Greetings everyone. As Editor-in-Chief of Corporate Taxation (WG&L), a leading tax journal of world-wide circulation (as well as published in electronic form in WESTLAW and RIA Checkpoint"), I thought it would be helpful to comment on the TCJA 2017 extenders due to expire at the end of this year as well as provide other thoughts and comments on important areas that were addressed in TCJA 2017, including in international taxation. The article just published is "Congressional Action to Rescue the Tax Cuts and Jobs Act of 2017 from Falling Off the "2025 Tax Cliff" Under the Second Trump Administration", Corporate Taxation 52, No. 01 (January/February 2025). It is set forth in this post in its entirety. It will shortly be posted on WESTLAW.
"Congressional Action to Rescue the Tax Cuts and Jobs Act of 2017 from Falling Off the “2025 Tax Cliff” Under the Second Trump Administration
Author: JERALD DAVID AUGUST
JERALD DAVID AUGUST, our Editor-in-Chief and Cross-Borders Columnist, practices U.S. and international taxation, including trials, in his boutique law firm in suburban Philadelphia — August Tax Law, P.C. in Blue Bell, Pennsylvania.
This article explores the outlook for tax legislation in the second Trump Administration.
With the landslide victory President-elect Trump and Republican candidates for the House and Senate recently enjoyed in the election, the question now is how will Congress react with respect to the “extender” provisions that are scheduled to expire at the end of 2025 (and 2026), as well as other substantive provisions enacted under the Tax Cuts and Jobs Act of 2017 (“TCJA 2017”), P.L. 115-97 (12/23/2017). 1
The Republicans will have 53 seats in the Senate and a wafer-thin majority of 220 also in the House. It is most likely that the Republican leadership will seek to renew the TCJA 2017 legislation and address other important tax issues under a reconciliation bill that requires only a 51-member majority vote of the Senate (and majority vote of the House). Presumably the TCJA 2017 extenders will be further extended for another eight-to-ten-year period, or, alternatively, perhaps a few provisions will be made permanent. Deficit reduction is most likely first on the Republican leadership's radar. The TCJA 2017 did have an estimated cost of $3.5 trillion over the budget reconciliation period.2 Therefore, it could be that the majority side of Congress may prioritize deficit reduction over lowering taxes to business and taxpayers in general, both of which were promised by President-elect Trump. This would suggest that keeping TCJA 2017 in place for another ten years may be what will happen.
At the time this article was submitted, Senator Crapo (R-Idaho) announced before the election that the primary focus of Senate Republicans for tax legislation is the 2025 TCJA 2017 tax cliff of approximately two dozen expiring provisions. There are other non-expiring provisions of the Code that the Republican-controlled Congress will address. Top on the list of non-extenders is retaining the corporate tax rate of 21%. There are reports, however, that the Republican side of the aisle wants the corporate tax rate to be set at 15%.3 There also is the corporate minimum tax and integration (or non-integration) with Pillars One and Two reforms of the Organization of Economic Development (“OECD”). At issue will be effective tax rates on U.S.-based versus foreign-based multinational business enterprises (“MNEs”).
There is serious doubt that the Trump II Administration will fully embrace adoption of the Pillar Two international tax regime based on economic and tax sovereignty concerns.4 Trade tariffs, e.g., such as on imported goods from China, Mexico, and/or Canada, are more likely to be debated and addressed by President Trump than entering into an international tax agreement adopting Pillar Two GLOBAL rules. At a more ground level view, the Trump II Administration is likely to prioritize action by Congress to allow 100% deductibility of research and development expenses. Full expensing of R&D goes beyond the boundary set by the Trump I Administration in the TCJA 2017.
The topics set forth in this article are likely to be taken up by the tax-writing Committees when the new Congress convenes in January 2025. Also listed are items that should be given consideration. The list is not intended to be all-inclusive. Just a starting point. Perhaps for most non-corporate taxpayers what is at the top of their list for Congress to act upon is whether the maximum individual income tax rates, standard deduction, and even itemized deductions after 2025 will revert back to pre-TCJA 2017 law. That seems, at least at this time, unlikely. Also consider that President-elect Trump promised lower taxes, no tax on tips, and no tax on Social Security payments amongst other things during the election cycle. What sort of offsets will Congress adopt to project positive offsets in the scoring process?5
Corporate Income Tax Rate
Under TCJA 2017, the U.S. corporate tax rate was dramatically reduced from the prior maximum rate of 35% to a flat 21%. The 21% flat corporate income tax rate announced in TCJA 2017 was in marked contrast to the maximum non-corporate income tax rate of 37%, which was reduced by 6.6% from 39.6%. As mentioned, expectation is that the Trump II Administration will recommend the corporate tax rate be reduced to a flat rate of 15% or at least 17%.6 Under current law there is no sunset scheduled for the flat 21% rate.
Corporate Alternative Minimum Tax (“AMT”) Repeal and Replacement by the Inflation Reduction Act of 2022 (“CAMT”)
The corporate AMT was repealed by TCJA 2017. Prior to repeal, the corporate AMT was the amount by which a C corporation's tentative minimum tax exceeded its regular tax liability. The tentative minimum tax was 20% of the amount of the minimum tax base, adjusted for tax preference items and reduced cost recovery allowances, less an exemption amount subject to phase-out. A key adjustment or “add-on” to the tax base was made for “adjusted current earnings” or “ACE” adjustment. The ACE adjustment was 75% of the amount adjusted current earnings and profits of the corporation exceeded its adjusted minimum taxable income (“AMTI”). The operating rules and computations were complex.
