President Donald Trump signed the Tax Cuts and Jobs Act (TCJA) into law on 22 December 2017, putting the seal on an unusually swift legislative process – by the recent standards of theUnited States Congress – that began with the introduction of proposals in the House of Representatives in November 2017.
Representing the most significant overhaul of the US tax code in 30 years, the TCJA includes a substantial tax cut for corporations, as well as lower taxes for small businesses and individuals. The main points are summarised in today's post.
Arguably the most significant aspect of the tax reform, the bill slashed corporate tax effective 1 January 2018, from 35%, previously the highest rate of corporate tax in the OECD, to 21%, which is below the OECD average.
Corporate tax reform is supported by an important provision which effectively reduces income tax on the foreign income of US multinational groups to 0%. This is achieved through a 100% deduction for the foreign-source portion of dividends received by US corporations from foreign subsidiaries in which they own at least 10% of the shares.
The dividend deduction is designed to replicate the territorial corporate tax systems seen elsewhere in the world, and is intended to unlock an estimated $2 trillion in foreign income for investment in the US economy, money which has been sheltered from the high US corporate tax by being held in foreign companies.
However, this incentive comes with a price, as income held abroad since the last tax reform in 1986 will face a one-off deemed repatriation tax, of 15.5% for cash, and 8% for illiquid assets, irrespective of whether it is actually repatriated.
In a measure intended to benefit small businesses, specifically those arranged as “pass-through” entities, whereby business income flows through to owners and shareholders and is taxed at the individual level (and not under the corporate tax code), the TJCA provides for a 20% deduction on the first $315,000 of income for joint filers (typically, married couples).
When combined with new rates of individual income tax (see below), this is designed to provide an effective tax rate on pass-through income of 29.6%, which is lower than both the previous and the new top rate of individual income tax.
Republicans claim that individual taxpayers will be able to file their tax returns on a postcard-sized form as a result of the tax reforms. However, a complex seven-tier tax rate schedule is retained, albeit with lower rates.
For single individuals, the new rates are placed at the following income thresholds:
- Up to $9,525 – 10% of the taxable income
- Over $9,525 but not over $38,700 – 12%
- Over $38,700 but not over $82,500 – 22%
- Over $82,500 but not over $157,500 – 24%
- Over $157,500 but not over $200,000 – 32%
- Over $200,000 but not over $500,000 – 35%
- Over $500,000 – 37%
Previously, these rates were 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
The individual tax burden has been further reduced by increases to the standard deduction, to $12,000 for single filers, and to $24,000 for joint filers. Previously, the deduction was set at $6,500 and $13,000, respectively.
Winners & Losers?
While it was the intention of Republican lawmakers to provide across-the-board tax cuts, some taxpayers stand to benefit more than others. Businesses organized as corporations, and particularly multinationals, are likely to benefit the most in the long-term due to a much lower corporate tax rate. Small businesses and individuals less so.