The Tax Cuts and Jobs Act Bill successfully passed through both the House of Congress and the Senate. It is the most noteworthy tax reform bill in decades and will impact American companies of every size.
Here's what businesses need to know:
1. Tax cuts
The biggest change that the bill will implement is the permanent reduction in corporate income tax from 35% to a likely 20%, starting in 2019.
Companies that are exempt from paying the corporate income tax, including most small to medium-sized businesses such as limited liability companies (LLC), partnerships, and S-corporations, will receive a "pass through tax" rate reduction.
The top rate is just under 40% currently. Under the new tax bill, the rate would be capped at no higher than 25%, representing a sizeable tax reduction. It is estimated that the new bill will see tax cuts of $350 billion for pass throughs over the next ten years.
2. Income earned abroad
A new "territorial" tax system means that income made abroad will essentially become tax-free. Under the current system, profits made overseas have been subject to a statutory 35% tax deduction.
US companies will no longer
have incentives to avoid
repatriating foreign income
or to change their country of
US companies have long complained that this "worldwide" tax system has placed them at a competitive disadvantage compared with foreign companies that operate under a territorial system. The proposed amendment means that income earned abroad will be subject to the tax laws of the country—the territory—in which it is earned.
What this means is that US companies will no longer have incentives to avoid repatriating foreign income or to change their country of incorporation.
3. Overseas subsidiaries
There will be a minimum tax of a possible 12.5% on profits made by overseas subsidiaries of US companies regarding intangible assets such as patents, and a probable 10% tax on money transferred out of the US to overseas subsidiaries.
How will the bill impact the US economy, the dollar, and the world?
The Joint Committee on Taxation estimates that the bill will increase GDP by 0.8% over ten years, although it would add $1.5 trillion to the country's economic deficit over the same period. The US Treasury however claims that the bill will "pay for itself."
Beginning 2018, the tax bill is expected to accelerate economic growth, which could in turn raise inflation, and as a result, the strength of the US dollar. In addition to this, the Federal Reserve is expected to raise interest rates four times in 2018. These factors added together translate into predicted consolidated strength for the greenback for 2018.
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Some economic observers believe that the new tax system will have a far-reaching impact across the world, with developed countries in particular making their own reactionary tax reforms in order to remain competitive.
The new 20% corporate income tax rate would be below the OECD average of 22.5%. This gives companies from other countries an incentive to incorporate in the United States and investors a reason to direct capital flows to US-based companies. In order to stop this from happening, it is highly likely that other countries will react with their own tax reforms.
Treasury departments need not make any significant changes in response to the bill regarding foreign exchange management. Some companies based in the United States may wish to look into the possible benefits of changing the system through which they pay taxes, if applicable.
The final word
This historic tax reform bill will certainly benefit corporations, with a massive income tax cut of 15%. It will also benefit some pass through businesses by allowing them to deduct 23% of revenue from their taxable income, although others will not benefit from the tax cut.
The US Republican party insists that the bill will boost economic growth, although analysts predict that it will lead to little or no change. The country's economic outlook and US dollar stability will likely continue without any significant impact.