A new corporate AMT (CAMT) was enacted into law as part of the Inflation Reduction Act of 2022, P.L. 117-169, section 10101 (8/16/2022) (“IRA 2022”). The CAMT applies to large corporate groups, which may include affiliated partnerships, RICs, or REITs, who report financial income in accordance with GAAP and have average annual adjustment financial statement income (“AFSI”) of $1 billion or more. 7 Prior to 2018, the corporate AMT was based on taxable income, not book income.8 The tax base was changed to GAAP income by Congress since many large public companies reported much higher levels of AFSI than their regular taxable income.9 The Joint Committee on Taxation estimated that only 150 companies will be subject to the minimum tax.10 The new CAMT applies for taxable years beginning after December 31, 2022.11
Under current law, CAMT is 15% of the corporate group's AFSI to the extent such amount exceeds its regular income tax liability under the 21% rate plus its liability for the BEAT tax. The applicable corporate group must have an average annual AFSI exceeding $1 billion over a three-year period to be subject to the 15% CAMT. 12
Switching from a taxable income base under the long-standing corporate AMT to “book income” under the CAMT opens up a very large pandora's box of financial and tax accounting, tax controversy, and litigation problems and complexities issues which Congress did not consider apparently when it enacted the CAMT in IRA 2022. Based on the obvious problems in imposing an “income” tax based on financial accounting principles and “book income,” the CAMT should be repealed by Congress and the base of a corporate minimum tax, if any, should be based on taxable income plus required adjustments.13
Base Erosion and Anti-Abuse Tax Under New Section 59A
TCJA 2017 enacted into law a limited excise tax, i.e., the Base Erosion and Anti-Abuse Tax (BEAT), set forth in Section 59A , on certain amounts paid by U.S. payors to related foreign recipients to the extent such payments are deductible to the U.S. payor. The excise tax does not apply, however, where the foreign recipient elects to be subject to U.S. income tax on the deductible payment amounts received. The BEAT tax is 10% (5% for years beginning in calendar year 2018) of a corporation's modified taxable income in excess of its regular tax liability less certain credits in accordance with then new Section 59A(a) . In short, the BEAT targets earnings-stripping strategies resulting in U.S. tax base erosion for payments made between related affiliates or members of an expanded affiliated group.
The BEAT applies to multinational corporations having at least $500 million in average gross receipts over a three-year testing period and which realize at least 3% of the so-called “base erosion percentage.”14 There are certain foreign-related party payments that are not subject to the BEAT, such as payments for the cost of goods sold and payments for services provided at cost. In addition, certain tax credits (but not R&D credits, certain energy credits, and 80% of low-income housing credits) are added to the minimum tax. While certain foreign-based companies owning U.S. subsidiaries may also become subject to the BEAT, mitigation of the add-on tax to such foreign corporations may be achieved where various forms of economic payments that would otherwise be characterized as fees, licensing payments, royalties, etc. are “dumped” into cost of goods sold. The BEAT rate of 10% increases to 12.5% for tax years beginning after 2025.15
With the new Administration likely to resist adoption of OECD Pillar Two as part of a global international tax agreement, Section 59A should be expected to be retained unless a “big picture” fix can be made with respect to the CAMT. It is foreseeable, therefore, that Section 59A will continue to be part of the Code.16
Excise Tax on Corporate Stock Buybacks
IRA 2022 imposes a 1% tax on the value of stock repurchased by a publicly traded U.S. corporation during the taxable year. The amount subject to the 1% excise tax set forth in Section 4501 is generally the amount paid by the issuing corporation in the redemption exchange, reduced by the value of any stock issuances during the taxable year. Section 4501 is effective for repurchases made after December 31, 2022. The Biden Administration had proposed to increase the excise tax to 4% as reflected in a Senate bill introduced by Senators Brown (D-Ohio) and Wyden (D-Oregon).
The excise tax applies to redemptions described in Section 317(b) , economically similar transactions, and stock acquired by a corporation's specified affiliate from another person. It also applies to certain acquisitions and repurchases of publicly traded foreign corporation stock. There are six exceptions from the excise tax, including tax-free reorganizations, smaller levels of stock redemptions, repurchases treated as dividends, repurchases that are contributed to ESOPs, etc.17
President-elect Trump should be expected to want Congress to repeal the excise tax on stock repurchases.18
Dividends Received Deduction
The TCJA 2017 reduced the 70% dividends received deduction (“DRD”) under Section 243 to 50% and the 80% DRD for 20% or more owned corporations to 65%. Were the corporate income tax rate to be reduced to 15% or 17%, the DRD under Section 243 should be expected to be correspondingly reduced to arrive at a prescribed flat rate of approximately 7% to 10% depending on the percentage of stock ownership of the corporation remitting the dividend.
Deduction for Qualified Business Income of Pass-Through Entities and Sole Proprietors: Section 199A
For taxable years beginning after December 31, 2017, and before January 1, 2026, an individual taxpayer generally may deduct 20% of qualified business income with respect to a partnership, S corporation, or sole proprietorship, as well as 20% of aggregate qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income. Eligible taxpayers also generally include fiduciaries and beneficiaries of trusts and estates with qualified business income. Special rules apply to specified agricultural or horticultural cooperatives. A limitation based on W–2 wages, or W–2 wages and capital investment, phases in above a threshold amount of taxable income. A disallowance of the deduction on income of specified service trades or businesses also phases in above the same threshold amount of taxable income. Qualified business income does not include any amount paid by an S corporation as reasonable compensation of the taxpayer-shareholder or any guaranteed payment under Section 707(c) , and to the extent provided by regulations, payments for services to a partner described in Section 707(a) .
