a married couple.
  • Employee benefits and executive compensation
    • The Senate bill provides for taxation of most nonqualified deferred compensation when no longer subject to a service condition.  The current version of the House bill does not include this change.
  • Tax-exempt organizations
    • The House bill provides for a repeal of the exemption for interest on private activity bonds, advanced refunding bonds, and stadium-financing bonds.  The Senate bill provides only for the exemption for advanced refunding bonds.
    • Only the Senate bill provides for a 10% entity-level tax on excess benefit transactions.
    • Only the Senate bill repeals the current law rebuttable presumption of reasonableness for transactions with disqualified persons satisfying certain procedural requirements.

Detailed discussion of Senate bill provisions

I.             Business Provisions.

20% tax rate on corporate income beginning in 2019; repeal of corporate AMT.

The Senate bill proposes a permanent reduction of the corporate tax rate from 35% to 20%.  Unlike the House bill, which also would reduce the corporate tax rate from 35% to 20%, the Senate bill would delay the rate reduction one year until 2019.  Both bills would repeal the corporate alternative minimum tax (“AMT”).  A current 35% and delayed 20% rate presents planning opportunities for U.S. corporations.  For example, a U.S. corporation could purchase an asset, and sell it in 2018 if it had decreased in value (and claim a deduction at the 35% rate) or hold it until 2019 if it increases in value (and benefit from the new lower rate).

Correlative adjustment to corporate dividends received deduction (“DRD”).

Under each bill, the amount of dividends received that a corporation could deduct from its taxable income would be reduced to 50%, in the case of 70% deductible dividends under current law, or 65%, in the case of 80% deductible dividends.  The effect would be to reduce the rate of tax for a corporate shareholder entitled to a 70% DRD under current law from 10.5%[1] to 10%[2] and maintain it at 7% for a corporate shareholder entitled to the 80% DRD under current law.  A corporation would continue to deduct 100% of the dividends received from another corporation within the same affiliated group.

Net business interest deductions limited to 30% of earnings before interest and taxes.

Under each bill, net business interest deductions would generally be limited to 30% of a taxpayer’s adjusted taxable income, calculating using a method similar to earnings before interest and taxes (“EBIT”).  (The two bills apply a slightly different method for calculating the base amount.)  “Business interest” would include any interest paid or accrued on indebtedness “properly allocable to a trade or business” but would not include “investment interest” (as described in section 163(d)).  Excluded interest deductions could be carried forward indefinitely under the Senate bill, compared to only five years in the House bill.

For a partnership, the limitation would be applied at the partnership level, applying additional rules to prevent any double counting of the deduction and to allow for an increased deduction limit for excess taxable income applying rules similar to those in current section 163(j).

The limitation would not apply to taxpayers with gross receipts of $15 million or less  or certain regulated public utilities.  Additionally, real property development, construction, rental property management, or similar companies could elect not to be treated as a trade or business and, as a result, would not be subject to this limitation.

90% limitation on net operating loss deductions.

Under both the Senate bill and the House bill, deductions for net operating losses (“NOLs”) would be limited to 90% of taxable income for any tax year.  NOLs would no longer expire after 20 years but could be carried forward indefinitely to future tax years.  Unlike the House bill, the Senate bill does not include an inflation adjustment for amounts carried forward.  The current two-year carryback of NOLs would be repealed in both bills, with exceptions made for certain disaster losses.

Denial of nonrecognition for like-kind exchanges of personal property.

Each bill would limit nonrecognition treatment under section 1031 to like-kind exchanges of real property.  Non-simultaneous transfers not completed by December 31, 2017 would be grandfathered, so long as the taxpayer has either received or disposed of the property to be exchanged on or before December 31, 2017.

Temporary full expensing of business assets; other cost recovery changes.

  • Temporary 100% expensing for certain business assets.

 Each bill would permit 100% expensing of the cost of certain business property placed into service after September 27, 2017 and before January 1, 2023.  (Property placed into service on or after January 1, 2023 would generally be eligible for a 50% cost recovery deduction in the year when placed into service, as under current law.)

  •  Reduction of cost recovery periods for residential rental and nonresidential real property.

 The Senate bill would reduce cost recovery periods for residential rental and nonresidential real property from, respectively, 27.5 years and 39 years to 25 years in both cases.  The House bill does not contain an analogous provision.

  •  Expansion of section 179 expensing.

The Senate bill permits immediate expensing for up to $1,000,000 of the cost of qualifying tangible personal property placed into service after December 31, 2017, an increase from the $500,000 cap under current law, but less than the House bill’s proposal to allow expensing of up to $5 million.  The benefit under the Senate bill would be reduced (but not below zero) to the extent the value of qualifying property placed into service exceeded $2,500,000 for the tax year (compared to $2 million under current law and $20 million under the House bill).  The expansion would be permanent under the Senate bill but would expire after 5 years under the House version.

Modification of accounting methods for taxpayers with gross receipts of $15 million or less.

The Senate bill would generally permit taxpayers (other than tax shelters) with gross receipts not exceeding $15 million for the three prior tax years (the “$15 million gross receipts test”) to elect to use the cash method of accounting.  The current exceptions from the required use of accrual accounting for certain categories of taxpayers—including taxpayers that do not satisfy the $15 million gross receipts test—would remain.

Taxpayers satisfying the $15 million gross receipts test would not be required to comply with the specific inventory accounting rules imposed under current section 471 but could instead determine cost of goods sold applying their financial accounting method.  Additionally, taxpayers meeting this test would be exempt from the uniform capitalization rules under section 263A and, if additional requirements are satisfied, from required use of the percentage-of-completion method of calculating taxable income from certain small construction contracts.

Taxpayers satisfying the $15 million gross receipts test would not be subject to the limitation on net interest expense deductions, discussed above.

Repeal of the domestic production activities deduction.

Both bills would repeal the deduction for domestic production activities under section 199.

