We are continuing the exploration of the proposed new tax law.  Parts 1 and 2 covered individual taxation issues.  (There was  a preamble, as well.)  Yesterday, we started our discussion of what may happen to business taxes.

We are going to start off today with a hot potato issue.

Entertainment

Most of you know that entertainment expenses are currently only 50% deductible.  Just like meals, unless the meals are provided to one’s employees as a means to have them keep working (like overtime or working through lunches).  The other half of the expense was not deductible against one’s profits.

Except the new law outlaws ALL entertainment expenses.  No amusement or recreational activities or membership dues related to these activities or for social purposes.  No transportation fringe benefits and no on-premises gyms.

And, if this were a non-profit entity, these activities will now be taxable to the non-profit!

Patents

This one is going to hit my firm pretty hard.  Up to now,  patents and trade secrets were treated as capital assets.  When we sold them (or were paid for their value), it would have been considered a long term capital gain.  (Unless we sold it in 1 year or less, which made it a short term capital gain.)

Under the new law, patents and trade secrets will be considered identical to copyrights (literary, musical, or artistic creations), which means their sale constitutes ordinary income.  (Exception:  Creator of music or copyrights in a musical or opera can elect to treat these as capital assets.)

While not discussed, this change is going to also hurt many firms’ balance sheets.  If patents are not capital assets, my guess is they’ll be treated as inventory, which is to be disposed.

Partnership Terminations

Termination of a partnership has heretofore been defined as when the business ceases to be functional or there is a sale of 50% or more (in a given year) of the partnerships’ capital and/or profit interests.  The latter reason is called a technical termination.

Under the proposed law, technical terminations would no longer be mandated.  The partnership can still be considered to be ongoing and patent.

Credits

This section is more of a list of what has been removed.

The employer-provided child care credit for children of one’s employees is terminated.  It had been limited to 25% of the costs up to $ 150K.   Like this credit,  the expenses to rehabilitate an historic building is no longer.

The work opportunity credit, which was an incentive to hire certain targeted groups, disappears.   Yup, the credit to make one’s business accessible to the disabled- gone.

Moreover, any unused business credit- for any reason- can no longer be carried forward or backward.  (It’s now ‘use it or lose it’.)

Municipal Bonds

Some localities offer what is termed Private Activity Bonds- bonds that are sold to help (or induce) local firms stay in their locations and upgrade their facilities.  (Some are also offered to help firms decide to relocate to the municipality in question.)  Taxpayers who purchased such bonds (in essence, they funded the activity) will no longer be able to deduct the interest received on these bonds as tax-free; that interest will now be taxable.  In particular, those public stadiums that localities have been financing?  That interest payment will now be taxable.

Excessive compensation

Did you know that when a public entity pays its top five employees (by compensation, not title) more than $ 1 million, the portion that exceeded $ 1 million was not deductible by the company?  Which is why so many firms have been providing stock incentives and other commissions to those folks- to get around the limitation.

That’s not going to fly anymore.  The bill recognizes that companies switched from cash compensation to stock options and other pay-for-performance options.  And, then the executives manipulate the firm’s short-term results to ensure they obtain those incentives.  The executives may still manipulate the numbers, but any compensation so received would still be part and parcel of that $ 1 million threshold.

Non-profit entity executives were also subject to the $ 1 million threshold.  Now, any such compensation to the five highest paid executives in excess of $ 1 million will be subject to  a 20% excise tax.

Foreign Income

Right now, foreign income earned by a foreign subsidiary of an American firm is not taxed until the profits are returned to the American firm.  And, the tax on that income is subject to a reduction to the US taxes due, so as to reflect the foreign taxes the firm paid on said income before it was repatriated.

Now, under the proposed law, if the foreign entity is more than 10% owned by the US corporation, that repatriated income would be totally exempt from US taxes.

As I stated last Thursday,  HR-1 also includes is a hint of  the plan I’ve been advocating for some 5 years.  Those foreign entities will now be responsible for paying a  20% excise tax on subsidiary payments made for goods or services paid to a foreign affiliate.   Up to now, this is how folks like Apple have hidden their taxable transactions from the IRS (in plain sight, of course).

Under this new proviso. those “royalties”  that tech firms and big pharma “pay” their subsidiaries to shelter the profits from taxation will now be subject to this 20% levy.  Not quite as good as my plan- but it’s better than a poke in the eye.

Banks

Not surprisingly, banks are going to do very well under this new program.  They’ll be raking in the money subject to the 20% tax rate.  Until now, they paid significantly higher rates than the rest of US businesses.  Now, they’ll probably save more than $ 12 billion (assuming they do as well/badly as they had in 2016).  As a matter of fact, just the 5 largest banks will have more than $ 11 billion in their treasuries under this plan.)

Not even the change in interest deductibility will hurt them!  Since banks rake in far more interest payments than they shell out, the 30% limitation on deductible interest (based upon cash flow) won’t exacerbate their new tax situation.

The biggest hit (for the biggest banks) will be the removed deduction of FDIC (Federal Deposit Insurance Corporation) payments, when the bank’s assets exceed $ 50 billion.

Base Erosion

This is a recognition that the world is adopting a base erosion program to fully obtain taxes on income that heretofore was not considered to be subject to that nations’ taxes.

This provision now taxes what is termed Part F income from foreign subsidiaries, regardless of whether those funds are repatriated or not.  If the entity exceeded the total of the Federal short-term rate plus 7% on the basis of depreciable tangible property (this is called its asset base), then that excess will be taxed at the appropriate rate (the existing tax bracket) for the corporation.

As discussed above, there also will be that excise tax charged to funds that an American firm provides a related foreign corporation (other than interest) that are considered costs of goods sold or are part of a depreciable or amortization asset would be subject to an excise tax of 20%.

Whew!  That certainly was a lot of changes.

Tomorrow, we’ll examine what’s different in the Senate version of this bill.

 

 

The Entire 7 Part Series on the “Tax Reform & Jobs Act”
Preamble 
Personal Taxes, part 1 
Personal Taxes, part 2 
Grad Students, private colleges
Biz Taxes, part 1
Biz Taxes, part 2 
Senate’s version changes