Qualified business income is separately determined for each qualified trade or business of the taxpayer. For any taxable year, qualified business income (or loss) is the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer. Qualified items of income or deduction are used in computing qualified business income only to the extent they are included in taxable income for the tax year under the method of accounting utilized by the qualified trade or business. Items are “qualified” only to the extent such items are effectively connected with the conduct of a U.S. trade or business as applied in Section 864(c) . Special rules are provided for QBI sourced within Puerto Rico. Complex operating rules are set forth in the regulations, such as rules permitting a business to elect to aggregate one or more trade or business activities or rental activities.19
Net business income or loss does not include specified investment-related income, deductions, or loss including: (1) such items resulting in net long-term capital gain or net long-term capital loss; (2) dividends, actual or constructive; (3) interest income; (4) excess commodities gains over loss from commodities transactions, other than those entered into in the normal course of the trade or business or with respect to stock in trade or property held primarily for sale to customers in the ordinary course of the trade or business; (5) excess foreign currency gains (over losses) from Section 988 transactions, other than transactions directly related to the business needs of the business activity; and (6) net income from certain notional principal contracts. Carryover business loss from a preceding taxable year can reduce QBI in the succeeding taxable year.
Some have contended that Section 199A suffers from a strong case of “horizontal inequity,” due to the large carve out denying access to the 20% deduction for “specified service trade or business” income. For QBIs the rate reduction can reach up to 10 percentage points and is subject to applicable limitations based on wage base or qualified investment asset base. Section 199A was a key feature of the TCJA 2017, especially for owners of closely held businesses operating in non-corporate solution. Indeed, the Section 199A reduction to taxable income can be accessed by sole proprietors, shareholders in S corporations, and partners in partnerships engaged in a specified service trade or business where the taxpayer's taxable income is below a threshold amount, i.e., $157,500 ($315,000 on a joint return), subject to inflation adjustment.
Accordingly, for a taxpayer having taxable income at or below the threshold amount, the deductible amount for each QBI (and specified service business) is 20% of the QBI. Where the taxpayer has taxable income above the threshold amount, the taxpayer is permitted a deductible amount, in computing net taxable income, for each qualified trade or business equal to the lesser of: (1) 20% of the QBI of each such trade or business; or (2) the greater of (a) 50% of W-2 wages paid for each qualified trade or business; or (b) 25% of W-2 wages paid plus 2.5% of the unadjusted basis of all qualified property of the qualified trade or business.
Section 199A sunsets for taxable years beginning after 2025 and is therefore a key factor in the “extender” debate by the tax-writing committees of Congress expected the winter of 2025. The Republican side of the aisle has been reported to support making permanent Section 199A . Making Section 199A permanent is a good idea, but it already suffers from the lack of horizontal equity or fairness in only applying to non-service businesses.20 Alternatively, to expand the need to provide greater horizontal equity on business taxation in general, Congress should re-consider integrating the corporate tax with pass-through taxation and subject business entities and their owners to the same effective U.S. income tax rate.21
Repeal of Section 461(l)
There are several if not more loss limitation rules in the Code that apply to individuals conducting business in a pass-through entity, such as a partnership or S corporation, or as a sole proprietor. There is the passive activity loss limitation provision contained in Section 469 . There also is the at-risk provision in Section 465 . Yet another limitation applies to the deductibility of interest, such as the investment income expense limitation and the excess business interest rule. In order to get to these rules of limitation, a shareholder in an S corporation or a partner in a partnership must first climb over the outside basis hurdle under Section 1366(d) (S corporation shareholders) or Section 704(d) (partners in a partnership). There are more limitations to consider, including the idea that you can't expense that which must be capitalized and further assuming as capitalized such expenditure is not amortizable or can be immediately expensed as a cost recovery allowance.
The Tax Cuts and Jobs Act of 2017 went well beyond these limitations when Congress enacted Section 461(l) . It provides that for those taxable years beginning after 2017, and before 2026, an “excess business loss” of a taxpayer other than a corporation is not allowed for the taxable year. The disallowed excess business loss is treated as a net operating loss (“NOL'') for the taxable year for purposes of determining any NOL carryover to subsequent taxable years. A business loss for this purpose is: (1) the sum of otherwise allowable deductions for the tax year attributable to trades or businesses of the taxpayer; less (2) all gross income or gain for the year attributable to such trades or businesses. Deductions for NOL carryovers or carrybacks and the deduction allowed under Section 199A are not taken into account. The provision applies after application of the passive loss limitation rules and all other rules of limitation or capitalization mentioned in the preceding paragraph. Moreover, tax items attributable to a trade or business of performing services as an employee are disregarded. A business loss, as computed, is an “excess business loss” and is non-deductible where it exceeds $250,000 ($500,000 for joint returns) as adjusted for inflation.
This provision received strong criticism right out of the box.22 This revenue raiser provision, surgically inserted into the TCJA 2017, was “scored” to raise almost $150 billion over 10 years. The Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, extended the effective date of Section 461(l) , in general, from 2021 through taxable years beginning before 2029. Note again that Section 461(l) applies after application of the “basis triathlon” of the outside basis rules for partners in partnerships under Section 704(d) , shareholders owning stock (and debt) under Section 1366(d) , the at-risk rules under Section 465 , and the passive activity loss rules in Section 469 . Don't forget the 80% NOL carryover limitation that applies once the Section 461(l) “excess” is converted into business loss in each succeeding year.
Section 461(l) is just bad tax policy. While deductions granted are a matter of legislative grace by act of Congress, in reality Section 461(l) can, as a matter of economic reality, impose income tax on “gross receipts” for a taxpayer actively engaged in business which generate an operating loss in excess of the threshold amount for which the taxpayer is otherwise not subject to any other limitation that Congress did not previously prescribe.23 The idea of disallowing business losses to non-corporate taxpayers of a substantial amount whereas corporate taxpayers are not subject to such limitation is Congress' “hidden ball trick” that seeks to obtain approval from entrepreneurs and investors, but fails to be convincing. It needs to be repealed.