31.8% maximum effective rate for qualified business income of certain pass-through businesses; other changes to pass-through taxation.

  •  17.4% deduction for “qualified business income” earned by pass-through entities.

The Senate bill provides for a maximum effective rate of 31.8% on an individual’s domestic “qualified business income” from a partnership, S corporation, or sole proprietorship.  The reduced rate arises from a 17.4% deduction ([100-17.4] * 38.5% maximum rate = 31.8%).  Amounts received as dividends from real estate investment trusts (or “REITs”) would also be eligible for this deduction.

The deduction would not be available to owners of “specified service businesses,” except for taxpayers with taxable income below a given threshold ($150,000 for married individuals filing jointly and $75,000 for single taxpayers).  Specified service businesses include any trade or business activity involving the performance of services in the areas of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any other trade or business the principal asset of which is the reputation or skill of its employees.  Qualified business income also would not include most investment income.

The amount of the deduction available to a taxpayer from a partnership or S corporation could not exceed 50% of the “W-2 wages paid by the taxpayer” for the tax year and only those wages “properly allocable to qualified business income” could be taken into account.  It is unclear whether W-2 wages is intended to include amounts paid to the owners who participate in management or perform services for the business, as partners (including active partners) generally do not receive W-2 wages from a partnership.

Qualified business losses would carry forward to the next tax year, and presumably would reduce the amount of qualified business income included in determining amount of the deduction for that year.

The Senate approach differs from that of the House, which would tax qualified business income at graduated rates ranging up to 25%, but in the case of active trade or business income would presume that 70% of income derives from labor and only 30% is entitled to the reduced rate, effectively taxing the active income at a blended 35.22% rate.

  • Limitation on active pass-through losses.

Under the Senate bill (but not the House bill), deductions for “excess business losses” of flow-through taxpayers (i.e., taxpayers other than C corporations) would not be permitted.  These losses would be treated as NOLs and carried forward into subsequent tax years.  An “excess business loss” is the excess of a taxpayer’s aggregate deductions attributable to trades or business of the taxpayer over the sum of the taxpayer’s AGI plus an additional amount ($500,000 for married individuals filing jointly and $250,000 for single individuals, indexed for inflation).

  • No extended holding period required for carried interests.

 The Senate bill does not contain the provision in the House bill that would require holders of carried interests to satisfy a 3-year holding period (rather than the one-year period under current law) for long-term capital gains rates in respect of profits interests received in exchange for services.

  •  Changes to partnership taxation.

 The Senate bill (but not the House bill) modifies the definition of substantial built-in loss for purposes of section 743(d), which under current law requires certain basis adjustments upon transfer of an interest in a partnership that has significant built-in losses.  Under the proposed change, a substantial built-in loss would exist if, immediately after the transfer of the partnership interest, a liquidation of the partnership would result in an allocation of loss to the transferee in excess of $250,000.

 A partner’s distributive share of partnership charitable contributions and foreign taxes paid would also be limited to the partner’s adjusted basis in its partnership interest.

 II.           Foreign income provisions.

Current tax on deemed repatriated foreign earnings.

The Senate bill imposes a one-time tax on a U.S. shareholder’s pro rata share of the accumulated, undistributed earnings of foreign corporations of which it is a 10% or more shareholder.  The tax rate would be 10% on earnings attributable to cash assets and 5% on earnings attributable to noncash assets, compared with 14% and 7% under the House bill.  The deemed repatriations giving rise to this tax would occur during the foreign corporation’s last tax year beginning before January 1, 2018.  Under each bill, the tax would be payable over an 8-year period at the taxpayer’s election.

Recapture tax on expatriated entities.

Under the Senate bill (but not the House bill), if a U.S. corporate shareholder becomes an “expatriated entity” within the 10-year period following enactment of the proposed legislation, the reduced tax rate applicable to its share of any foreign earnings deemed repatriated by virtue of this provision would be retroactively increased to 35%.  The amount of additional tax due would be computed by reference to the year of the deemed inclusion, but would be assessed in the year of the U.S. shareholder’s expatriation.

Shift to territorial system of international taxation through deduction of foreign source dividends.

The Senate bill, as with the House bill, would shift the current U.S. “worldwide” international tax system, under which U.S. companies are taxable on worldwide income, to a “territorial” system under which foreign active profits are generally exempt from tax.  The mechanism under both bills would be generally to exempt the foreign-source portion of dividends paid by a foreign corporation to a U.S. corporate shareholder that owns 10% or more of the foreign corporation (referred to here as a “U.S. corporate shareholder”), provided the recipient satisfies a holding period requirement with respect to the underlying stock.

No foreign tax credit or deduction would be permitted for any exempt foreign-source dividend, and neither the exempt dividend nor deductions allocable to the foreign-source portion of the underlying stock would be considered in calculating the foreign tax credit limitation of the U.S. corporate shareholder.  A U.S. corporate shareholder’s basis in the foreign corporation stock would be reduced solely for purposes of determining a loss on later disposition of the stock.

Gain from the of stock of a foreign corporation by a U.S. corporate shareholder that has been held for at least one year would be treated as a dividend for purposes of calculating any foreign-source deduction.  Similar rules would apply to treat gain from the sale by a CFC of stock in a lower-tier CFC as a dividend to the U.S. shareholder of the selling CFC.

Foreign-source dividend disallowed for hybrid dividends.

Under the Senate bill (but not the House bill), the deduction for foreign source dividends would not be available for “hybrid dividends” received by a U.S. corporate shareholder from a controlled foreign corporation (a “CFC”).  Accordingly, repatriated hybrid dividends would be taxable.  A hybrid dividend is any payment received from a foreign corporation for which the foreign corporation received a deduction or other tax benefit with respect to foreign taxes if the payment would otherwise be deductible under the proposal.

