The House Bill notably extends or makes permanent provisions from the Tax Cuts and Jobs Act of 2017 (the “TCJA”)1 that were scheduled to expire or be subject to an increased rate of tax at the end of the 2025 taxable year, including permanently extending the reduced U.S. federal income tax bracket schedule and rates created by the TCJA (which was scheduled to expire for taxable years beginning before January 1, 2026), permanently extending the deduction for qualified business income (“QBI”) under section 199A of the Internal Revenue Code of 1986, as amended (the “Code”),2 and permanently setting the deduction for foreign-derived intangible income (“FDII”) at 36.5 percent and the deduction for global intangible low-taxed income (“GILTI”) at 49.2 percent (resulting in an effective rate of U.S. and foreign tax on such income of 13.335 percent).
The House Bill also adds a new provision to the Code that increases the U.S. tax rates on certain items of income received by individuals, entities, and governments connected to countries that are deemed to levy discriminatory or extraterritorial taxes on U.S. taxpayers.
The House Bill also temporarily extends 100 percent bonus depreciation and amends the definition of “adjusted taxable income” for purposes of the section 163(j) limitation to exclude depreciation, amortization, or depletion, in each case beginning after December 31, 2024 and before January 1, 2030.
In addition, the House Bill increases the cap on the deduction for state and local taxes (“SALT”) from USD10,000 to USD40,000 (subject to a phase-out), but it restricts the use of the pass-through entity tax (“PTET”) workarounds that many states adopted following the issuance of IRS Notice 2020-75 (possibly even for pass-through entities that are not engaged in a specified service trade or business).
Finally, the House Bill accelerates the phase-out of most clean energy tax credits that were added by the Inflation Reduction Act of 2022 (the “IRA”).3
Notably, among other items that were not addressed, the House Bill does not include any changes to the taxation of carried interest and does not address the TCJA’s prior repeal of the limitation on foreign “downward attribution” under old section 958(b)(4).
Despite its passage in the House, the House Bill faces significant hurdles in the Senate, where Republicans hold only a narrow three-seat majority. Senate Republicans have already signaled their intent to address their own priorities in the final bill, such as making permanent certain temporary business tax provisions in the House Bill and opposing the accelerated elimination of the clean energy tax credits and the changes to the SALT cap.
Furthermore, the Senate has a specific procedural rule, known as the Byrd rule, which prohibits reconciliation bills from containing provisions considered “extraneous” to the budget, meaning the House Bill and any Senate amendments will need to be reviewed by the Senate parliamentarian to ensure that the bill complies with the Byrd rule, which could result in a number of provisions being challenged or removed.
This client alert summarizes in more detail the key individual, business, and international tax provisions, as well as other significant provisions contained in the House Bill.4
Changes to individual tax rates (Section 1)
The House Bill permanently extends the lower tax rates and wider income brackets introduced by the TCJA that were originally slated to sunset for taxable years beginning after December 31, 2025, meaning the top marginal individual income tax rate remains 37 percent rather than reverting to its pre-TCJA rate of 39.6 percent and the income brackets remain slightly wider than their pre-TCJA counterparts.
Further, the House Bill provides for an additional year of inflation adjustment for all tax brackets except the top 37 percent bracket, which will shift the dollar threshold for those brackets up and increase the amount of income subject to the lower tax rates.
Additionally, the House Bill permanently increases individual alternative minimum tax exemption and its phaseout.
The House Bill permanently extends the modified tax bracket schedule and lower tax rates created under the TCJA, which under current law are scheduled to expire for taxable years beginning after December 31, 2025.
Disallowance of miscellaneous itemized deductions (Section 67)
The House Bill permanently eliminates the deductibility by individuals of all miscellaneous itemized deductions, which had been temporarily disallowed under the TCJA but were scheduled to return for taxable years beginning after December 31, 2025.5 Miscellaneous itemized deductions include work-related travel expenses, liability insurance premiums, home office expenses, non-capitalized investment-related expenses, and certain legal fees.
Thus, the only itemized deductions that will be allowed for individuals will be those specifically enumerated in section 67(b) as being expressly excluded from treatment as miscellaneous itemized deductions, including interest deductions under section 163, deductions for certain taxes (including the SALT deduction) under sections 164 and 275, deductions for casualty or theft losses, charitable deductions, and deductions for medical expenses.
Temporary increase to standard deduction and permanent limitations on itemized deductions (Sections 63, 67, 163, 165, 275, and more)
The House Bill permanently extends the increased standard deduction, which was slated to sunset for taxable years beginning after December 31, 2025, and further provides for both a temporary increase to the standard deduction for taxable years beginning after December 31, 2024 and before December 31, 2028 and an adjustment for an extra year of inflation. The temporary increase will amount to USD1,000 for single filers and USD2,000 for individuals who are married filing jointly, resulting in an aggregate standard deduction of USD16,300 for individual filing single and USD32,600 for individuals who are married filing jointly in 2026.
