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The Tax Policy Center's

Briefing Book

A citizen’s guide to the fascinating (though often complex) elements of the US tax system.

Tax Policy Center Briefing Book

Some Background

  • Briefing Book
  • Recent History of the Tax Code
  • How did the Tax Cuts and Jobs Act change business taxes?
  • Chapters
    • Introduction
      • Introduction
        • Introduction
    • Some Background
      • Federal Budget
        • What are the sources of revenue for the federal government?
        • How does the federal government spend its money?
        • What is the breakdown of revenues among federal, state, and local governments?
        • How do US taxes compare internationally?
      • Federal Budget Process
        • How does the federal budget process work?
        • What is the history of the federal budget process?
        • What is the schedule for the federal budget process?
        • What is reconciliation?
        • How is a budget resolution enforced?
        • What is PAYGO?
        • What are rescissions?
      • Federal Budget Outlook
        • How accurate are long-run budget projections?
        • What have budget trends been over the short and long term?
        • How much spending is uncontrollable?
        • What are tax extenders?
        • What options would increase federal revenues?
        • What does it mean for a government program to be off-budget?
        • How did the TCJA affect the federal budget outlook?
      • Taxes and the Economy
        • How do taxes affect the economy in the short run?
        • How do taxes affect the economy in the long run?
        • What are dynamic scoring and dynamic analysis?
        • Do tax cuts pay for themselves?
        • On what do economists agree and disagree about the effects of taxes on economic growth?
        • What are the economic effects of the Tax Cuts and Jobs Act?
      • Economic Stimulus
        • What is the role of monetary policy in alleviating economic downturns?
        • What are automatic stabilizers and how do they work?
        • What characteristics make fiscal stimulus most effective?
      • Distribution of Tax Burdens
        • How are federal taxes distributed?
        • Are federal taxes progressive?
        • How should progressivity be measured?
        • What is the difference between marginal and average tax rates?
        • What criticisms are levied against standard distributional analysis?
        • How should distributional tables be interpreted?
        • Who bears the burden of the corporate income tax?
        • Who bears the burden of federal excise taxes?
        • How do financing methods affect the distributional analyses of tax cuts?
        • How do taxes affect income inequality?
      • Tax Expenditures
        • What are tax expenditures and how are they structured?
        • What is the tax expenditure budget?
        • Why are tax expenditures controversial?
        • What are the largest tax expenditures?
        • How did the TCJA affect tax expenditures?
      • Tax Gap and Tax Shelters
        • What is the tax gap?
        • What does the IRS do and how can it be improved?
        • What is a tax shelter?
      • Recent History of the Tax Code
        • What did the 2008–10 tax stimulus acts do?
        • What did the American Taxpayer Relief Act of 2012 do?
        • How did the Tax Cuts and Jobs Act change personal taxes?
        • How did the Tax Cuts and Jobs Act change business taxes?
    • Key Elements of the U.S. Tax System
      • Individual Income Tax
        • What is the standard deduction?
        • What are itemized deductions and who claims them?
        • How did the TCJA change the standard deduction and itemized deductions?
        • What are personal exemptions?
        • How do federal income tax rates work?
        • What are tax credits and how do they differ from tax deductions?
        • How do phaseouts of tax provisions affect taxpayers?
      • Capital Gains and Dividends
        • How are capital gains taxed?
        • What is the effect of a lower tax rate for capital gains?
        • What is carried interest, and how is it taxed?
        • How might the taxation of capital gains be improved?
      • AMT
        • What is the AMT?
        • Who pays the AMT?
        • How much revenue does the AMT raise?
        • How did the TCJA change the AMT?
      • Taxes and the Family
        • What is the child tax credit?
        • What is the adoption tax credit?
        • What is the earned income tax credit?
        • Do all people eligible for the EITC participate?
        • How does the tax system subsidize child care expenses?
        • What are marriage penalties and bonuses?
        • How did the TCJA change taxes of families with children?
      • Taxes and the Poor
        • How does the federal tax system affect low-income households?
        • What is the difference between refundable and nonrefundable credits?
        • Can poor families benefit from the child tax credit?
        • Why do low-income families use tax preparers?
        • How does the earned income tax credit affect poor families?
        • What are error rates for refundable credits and what causes them?
        • How do IRS audits affect low-income families?
      • Taxes and Retirement Saving
        • What kinds of tax-favored retirement arrangements are there?
        • How large are the tax expenditures for retirement saving?
        • What are defined benefit retirement plans?
        • What are defined contribution retirement plans?
        • What types of nonemployer-sponsored retirement savings accounts are available?
        • What are Roth individual retirement accounts?
        • Who uses individual retirement accounts?
        • How does the availability of tax-favored retirement saving affect national saving?
        • What’s the difference between front-loaded and back-loaded retirement accounts?
        • What is an automatic 401(k)?
        • How might low- and middle-income households be encouraged to save?
      • Taxes and Charitable Giving
        • What is the tax treatment of charitable contributions?
        • What entities are tax-exempt?
        • Who benefits from the deduction for charitable contributions?
        • How would various proposals affect incentives for charitable giving?
        • How large are individual income tax incentives for charitable giving?
        • How did the TCJA affect incentives for charitable giving?
      • Taxes and Health Care
        • How much does the federal government spend on health care?
        • Who has health insurance coverage?
        • Which tax provisions subsidize the cost of health care?
        • How does the tax exclusion for employer-sponsored health insurance work?
        • What are premium tax credits?
        • What tax changes did the Affordable Care Act make?
        • How do health savings accounts work?
        • How do flexible spending accounts for health care expenses work?
        • What are health reimbursement arrangements and how do they work?
        • How might the tax exclusion for employer-sponsored health insurance (ESI) be reformed?
      • Taxes and Homeownership
        • What are the tax benefits of homeownership?
        • Do existing tax incentives increase homeownership?
      • Taxes and Education
        • What tax incentives exist for higher education?