Hybrid dividends between CFCs sharing a common 10% U.S. shareholder would be treated as subpart F income of the recipient CFC and included in the income of the 10% U.S. shareholder in the same tax year.

Transferred loss recapture rules.

Under both bills, transferred loss recapture rules would apply to transfers of substantially all of the assets of a domestic corporation’s foreign branch to a foreign corporation in which the domestic transferor is a U.S. corporate shareholder.

12.5% global intangible low-taxed income (“GILTI”) tax.

Notwithstanding the general territoriality rule, the Senate bill would tax a U.S. shareholder’s share of the CFC’s global intangible low-taxed income, or “GILTI,” at a special 12.5% rate.  Very generally, GILTI is active (non-Subpart F) income in excess of 10% of the CFC’s adjusted bases in tangible depreciable property used to generate the active income.  The House bill has a similar concept but applies to income in excess of the short-term federal rate plus 7%, multiplied by the same base amount.

More specifically, a U.S shareholder’s GILTI is measured as the excess (if any) of its “net CFC tested income” over its deemed tangible income return from its aggregate share of CFC qualified business assets investments (assuming a 10% return on investment).  “Net CFC tested income” generally means the aggregate of a U.S. shareholder’s pro rata share of “active” net income (or loss) from each CFC of which it is a U.S. shareholder (i.e., Subpart F income and certain other categories of income are excluded).

GILTI would be treated similarly to subpart F income (and so includible currently).  GILTI would be in a separate foreign tax credit basket, with no carryforward or carryback available for excess credits.

The mechanism for arriving at the special 12.5% rate is a deduction.  Specifically, the Senate bill would allow a domestic corporation to deduct 37.5% of the lesser of either (1) the sum of its foreign-derived intangible income (described below) plus its GILTI inclusions, or (2) its taxable income (as determined without regard to this provision).  ([100% – 37.5%] * 20% corporate tax rate = 12.5%.)

12.5% “patent box.” 

Under the Senate bill (but not the House bill) a special 12.5% rate would also apply to the intangible income of a U.S. corporation attributable to foreign sales (the corporation’s “foreign derived intangible income,” or “FDII”), regardless of where the underlying intangible property was developed.  The effect is similar to a single-factor sales apportionment of the U.S. corporation’s deemed intangible income, with the U.S.-apportioned income subject to the general 20% rate on corporate income, and the foreign-apportioned income subject to a reduced 12.5% rate (i.e., the same rate applicable to intangible income of CFCs).

Mechanically, the proposal permits a 37.5% deduction for “foreign-derived intangible income” (“FDII”).  A 37.5% deduction results in a net tax of 12.5% ([100%-37.5%] * 20% = 12.5%).  FDII is the amount that bears the same ratio to the corporation’s “deemed intangible income” (“DII”) as its “foreign-derived deduction eligible income” (“FDDEI”) bears to its “deduction eligible income” (“DEI”).

DEI  is the gross income of a U.S. corporation (after deductions), excluding any subpart F income of the corporation includible under section 951, the corporation’s GILTI, dividends received from CFCs with respect to which the corporation is a United States shareholder, domestic oil and gas income, and the corporation’s foreign branch income.

DII is equal to the excess of the corporation’s DEI over its “deemed tangible income return,” which is 10% of the corporation’s “qualified business asset investment” (“QBAI”).  QBAI is the average of the corporation’s adjusted basis in depreciable tangible property used in its trade or business that generates DEI.  Finally, FDDEI is DEI that is derived in connection with (1) property that is sold by the taxpayer to any person that is not a United States person and is for foreign use or (2) services provided by the taxpayer that are propertied to any person, or with respect to property, that is not located in the United States.

In essence, as a U.S. corporation increases its exports relative to its domestic sales, it tends to benefit from the lower rate.  Also, because the formula is designed to measure intangible income, corporations that reduce their investment in depreciable property also tend to benefit from the lower rate (as opposed to the GILTI tax, which is minimized by increasing tangible property).  However, the formula does not provide any benefit depending upon whether the income is generated within the United States or abroad.

Because the provision tends to provide a lower rate of tax for exports, the provision bears some similarities to the destination-based cash flow tax (or “DBCFT”) proposed by the House Republicans in last year’s “Blueprint” for tax reform, which entirely exempted export income.  Also, the provision is similar to a single-factor apportionment test based on sales which, in a territorial system, would tend to eliminate taxes on income generated from foreign sales.  However, because the formula is not based on where property is developed, it arguably eliminates some incentives for U.S. multinationals to develop their intangible property abroad and license it to third parties.

The House bill does not have an analogous concept and would continue to tax foreign-derived royalties earned by U.S. corporations at the general 20% corporate tax rate.  Royalty income received by a CFC from third parties would continue to be treated as “active” non-Subpart F income—so long as the CFC had added substantial value to the underlying intangible properly and is regularly engaged in the development of similar intangibles through the activities of its office, staff, or employees located in a foreign country[3]—and would therefore be currently taxable at the reduced 10% rate under the House bill’s “foreign high return” provision (if at all).  Therefore, under the House bill, U.S. multinationals may still prefer to have their CFCs hire employees abroad to develop intangibles for sale or license to third parties outside of the United States to achieve the 10% rate on foreign high returns (rather than develop the intangibles in the United States and be taxed at the 20% general corporate rate).  The Senate bill appears to limit the tax advantages of doing so.

Three-year tax-free distribution of intangibles by CFCs.

Under the Senate bill (but not the House bill), a CFC (and therefore its United States shareholders) would not recognize gain on the distribution of intangible property to a United States shareholder that is a corporation if made by the CFC before the last day of the third tax year of the CFC beginning after December 31, 2017.  This provision would allow U.S. multinationals to repatriate their intellectual property on a tax-deferred basis if within this three-year window.

“United States shareholder” to include any United States person that owns 10% or more of the value of a foreign corporation; downward attribution from a foreign person to a related U.S. person.