Additionally, for taxable years beginning after December 31, 2025, the House Bill imposes additional limitations on itemization such as, among numerous other limitations, (i) permanently eliminating personal exemptions, which under current law was scheduled to return for taxable years beginning after December 31, 2025, (ii) terminating all miscellaneous itemized deductions (as discussed in more detail above), (iii) limiting deductions for SALT (as discussed in more detail above), (iv) permanently limiting the deduction for qualified residence interest (colloquially called the home mortgage interest deduction) to USD750,000 instead of returning it to the pre-TCJA limitation of USD1,000,000, (v) permanently limiting itemized deductions for personal casualty losses to only those losses resulting from federally declared disasters, and (vi) generally reducing the value of each dollar of itemized deductions for taxpayers in the highest individual income tax bracket.
State and local taxes (Sections 275, 702, 703, 704 and 1366)
The House Bill retains the limitation on the deductibility of SALT while also increasing the cap on SALT deductions from USD10,000 to USD40,000 (except for married individuals filing separately, who are subject to a USD20,000 cap instead). The increased cap is phased down to USD10,000 for individuals with a modified adjusted gross income over USD500,000 or down to USD5,000 if the individual has a modified adjusted gross income of USD250,000 and is married and filing separately.
The SALT deduction cap applies to the “specified taxes”: (i) state and local and foreign property taxes, (ii) state and local income, war profits, excess profits and general sales taxes, (iii) real estate taxes paid by a cooperative housing corporation, and (iv) “substitute payments.”
Notably, excluded from the definition of specified taxes (and the cap) are the following taxes: (A) state and local property taxes paid or accrued in a trade or business or an activity described in section 212 and (B) state and local income, war profits, excess profits and general sales taxes paid or accrued by a partnership or S corporation in carrying on a qualified trade or business (within the meaning of section 199A(d)(1)) provided that at least 75 percent of the gross receipts of all trades or businesses under common control with such partnership or S corporation are derived from qualified trades or business.
Importantly, the House Bill targets common strategies that were widely adopted to avoid the cap on SALT deductions; namely, the use of PTET workarounds to the SALT deduction cap. After the TCJA was enacted, many high-tax states began allowing pass-through entities (such as partnerships and S corporations) to pay and deduct SALT at the entity level through various mechanisms, which generally reduced the amount of federally taxable income that flowed through to the owners of the entity.
The House Bill appears to eliminate this strategy by treating as “specified taxes” all “substitute payments.” A substitute payment is defined as any amount (other than a specified tax) paid, incurred, or accrued to a state or local jurisdiction where one or more persons are entitled to “specified tax benefits” that are equal to or exceeding 25 percent of the payment by reason of such payment.
Furthermore, the House Bill: (i) requires separately stating a partner’s shareholder’s share of the following items of the partnership or S corporation: (A) foreign income, war profits, and excess profits taxes, (B) income, war profits, and excess profits taxes paid or accrued to U.S. possessions, (C) specified taxes, and (D) disallowed foreign real property taxes, (ii) disallows a deduction by a partnership or S corporation for the taxes described in clause (i), (iii) requires that a partner’s distributive share of partnership losses for purposes of determining partnership loss limitations generally account for any “specified taxes” paid at the partnership level, (iv) penalizes the use of SALT credit carryforwards from previous taxable years, and (v) gives the Treasury Secretary regulatory authority to prevent avoidance of the SALT cap.
Finally, the House Bill completely disallows deductions for “disallowed foreign real property taxes,” which generally include foreign real property taxes described in sections 164(a)(1) or 216(a)(1), unless paid or accrued in carrying on a trade or business or the production of income.
- The elimination of the PTET workaround strategies should be considered by taxpayers when making choice of entity decisions.
- It is unclear whether the drafters intended to eliminate the PTET workaround strategies for partnerships and S corporations engaged in a qualified trade or business (within the meaning of section 199A(d)(1)). As discussed above, the definition of specified taxes expressly excludes any state and local income, war profits, excess profits and general sales taxes paid by a partnership or S corporation in carrying on a qualified trade or business. However, the definition of “substitute payments” does not appear to include the carve-out for state and local income, war profits, excess profits and general sales taxes paid by a partnership or S corporation in carrying on a qualified trade or business. A literal reading of the House Bill suggests that substitute payments made by a partnership or S corporation in carrying on a qualified trade or business would not be exempt from the definition of specified taxes and the USD40,000 cap.6
Changes to treatment of excess business losses for noncorporate taxpayers (Section 461(l))
The House Bill makes permanent the disallowance of the deduction for excess business losses of an individual under section 461(l). Section 461(l) currently provides that, for taxable years beginning before January 1, 2029, no deduction is allowed for the excess business losses of non-corporate taxpayers, but disallowed excess business losses are carried forward as part of the taxpayer’s net operating loss (“NOL”) carryforwards, which are not subject to disallowance under section 461(l).
An individual’s excess business losses are equal to the deductions attributable to the individual’s trades or businesses over (i) the aggregate gross income of the individual attributable to such trades or businesses plus (ii) a threshold amount (which, under the House Bill, is USD626,000 for a married couple filing jointly). In the case of a partnership or S corporation, the excess business loss rules apply at the partner or shareholder level.