Restore the Income Tax Deduction for Regular Tax Purposes for State and Local Taxes Under Section 164 : Repeal of the SALT Cap
Prior to TCJA 2017, individuals were permitted a deduction for certain taxes accrued or paid, regardless of whether incurred in the taxpayer's trade or business or activity engaged in for the production of income. Such taxes included: (1) state and local, and foreign, real property taxes; (2) state and local personal property taxes; and (3) state and local, and foreign, income, war profits, and excess profits taxes. A taxpayer could further elect to claim an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes. Another rule permits an individual to claim a foreign tax credit in lieu of a deduction for foreign income, war profits, and excess profits taxes. Property taxes were also allowable as a deduction in computing adjusted gross income in connection with property held for investment or used in a trade or business; otherwise, such tax is an itemized deduction. In computing an individual's alternative minimum tax, no itemized deduction for property, income or sales tax was allowed.
Under TCJA 2017, by amendment to Section 164(b)(6) , an individual, for tax years beginning after 2017 and before 2026, is only permitted to deduct state and local taxes to $10,000 ($5,000 for a married individual filing a separate return). The SALT limitation or cap applies to state and local real and personal property taxes, state, local, and foreign income taxes, and general sales taxes. It does not apply to foreign income taxes and state and local real and personal property taxes where the taxes are incurred in carrying on a trade or business or in an activity engaged in for profit. But the cap does apply to state and local income taxes even if derived from a trade or business or income-producing activity. This $10,000 ceiling rule contained in Section 164(b)(6) is referred to as the “SALT Cap” and significantly burdens individual taxpayers subject to income tax in high tax states.
In reaction to the SALT Cap, some states allowed taxes in excess of the SALT Cap to reduce, for example, a partner's or S shareholder's distributable or pro-rata share of business income or elect entity level income tax on pass-through entities having income sourced or otherwise resident in the particular state.24 Where a state enacted a pass-through entity (“PTE”) tax, such works-around the SALT Cap by permitting the PTE to pay state income taxes at the entity level, which taxes are allowed to be fully deductible for federal income tax purposes. The partner in a partnership or shareholder in an S corporation may either claim credit for the amount of the owner's distributive share of the taxes paid by the PTE or allow the owner to exclude their distributed share of the PTE's income. Approximately 30 states have enacted different versions of the work-around the SALT Cap. Note that the relief in this area is limited to members of pass-through entities and generally does not extend to highly compensated wage earners in “blue states.” The various formulations of the PTE rules are complex and result in additional professional fees, tax administration issues, and problems.
The SALT Cap, like Section 461(1) , may have its advocates and critics, which competing views reflect the highly partisan “red-state vs “blue-state” sentiments between members of Congress, but, to this commentator, regardless of politics, both provisions are “bad sausage” cooked up by Congress in TCJA 2017 for “scoring” and/or “politics.” Regardless of which side is “right,” both provisions need to be removed from the Internal Revenue Code.25
Bonus Depreciation: Full Expensing of Depreciable Business Assets in Section 168(k)
Under TCJA 2017, Congress provided for full expensing of the adjusted basis of qualified property to 100% in the year in which qualified property is placed in service. This rule, allowing an additional first-year depreciation deduction, is separate from the “expense-in-lieu-of-depreciation” deduction allowed under Section 179, as adjusted and modified by the TCJA. Under Section 168(k), prior to TCJA 2017, the allowance was 50%. The Section 179 limit was increased to $1 million (annual limit on expensing) and $2.5 million (annual phase-down threshold based on investment). 26 As modified, the full expensing percentages under Section 168(k) apply, in general, to property acquired and placed in service after September 27, 2017, and before January 1, 2023. The 100% allowance is phased down by 20% per calendar year for basis of qualified property acquired after 2022 until it is 20% for 2026 and 0% in 2027 and thereafter. There are many applicable rules and exceptions. The 100% Section 168(i) bonus depreciation rules for property acquired and placed in service expires after 2026 (or after 2027 for certain longer useful life and transportation property). Expect Congress to address this area as part of the extender package.
Repeal of the Excess Business Interest Limitation in Section 163(j)
The limitation on the current deductibility of business interest under Section 163(j) was substantially revised in TCJA 2017.27 In general, the business interest deduction may not exceed the sum of: (1) the taxpayer's business interest income; (2) 30% of the taxpayer's adjusted taxable income; and (3) the amount of the taxpayer's floor plan financing interest, which last item is fully deductible. The overall limitation under Section 163(j) only applies to taxpayers with annual gross receipts exceeding $25 million. Excess business interest is carried forward to the immediately succeeding year as business interest, again subject to the overall limitation.28 Section 163(j) applies at the partnership level and is subject to a complex “netting rule” at the partner level.29 Similar rules are intended to be applied to shareholders of S corporations. There was a problem with TCJA 2017's limitation, adding back depreciation and amortization, thereby pushing more business interest to be carried over to the succeeding taxable years.30 The controversial add-back of depreciation and amortization in increasing taxable income expired for tax years beginning after 2021. Perhaps Congress will “free-up” business interest (not otherwise required to be capitalized under Section 263A ) to be fully deductible in computing taxable income, and Section 163(j) can be relegated to “deadwood.”31 Where business interest is paid with respect to non-cost recovery assets, there should be no limitation imposed under this arbitrary 30% rule, subject to a base-erosion outcome which can easily be addressed by Congress.32 In periods of high interest rates, imposing additional “tax” rate charges for “excess business interest” is a difficult issue to explain to clients.
Amortization of Research and Experimental Expenditures Under Section 174
Business expenses incurred in the development or creation of an asset having a useful life of more than one year generally must be capitalized and depreciated, if at all, over its useful life. Prior to TCJA 2017, taxpayers, however, could elect to currently deduct the amount of certain reasonable research or experimental expenditures paid or incurred in connection with a trade or business under Sections 174(a) and (e). 33 Alternatively, taxpayers may elect to forgo a current deduction, capitalize their research or experimental expenditures, and recover them ratably over the useful life of the research, but in no case over a period of less than 60 months under Section 174(b) or alternatively, over a period of 10 years per Section 174(g)(2) in order to mitigate the AMT adjustment for research expenditures under Section 56(b)(2) (prior to TCJA 2017). Section 174 research and experimental expenditures deductible under Section 174 are not subject to capitalization rules under Section 263(a) or Section 263A (UNICAP rules). Section 174 deductions are generally reduced by the amount of the taxpayer's research credit under Section 41 , although a “reverse” election to expense-in-lieu-of-crediting is available.
