US tax reform legislation enacted on 22 December 2017 (P.L. 115-97) moved the United States from a ‘worldwide’ system of taxation towards a ‘territorial’ system of taxation. Among other things, P.L. 115-97 permanently reduced the 35% CIT rate on resident corporations to a flat 21% rate for tax years beginning after 31 December 2017.
US taxation of income earned by non-US persons depends on whether the income has a nexus with the United States and the level and extent of the non-US person's presence in the United States.
Prior to enactment of P.L. 115-97, a non-US corporation engaged in a US trade or business was taxed at a 35% US CIT rate on income from US sources effectively connected with that business (i.e. effectively connected income or ECI). However, as noted above, P.L. 115-97 significantly revised the federal tax regime. P.L. 115-97 permanently reduced the 35% CIT rate on ECI to a 21% flat rate for tax years beginning after 31 December 2017. Certain US-source income (e.g. interest, dividends, and royalties) not effectively connected with a non-US corporation’s business continues to be taxed on a gross basis at 30%.
Alternative minimum tax (AMT)
AMT previously was imposed on corporations other than S corporations (see below) and small C corporations (generally those with three-year average annual gross receipts not exceeding 7.5 million US dollars [USD]). The tax was 20% of alternative minimum taxable income (AMTI) in excess of a USD 40,000 exemption amount (subject to a phase-out). AMTI was computed by adjusting the corporation's regular taxable income by specified adjustments and 'tax preference' items. Tax preference or adjustment items could arise, for example, if a corporation had substantial accelerated depreciation, percentage depletion, intangible drilling costs, or non-taxable income.
P.L. 115-97 repeals the corporate AMT effective for tax years beginning after 31 December 2017 and provides a mechanism for prior-year corporate AMT credits to be refunded by the end of 2021.
Corporations with 100 or fewer eligible shareholders, none of whom may be corporations, that meet certain other requirements may elect to be taxed under Subchapter S of the Internal Revenue Code (IRC or 'the Code') and are thus known as S corporations. S corporations are taxed in a manner similar, but not identical, to partnerships (i.e. all tax items [e.g. income, deductions] flow through to the owners of the entity). Thus, S corporations generally are not subject to US federal income tax.
Gross transportation income taxes
Foreign corporations and non-resident alien individuals are subject to a yearly 4% tax on their US-source gross transportation income (USSGTI) that is not effectively connected with a US trade or business. Transportation income is any income derived from, or in connection with, (i) the use (or hiring or leasing) of any vessel or aircraft, or (ii) the performance of services directly related to the use of any vessel or aircraft.
Base erosion and anti-abuse tax (BEAT)
P.L. 115-97 creates a new US federal tax called the ‘base erosion and anti-abuse tax' (BEAT). P.L. 115-97 targets US tax-base erosion by imposing an additional corporate tax liability on corporations (other than regulated investment companies [RICs], real estate investment trusts [REITs], or S corporations) that, together with their affiliates, have average annual gross receipts for the three-year period ending with the preceding tax year of at least USD 500 million and that make certain base-eroding payments to related foreign persons during the tax year of 3% (2% for certain banks and securities dealers) or more of all their deductible expenses apart from certain exceptions. The most notable of these exceptions are the net operating loss (NOL) deduction, the new dividends received deduction (DRD) for foreign-source dividends, the new deduction for foreign-derived intangible income (FDII) and the deduction relating to the new category of global intangible low-taxed income (GILTI), qualified derivative payments defined in the provision, and certain payments for services.
The BEAT is imposed to the extent that 10% (5% for the 2018 calendar year) of the taxpayer’s ‘modified taxable income’ (generally, US taxable income determined without regard to any base-eroding tax benefit or the base-erosion percentage of the NOL deduction) exceeds the taxpayer’s regular tax liability net of most tax credits. The above percentages are changed to 11% and 6%, respectively, for certain banks and securities dealers.
A base-eroding payment generally is any amount paid or accrued by the taxpayer to a related foreign person that is deductible for acquiring property subject to depreciation or amortisation, or for reinsurance payments. The category also includes certain payments by ‘expatriated entities’ subject to the anti-inversion rules of Section 7874.
The provision is effective for base-erosion payments paid or accrued in tax years beginning after 31 December 2017. For tax years beginning after 31 December 2025, the percentage of modified taxable income that is compared against the regular tax liability increases to 12.5% (13.5% for certain banks and securities dealers) and allows all credits to be applied in determining the US corporation’s regular tax liability. Special rules apply for banks, insurance companies, and ‘expatriated entities'.
Mandatory deemed repatriation 'toll charge'
P.L. 115-97 uses the mechanics of Subpart F to impose a one-time ‘toll charge’ on the undistributed, non-previously taxed post-1986 foreign earnings and profits of certain US-owned foreign corporations as part of the transition to a new territorial regime. The 'toll charge', found in revised Section 965, is reduced by a deduction computed in a manner that ensures a 15.5% effective tax rate on earnings represented by ‘cash’ and an 8% effective tax rate to the extent the earnings exceed the cash position.
State and local income taxes
CIT rates vary from state to state and generally range from 1% to 12% (although some states impose no income tax). The most common taxable base is federal taxable income, which is modified by state provisions and generally is apportioned to a state on the basis of an apportionment formula consisting of one or more of the following: tangible assets and rental expense, sales and other receipts, and payroll. Many states are moving away from a three-factor formula in favour of a one-factor receipts apportionment methodology. State and municipal taxes are deductible expenses for federal income tax purposes.