Will the New Tax Act Affect You? Part Four

In my last post, I discussed how the Tax Cuts and Jobs Act may impact an individual’s decisions regarding estate planning.  In this post, I will briefly survey several significant changes affecting the U.S. international tax realm.

Part Four: International Tax Reform

New Dividends Received Deduction

The Act enacted a new Code Section 245A which provides for a 100 percent deduction for dividends received by a U.S. shareholder of foreign corporate stock, provided that the foreign corporation is a 10 percent-owned foreign corporation, is not a passive foreign investment company, and meets all other relevant requirements under the Code Section. 

The key takeaway of this code section is that for those multinational corporations that qualify for the new deduction, they will no longer be subject to the tax on dividends they receive from their foreign subsidiaries. 

New tax on Global Intangible Low Tax Income

A new Code Section 951A creates a sub-category of income (GILTI income) that is formula-driven and creates a minimum threshold for income that will be subject to U.S. taxation.  For tax years 2018 through 2025, U.S. corporations can deduct 50 percent of GILTI income, resulting in a 10.5 percent effective tax rate. 

While this new tax aims to reduce the incentive for U.S. companies to shift assets offshore, it is less clear why the Act imposed 10 percent as the minimum threshold figure.  Furthermore, due to the formula-driven nature of this new rule, U.S. corporations will have planning opportunities aimed at minimizing their exposure to the GILTI income that will be subject to tax.

New Deduction for Foreign-Derived Intangible Income

This is essentially a relief provision to the newly-enacted GILTI rules.  The Act allows a deduction under new Code Section 250 for a U.S. corporation’s foreign-derived intangible income (FDII) of 37.5 percent for tax years 2018 through 2025, and 21.875 percent for tax years after 2025.  Corporate taxpayers can also use up to 80 percent of foreign tax credits against their GILTI income. 

The net effect of all of the deductions, foreign tax credits, and gross-ups is that the effective tax rate on FDII is 13.125 percent for tax years 2018 through 2025 and 16.406% after 2025.

New Base Erosion Minimum Tax

The new “base erosion and anti-abuse tax” (BEAT) operates as a limited-scope alternative minimum tax, which is applied by adding back to taxable income certain deductible payments made to related foreign persons.  Note that this new tax, imposed under Code Section 59A, applies to taxpayers with an average annual gross receipts for the last 3 taxable years of at least $500,000,000.

The new minimum tax rate is 5 percent for tax year 2018, 10 percent for tax years 2019 through 2025, and 12.5 percent for tax years after 2025.  Taxpayers now must calculate their tax liability under the new rules to determine whether they are subject to the BEAT. 

One-Time Transition Tax

Finally, a transition tax imposed under Code Section 965 applies to U.S. shareholders on deferred foreign earnings as part of the transition to the new participation exemption system of taxation under the Act.  Deferred foreign earnings refers to the accumulated post-1986 deferred foreign earnings.  Such foreign earnings that are held as cash or cash equivalents are taxed at a rate of 15.5 percent and all other earnings are taxed at 8 percent.  U.S. shareholder may elect to pay the transition tax in eight installments.

Will the New Tax Act Affect You? Part Three

In my last post, I discussed some key changes of the Tax Cuts and Jobs Act that will be affecting business entities. In this post, I will discuss how the Act will impact an individual’s decisions on estate planning.

Part Three: Estate Planning

Unlike some of the tax law changes that affect corporations (as discussed in Part Two) which are permanent, the changes to estate tax, gift tax, and generation-skipping transfer tax are effective in tax year 2018 and set to expire after 2025. 

Beginning 2018, the Tax Cuts and Jobs Act increased the exemption amount (the amount that an individual can gift or own at death without being subject to gift or estate tax) from $5,490,000 (for 2017) to $11,180,000.  The exemption amount is $22,360,000 for a married couple.  The generation-skipping transfer tax exemption has also been increased to the same amounts for individuals and married couples and also set to expire after 2025.

While the change may not affect estate planning considerations for individuals or married couples with estates below the pre-Tax Act exemption amounts, those who are at or above the pre-Act exemption should re-evaluate their estate plan accordingly.

One of the starting points is to consider both the income tax consequences and the estate tax consequences in the assessment of your estate plan.  For example, an individual who currently holds an asset with a low adjusted basis and that asset has significantly appreciated in value (and is expected to continue to appreciate throughout the individual’s lifetime) may want to hold the asset until death in order to obtain a step-up in the basis of the asset.  At death, the basis of the asset will be treated as equal to its fair market value, thereby resulting in income tax savings on the gains of the asset.  While the value of the asset in includible in the gross estate of the decedent, the increase in the estate tax exemption may eliminate the concern of triggering the estate tax liability for those individuals and married couples below the newly-increased exemption amounts.

Individuals and married couples with estates that are above the increased exemption amounts should consider making gifts to irrevocable trusts up to the exemption.  By doing so, the value of those assets transferred over to the irrevocable trusts will be removed from the decedent’s gross estate and will not be included in the calculation of the estate tax liability.  Furthermore, the irrevocable trusts may be drafted in such a way as to allow the transferred assets to grow tax-free while the trusts are administered for the benefit of loved ones. 

There are different estate plan considerations for a U.S. citizen who wishes to provide for a non-U.S. citizen spouse.  While one U.S. citizen spouse can gift and bequest to another U.S. citizen spouse an unlimited amount of assets free of tax, a U.S. citizen spouse may not do the same with a non-U.S. citizen spouse (even if that spouse is a U.S. resident or a U.S. green card holder).  Rather, an annual exclusion amount ($149,000 for 2017) is allowed for transfers from a U.S. citizen spouse to a non-citizen spouse.  As a result of the temporary increase in the exemption amount, however, the U.S. citizen spouse may now have more flexibility to gift assets to the non-citizen. 

For example, the U.S. citizen can make a gift (up to, or even more than, the annual exclusion amount) to an irrevocable life insurance trust for the benefit of the non-citizen spouse.  The trust then purchases a life insurance policy on the life of the U.S. citizen spouse.  The death proceeds do not have to qualify for the marital deduction because the death benefits will generally be excluded from the insured’s estate.  Alternatively, the life insurance policy could be owned by the noncitizen spouse.  Again, the proceeds do not need to qualify for the marital deduction because the death benefit generally will be excluded from the U.S. citizen’s estate.

Whether you currently have an existing estate plan, or you are considering whether to create one, please visit the five common misconceptions you should avoid and talk to an estate planning attorney to determine the best strategy that will most benefit you and your love ones.