For taxable years beginning after 2021, Section 174 allows research or experimental expenditures incurred in connection with a trade or business to be either deducted in the year paid or accrued or deferred and amortized over a period selected by the taxpayer, which period may not be shorter than 60 months. Specified research or experimental expenses with respect to research conducted outside of the U.S. are required to be capitalized and amortized ratably over a 15-year period beginning with the midpoint of the taxable year in which such expenditures were paid or incurred. This provision applies to amounts paid or incurred for tax years beginning after 2021.
This five-year amortization rule has been controversial, with some members of Congress seeking outright repeal in order to facilitate greater levels of research and development, particularly for R&D conducted within the United States. Trump should be expected to urge Congress to allow immediate expensing of domestic R&D.
TCJA 2017 International Tax Law Reforms: Making the U.S. More Competitive in a Global Economy
The international tax law changes enacted into law by the TCJA 2017 reflected the adoption of a territorial based system for income taxation of U.S. companies, including U.S. subsidiaries of foreign corporations. The package of international tax legislation in TCJA 2017 was intended by Congress to remove the prior incentives for U.S. corporations to invest in additional capital and labor in conducting business operations overseas. This off-shoring of active business operations also affected the business and tax decisions of foreign holding companies engaged in U.S. business operations through one or more U.S. subsidiaries. Active business income that was not subpart F income of a controlled foreign corporation (“CFC”), in which a domestic corporation was a U.S. shareholder, would be “blocked” and not includible in U.S. taxable income until dividends were received or the CFC's assets were invested back in the United States.
TCJA 2017 required, however, that a U.S. shareholder's share of CFC foreign accumulated earnings and profits from 1986 through 2017 be included in taxable income in 2017 under Section 965. The included income would be subject to a lower rate of 15.5% for cash and 8% for other assets of the CFC regardless of whether actual distributions were received. A U.S. shareholder could elect to pay its resulting tax liability on a deferred, rear-end loaded, basis over an eight-year period under Section 965(h). The Supreme Court recently upheld the constitutionality of the TCJA 2017's repatriation income tax on foreign accumulated earnings and profits under Section 965 in Moore.34
Congress then, under Section 951A, required mandatory inclusion of foreign active business income of a U.S. shareholder's share of global intangible low-taxed income (“GILTI”). Another international tax reform introduced in TCJA 2017 included the adoption of a participation exemption popular in many EU jurisdictions in Section 245A.
Dividend Received Deduction for 10% Owned Foreign Corporation by Domestic Corporation Under Section 245A
In adopting the “participation exemption” that has been in place in various countries for years, TCJA 2017 permits U.S. corporations owning 10% or more of the stock of a foreign subsidiary to qualify for 100% dividends received deduction (DRD) for dividends sourced from foreign income other than derived by a passive foreign investment company as defined in Section 1297 .35 There is a longer than one-year holding period requirement for allowing a domestic corporation access to Section 245A . No foreign tax credit under Section 901 or deduction for foreign taxes paid is allowed. Section 245A does not apply to any hybrid dividend received by a U.S. shareholder. It only applies to domestic corporations. Presumably Congress will not modify or otherwise repeal Section 245A . It levels the playing field for U.S. domestic corporations in conducting business operations overseas through foreign subsidiaries, particularly for business operations conducted in high-tax jurisdictions. Consider, however, the 100% DRD where there is low or no foreign tax applicable, subject to application of a minimum corporate tax on corporate earnings or financial statement accounting income. Perhaps that is why we have Section 951A and subpart F, but not all foreign income sourced dividends may fall within the CFC regimes.36
Income Inclusion for Global Low-Taxed Income of a U.S. Shareholder Under Section 951A
As mentioned, TCJA 2017 enacted the global intangible low-taxed income (“GILTI”) regime in new Section 951A . It applies for tax years of foreign corporations beginning after 2017 and to tax years of U.S. shareholders in which or within which such tax years of foreign corporations end. The provision is permanent.
Under the GILTI rules, a U.S. shareholder of any CFC must include in gross income for a tax year its global intangible low-taxed income in a manner that strongly resembles income inclusions of Subpart F income.37 As to a U.S. shareholder, GILTI is the excess (if any) of the shareholder's net CFC tested income over the shareholder's net deemed tangible income return. The U.S. shareholder's net deemed tangible income return is an amount equal to 10% of the aggregate of the shareholder's pro rata share of the qualified business asset investment (“QBAI”) of each CFC with respect to which it is a U.S. shareholder. The U.S. shareholder's GILTI inclusion amount is calculated based on certain items – such as tested income, tested loss, and QBAI – of each CFC owned by the U.S. shareholder (tested items). 38 The stock attribution rules under Section 958 apply for purposes of determining whether a foreign corporation is a CFC and also for purposes of determining whether a person is a U.S. shareholder under Section 951(b) .
The formula for GILTI, which is calculated at the U.S. shareholder level, is:
GILTI = Net CFC Tested Income – (10% × QBAI) less interest expense.
The long-standing Subpart F income regime was not overridden by TCJA 2017's enactment of GILTI. Instead, the provisions are siblings, with the older sibling retaining priority where both provisions might overlap. Accordingly, in addition to Subpart F income, a U.S. shareholder is also taxed on the amount of CFC's earnings invested in U.S. property from previously excluded Subpart F income. Again, it is important to recognize that GILTI “tested income” does not include Subpart F income, whether subject to an exception or not. In other words, the particular species of Subpart F income involved takes income inclusion priority and, if applicable, the species of Subpart F income is not included in computing GILTI tested income.