        • What tax incentives exist to help families pay for college?
        • What tax incentives exist to help families save for education expenses?
        • What is the tax treatment of college and university endowments?
      • Tax Complexity
        • Why are taxes so complicated?
        • What are the benefits of simpler taxes?
        • What policy reforms could simplify the tax code?
      • Wealth Transfer Taxes
        • How do the estate, gift, and generation-skipping transfer taxes work?
        • Who pays the estate tax?
        • How many people pay the estate tax?
        • What is the difference between carryover basis and a step-up in basis?
        • How could we reform the estate tax?
        • What are the options for taxing wealth transfers?
        • What is an inheritance tax?
      • Payroll Taxes
        • What are the major federal payroll taxes, and how much money do they raise?
        • What is the unemployment insurance trust fund, and how is it financed?
        • What are the Social Security trust funds, and how are they financed?
        • Are the Social Security trust funds real?
        • What is the Medicare trust fund, and how is it financed?
      • Excise Taxes
        • What are the major federal excise taxes, and how much money do they raise?
        • What is the Highway Trust Fund, and how is it financed?
      • Energy and Environmental Taxes
        • What tax incentives encourage energy production from fossil fuels?
        • What tax incentives encourage alternatives to fossil fuels?
        • What is a carbon tax?
      • Business Taxes
        • How does the corporate income tax work?
        • What are pass-through businesses?
        • How are pass-through businesses taxed?
        • Is corporate income double-taxed?
      • Tax Incentives for Economic Development
        • What is the new markets tax credit, and how does it work?
        • What is the Low-Income Housing Tax Credit and how does it work?
        • What are Opportunity Zones and how do they work?
      • Taxes and Multinational Corporations
        • How does the current system of international taxation work?
        • How do US corporate income tax rates and revenues compare with other countries’?
        • What are the consequences of the new US international tax system?
        • How does the tax system affect US competitiveness?
        • How would formulary apportionment work?
        • What are inversions, and how will TCJA affect them?
        • What is a territorial tax and does the United States have one now?
        • What is the TCJA repatriation tax and how does it work?
        • What is the TCJA base erosion and anti-abuse tax and how does it work?
        • What is global intangible low-taxed income and how is it taxed under the TCJA?
        • What is foreign-derived intangible income and how is it taxed under the TCJA?
    • How Could We Improve the Federal Tax System?
      • Comprehensive Tax Reform
        • What is comprehensive tax reform?
        • What are the major options for comprehensive tax reform?
      • Broad-Based Income Tax
        • What is a broad-based income tax?
        • What would and would not be taxed under a broad-based income tax?
        • What would the tax rate be under a broad-based income tax?
      • National Retail Sales Tax
        • What is a national retail sales tax?
        • What would and would not be taxed under a national retail sales tax?
        • What would the tax rate be under a national retail sales tax?
        • What is the difference between a tax-exclusive and tax-inclusive sales tax rate?
        • Who bears the burden of a national retail sales tax?
        • Would tax evasion and avoidance be a significant problem for a national retail sales tax?
        • What would be the effect of a national retail sales tax on economic growth?
        • What transition rules would be needed for a national retail sales tax?
        • Would a national retail sales tax simplify the tax code?
        • What can state and local sales taxes tell us about a national retail sales tax?
        • What is the experience of other countries with national retail sales taxes?
        • What did the President’s Advisory Panel on Federal Tax Reform say about the national retail sales tax?
      • Value Added Tax (VAT)
        • What is a VAT?
        • How would a VAT be collected?
        • What would and would not be taxed under a VAT?
        • What would the tax rate be under a VAT?
        • What is the difference between zero rating and exempting a good in the VAT?
        • Who would bear the burden of a VAT?
        • Is the VAT a money machine?
        • How would small businesses be treated under a VAT?
        • What is the Canadian experience with a VAT?
        • Why is the VAT administratively superior to a retail sales tax?
        • What is the history of the VAT?
        • How are different consumption taxes related?
      • Other Comprehensive Tax Reforms
        • What is the flat tax?
        • What is the X-tax?
      • Recent Comprehensive Tax Reform Proposals
        • Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System, Report of the President’s Advisory Panel on Federal Tax Reform, November 2005
        • The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform, December 2010
        • Debt Reduction Task Force, “Restoring America’s Future,” Bipartisan Policy Center, November 2010
        • The Tax Reform Act of 2014: Fixing Our Broken Tax Code So That It Works for American Families and Job Creators, House Ways and Means Committee
        • The Graetz Competitive Tax Plan, Updated for 2015
      • Return-Free Tax Filing
        • What is return-free filing and how would it work?
        • What are the benefits of return-free filing?
        • What are the drawbacks of return-free filing?
        • How would the tax system need to change with return-free filing?
        • Who would qualify for return-free filing?
        • Would return-free filing raise taxes?
        • What was the experience with return-free filing in California?
        • What other countries use return-free filing?
    • The State of State (and Local) Tax Policy
      • State and Local Revenues
        • What are the sources of revenue for state governments?
        • What are the sources of revenue for local governments?
      • Specific State and Local Taxes
        • How do state and local individual income taxes work?
        • How do state and local sales taxes work?
        • How do state and local property taxes work?
        • How do state and local corporate income taxes work?
        • How do state estate and inheritance taxes work?
        • How do state earned income tax credits work?
        • How do state and local severance taxes work?
        • How do state and local soda taxes work?
        • How do marijuana taxes work?
      • Fiscal Federalism and Fiscal Institutions
        • How does the deduction for state and local taxes work?
        • What are municipal bonds and how are they used?
        • What types of federal grants are made to state and local governments and how do they work?
        • What are state rainy day funds, and how do they work?
        • What are tax and expenditure limits?
        • What are state balanced budget requirements and how do they work?
    • Glossary
      • Glossary
        • Glossary