Under current law, a United States shareholder is defined as a United States person that owns more than 10% of the voting power of a foreign corporation.  The Senate bill (but not the House bill) would change the definition so that any U.S. person that owns shares worth 10% or more of the total value of all classes of stock of a foreign corporation would be a “United States shareholder” of that corporation required to include in income its share of the corporation’s subpart F income if that corporation were a CFC.  This change would represent a fundamental expansion of the CFC rules that have been in place since 1962.  The Senate bill would also provide for expanded downward attribution from a foreign person of its stock in a foreign corporation to a related U.S. person for purposes of determining whether the U.S. person is a United States shareholder and whether the foreign corporation is a CFC.  A United States shareholder’s ratable share of a CFC’s subpart F inclusion would be determined without regard to this attribution.

This change would be effective for the last tax year of a foreign corporation beginning before January 1, 2018 and for tax years of United States shareholders ending with or within the tax year of the foreign corporation.

Repeal of section 956 for U.S. corporate shareholders; look-through rule for related CFCs made permanent in 2020.

The Senate bill (as well as the House bill) would repeal section 956 with respect to a corporate United States shareholder of a CFC.  Accordingly, the United States shareholder would not include in income its share of the CFC’s earnings invested in “United States property.”  Indirect corporate United States shareholders of CFCs that hold their CFC interests through a domestic partnership would also be eligible for this exemption.

Foreign base company oil-related income would be removed from the subpart F regime.  The amount of foreign base company income considered de minimis ($1 million in 2017) would be indexed for inflation.  Withdrawals of excluded subpart F income from qualified shipping operations would no longer give rise to subpart F inclusions.

The look-through rule for payments of dividends, interest and equivalents, rents, and royalties from one CFC to another CFC would be made permanent for tax years of foreign corporations beginning after 31, 2019.

Proposals to prevent base erosion.

  • Base erosion minimum tax imposed on large C corporations.

 The Senate bill would impose a 10% “base erosion” minimum tax equal to roughly the excess of 10% over the difference between a taxpayer’s actual tax liability over the tax liability it would had if payments to foreign affiliates were not deductible, property purchased from foreign affiliates was not depreciable, and payments to foreign parents of inverted companies were not deductible.  Specifically, the Senate bill would require a corporate taxpayer to pay an amount equal to the excess of 10% of the taxpayer’s “modified taxable income” for the tax year over an amount of “regular tax liability,” subject to certain adjustments.  “Modified taxable income” is the taxpayer’s taxable income under chapter 1, determined without regard to any “base erosion tax benefit” or payment or the “base erosion percentage” of any allowable NOL deduction.  A “base erosion payment” generally includes any amount paid or accrued by a taxpayer to a related foreign party if the payment is either deductible or subject to the allowance for depreciation, as well as any reduction in gross receipts due to a payment or accrual to a related surrogate foreign corporation or a member of its expanded affiliated group.  Related parties include a 25% owner of the taxpayer, any person related to the taxpayer or the 25% owned applying the attribution rules of sections 267(b) and 707(b)(1), and any person that would be related to the taxpayer for purposes of section 482.  Additional reporting requirements would also be imposed.

The base erosion minimum tax would only apply to taxpayers that are corporations (other than a RIC, a REIT, or an S corporation) with average annual gross receipts equal to or exceeding $500 million, and would only apply if at least 4% of the taxpayer’s deductions related to payments to related foreign persons.

The House bill instead imposes a 20% excise tax on certain payments made by U.S. corporations to related foreign corporations in the same international financial reporting group if the payments are deductible, includible in cost of goods sold, or eligible for depreciation or amortization.  (This excise tax would not apply to a recipient corporation that elects to treat the payments received as income effectively connected with a U.S. trade or business carried on by the recipient corporation through a permanent establishment in the United States.)

  • Limit on disproportionate net interest expense deductions.

 The Senate bill would limit the net interest expense deductions of a U.S. corporation that is a member of a worldwide affiliated group based on the amount by which the total U.S. group indebtedness exceeds 110% of the debt the U.S. group would have if all members of the worldwide affiliated group had proportionate debt-to-equity ratios.  The House bill would similarly limit a U.S. corporation’s net interest expense deduction to 110% of the U.S. corporation’s allocable share of group EBITDA.  Disallowed interest expense deductions could be carried forward indefinitely (compared with only 5 years under the House bill).

  • Changes to section 482 transfer-pricing rules with respect to intangibles.

The Senate bill (but not the House bill) would also modify the definition of intangible property for purposes of sections 367 (relevant to outbound restructurings) and 482 (intercompany transfer pricing) to explicitly include workforce in place, goodwill, and going concern value.  The proposal would codify the “realistic alternative” principle adopted by the IRS in regulations for determining the arm’s length price for intangibles in an intercompany transaction and would authorize the IRS to require an aggregate method of valuating intangibles.  These changes would appear to reverse the Tax Court’s recent decision in Amazon.com v. Commissioner[4], currently on appeal to the Ninth Circuit.

  • Denial of deductions for amounts paid or accrued to related parties that are hybrid entities.

Under the Senate bill, deductions for amounts of interest or royalties paid or accrued to a related party would be disallowed if the payment or accrual was either (1) not included in income under the tax law of the recipient’s country of residence, or (2) deductible by the recipient under the tax law of the recipient’s country of residence.  The House bill instead would impose a general 20% tax on deductible payments to related foreign entities (regardless of whether deductible in the recipient country).  The Senate bill authorizes the Treasury generally to issue regulations addressing hybrid transactions.

  • Repeal of special rules for DISCs.

 The Senate bill (but not the House bill) would repeal the special rules applicable to domestic international sales corporations (DISCs).  The proposal would take effect for tax years beginning after December 31, 2018, and provides transition rules for current DISC shareholders.

  • Dividends from surrogate foreign corporations not eligible for QDI treatment.