The resulting GILTI tax rate per TCJA 2017 for a domestic corporation that is a U.S. shareholder is 10.5% (50% × 21% corporate tax rate) less 80% of available foreign tax credits (FTCs). If the foreign corporation tax rate were higher than 13%, the resulting U.S. income tax rate to the domestic corporation would be 0% (10.5% - (0.8 × >13% (foreign tax rate)). For GILTI, to “zero out” the U.S. income tax, the foreign tax rate would equal or exceed 16.4%. GILTI FTCs constitute a separate basket for applying the FTC limitation rule in Section 904(d) . Under Section 250(a)(1)(B) , a domestic corporation that is a U.S. shareholder is allowed a deduction of 50% of the GILTI inclusion amount plus the amount received as a dividend under Section 78 , subject to a taxable income limitation.
A GILTI inclusion is treated in the same manner as an income inclusion with respect to Subpart F income. The complex set of distribution tracking and characterization rules for previously included GILTI or subpart F income under Sections 959-962 are part of the GILTI regime.39
The Biden Administration had recommended that the QBAI exclusion be removed from the computation of Section 951A . While this issue of allowing a rate of return on foreign investment in capital has a logical rationale, the attendant complexity involved should suggest to Congress that the qualified business asset investment exception be eliminated on a go forward basis.
Deduction for Domestic Corporation's Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income
The TCJA added Section 250 to the Code, which allows a domestic corporation a deduction equal to 37.5% of its foreign-derived intangible income (“FDII”) and 50% of its GILTI inclusion. Where the applicable foreign tax rate on GILTI is 0%, the U.S. residual corporate tax rate on FDII is 13.125% (62.5% of 21%) and 10.5% on GILTI (50% of 21%) with respect to applicable foreign source income. Where the Section 250 deduction, in the aggregate, exceeds taxable income, there is a proportionate amount of the allowable deduction under Section 250 . The Section 250 deduction cannot contribute to a net operating loss.
While Section 250 does not sunset, for tax years beginning after 2025, the percentage of the deductible amount is reduced to 21.875% for FDII and 37.5% for GILTI. Accordingly, the effective tax rate for GILTI increases to 13.125% and FDII increases to 16.406% for tax years beginning in 2026.
Foreign-derived intangible income (“FDII”) is income derived from exported U.S. generated goods and services that are attributable from intangible business assets. 40 There are three components of the FDII computation: (1) domestic content and production; (2) foreign use; and (3) return on intangibles. Definitions of these factors and other applicable rules are set forth in comprehensive regulations.41
Trump II Administration's Expected Rejection of OECD's Two-Pillar Global Tax Reform Plan
For the Pillar Two fans out there, many would argue that with a worldwide 15% tax on large multi-national business enterprises, there is no need for both subpart F and GILTI.42 In fact, this argument is incorrect and provides too much benefit for U.S. corporations. There is rate reduction through Section 250 and the rules under Subpart F are too complex. Supporters of this “reformist” movement that were very much involved in making recommendations to the Biden Administration on tax reforms are still vocal in their opposition to lower taxes in general and reject limiting tax incentives for U.S. companies to “onshore” business operations. The heart of Pillar 2 are the global anti-base-erosion (GLOBE) rules which consist of an income inclusion rule and a backup provision, the undertaxed profits rule (“UTPR”). Jurisdictions may adopt qualified domestic minimum top-up taxes that conform with the GLOBE rules. These rules were in response to the TCJA 2017's GILTI and BEAT provisions. Both would have to be revised to conform with the GLOBE rules.
It will be interesting to see what happens in Trump II in this area. As mentioned, it is unlikely Section 250 , subpart F, or the GILTI rules will be repealed. They are “user friendly” for U.S. corporations and remove incentives to grow companies overseas due to higher tax rates on worldwide income or U.S. source business income. The repeal of the participation exemption under Section 245A is also unlikely. Expect that the Trump II Administration will not embrace Pillar 2 but will pivot in the opposite direction to seek to impose up-tax rates or surcharges to foreign companies doing business in the U.S. which reside in countries that have the UTPR.43 Such reciprocal tax idea is reflected in H.R. 4695, “The Unfair Tax Prevention Act“ (H.R. 4695), previously introduced in July 2023 by Rep. Ron Estes (R-Kan) which, if enacted into law, would increase the impact of the BEAT on foreign-owned entities affiliated with extraterritorial tax regimes such as the UTPR.
FOOTNOTES
1 There were early signals of what a Republican controlled Congress would do. See Statement of House Ways & Means Committee Chairman Smith (R-M0) and Tax Subcommittee Chairman Kelly (R-Pa) announced on April 24, 2024. The Republican Members of Ways & Means were organized into ten working groups, with each group assigned specific areas of tax policy for review. See Tax Notes, “W&M Republicans Announce Teams to Study Expiring Provisions,” 4/24/2024. See Joint Committee Report JCS-1-18: General Explanation of the Tax Cuts and Jobs Act” (Public Law 115-97) (12/20/2018). See also Stanton, “Myriad Issues Await as House GOP Contemplates Quick Tax Action,” Tax Notes (11/11/2024); “Tax World May Have to Wait for Big Tax Bill,” Tax Notes (12/4/2024).
