The Treasury Department has been directed to remove two existing regulations for every new one it issues going forward. While these moves are intended to reduce the volume of regulations and to clarify the new law, tax and regulatory executives at businesses of varied sizes are still looking for clarification across many key areas, particularly when it comes to the ramifications of the Tax Cuts and Jobs Act.
While the size, entity type and geographic footprint of a business yields many company-specific questions and tax scenarios, what is known about the implementation of the new tax law today does permit the identification of some broad areas of observation and discussion. Here are several specific examples:
When the Tax Cuts and Jobs Act became law, most of the discussion centered on individual and domestic business tax reform changes. However, several of the international tax provisions in this law may have a significant impact on taxpayers. A new category of income, “global intangible low-taxed income,” or GILTI, will require businesses to recognize a percentage of previously deferred foreign earnings via a minimum tax on a controlled foreign corporation’s income, offset by a 10 percent reduction roughly equal to the adjusted tax basis of the CFC’s depreciable tangible personal property. While conformity laws are expected in some states, not all states may conform to the federal GILTI provisions.
To prepare, taxpayers should analyze their existing foreign structures to ensure they have appropriate expense allocations and add GILTI implications into their tax rate forecasts and provisions. Similarly, as some of the offsets of this provision are only available to C corporations, taxpayers should examine their overall tax position to determine which alternative tax strategies could be required to mitigate the GILTI impact.
2. Section 162(m)
This section of the Tax Code prohibits publicly held corporations from deducting more than $1 million per year in compensation paid to each of certain covered employees. With an eye toward reining in performance-based compensation exceptions, the proposed revisions to this section stem from public outcry in the late 2000s over exorbitant executive bonus structures. Questions remain as to what might be grandfathered in from previous law and what might not. “There was always an exception for performance-based compensation,” said Ronnie Brown, vice president of tax at National Vision Inc., who teaches at Georgia State University’s J. Mack Robinson College of Business. “Those rules have been tightened a bit. Companies may look at their compensation structures more and make sure they look at the 162(m) regime.”
3. Transition taxes
To offset potential revenue from transitioning to a quasi-territorial tax regime, a one-time deferred income inclusion on previously deferred and untaxed income will be subject to a mandatory transition tax in the United States at either an 8 percent tax rate for illiquid assets or a 15.5 percent tax rate for earnings attributable to liquid assets measured at Nov. 2, 2017, or Dec. 31, 2017, whichever is higher. New sourcing rules also change where activities are considered taxed. The law changes the current worldwide taxation system (with some deferrals) to a participation exemption (via a dividend received deduction) with current taxation of some types of income. This tax will affect U.S. persons who own 10 percent of the vote or value of a specified foreign corporation. Therefore, this provision could impact not just U.S. corporations owning foreign subsidiaries, but also foreign private equity funds and their U.S. owners.
The relatively low rates of the transition tax are designed to facilitate the return of the estimated $2.5 trillion in accumulated foreign earnings – earnings that, under the higher tax rates of the prior tax law, were largely left tax-deferred in foreign subsidiaries. Early trends indicate that the law is achieving its desired impact. However, some companies may still not be able to bring this money back to the United States due to the working capital needs in their foreign operations, as well as withholding tax at the local level.
4. Section 163(j)
The deductibility of net business interest expense generally will be limited to 30 percent of adjusted taxable income. Moreover, there is no grandfather provision for loans made prior to the enactment of the law, so interest on these prior loans will also be subject to this new limitation. This may result in less borrowing by businesses with a corresponding turn to equity transactions, as not only will the interest deduction be limited but the deduction itself is not as valuable now that the corporate tax rate has been reduced to 21 percent. Additionally, the law does not address whether a consolidated group is treated as a single taxpayer in the calculation of this deduction, which requires further clarification.
5. Conformity laws
For companies operating across numerous states, new federal regulations present challenges if states do not conform with the federal provisions. The state income tax implications of the new legislation vary widely depending on states’ automatic or fixed conformity to the Internal Revenue Code and based on states’ appetite for amending their tax laws after the law’s enactment. Generally, however, the tax reform will have the effect of increasing most businesses’ effective state income tax rate due to the broadened federal income tax base without a corresponding reduction in the state tax rate. For example, Georgia recently enacted HB 918, which resulted in GILTI income being subject to tax despite Georgia’s historical stance of not subjecting foreign dividend income to taxation.
Shortly after taking office last January, the Trump administration set in motion a process requiring the Treasury to identify and reduce tax regulatory burdens. The Treasury has responded by proposing the removal of hundreds of burdensome or obsolete regulations. Under the requirement to remove two old regulations for every new one, the Treasury now can issue regulations to answer the many questions and provide the clarity that corporations will need as they plan for and comply with the provisions of the most significant tax legislation in the last 30 years.