Dividends received by individuals with respect to stock owned in “surrogate foreign corporations” would not be eligible for reduced tax rates applicable to “qualified dividend income” (generally, long-term capital gains rates if holding periods are satisfied).

Changes to foreign tax credit system.

Both the Senate and House bills repeal the deemed-paid credit on dividends received by a 10% U.S. corporate shareholder of a foreign corporation.  Instead, a deemed-paid credit would be provided for any income inclusion under subpart F (but only to the extent attributable to the subpart F inclusion).  Foreign branch income, which generally includes business profits allocable to a qualified business unit but excludes passive category income, would be allocated to its own foreign tax credit basket.

  • Source of inventory sales determined solely based on the location of production activities.

The determination of the source of income from inventory sales would be based solely on the location of production activities (and allocated among two or more jurisdictions, where appropriate).

Effective date of the worldwide interest allocation rules accelerated to 2018.

The long-deferred effective date of the previously enacted worldwide interest allocation rules would be advanced three years to apply to tax years beginning after December 31, 2017.

Treatment of foreign insurance companies as PFICs unless loss, loss adjustment expenses, and reserves constitute 25% of total assets.

Under the Senate bill (as well as the House bill), the determination whether a foreign insurance company is a passive foreign investment company (PFIC) would be based on the company’s insurance liabilities.  Under the proposal, a foreign insurance company would generally be treated as a PFIC unless (1) the foreign company would be taxed as an insurance company were it a U.S. corporation and (2) the company’s loss and loss adjustment expenses and certain reserves constitute more than 25% of the foreign corporation’s total assets as represented on the company’s GAAP (or equivalent) financial statements.  The 25% threshold could be reduced to 10% in certain situations if a U.S. owner of the company so elects and the failure to reach the 25% threshold is due to circumstances specific to the insurance business.

Codification of Revenue Ruling 91-32; treatment of gain on the sale of an interest in a partnership that is engaged in a trade or business in the United States as income that is effectively connected with a U.S. trade or business.

The Senate bill would reverse the recent Tax Court decision Grecian Magnesite Mining v. Commissioner[5],  and would thus effectively codify Revenue Ruling 91-32, by treating gain or loss from the sale of an interest in a partnership as income that is “effectively connected” with a U.S. trade or business to the extent attributable to a trade or business of the partnership in the United State.  Specifically, the Senate bill would treat the sale of a partnership interest as a sale of all of the partnership’s assets for their fair market value as of the date of sale, and would determine the amount of effectively connected gain or loss allocable to the selling partner based on the amount that would be allocated to that partner in a hypothetical liquidation.  The House bill does not contain a similar provision.

The Senate bill would also require the transferee of a partnership interest to withhold 10% of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that it is neither a nonresident alien nor a foreign corporation.

III.          Individuals.

Retains seven bracket structure (10%; 12%; 22.5%; 25%; 32.5%; 35%; 38.5%); top rate reduced to 38.5% from 39.6%

The Senate bill would retain the current seven bracket structure, adjusting the brackets and modestly and reducing the top rate from 39.6% to 38.5%.  Taxpayers currently in the 10% bracket would remain in the 10% bracket.  (The House bill would reduce the number of brackets from seven to four, increase the rate applicable to lowest bracket from 10% to 12%, and retain the top bracket at 39.6%.)  Unlike the House bill, the Senate bill does not contain the 6% “surtax” (i.e., the recapture of the 12% rate) for high income taxpayers.  The Senate bill also retains a separate rate structure for heads of household; the House bill does not.  A comparison of the proposed rate structures in the House and Senate bills to current law is illustrated in the chart below.

Single individuals          
             
  Current Law Senate Markup House Bill
  Taxable income between: Marginal tax rate Taxable income between: Marginal tax rate Taxable income between: Marginal tax rate
  0 – $9,525 10% 0 – $9,525 10% 0 – $45,000 12%
  $9,526 – $38,700 15% $9,526 – $38,700 12%
  $38,701 – $93,700 25% $38,701 – $60,000 22.5% $45,001 – $200,000 25%
  $93,701 – $195,450 28% $60,001 – $170,000 25%
  $170,001 – $200,000 32.5%
  $195,451 – $424,950 33% $200,001 – $500,000 35% $200,001 – $500,000 35%
  $424,951 – $426,700 35%
  Over $426,700 39.6% Over $500,000 38.5% Over $500,000 39.6%
             
  Married filing jointly        
  Current Law Senate Markup House Bill
  Taxable income between: Marginal tax rate Taxable income between: Marginal tax rate Taxable income between: Marginal tax rate
  0 – $19,050 10% 0 – $19,050 10% 0 – $90,000 12%
  $19,051 – $77,400 15% $19,051 – $77,040 12%
  $77,401 – $156,150 25% $77,041 – $120,000 22.5% $90,001 – $260,000 25%
  $156,151 – $237,850 28% $120,001 – $290,000 25%
  $237,951 – $424,950 33% $290,001 – $390,000 32.5% $260,001 – $1,000,000 35%
  $424,951-$480,050 35% $390,001 – $1,000,000 35%
  Over $480,050 39.6% Over $1,000,000 38.5% Over $1,000,000 39.6%
                       

The current maximum rates for net long-term capital gains (including qualified dividend income) would be retained, as would be the 25% rate applicable to unrecaptured section 1250 gain and the 28% rate on 28%-rate gain.  The 3.8% tax on net investment income (also known as the “Medicare tax”) is retained.

Like the House bill, the Senate bill would adjust the brackets for inflation based on “chained CPI-U,” a method generally thought to increase the brackets at a slower rate than currently and may shift taxpayers into higher brackets over time.

Increased standard deduction; repeal of personal exemptions.