2 During his campaign, President-Elect Trump promised a few tax provisions would be immediately enacted into law were he to be elected. First, he promised to extend the TCJA 2017 business tax cuts. He then promised that there would be “no tax on tips,” “no tax on overtime pay,” and “no tax on Social Security benefits.” These added promises, presumably designed to get more votes, may not be accomplished under the budget reconciliation process unless Congress believes it can do so without a 60 plus majority vote of approval from the Senate. See 2 USC §§ 643 , 644(b) . Trump also made comments on restoring the full state and local tax deduction although beneficiaries of such reform may pay alternative minimum tax. Trump represented roughly $11 trillion in tax cuts, including TCJA 2017 renewal over ten years. The good news is further discussion of an unrealized capital gains tax is put on the shelf, hopefully for good. Taxing unrealized gains is a monstrous idea subject to constitutional challenge,
3 Democrats are reported as favoring increasing the corporate tax rate to as high as 28%.
4 The Biden Administration had previously agreed, in concept, to the OECD Pillar Two regime, which would require changes in the global-intangible low-income tax (GILTI) provision as well as under the BEAT rules on base erosion. Consider the OECD's Action 3 Final Report, the GILTI provision under TCJA 2017, and the OECD's current work on Pillar Two. These proposals pertain to the ability to require taxation of “excess returns” with respect to controlled foreign corporations. See August, “President Biden's 'Made in America' Tax Plan: Reversing the International Tax Benefits Extended to U.S. Corporations Under The TCJA,” Corporate Tax'n (May/June 2021); Faulhaber, “Lost in Translation: Excess Returns and the Search for Substantial Activities,” 25 Fla. Tax. L. Rev. 545 (Spring, 2022).
5 Comments made from time to time in this article suggesting that a particular provision of TCJA 2017 be retained, modified, or repealed, reflect the personal views of this author (and Editor-in-Chief of Corporate Taxation) and not the views of this Journal or the publisher.
6 The Tax Foundation reported in December, 2023 that the worldwide average statutory corporate income tax rate of 181 jurisdiction is 23.45%. See https://taxfoundation.org/data/all/global/corporate-tax-rates-by-country-2023.
7 See Notice 2023-64, 2023-40 IRB 974 (9/12/223). Controlled corporations and partnerships are included in a group which is identified under Section 59(k)(1)(D) as an applicable corporation.
8 See Section 52(a) . See, in general, Cummings, “The 2022 Corporate AMT,” 176 Tax Notes Fed. 2005 (9/26/ 2022); Sheppard, “Controlled Partnerships and the Book Income Tax,” 176 Tax Notes Fed. 1801 (9/19/2022); Blanchard, Maydew, Newton & Wolfe, “The Corporate AMT: Are the Issues Insurmountable?” 178 Tax Notes Fed. 343 (1/16/2023).
9 See Sullivan, “What Companies Are Saying About the Corporate AMT,” Tax Notes (11/11/2024); Rizzi, “IRS Gets Serious About CAMT: New Proposed Regulations Implement Parallel Tax System,” Corporate Taxation (WG&L) (Nov/Dec 20224).
10 For a corporation that is a member of a foreign-parented multinational group, the three-year average annual AFSI must be (1) over $1 billion from all members of the foreign-parented multinational group, and (2) $100 million or more of income from only the U.S. corporation(s), a U.S. shareholder's pro rata share of a CFC's AFSI, effectively connected income, and certain partnership income.
11 The IRS recently issued guidance in the form of proposed regulations with respect to the computation of corporate AMT. See REG-112129-23.
12 The corporate AMT was signed into law in August 2022.
13 See Notice 2024-68, 2024-40 IRB 682 (9/12/2024). See August, “President Biden's 'Made in America' Tax Plan: Reversing the International Tax Benefits Extended to U.S. Corporations Under the TCJA,” Corporate Taxation (WG&L) (May/Jun 2021); Keck, “Multinationals May Be Surprised New Corporate AMT Applies,” Forbes (10/4/2022). For example, the CAMT partially repeals the foreign dividend exemption. The application of the CFC rules, including the GILTI provisions and corresponding distribution rules under Section 959 et seq., heightens the complexity in making the CAMT computations. There is the potential for duplication of dividend inclusion income, such as in instances where CFC books of affiliated CFCs are not consolidated and are accounted for using the equity method. See discussion of this problem in Sheppard, supra, note 7. See also Sheppard, “CAMT and CFC Dividends, Part 2,” Tax Notes (1/15/2024). See IRS Notice 2024-10, 2024-2 IRB 1 .
14 See Ouyang and Yang, “A New Tax Regime: The Base Erosion and Anti-Abuse Tax,” Corporate Taxation (Sept/Oct 2019). It is possible that the BEAT violates certain U.S. treaty non-discrimination provisions. The excise tax imposed under Section 59A is neither deductible nor creditable.
15 See August, “President Biden's 'Made in America' Tax Plan: Reversing the International Tax Benefits Extended to U.S. Corporations Under the TCJA”, Corporate Taxation (WG&L) (May/Jun 2021), pgs. 17-18.
16 See discussion in August, supra, note 8.
17 Final regulations under the stock buyback excise tax under Section 4501 were issued on June 3, 2024, in TD 100002 . Proposed regulations had been issued earlier in the Spring, 2024. See REG-118499-23 and REG-115710-22. See also Notice 2023-2, 2023-3 IRB 374 .
18 This is part of the list of tax reforms set forth in “Project 2025” issued by the Heritage Foundation, which was released in 2023 and addresses areas for reforming the executive branch of the government. Project 2025 tax recommendations include: (1) repeal of the corporate AMT and the stock buyback tax; and (2) “repeal” of the clean energy credits. See Wallace, “Repeal of Corporate AMT and Buyback Tax May Soon Be Possible,” Tax Notes (11/7/2024). See also Sullivan, “Your Guide to Tax Policy in Project 2025,” Tax Notes (7/8/2024).
19 See August, Levitt, & Looney, “Demystifying the 20 Percent Deduction for Qualified Business Income Under Section 199A (Parts 1 and 2),” 35 Prac. Tax Law No. 3 (May 2021); August, “Understanding the Section 199A Deduction After the New Final Regulations: An IRS Perspective,” ALI-CLE (4/16/2019) VCAG0416-ALI-CLE 1 (WESTLAW).
20 For a view that Congress should repeal Section 199A , see Avi-Yonah, “Three Proposals for Fixing the TCJA,” Tax Notes (12/2/2024).