How did the Tax Cuts and Jobs Act change business taxes?

Recent History of the Tax Code

<4/4
Q.

How did the Tax Cuts and Jobs Act change business taxes?

A.

The Tax Cut and Jobs Act made significant changes to the corporate income tax and taxes on pass-through businesses. Unlike almost all personal tax provisions, which expire after 2025, most corporate tax provisions are permanent.

Corporate tax rate and corporate alternative minimum tax

The Tax Cut and Jobs Act (TCJA) reduced the top corporate income tax rate from 35 percent to 21 percent, bringing the US rate below the average for most other Organisation for Economic Co-operation and Development countries, and eliminated the graduated corporate rate schedule (table 1). TCJA also repealed the corporate alternative minimum tax.

Tax Rates and Tax Brackets

TCJA allowed businesses to deduct the full cost of qualified new investments in the year those investments are made (referred to as 100 percent bonus depreciation or “full expensing”) for five years. Bonus depreciation then phases down in 20 percentage point increments beginning in 2023, and is fully eliminated after 2026. Prior law allowed 50 percent bonus depreciation in 2017, decreasing the percentage in subsequent years and fully eliminating it after 2020.

TCJA doubled the Section 179 expensing limit for investments by small businesses from $500,000 to $1,000,000 for qualified property (sometimes called “small business expensing”). It also simplified accounting rules for smaller firms.

TCJA limited the amount of net business interest (interest paid less interest received) that businesses can deduct to 30 percent of business income before interest, depreciation, and amortization. Starting in 2022, the adjustment for amortization and depreciation will be removed from the limitation. Businesses with gross receipts below $25 million are exempt from the limitation. Previously, interest paid was generally fully deductible in computing taxable income for all businesses.

TCJA limited the deduction for net operating losses to 80 percent of taxable income. It also repeals carrybacks of losses, except for certain businesses, but allows taxpayers to carry forward losses indefinitely. Under prior law, net operating losses could offset 100 percent of taxable income and businesses could carry back unused losses for two years or carry them forward for 20 years.

The new law also eliminated the domestic production activities deduction (Section 199) and modified other smaller provisions such as the orphan drug credit, the deduction for Federal Deposit Insurance Corporation premiums, and the computations for life insurance reserves. In addition, starting in 2022, expenditures for research and experimentation must be amortized over five years (15 years for offshore research and experimentation expenses) instead of being immediately deductible.

Pass-through business income deduction

Unlike C-corporations, pass-through firms such as sole proprietorships, partnerships, and S-corporations are not subject to the corporate income tax. Instead the owners include their share of profits as taxable income under the individual income tax.