The Senate bill would increase the 2018 standard deduction from $6,500 to $12,000 for individuals, from $9,350 to $18,000 for heads of household, and from $13,000 to $24,000 for married couples, to be adjusted for inflation based on chained CPI-U starting in tax years after December 31, 2017.  (The House bill would increase the brackets to $12,200 and $24,400, respectively.)  Like the House bill, the Senate bill would repeal personal exemptions ($4,150 for each exemption in 2018 under current law).  Taxpayers with gross income below the applicable standard deduction would not be required to file U.S. federal income tax returns.

This increase in the standard deduction is expected to simplify tax filings for millions of low-and middle-income families.  However, because the charitable deduction is available only for taxpayers who itemize, the increased standard deduction would tend to reduce charitable contributions.

Expanded child tax credit; new non-child dependent credit.

The Senate bill would increase the child tax credit from $1,000 under current law to $1,650 (a modest increase over the House bill’s $1,600 credit).  Significantly, the phase out for the credit would not start for joint filers until income reached $1 million, compared with a $115,000 phase out under current law and $230,000 proposed by the House.  The Senate bill would provide a $500 nonrefundable credit for all non-child dependents (compared to $300 per member of the household under the House bill) which would not expire.  (The $300 credit in the House bill expires after 2022).

Repeal of Individual Alternative Minimum Tax (AMT).

Both the Senate bill and House bill would repeal the alternative minimum tax (AMT) on individuals in its entirety.

Limitations, repeals, and other changes to individual itemized deductions.

  • Repeal of the “Pease” Limitations on Deductions.

 Both the Senate bill and House bill would repeal the Pease limitation on deductions, which under current law effectively amount to a 1.18% marginal tax (3% x 39.6%) for certain high-income taxpayers.

  • Increased Charitable Deduction.

Under current law, cash contributions to a public charity are deductible only to the extent of 50% of the taxpayer’s adjusted gross income (AGI).  Both the Senate bill and House bill would increase this limit to 60% of AGI.         

  • Repeal of deduction for state and local taxes paid.

The Senate bill repeals the individual deduction for state and local taxes entirely.  (The House bill would permit a deduction of up to $10,000 for state and local property taxes paid.)  The loss of deduction for state and local income taxes would have the greatest impact on individuals living in high-tax states and municipalities, such as New York City, New York State, California, Massachusetts, and New Jersey.

Taxes paid or accrued in carrying on a trade or business or section 212 activity (relating to the production of income) that are presently deductible in computing income on an individual’s Schedule C, Schedule E, or Schedule F would continue to be deductible.  (These taxes include real estate and personal property taxes on business assets, highway use taxes, licenses, regulatory fees, and similar items.)

  • Limitation on home mortgage interest deduction.

The Senate bill retains the deduction for home mortgage interest accrued on acquisition indebtedness of up to $1 million.  (The House bill would have reduced the cap on principal to $500,000.)  Both the Senate and House versions would repeal the deduction for interest on home equity indebtedness.

  • Repeal of casualty and theft loss deduction except for presidential declared major disasters.

 Under the Senate bill, deductions for personal casualty and theft losses would be allowed only if incurred in disasters officially recognized by the President under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act (for example, recent hurricanes Harvey, Irma, and Maria.)  The House bill would eliminate this deduction entirely except with respect to individual personal casualty losses arising from hurricanes Harvey, Irma, and Maria.

  • Wagering loss limitation.

Under both bills, deductions for wagering losses would only be allowed to the extent of wagering gains from the same tax year.

  • Repeal of miscellaneous itemized and other deductions; student loan interest deductions.

The Senate bill would generally repeal miscellaneous itemized deductions subject to the 2% AGI floor under current law (e.g., deductions for the production or collection of income, unreimbursed expenses attributable to the trade or business of being an employee, repayments of income received under a claim of right, repayments of Social Security benefits, etc.).  The House bill does not repeal miscellaneous itemized deductions.  The deductions for tax preparation expenses and moving expenses would also be repealed.

Unlike the House bill, the Senate bill retains the deductions for student loan interest.

  •  Repeal of certain individual exclusions from income.

The Senate bill would repeal the exclusions from income under current law for qualified moving expense reimbursements and qualified bicycle commuting reimbursements.  (The House bill would retain the exclusion for qualified moving expenses for members of the armed services.)

The current law exclusion of gain on sale of a personal residence ($250,000 for a single individual, $500,000 for married individuals filing jointly) would only be available to individuals who have owned and used the residence as a principal residence for at least 5 of the 8 years preceding the sale (subject to certain exceptions), compared with a 2-year use and ownership requirement under current law.  The House bill would retain the current-law 2-year use and ownership requirement, but would phase out the exclusion beginning at incomes greater than $250,000 for a single individual or $500,000 for married individuals filing jointly.  Both bills would limit the availability of the exclusion to one sale or exchange during a 5-year period.

The denial of an income exclusion for discounted tuition benefits received by university employees and their family members, proposed in the House bill, does not appear in the Senate bill.

Estate and generation-skipping transfer taxes retained with increased exemption amount.

Unlike the House bill, which would repeal the estate tax fully after 2024, the Senate bill would retain the tax but double the estate and gift tax exemption amounts from $5 million per person under current law to $10 million (both current and proposed exemption amounts indexed for inflation occurring after 2011).  The proposal would be effective for generation-skipping transfers, gifts made, and estates of decedents dying after December 31, 2017.

The income tax basis of inherited property would continue to be adjusted to fair market value at death under both the House and Senate bills.

IV.          Employee benefits and executive compensation.

Loss of deduction for performance pay over $1 million.

The Senate bill, like the House bill, would amend section 162(m), which under current law imposes a $1 million limit on the annual compensation deduction for any “covered employee,” in the following significant ways.  First, both proposals eliminate the exemption for “performance-based” compensation currently relied upon by a majority of publicly held corporations paying executive officers annual compensation exceeding $1 million.

