06 December 2017

US tax reform - staying prepared

A version of this article was first published in the December 2017 issue of The Business Times Wealth Magazine.

Tax reform has been a key initiative for the Trump administration to tackle during the president's first year in office. Such a large-scale reform of the Internal Revenue Code has not been successfully undertaken since 1986 so taxpayers are closely tracking its progress.

Although the complicated legislative process is in its early stages, the US Congress aims to pass this sweeping legislation by the end of the year. The US House of Representatives, one of the two legislative bodies, voted in November in favour of its tax-reform bill, comprising 429 pages of potential changes to current law. Below are some highlights of the most widely applicable modifications for taxpayers.

Taxation of foreign income and foreign persons

The proposed tax bill outlines a new approach to the taxation of foreign income. The major provisions of the proposal include, but are not limited to:

  • Exempting taxation of foreign-source dividends from foreign corporations that are paid to 10 per cent of US corporate shareholders;
  • Repealing the tax on foreign-subsidiary investment in US property;
  • An immediate 12 per cent tax imposed on deferred foreign income of 10 per cent of US corporate shareholders;
  • Changes related to corporate foreign tax credits;
  • Modifications to the treatment of Subpart F income, which only applies to corporations in which a US person owns more than 50 per cent of the corporation's stock;
  • Taxation of foreign high returns to prevent US tax base erosion;
  • Limiting interest deductions on international company financing; and
  • A 20 per cent excise tax on certain payments to related foreign corporations.

A comprehensive discussion of each of the proposals is currently premature given their specificity and likelihood of change throughout this process. However, the above summary highlights that potentially affected taxpayers should keep a watchful eye on the evolution of these proposals.

Singaporeans who have personal investments in US corporations should pay close attention to the effect these provisions may have. By virtue of their foreign status, the provisions may trigger controlled foreign corporation treatment of such corporation's subsidiary entities. In addition, Singapore subsidiaries of US corporations or Singapore corporations doing business with US partners may soon have certain transactions met with new or higher income-tax liability or tax withholding in the US.

Transfer taxes

Under the current law, assets held by an individual at death are generally subject to a top estate tax rate of 40 per cent before assets are passed on to an estate's beneficiaries. Gifts transferred during life are also subject to a top gift tax rate of 40 per cent with an annual US$14,000 exclusion per donee. In addition, transfers to individuals beyond one generation of the donor are subject to an additional generation-skipping transfer tax at a top tax rate of 40 per cent. In 2017, the first US$5.49 million (inflation indexed) of transferred property is exempt from such transfer taxes.

Under the proposed bill, the exemption amount will immediately be doubled to US$10 million (indexed for inflation) beginning in tax years after 2017. After 2023, the estate tax and generation-skipping transfer tax will be repealed entirely, and beneficiaries will continue to benefit from a 'step-up in basis' , meaning they will continue to hold the transferred assets with a basis equal to the fair market value at the time of transfer.

Further, in 2017, the gift tax rate will be lowered to a top rate of 35 per cent and donors will retain the basic lifetime exclusion amount of US$10 million and the annual exclusion of US$14,000 per donee (inflation indexed). Singapore citizens with US investments and real estate are subject to estate tax on US assets and should continue to watch the evolution of these proposals to see if later developments directly alter the tax liability of foreign individuals at death between the passage of the bill until the ultimate estate tax repeal.

Income tax

Individuals – Individual income tax rates currently fall within seven brackets ranging from 10 to 39.6 per cent, depending on an individual's taxable income. The proposed bill condenses the rate brackets to 12, 25, and 35 per cent for the majority of taxpayers and has retained the 39.6 per cent rate for high-net worth individuals who have an annual taxable income in excess of US$500,000.

Corporations – Corporate income tax rates currently fall within four brackets ranging from 15 to 35 per cent, depending on an entity's annual taxable income. The proposed bill applies a flat 20 per cent rate to most corporations and a 25 per cent rate to “pass-through” entities such as partnerships and sole proprietorships.

Deduction and Exclusion Reform – While the proposed tax bill has altered the tax rates for many taxpayers, the proposal also modifies many of the provisions related to deductible expenses. The current proposed modifications include, but are not limited to:

  • Raising the standard deduction to US$12,000 for single filers (US$24,000 for married couple filing jointly);
  • Repeal of deductions for: moving expenses, tax-preparation expenses, mortgage interest, and certain medical expenses;
  • Raising the cap on annual charitable deductions;
  • Repeal of the Alternative Minimum Tax and limitation on itemised deductions;
  • Additional restrictions to the exclusion of gain from the sale of a principal residence.

Exempt organisations

Proposed reform in regard to exempt organisations is mild, but noteworthy. Specifically, the bill proposes a simplification of excise taxes on investment income for private foundations and additional reporting requirements for donor-advised fund sponsoring organisations.

What happens next?

As previously mentioned, this proposed bill is the first step in a process that will surely be modified before final adoption. Be on the lookout for a few benchmark points in the 'tax-reform timeline' such as:

  • The US Senate, the other legislative body in Congress, will soon propose a separate tax-reform bill that will have been developed independently from the bill proposed by the House of Representatives;
  • The two bills will then be reconciled into a final piece of legislation;
  • Both legislative bodies vote on this bill before being sent to the president.

Congressional leaders have a shared goal of approving a bill to send to President Donald Trump by early December so the last two months of 2017 are sure to be consequential for many taxpayers around the world. Singaporeans potentially affected by these proposals should be mindful that the provisions, if enacted by the end of the year, would likely become effective the beginning of 2018.

A version of this article was first published in the December 2017 issue of The Business Times Wealth Magazine.

Category: Article