Stunning changes to tax code are underway in the US and are already resetting the global stage for capital investment.
Pursuant to the House bill passed on 16 November, on 2 December Senate approved its version of tax reform en route to enactment of the Tax Cuts and Jobs Act later this month.
A narrow 51-49 vote resulted in some major changes being contained in the 500-page bill passed by the Senate.
The main changes are as follows.
1. Reduction of individual income tax rates with a revised top individual tax rate drop from 39.6% to 38.5%. The proposed rates represent a temporary tax cut expiring 31 December 2024.
2. Increased standard deduction[1] from $6,000 to $12,000 for single filers and from $12,000 to $24,000 for joint filers.
3. Elimination of the personal exemption[2].
4. Increase in the child tax credit from $1,000 to $2,000.
5. Reduction in the top corporate tax rate from 35% to 20% representing a permanent reduction.
6. Increase in the maximum amount of annual section 179 business expense[3] deduction from $500,000 to $5million with a higher phaseout threshold.
7. Reduction in the alternative minimum taxable income threshold by way of lifting the floor over which the AMT applies.
8. New deduction applicable to pass-through entities (partnerships, S corporations and limited liability companies) where the entity will be able to take a 23% deduction on earnings.
9. Reversion of the medical expenses deduction[4] from the 10% of adjusted gross income floor back to the 7.5% of adjusted gross income floor.
10. Repeal of the state and local tax deduction on Schedule A[5].
11. Introduction of a $10,000 ceiling on the Schedule A property taxes deduction.
12. Increased estate tax exemption from $5.6 million to $11 million.
13. Repeal of the health insurance requirement, also referred to as Obamacare, under the Affordable Care Act.
14. Broadening of the educational institutions that qualify for funding under section 529 plans to include K-12 schools and homeschooling.
15. Addition of a new international tax regime including a one-time repatriation tax for returning profits to the United States.
16. Reduction in the availability of the section 121 exclusion of gain on sale of a principal residence by way of expanding the usage requirements from two years out of the five years prior to sale, to five years out of the past eight years prior to sale.
Whilst many of the proposed changes affecting individuals are relatively minor, save for the lift in the threshold to which estate tax would apply, it is in the arena of corporate taxation that the most dramatic changes are set to come in.
This comes after decades of the status quo, the last major round of tax reform being the 1986 Reagan tax reform changes.
The US would go from having the highest corporate tax rate in the world to one of the lowest, sharing that position with the UK, Finland, Iceland, Russia and Turkey.
The changes proposed to US corporate tax law have sparked worldwide controversy and a sense of urgency; concerns arising in many countries around everything from potential violation of tax treaties to which the US is a party, to unfair tax advantages resulting in the US being called a tax haven, to calls for review of other jurisdiction’s corporate tax rates.
In Australia, the revision of the 30% corporate tax rate (previously stalled due to the dividend imputation issue in that a reduction in the corporate tax rate would ultimately be paid for by the shareholders, who would receive less franking credits) has reignited discussion about a possible reduction.
China is preparing to deal with the implications of the US tax changes, notably the prediction that investments will flow out of China and into the US by way of the US becoming a more attractive place to invest. Strategies set to be deployed by China include higher interest rates and tighter monetary restrictions.
The finance ministers of several European countries have sent a letter to Treasury Secretary Steven Mnuchin expressing concerns which include, amongst other things, potential violation of tax treaties, a proposed excise tax of up to 20% on goods or services sold by a US-based subsidiary of a foreign group, and a minimum 10% tax on payments out of the US to foreign parents or associated entities.
Industries specifically affected include the airline industry, which may face US tax on US-sourced profits which have otherwise been taxable only in the home country, and the automobile manufacturing industry.
The bill, in two versions – the House version, and the Senate version, is set to be moulded into one final bill to be signed by President Trump in time for a 1 January 2018 application.
[1] Under US tax code, individual taxpayers can elect to take the standard deduction, an automatic deduction of a set amount, from gross income, or itemize their deductions, in which case specific deductions are taken within a set of parameters specified under US tax code.
[2] Individual US income taxpayers can take a deduction called the personal exemption subject to qualifying criteria. This results in a deduction from adjusted gross income.
[3] A business deduction available for tangible, depreciable property purchased for use in an active trade or business enabling expensing of up to $500,000 per annum of qualifying property.
[4] The medical expenses deduction is an itemized deduction subject to limitations including qualifying medical expenditure and a floor on deductions able to be claimed involving the percentage of adjusted gross income.
[5] Itemized deductions are claimed on Schedule A, a form frequently included in the US individual income tax return.