Second, the Senate bill, like the House bill, modifies the definition of “covered employee” to include the principal executive officer and principal financial officers of the company at any time during the tax year, as well as the three highest paid employees of the company (excluding the principal executive office and principal financial officer).  An individual who becomes a covered employee for any taxable year beginning after December 31, 2016 would continue to be a covered employee in subsequent years, even if the individual is no longer an employee of the company or is deceased.

Third, the Senate bill, like the House bill, expands the number of corporations subject to the limitation to include all domestic publicly traded corporations and all foreign companies publicly traded as American depository receipts (ADRs).  While the limit in section 162(m)(1) is currently applicable to publicly held corporations only, the Senate bill suggests that the limitation may also apply to “certain additional corporations that are not publicly traded, such as large private C or S corporations,” although details are not specified.

20% excise tax on excessive compensation paid by tax-exempt organizations.

The Senate bill, like the House bill, would impose a 20% excise tax on any compensation paid by most exempt organizations to their five highest paid employees in any given year (“covered employees”) to the extent exceeding $1 million for the year.  An individual who becomes a covered employee for any taxable year beginning after December 31, 2016 would continue to be a covered employee in subsequent years.  Compensation for this purpose includes all cash and non-cash remuneration (including most benefits other than designated Roth contributions) as well as payments from persons or organizations related to the employer.

Certain “excess parachute payments” to covered employees would also be subject to the 20% excise tax to the extent in excess of the base amount allocated to the payment.  A “parachute payment” is defined for this purpose as a payment to a covered employee (other than a payment under certain specified retirement, pension, and deferred compensation plans) that is contingent on the employee’s separation from the organization, if the aggregate present value of all such payments equals or exceeds three times the base amount of the employee’s compensation.  The excise tax on excess parachute payments could therefore apply even if the covered employee’s remuneration did not exceed $1 million for the year.

Changes to taxation of nonqualified deferred compensation.

The Senate bill would generally tax nonqualified deferred compensation (generally, any compensation deferred under a plan other than a qualified employer plan, bona fide vacation leave, sick leave, compensatory time, disability pay, death benefit plan, or similar plan) once it is no longer subject to a “substantial risk of forfeiture.”

Significantly, compensation would be considered to be subject to a substantial risk of forfeiture only if an individual’s right to the compensation is conditioned upon the future performance of substantial services; covenants not to compete and payment conditions that relate to a purpose other than the future performance of services would not count as substantial risks of forfeiture.  (The original version of the House bill proposed a similar change, although this was eliminated in the final draft submitted to the Rules Committee.)

Standardized contribution limits for employer retirement plans.

The Senate bill would generally maintain the current elective deferral contribution limits for 401(k) plans and 403(b) plans and limits on contributions for employees in governmental 457(b) plans ($18,000 in 2017), while requiring a single aggregate limit for such contributions.

In addition, the Senate bill would place a single aggregate limit on contributions for an employee to any qualified defined contribution plan (such as a 401(k) plan), any 403(b) plan, or any governmental 457(b) plan maintained by the same employer, including any members of a controlled group or affiliated service group.  The House bill does not contain a similar provision.

Under the Senate bill, special rules allowing for certain additional catch-up contributions under governmental 457(b) and 403(b) plans would be eliminated; the same allowances for catch-up contributions applicable to 401(k) plans would also apply to 403(b) plans and governmental 457(b) plans.  The House bill does not contain a similar provision.

The Senate bill would also eliminate “catch-up contributions” for employees earning wages of $500,000 or more in the previous year.  (Under current law, employees age 50 or older can increase their 401(k), 403(b), or governmental 457(b) contributions by an additional $6,000 per year, raising their annual limit to $24,000 (as of 2017).)  The House bill does not contain a similar provision.

Finally, under the Senate bill, a 10% early withdrawal tax would generally apply to withdrawals from a governmental 457(b) plan prior to age 59 ½ (to the extent includible in the recipient’s income), which is similar to rules currently in place for 401(k) plans and 403(b) plans.

Limitation on deductions associated with fringe benefits and entertainment expenses.

Both bills would generally disallow deductions with respect to entertainment and recreation activities, membership dues, and facilities used in connection with recreation or membership activities even if directly related to the active conduct of the taxpayer’s trade or business.  Deductions for food and beverages provided by an employer and qualifying as de minimis fringe would be limited to 50% of the expenses incurred, and deductions for expenses associated with providing any qualified transportation fringe or commuter transportation would generally be disallowed.

V.           Miscellaneous provisions.

Acceleration of accruals to conform with financial accounting.

Under the Senate bill, taxpayers would be required to recognize income no later than the tax year in which it is taken into account for financial accounting purposes on an audited financial statement (or similar statement as provided in regulations).  Certain long-term contract income would not be subject to this rule.  Taxpayers could continue to defer recognition of income associated with certain advance payment contracts as currently provided in Revenue Procedure 2004-34.  The House bill does not contain a similar provision.

First-in, first-out method used to determine basis in securities sold or exchanged.

Under the Senate bill, a taxpayer’s basis in securities for purposes of calculating the gain or loss on the sale or exchange of securities would be determined on a first-in, first-out basis (subject to limited exceptions).  Under current law, a taxpayer that is able to adequately identify the shares being sold is allowed to use the cost basis of the shares identified (known as “specific identification”).  The specific identification method would no longer be available.  The House bill does not contain a similar provision.

New rules for classifying workers as independent contractors.

The Senate bill includes new statutory guidelines for distinguishing between employees and independent contractors based on a bill earlier proposed by Sen. John Thune (R-S.D.) (the New Economy Works to Guarantee Independence and Growth, or NEW GIG, Act).  The proposal creates a safe harbor for service providers to be treated as independent contractors with respect to service transactions that meet certain objective criteria.  Under the proposal, the payor in a qualifying transaction would generally be required to withhold income tax equal to the lesser of 5% of the amount paid for the service or $20,000.  Additional information reporting requirements would be imposed on the recipient of the service and/or certain third party operators of certain marketplace platforms, if the third party settles the transactions and/or guarantees payments to providers.