In general, TCJA’s changes to the business income tax base, including the limits on interest deductions and net operating losses, apply to pass-through businesses as well as to business subject to the corporate income tax. However, TCJA included changes specific to pass-through businesses (table 2). The pass-through businesses specific provisions are scheduled to expire after 2025.

TCJA introduced a complex new deduction for income from pass-through businesses. Under the new law, joint tax filers with taxable income below $315,000 ($157,500 for other filers) can deduct 20 percent of their qualified business income (QBI). The 20 percent deduction lowers the effective top individual income tax rate on business income from 37 to 29.6 percent.

If taxable income exceeds those thresholds, however, the deduction can be reduced depending upon the type of business, the wages paid, and the investment property owned by the business. For personal service businesses (such as law firms, medical practices, consulting firms, or professional athletes), QBI phases down on a pro rata basis. Once taxable income reaches $415,000 for joint filers ($207,500 for other filers), QBI is zero and there is no longer any deduction.

For all pass-through businesses, whether they are personal service firms or not, an additional two-part formula limits the deduction once taxable income exceeds the $315,000/$157,000 thresholds. Under the formula, the deduction is limited to the greater of either 50 percent of the wages the business pays its employees or 25 percent of wages plus 2.5 percent of the basis of the business’ qualified property. Business owners compare those calculations to 20 percent of their QBI and may deduct only the smaller amount. The limit on the deduction phases in over the same income range as above.

Limit on Pass-through business losses

A major advantage of organizing as a pass-through business rather than as a C-corporation is that pass-through business owners can use business losses to offset taxable income from other sources. TCJA limits the amount of active pass-through business losses that business owners can deduct against other income to $500,000 for joint filers ($250,000 for other filers). Unused losses, however, can be carried forward and used in future years (table 2).

International issues

TCJA made sweeping changes to the treatment of foreign source income and international financial flows. Under prior law, the United States taxed the income of multinational firms on a worldwide basis, meaning that all income was taxed, regardless of where it was earned, less a credit for foreign taxes paid. However, the tax due on active foreign-source income of foreign subsidiaries of US multinationals was deferred until the income was made available to the US parent company.

The TCJA created a modified territorial tax system. US corporations continue to owe US taxes on the profits they earn in the United States. But TCJA exempted from taxation the dividends that domestic corporations receive from foreign corporations in which they own at least a 10 percent stake.

Under a pure territorial system, firms would have a strong incentive to shift real investment and reported income to low-tax jurisdictions overseas and to shift deductions into the United States. Several provisions were created as guardrails to reduce the extent to which companies take those actions.

The minimum tax on global intangible low-taxed income (GILTI) imposed a 10.5 percent minimum tax without deferral on profits earned abroad that exceed a firm’s “normal” return (defined in the law as 10 percent on the adjusted basis in tangible property held abroad). Companies can use 80 percent of their foreign tax credits, calculated on a worldwide basis, to offset this minimum tax.

Whereas GILTI acts as a “stick” to prevent companies from making investments in intangible assets overseas, a deduction for foreign-derived intangible income (FDII) acts as a “carrot” to provide an incentive for firms to hold intangible assets in their US affiliates. FDII is income received from exporting products whose intangible assets are held in the United States. For example, a pharmaceutical company will be able to deduct some income from overseas drug sales if the patent on the drug is held in its US parent company.

TCJA also created a new base erosion and antiabuse tax (BEAT), which—not surprisingly, given the acronym—is another “stick.” BEAT imposes a minimum tax on otherwise deductible payments between a US corporation and a related foreign subsidiary.

To transition to the new system, TCJA created a new deemed repatriation tax for previously accumulated and untaxed earnings of foreign subsidiaries of US firms equal to 15.5 percent for cash and 8 percent for illiquid assets. In 2015, it was estimated that US companies held more than $2.6 trillion in untaxed income in their foreign affiliates (Barthold 2016). Companies have eight years to pay the tax, with a back-loaded minimum payment schedule specified in the law.

Data Sources

Congressional Budget Office, “Cost Estimate for the Conference Agreement on H.R. 1, a Bill to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” memo, December 15, 2017.

Joint Committee on Taxation. 2017. “Estimated Budget Effects of the Conference Agreement for H.R. 1, The ‘Tax Cuts and Jobs Act‘.” JCX-67-17.

Further Reading

Gale, William G., Hilary Gelfond, Aaron Krupkin, Mark J. Mazur, and Eric Toder. 2018. “Effects of the Tax Cuts and Jobs Act: A Preliminary Analysis.” Washington, DC: Urban-Brookings Tax Policy Center.

Barthold, Thomas A. 2016. “Letter to Kevin Brady and Richard Neal.” Washington, DC: Joint Committee on Taxation.

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