21 August, "Benefits and Burdens of Subchapter S in a Check-the-Box World," 4 Fla. Tax Rev. 289, 334 (1999); Schenk, “Reforming Entity Taxation: A Role for Subchapter S,” Tax Notes (3/9/2015); Sullivan, “Economic Analysis: Corporate Integration Would Tilt Investment to the U.S.,” Tax Notes (2/15/2016).
22 Hodaszy, “The Curious Case of Section 461(l) : Why This Unclear and Unwise New Rule Should Be Construed as Narrowly as Possible,” 73 Tax Law. 61 (2019); Joslin, ”Application and Sequence: Limiting Business Loss and Interest,” Tax Notes 631 (2/11/2019).
23 Sixteenth Amendment to the U.S. Constitution. See discussion of the Supreme Court in Merchants' Loan & Trust Co. v. Smietanka, 255 U.S. 509 (1921); Eisner v. Macomber, 252 U.S. 189 (1920). Cf. 26 USC § 305(a) . See Jensen, “The Taxing Power, the Sixteenth Amendment, and the Meaning of 'Incomes,'” 33 AZSJJ 1057 (2001); Kay & Mazza, “United States—National Report: Constitutional Limitations on the Legislative Power to Tax in the United States,” 15 Mich. St. J. Int'l L. 481 (2007). See also Charles G. Moore, et al v. United States, 144 S.Ct. 1680 (2024).
24 Notice 2020-75, 2020-49 IRB 1453 , §§ 3.01, 3.02(3) (deduction for SALT payments at entity level). The regulations will apply to payments made after November 8, 2020, but they will allow taxpayers to apply them for all taxable years ending after 2017. Taxpayers may rely on the Notice pending the issuance of regulations. Id. § 4. See Kahn, Romney, & Treu, “Too Much SALT? The Nuanced Impact of the State and Local Tax Deduction Cap on Pass-Through Business Taxpayers,” 25 Fla. Tax Rev. 339 (2021).
25 See New York v. Yellen, cert. den., 142 S.Ct. 1669 (4/18/2022); Varner, “The SALT Deduction CAP: State Pass-Through Entity Taxes as a Workaround,” J. of Tax'n (July 2023); Brashers, “SALT Deduction: Debunking the 'Moocher State' and Cost-of-Living Justifications,” The Heritage Foundation (2/18/2022).
26 TCJA 2017, §§ 13101(a)(1) -(a)(3).
27 TCJA 2017, § 13301(a).
28 The CARES Act of 2020 added special rules increasing the Section 163(j) limitation for 2019 and 2020.
29 Section 163(j)(4) . See generally Orbach, “Simplifying the Business Interest Expense Rules for Passthroughs,” 160 Tax Notes 1553 (9/10/2018); Ray, “Structuring Partner Returns After the Tax Cuts and Jobs Act,” 159 Tax Notes 57 (4/2/ 2018).
30 See Willens, “Twitter Inc. Has Gone Private,” Tax Notes (11/28/2022). See also NYSBA Tax Section Report on final and proposed regulations on Section 163(j) .
31 See Section 469(c)(7)(B) , permitting taxpayers owning real property trade or business property to elect to avoid Section 163(j) under Section 469(c)(7)(B) in exchange for using ADR cost recovery and foregoing bonus depreciation.
32 Fleming, Jr., Peroni, & Shay, “Getting Serious About Cross-Border Earnings Stripping,” 93 NCLR 673 (2015).
33 See Snow v. Comm'r, 416 US 500 , 504 (1974).
34 602 U.S. 572 (2024), aff'g, 36 F.4th 930 (2022), aff'g 2000 WL 6799022 (W.D. Wash. 2020).
35 Countries having a participation exemption include: (1) Austria; (2) Belgium; (3) Ireland; (4) Luxembourg; (5) Malta; (6) Netherlands; (7) Norway; (8) Portugal; (9) Italy; (10) Sweden; and (11) the United Kingdom. It is reported that Ireland may enact a dividend participation exemption starting in 2025.
36 The 100% DRD does not, per se, create an incentive for a U.S. parent corporation to repatriate foreign based profits in the form of dividends provided the foreign source income is not GILTI or subpart F income. But note that TCJA 2017 repealed Section 902 , which allowed dividends from a foreign corporation to a U.S. corporate shareholder to generate FTCs for such shareholder's deemed percentage of such foreign corporation's foreign taxes under applicable rules. But see Section 960 on FTCs attributable to GILTI or subpart F inclusions.
37 See Najjar and Kontopoulos, “GILTI, the Commerce Clause, & State Taxation of Foreign Source Income: Florida as a Microcosm,” 32 J. Int'l Tax'n 35 (March 2021) .
38 See Reg. 1.951A-1(c) . Where a U.S. shareholder is a domestic corporation, the 10% return percentage is effectively removed from U.S. income taxation by application of the Section 245A deduction. But see Section 1248 .
39 Note, in particular, Section 959 (exclusions for previously taxed earnings and profits), Section 960 (deemed paid credit for subpart F inclusions), and Section 962 (elections by individuals to be subject to tax at corporate rates). See August, “The Maze of Tunnels and Bridges Pass-Through Entities Must Traverse in Reporting Subpart F and GILTI Income Inclusions and Previously Taxed Income Recoveries,” Corporate Tax'n (WG&L) (Jul/Aug 2021).
40 See Section 250(b) .
41 See T.D. 9901 (7/9/2020), T.D. 9901 (10/27/2020), amend T.D. 9956 (9/21/2021).
42 See, e.g., Avi-Yonah, “Three Proposals for Fixing the TCJA,” Tax Notes (12/3/2024).
43 See H.R. 3665, introduced by Ways and Means Chair Jason Smith, R-Mo., co-sponsored by all Republican Ways and Means Committee members, which targets investors and companies from countries which impose “extraterritorial taxes” that are discriminatory, i.e., countries that have an UTPR. H.R. 3665 would impose reciprocal taxes on the U.S. income of companies and investors of such foreign countries ranging from 5% to 20%."
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Jerry August
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