The changes brought about by the 2017 tax act are — overall — good news for technology, media, and telecommunications companies. AT&T CEO Randall Stephenson, in discussing the reform proposals in December 2017, said that his company would invest $1 billion more in U.S. infrastructure in 2018 if President Trump signed off on tax reform.
The major benefits of the reform package that he cited included the reduction in the corporate income tax rate and enhanced deductions for capital expenditures over the next five years.
While most of the reform provisions should be beneficial, however, the international tax changes are more of a mixed bag. On one hand, firms stand to benefit from the provision allowing cash stockpiled overseas to be returned home at reduced tax rates (8 percent and 15 percent, depending on how the assets are held). But some reforms to international tax provisions could actually raise taxes on foreign income over the long run.
Reduced Tax Rates for Corporations and Pass-Through Entity Income
The headline change in the tax reform act was the reduction in the corporate tax rate to a flat rate of 21 percent. The reduced tax rate will likely boost corporate profits and help spur investment and create jobs. Also, while the Senate tax reform bill would have retained the corporate alternative minimum tax (AMT) — which would have precluded the use of important and widely used tax breaks related to intellectual property, investment in new equipment, and research and development — the act repealed the corporate AMT altogether.
Another major change was the introduction of a deduction for income earned by pass-through entities and sole proprietors. The act permits a 20 percent deduction from such taxpayers’ qualified business income, subject to some limitations that should not be problematic for technology, media, and telecommunications companies. The limitations are based on the type of services performed by the business, the amount of wages paid to employees, and the amount of tangible depreciable property owned by the business. They primarily target businesses whose principal asset is the reputation or skill of one or more of its employees or owners, such as law firms and consulting firms.
Expanded Expensing of Depreciable Assets
Under prior law, taxpayers were generally not permitted to immediately deduct the full cost of acquiring property for business use in the year they purchased it. Instead they had to take depreciation deductions over the useful life of the property. Taxpayers were permitted additional first-year depreciation of 50% of the adjusted basis of certain depreciable property that was placed in service before January 1, 2020. If the property was manufactured or produced by the taxpayer, the manufacture or production had to begin before January 1, 2020.
Additionally, prior law permitted businesses to elect to expense up to $500,000 in acquisition of certain depreciable assets, subject to a phaseout if the costs exceeded $2 million (both figures indexed for inflation). Because of the phaseout, it was generally not available for larger companies.
The 2017 tax act expands these provisions to allow taxpayers to immediately expense 100% of the cost of qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (one year longer for property with longer production periods). The act incrementally phases this out beginning in 2023 so that taxpayers would only be able to immediately expense 20% of the cost of qualified property acquired and placed in service in 2026 (one year longer for property with longer production periods).
The act increases the §179 expensing limitation and the phaseout amount, and expands the types of property subject to the election. It allows businesses to expense up to $1 million, subject to a phaseout of $2.5 million (both amounts indexed for inflation).
The act also adds energy-efficient heating and air conditioning to the list of property eligible for expensing, as well as permits the expensing of improvements to roofs; heating, ventilation, and air-conditioning; fire protection and alarm systems; and security systems.
Interest Expense Deduction
Businesses will encounter rules that may modify the deductibility of interest expense, depending on how leveraged the business is. The act limits the deductibility of interest expense to the sum of:
– Business interest income
– 30 percent of the business’s adjusted taxable income; and
– Floor plan financing interest
Business interest not allowed as a deduction in a tax year can be carried forward indefinitely. The act provides that adjusted taxable income is computed without regard to any deduction allowable for depreciation, amortization, or depletion, for tax years beginning before January 1, 2022.
Repeal of Domestic Production Activities Deduction
Prior law allowed a deduction of 9 percent of the lesser of taxable income from qualified domestic production activities or 50 percent of the W-2 wages paid by the taxpayer. The act repeals the deduction effective for tax years beginning after December 31, 2017. However, the final bill did not contain a provision in the House bill that would have extended the deduction through 2017 for domestic production activities in Puerto Rico.
The act retains the prior law research credit. However, beginning in 2022, it requires capitalization and amortization of research and experimental expenses over five years, compared to deducting them currently as permitted under prior law. This change applies to software development expenditures as well.
The value of the research credit might be increased by the repeal of the corporate AMT in the final act.
International Tax Reform
The primary downside for technology, media, and telecommunications companies may be the new provisions relating to international tax. The new reforms added layers on top of pre-existing law and have made this area of tax law even more complex than it once was. Here are the major elements:
– “Territorial” tax regime. The tax reform act was cited as a move from a “worldwide” tax regime to a territorial regime. This is true — under the new law, there is a 100 percent deduction for the foreign-source portion of dividends received from “specified 10-percent owned foreign corporations” by U.S. corporate shareholders. However, the new base protection provisions, discussed below, undermine much of the benefit of this new regime.
– Deemed repatriation. As part of the transition to the territorial system, taxpayers are required to include accumulated foreign earnings in income, which may cause cash flow problems for some taxpayers. There are two rates for different kinds of assets. One rate is for liquid assets like cash and cash equivalents (15.5 percent); the other rate is for noncash assets (8 percent). Taxpayers can elect to pay this tax over an eight-year period.
To prevent erosion of the U.S. tax base, the act imposes additional tax liability on some income. Taxpayers should consider how to reduce exposure, particularly with regard to the following new provisions:
– GILTI tax. The act imposes tax on the “global intangible low-taxed income” (GILTI) of U.S. shareholders of controlled foreign corporations (CFCs), with a deduction of 37.5 percent for foreign-derived intangible income (FDII) plus 50 percent of the GILTI, and the amount treated as a dividend under §78. For tax years beginning after December 31, 2025, the deduction for FDII is 21.875 percent and 37.5 percent for GILTI.
– BEAT tax. The act imposes a base erosion and anti-abuse tax (BEAT) for certain taxpayers, which is imposed in addition to other taxes. The calculation of the amount to be paid is based on the excess of 10 percent of the modified taxable income over the amount of regular tax liability, which is reduced by certain credits. The 10 percent rate used for the calculation of the tax liability is 5 percent for tax years beginning in calendar year 2018, and 12.5 percent for tax years beginning after December 31, 2025.
The international provisions take aim at U.S. drug and technology giants with overseas operations. The base erosion measures prevent multinationals from shifting profits, even as it allows repatriation of those profits to the United States — with caveats — tax free.
The tax affects companies that aren’t capital-intensive, practitioners have said — companies that don’t have a lot of physical property and do a hefty amount of business centered on intangibles. IT companies could fit that bill, according to Phil West, chairman of Steptoe & Johnson LLP.
“Those could suffer quite a bit,” he said.
Filed Under: Industry regulations