 Limitation on deduction for FDIC premiums.

Under both the Senate and House bills, deductions for FDIC premiums paid by financial institutions with total consolidated assets worth $10 billion or more would be reduced by an increasing percentage based on the amount of total consolidated assets, with 100% of the deduction being disallowed for financial institutions with assets worth $50 billion or more.  FDIC premiums are generally fully deductible under current law as ordinary and necessary business expenses.

VI.          Tax-exempt organizations.

Excise tax on large private colleges and universities.

Both the Senate bill and the House bill would impose a 1.4% excise tax on the net investment income of private tax-exempt colleges and universities with at least 500 full-time students and assets with an aggregate fair market value of at least $250,000 per student (excluding those assets used directly for purposes of educating students).

Entity-level tax and new due diligence procedures for transactions with disqualified persons.

Under current law, an excise tax is imposed on an excess benefit payment received by a disqualified person from a tax-exempt organization.  The Senate bill (but not the House bill) would impose an additional excise tax on the organization making the payment equal to 10% of the excess benefit conferred, unless the organization’s participation in the transaction was not willful or due to reasonable cause.  An organization that satisfies specified minimum standards of due diligence or otherwise establishes that reasonable procedures to avoid an excess benefit transaction were in place would not be subject to this 10% tax.

The rebuttable presumption procedures under current law would not create a rebuttable presumption of reasonableness with respect to a transaction under the Senate bill but would instead only show that the organization satisfied minimum standards of due diligence, and would not provide any benefit to the disqualified person or to the managers who approved the transaction.

The intermediate sanctions rules would apply also to section 501(c)(5) and 501(c)(6) organizations.  The definition of “disqualified persons” would be expanded under the Senate bill to specifically include athletic coaches performing coaching services for an eligible educational institution and investment advisors of donor advised funds.

Royalty income from names and logos subject to tax on UBTI.

The Senate bill (but not the House bill) would treat royalty income derived from the licensing of a tax-exempt organization’s name or logo (including related trademarks and copyrights) as unrelated business taxable income (“UBTI”).  Under current law, royalty income generally is excluded from UBTI.  Additionally, the sale or licensing of logos would be treated as an unrelated trade or business of the organization, which, if substantial, could cause the organization to lose its tax-exempt status.

Separate netting required for unrelated trade or business activities.

The Senate bill also includes a provision requiring the computation of UBTI separately for each unrelated trade or business of the organization.  (Under current law, income from all of an exempt organization’s unrelated trade or business activities is calculated on an aggregate basis.)  This change would prevent a tax-exempt organization from using expenses related to one trade or business to offset UBTI generated from another trade or business.  Net operating losses could only be deducted against income from the specific trade or business from which the losses arose.

Repeal of tax-exempt status for professional sports leagues.

The Senate bill would eliminate the tax exemption for professional all sports leagues.  Since 1966, U.S. tax law has specifically exempted professional football leagues from tax under section 501(c)(6); the IRS has historically applied this exemption to all professional sports leagues.  The House bill does not include a corresponding provision.

Repeal of exemption for advanced refunding bonds; exemption for private activity bonds retained.

The Senate bill ends the tax exemption for interest earned on “advanced refunding bonds,” which under current law are used to refinance tax-exempt bonds issued by state and local governments and certain charitable activities of section 501(c)(3) organizations.  The repeal would apply to advanced refunding bonds issued after December 31, 2017.

The Senate bill, unlike the House bill, does not include a general repeal of the exemption for interest earned on private activity bonds.


[1] (100%-70%)*35% =10.5%.

[2] (100%-50%)*20%=10%.

[3] See Treas. Reg. § 1.954-2(d)(1)(i).

[4] 148 T.C. No. 8 (Mar. 23, 2017).

[5] 149 T.C. No. 3 (July 13, 2017) (holding that a foreign partner’s sale of a partnership engaged in a U.S. trade or business generated solely foreign-source gain).  The JCT description of the Senate bill refers to this decision specifically.

© 2017 Proskauer Rose LLP.

TRENDING LEGAL ANALYSIS


About this Author

David S Miller, Proskauer, derivatives issuance lawyer, cross border lending transactions attorney
Partner

David Miller is a partner in the Tax Department. David advises clients on a broad range of domestic and international corporate tax issues. His practice covers the taxation of financial instruments and derivatives, cross-border lending transactions and other financings, international and domestic mergers and acquisitions, multinational corporate groups and partnerships, private equity and hedge funds, bankruptcy and workouts, high-net-worth individuals and families, and public charities and private foundations. He advises companies in virtually all major industries,...

212.969.3006
Richard Corn, Tax, Private Equity Funds, Proskauer Rose Law Firm
Partner

Richard M. Corn is a partner in the Tax Department. He focuses his practice on corporate tax structuring and planning for a wide variety of transactions, including:

  • mergers and acquisitions

  • cross-border transactions

  • joint ventures

  • structured financings

  • equity and debt issurances

  • restructurings

  • bankruptcy-related transactions

Richard advises both U.S. and international clients, including multinational financial institutions, private equity funds, hedge funds, asset managers and joint ventures. He has particular experience in the financial services and sports sectors. He also works with individuals and tax-exempt and not-for-profit organizations on their tax matters.

212.969.3553
Martin T Hamilton, Tax Attorney, Proskauer Rose Law Firm
Partner

Martin T. Hamilton is a Partner in the Tax Department, resident in the New York office. He primarily handles U.S. corporate, partnership and international tax matters.

212.969.3964
Kathleen R Semanski, Tax Department Lawyer, New York,
Associate

Kathleen R. Semanski is an associate in the Tax Department.

  • University of California, Los Angeles, School of Law, J.D., 2016 
    Order of the Coif

  • Boston University, B.A., 2011 
    summa cum laude

212-969-3658