Eduardo Fernandez - Head of US Taxation da BP Tax Global Advisory
Thoughts about next year
2020 was full of challenges. While we are anxious of what 2021 will bring in the midst of a pandemic, the United States will probably undergo a few changes with the new administration. Although there is no one-size-fits-all approach, BP Tax Advisorymay tailor solutions to your particular needs.
The first piece of advice is that effective federal income tax rates are probably going to increase. The federal budget and federal debt are growing at exponential rates; COVID-19 relief bills in the billions and trillions take part of the blame. The vaccine campaign will be expensive, and someone has to pay this. Although many tax rate reductions in the Tax Cuts and Jobs Act (TCJA) approved in President Trump’s administration, will expire in 2025, it is mostly anticipated that federal tax rates will increase during next year as to reduce the huge deficit. In addition, if Republicans retain control of the Senate, it is probable that spending increases will be offset with tax increases or cuts in mandatory spending. As a result, Democrats will be seeking mechanisms to pay for their policy goals in a tax-neutral way.
As established by President-elect Biden’s campaign’s proposals, and listed in the August 10, 2020, Tax Notes Viewpoint “Implications of the 2020 Presidential Candidates’ Tax Positions”, the Urban-Brookings Tax Policy Center analyzed the following:
1. Repeal TCJA tax rate reductions for taxpayers with over $400,000 of income
2. Limit itemized deductions for taxpayers who have more than $400,000 of income
3. Limit itemized deductions for taxpayers in the 28% or higher brackets (in the U.S., the maximum tax bracket is 37%, starting at 12%)
4. Capital gain and qualified dividends would be taxed at ordinary income rates for taxpayers with income exceeding $1 million
5. Social Security tax would apply to taxpayers with over $400,000 of income
6. Capital gain would be taxable at death (which today is repealed)
7. “Other individual changes” would apply, such as reducing various deductions, incentives, benefits for families, etc.
8. The corporate income tax would be raised to 28% (from 21%)
9. Certain penalty provisions would be made more stringent.
Senate and Congress, then, will be a battle. One side will be blocking spending and the other side will be blocking tax increases. However, there are still two reasons that may allow us to believe that tax rates are going to increase. In the first place, some of the Tax Cuts and Jobs Act (TCJA) provisions will expire over the next several years. These are the immediate deductibility of Research and Development expenses, depreciation recapture, depletion expenses and 100% bonus depreciation (for all of those having commercial property, for example). In the second place, even without new legislation, Treasury can issue (or amend) regulations that disallow beneficial regulations or benefits in the existing regulations mostly for international transactions (i.e., amortization of interests and AHYDO rules under 163(j), or the Global Intangible Low Taxed Income (GILTI) high tax exception).
What to do now?
Depending on the taxpayer’s particular situation, such taxpayer will be in trouble… or not! For some of these taxpayers, the CARES act (which was the law passed by Congress when COVID started) will ameliorate their situation; for others, the situation will be tax neutral. The key provisions under the CARES Act are the following:
1. Changes to Net Operating Loss Rules (Repeal of the 80% limitation)
Under the CARES Act, taxpayers are allowed to carry back net operating losses (NOLs) arising in taxable years beginning after December 31, 2017, and before January 2021 to the five preceding taxable years, including years in which the federal corporate income tax rate was 35%. Under TCJA, as modified by the CARES Act, for the taxable year beginning after December 31st, 2020, the 80% limitation is amended such that it applies before taking into account the deductions allowed under Sections 199A and 250 and after taking into account the NOL deductions for NOL carryovers arising in taxable years beginning before January 1, 2018 and carried to such taxable year.
2. Changes on Interest Limitation Rules
The TCJA’s Section 163(j) limited a business’s ability to deduct its interest expense to 30% of “adjusted taxable income,” with any excess interest expense carried forward. The CARES Act increased that limit to 50% of adjusted taxable income for 2019 and 2020. Taxpayers may elect to calculate the interest limitation for 2020 using their 2019 adjusted taxable income as the relevant base, which often will be significantly higher.
3. Payroll Tax Deferral
The CARES Act allows the employer’s share of the 6.2% Social Security tax that would otherwise be due from the date of enactment through December 31, 2020, to be paid on December 31, 2021 (50%) and December 31, 2022 (50%). Taxpayers who entered this program will see lower than normal payroll costs in this year and the next.
4. Credits for Corporate AMT
The TCJA repealed the AMT for corporations for taxable years beginning after December 31st, 2018, and modified IRC Section 53 to treat 50% of any AMT credit as refundable in 2018, 2019, 2020, and 100% as refundable in 2021. The CARES Act makes the AMT credit 100% refundable for taxable years beginning in 2018 and 2019. Accordingly, the CARES Act provides relief to corporate taxpayers with non-refunded AMT credits in 2018, as they can amend their returns from 2018 and be refunded on such amounts (usually paid within 90 days of the refund request).
5. Qualified Improvement Property Depreciation
The TCJA defined the term "qualified improvement property” (QIP) in a manner that prevented such property from being eligible for 100% bonus depreciation. However, QIP was intended by Congress to be eligible for the 100% bonus depreciation. The CARES Act amends IRC Section 168(e)(3)(E) and establishes that QIP is 15-year property (instead of 39-year recovery period). This amendment is retroactive for property placed into service after 2017. However, Florida does not conform to the federal allowance for bonus depreciation (while, for example, Illinois and Michigan do).
6. Loss limitation for pass-through businesses and sole proprietors.
The limitation set forth in section 461(l) on the ability of owners of pass-through businesses and sole proprietorships to use trade or business losses to offset non-business income was deferred until taxable years beginning after December 31, 2020.
For some clients, accelerating income will be the most important before the end of the year, as the corporate rate may go up. Also, please review your net operating losses for this year, as a combination of acceleration of income and net operating losses may help with future tax payments.
As has been mentioned in most of our tax-planning documents sent to pre-immigration planning clients, it is good to think to repatriate funds and avoid international companies or streams of income (onshoring). Changing operating models and simplifying them would probably be beneficial. This is also a potential policy coming from Democrats and Republicans, who both agree to set forth penalties on taxes over profits of a U.S. company derived from offshore production, while giving a credit for costs associated to bringing back production to the United States. Moreover, transfer pricing will be probably affected in the move of the government to onshore taxpayers’ assets. Every day, taxpayers are urged to maintain much more documentation for the substantiation of their actions, which makes it easier to onshore assets.
For clients who live abroad and are not U.S. Persons, it is important to review estate and successional planning techniques. Please recall that the U.S. taxes estates over $60,000 in the United States and that a probate proceeding may be required to be able to access funds or assets in the United States for their families. Banks are particularly strict in this matter; U.S. revocable trusts (foreign trust qualification) might be able to solve this situation.
Article written by Eduardo Fernandez, Head of US Taxation da BP Tax Global Advisor. If you have any questions or doubts, please contact us.
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