Tax Cuts and Jobs Act – Impact on Financing Transactions

Tax Law Update | December.27.2017

The Tax Cuts and Jobs Act (the "Tax Act") was signed into law by President Trump on December 22, 2017. With respect to financing transactions, the relevant changes include the following:

  • New General Limit on Business Interest Deduction
  • Eliminates Exclusion of Certain Capital Contributions from Gross Income
  • New Base Erosion Minimum Tax
  • Reduced Tax Rate on Pass-Through Income
  • New Limit on Like-Kind Exchange Rules
  • Changes to Mortgage Interest Deduction
  • New Limit on State and Local Tax Deductions
  • Income Recognition Rules Conformed to Financial Accounting Rules in Certain Circumstances

In addition, a separate tax alert regarding the changes in the Tax Act to the U.S. international tax law provisions may be accessed here.

 

House Bill

Senate Bill

As Enacted

New General Limit on the Deduction of Business Interest

  • Deduction for net business interest expense limited to 30% of adjusted taxable income
  • Adjusted taxable income = EBITDA
  • Disallowed deductions can be carried forward five years
  • Owners of pass-through entities can use excess interest limitation of entity and pass-through income of entity will not be double counted
  • Exceptions for public utilities, real estate, small businesses ($25 million gross receipts) and personal services performed as an employee
  • Same 30% limit as House Bill, except—
  • Adjusted taxable income = EBIT
  • Disallowed deductions can be carried forward indefinitely
  • Includes exception for public utilities
  • Small business exception reduced to $15 million gross receipts
  • Additional exception for electing farming businesses and electing real property trades or businesses
  • Follows Senate Amendment, except—
  • Use EBITDA rather than EBIT to calculate adjusted taxable income for taxable years beginning after December 31, 2017 and before January 1, 2022 (include deductions allowable for depreciation, amortization and depletion starting January 1, 2022)
  • Includes House’s definition of small business (less than $25 million in gross receipts)

Exclusion for Capital Contributions Limited

  • Certain contributions to capital of corporation or partnership includible in gross income
  • Amount includable: value of contribution minus value of equity received
  • COD income exception for debt contributed to capital no longer available
  • Does not contain similar proposal
  • Generally retains rules under current law, but adds an exception for non-shareholder contributions from governmental entities and civic groups
  • Eliminates existing exemption for certain contributions to water and sewage disposal utilities
  • Applies to contributions made after the date of enactment, except for contributions made by governmental entities pursuant to a master development plan approved prior to that date

Base Erosion Anti-Abuse Tax (BEAT); Effect of Credits

  • 20% excise tax on covered payments from U.S. corporation to non-U.S. affiliate in same international financial reporting group
  • Exception if non-U.S. affiliate reports as effectively connected income
  • Covered payments—amounts deductible or includable in cost of goods sold, inventory, basis of depreciable/amortizable asset
  • Interest, payments for certain services provided at cost and payments in certain commodities/securities transactions not covered payments
  • No excise tax provision
  • BEAT is a minimum tax on U.S.corporation taxable income as determined without deductions for “base erosion payments” to foreign related parties
  • New provision denies deduction for disqualified related party interest or royalties paid or accrued by/to a hybrid entity or in hybrid transaction; not applicable to amounts includable in cost of goods sold
  • Follows Senate Amendment, with following modifications:
  • Taxpayers can use certain tax credits to reduce the base erosion minimum tax amount (equal to amount modified taxable income exceeds regular tax liability)
  • Reduce base erosion minimum tax amount by: the excess of Chapter 1 credits over (sum of (1)research credit under Section41(a), plus (2)80% of the amount of “applicable section 38 credits” or 80% of base erosion minimum tax amount, whichever is less)
  • After 2025, the BEAT will not be offset by these credits
  • Applicable section 38 credits are for low-income housing, renewable electricity production credit, and the investment credit (allocable to the energy credit in Section 48)
  • Follows Senate Amendment for disallowance of deduction for any disqualified related party interest or royalties paid or accrued by/to a hybrid entity or in a hybrid transaction, but authorizes Secretary to issue regulations

Tax Rate on Pass-Through Income Reduced

  • 25% tax rate applied to business income
  • Passive income: applied to 100% of income
  • Active income: applied to higher of 30% of income or result of deemed return calculation (DRC)
  • DRC = cost basis of business assets multiplied by (US federal short-term rate plus 7%)
  • Income from specified service activities generally not eligible
  • 23% deduction available on domestic qualified business income (“QBI”) from pass-throughs
  • QBI: net amount of income/gain/deduction/loss with respect to taxpayer’s business
  • Deduction limited to 50% of W-2 wages allocable to QBI (phase in for individuals with more than $250,000 of taxable income)
  • Specified service businesses generally not eligible
  • Follows Senate Amendment, with some modifications
  • 20% deduction
  • Limits deduction to the greater of (i) 50% of W-2 wages and (ii) 25% of W-2 wages plus 2.5% of the unadjusted basis after acquisition of qualified property (depreciable business property)
  • W-2 limit does not apply to qualified REIT dividends, publicly traded partnership income or cooperative dividends

Like-Kind Exchange Rule Limited to Real Property

  • Limited to exchanges of real property
  • Follows House Bill
  • Follows House Bill and Senate Amendment

New Limitations for Mortgage Interest and Real Property Tax Deductions and Exclusion of Gain from Sale/Exchange of a Principal Residence

  • Acquisition indebtedness: cuts cap from $1 million to $500,000
  • Home equity indebtedness: deduction eliminated entirely
  • Mortgage interest: deduction for interest on principal residence only
  • State and local tax deduction: $10,000 cap for real property taxes; all other SALT deductions eliminated
  • Gain on sale of principal residence: requires use as principal residence for at least 5 years in 8 year period; exclusion phase out for AGI above $250,000
  • Acquisition indebtedness: existing law
  • Home equity indebtedness: deduction suspended for tax years 2018–2025
  • State and local tax deduction: same as House Bill, except the limitation is only for tax years 2018–2025
  • Gain on sale of principal residence: same as House Bill, except no phase out and only applies for tax years 2018–2025
  • Acquisition indebtedness: cuts cap from $1 million to $750,000 for tax years 2018–2025
  • Home equity indebtedness: follows Senate Amendment
  • State and local tax deductions: $10,000 cap on deduction, can be allocated to real property taxes or income taxes; cap on deduction for tax years 2018–2025
  • Gain on sale of principal residence: no change to existing law

NEW: Modification of Certain Tax Income Recognition Rules to Conform to Financial Accounting Rules

  • No Provision

     

  • Would require a taxpayer to recognize income no later than the taxable year in which such income is taken into account as income on an “applicable financial statement”
  • Exception for certain IRC Section 460 long-term contracts and mortgage servicing contract income
  • New rules apply before applying the existing OID rules (e.g., late payment fees, cash advance fees and interchange fees (generally treated as OID under current law) includible in income when received to the extent such amounts are included in income for financial statement purposes when received)
  • Would also codify deferral method of accounting for advance payments under Revenue Procedure 2004-34 if such income is deferred for financial statement purposes
  • Applicable to taxable years beginning after 2017
  • No similar provision in House Bill
  • Follows Senate Amendment, except that in the case of a debt instrument having OID, applicable to tax years beginning after 2018