10 Jan Congressional Tax Bill and Its Impact on Private Equity Investing
This is not tax or accounting advice and is meant for informational purposes only.
On the 13th December 2017, the Republican-controlled House gave its final approval to the biggest overhaul of the U.S. tax code in 30 years, sending a sweeping $1.5 trillion tax bill to President Donald Trump for his signature.
Below we outline the key changes that are most relevant to PE funds. Unlike the reduction in the corporate rate, some of the changes have not been made permanent and will expire if not extended at a later date.
- Rate reduction and deductibility of State and local taxes (tax years beginning after 12/31/17)
- Corporate tax rate is reduced from 35% to 21%
- Corporate AMT is repealed
- Highest individual rate reduced to 37%, with an opportunity to reduce the rate on business income from pass-through entities to as low as ~30%
- State and local taxes are nondeductible by individuals
- Deduction of a portion of certain pass-through* (tax years beginning after 12/31/17)
* a pass-through is a business that does not pay corporate income tax and includes entities like sole proprietorships, partnerships, and S-corporations. The majority of businesses in the U.S. are categorized as a pass-through.
- A non-corporate partner is allowed a deduction for up to 20% of its distributive share of a pass-through entity’s qualifying business income.
- Certain services businesses (accounting, law, financial services, consulting) are generally ineligible for the reduced rate.
- Unrelated business taxable income (UBTI)
- The final bill dropped House provision that would have subjected all entities that are exempt from tax under Section 501(a) of the Code to the UBTI rules.
- This provision was intended to clarify that State and local entities such as government pension plans are subject to the UBTI rules.
- Losses from a business can no longer be netted against income from another business for UBTI purposes.
- Partnership acquisitions
- A purchase of more than 50% of the capital and profits interests in a partnership will no longer result in a technical termination of the partnership.
- Carried Interest (tax years beginning after 12/31/17)
- Where property held for less than 3 years is sold, the gain attributable to carried interest will be treated as short-term capital gain.
- In certain situations, the carried interest rules may apply to portfolio company management “profits interests”.
- Immediate expensing
- For property purchased or placed in service by the taxpayer prior to 2023, full and immediate expensing of a certain qualifying tangible personal property is allowed.
- The deduction is reduced for property placed in service in subsequent tax years.
- This change may motivate a purchaser to allocate a greater portion of the purchase price to PP&E, impacted asset values and business valuations
- Like-Kind Exchanges
- Like-kind exchanges are limited to exchanges involving real property not held primarily for sale.
- The change generally applies to exchanges completed after 12/31/17.
- Mandatory repatriation of earnings of foreign subsidiaries
- US shareholders that hold a 10% (or more) interest in a controlled foreign corporation (CFC) will incur a one-time tax on the corporation’s post-1986 accumulated earnings and profits as of 11/2/17 or 12/31/17 (whichever is greater) that are held offshore and have not yet been subject to US tax.
- Complex rules govern the calculation of the income inclusion and contain certain exclusions. We recommend seeking professional advice.
- The tax imposed will be at a 15.5% rate for earnings retained in the form of cash and cash equivalents and 8% for earnings retained in the form of other assets.
- Participation exemption for certain foreign source dividends (distributions made after 12/31/17)
- 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 generally would be exempt from US taxation.
- Controlled foreign corporation (“CFC”) status determinations
- For tax years beginning after 12/31/17 – a domestic person or entity will be US shareholder if it owns (directly or by attribution) 10% or more of the CFC’s stock (measured by vote or value).
- We expect the impact will involve the conversion many non-CFCs, under current law, into CFCs.
- Limitation on the deduction of business interest (tax years beginning after 12/31/17)
- The deduction of business interest generally is limited to:
- 30% of the business’ EBITDA (tax years before 1/1/22)
- 30% of EBIT for subsequent years
- Disallowed interest can be carried forward indefinitely
- For corporations, the carryforward of disallowed interest is treated like an NOL carryforward.
- For partnerships, the limitation is computed at the partnership level, and a partner’s share of disallowed interest is personal to the partner.
- Tax on “global intangible low-taxed income” (“GILTI”) of foreign subsidiaries (tax years beginning after 12/31/17)
- The bill would require a 10% US shareholder of a CFC to include in gross income its share of “global intangible low-taxed income.”
- The tax would be imposed at a 10.5% rate for a domestic corporation after taking into account any applicable deduction; no such deduction is available to individuals.
- Base erosion anti-abuse tax (“BEAT”)
- The bill generally would impose a tax at a 10% rate on the amount by which taxable income which is modified to strip out certain base erosion tax benefits. These are generally, deductions for payments to related persons that exceed regular taxable income.
- Contributions to capital
- In the original draft, the House had proposed that the bill would have taxed corporations upon receipt of certain capital contributions from existing stockholders who did not receive equivalent value in the form of stock in exchange for their contributions. The final bill rejected this provision.
For greater detail on the information contained in this report, please visit the bill directly: https://www.congress.gov/bill/115th-congress/house-bill/1/text
Sam Grice contributed to this report.