Furthermore, for any losses arising in taxable years beginning after December 31, 2024, the House Bill also requires individuals to account for any excess business losses from previous years when determining their excess business losses. In effect, this means any NOL carryforwards attributable to an excess business loss arising in taxable years beginning after December 31, 2024 will be treated as a deduction attributable to the individual’s trades or businesses for purposes of determining the individual’s limitation under section 461(l).
Thus, for example, assuming the amount of the annual excess of an individual’s net loss from trades or businesses over the applicable dollar threshold remains constant, the amount of disallowed deductions will grow year-over-year. Compare to current law, where each year’s excess business loss are converted in the next tax year into an NOL which would not be part of the taxpayer’s aggregate deductions attributable to trades or businesses for the year to which such NOL is carried and could be used to offset non-business income without limitation under section 461(l).
- Individuals should take the changes to section 461(l), together with the changes to section 199A and the qualified small business stock (“QSBS”) exclusion under section 1202, when making choice of entity decisions.
Estate and gift tax exemption (Section 2010)
The House Bill makes permanent the increase to the lifetime estate and gift tax exemption enacted with the TCJA. With this change, the House Bill sets the lifetime estate and gift tax exemption at USD30,000,000 for individuals who are married and filing jointly in taxable years beginning after December 31, 2025 and adjusts the exemption for inflation going forward.
Temporary extension of calculation of adjusted taxable income for business interest deductibility (Section 163(j))
The House Bill temporarily extends the determination of “adjusted taxable income” (for purposes of calculating a taxpayer’s limitation on business interest deduction) to exclude a taxpayer’s deductions for depreciation, amortization, or depletion for all taxable years beginning after December 31, 2024 and before January 1, 2030.
- Because the change to the definition of adjusted taxable income is effective for all taxable years beginning on or after December 31, 2024 (e., the 2025 calendar year), the benefits of the special allowances under sections 168(k), 168(n) and 179 (described below) will not reduce the taxpayer’s “adjusted taxable income” and therefore will not reduce the taxpayer’s business interest expense limitation under section 163(j).
Temporary extension of bonus depreciation (Section 168(k))
The House Bill extends, but does not make permanent, the special depreciation allowance under section 168(k). Under the House Bill, taxpayers may immediately expense 100 percent of the cost of “qualified property” that is (i) acquired by the taxpayer on or after January 20, 2025, and (ii) placed in service on or after January 20, 2025 and before January 1, 2030 (January 1, 2031, for certain property with longer production periods and certain aircraft). The deduction is equal to 100 percent of the adjusted basis of the property.
Because the House Bill removes the phasedown of the deduction (currently, the deduction is at 40 percent of the adjusted basis of qualified property), any qualifying property placed into service after January 1, 2030 (or January 1, 2031 for certain property) is not eligible for any bonus depreciation under section 168(k). For purposes of determining the acquisition date of property, property is generally treated as acquired on the date on which a written binding contract is entered into for such acquisition. The House Bill does not otherwise modify the definition of “qualified property” in section 168(k)(2) (including the types of property for which the special depreciation allowance is available).
- Taxpayers should be wary of the “cliff” effect of this amendment, and specifically that unless the special depreciation allowance under section 168(k) is extended, property placed in service on or after January 1, 2031 will need to rely on section 179 for bonus depreciation.
New temporary special allowance for qualified production property (Section 168(n))
While a generic domestic manufacturing deduction akin to prior section 199 was excluded from the House Bill, the House Bill does propose a temporary immediate depreciation deduction for a taxpayer’s adjusted basis in qualifying domestic production facilities that are used by the taxpayer as an integral part of the production of tangible goods.
Specifically, section 168(n) allows for a 100 percent depreciation deduction for that portion of a taxpayer’s adjusted tax basis of “qualified production property,” which is defined as nonresidential real property (e.g., factories): (i) used by the taxpayer as an integral part of qualified production activities (discussed in more detail below), (ii) located in the United States (or any possession of the United States), (iii) the original use of which commences with the taxpayer, (iv) the construction of which commenced after January 1, 2025 and before January 1, 2029, (v) placed into service before January 1, 2033, and (vi) for which the taxpayer has made an election to apply section 168(n).7
Qualified production activities are generally manufacturing, production (limited to agricultural production or chemical production), or refining, of tangible personal property, but only if the taxpayer’s activity results in a substantial transformation of the property. However, qualified production activities do not include nonresidential real property used as offices, administrative services, lodging, parking, sales activities, or other functions unrelated to the production of qualified products.
Furthermore, the manufacturing deduction is unavailable for property subject to the alternative depreciation system (e.g., tax-exempt use property) or property eligible for section 168(k).
If a taxpayer elects to obtain the special depreciation allowance under section 168(n) for “qualifying domestic production facilities,” if any qualified production property for which the taxpayer elected to obtain the special depreciation allowance under section 168(n) ceases to be associated with a qualified production activity within 10 years of being placed in service and is used by the taxpayer in a productive use that is not an integral part of a qualified production activity, recapture under section 1245 will be required as if such property was disposed of for an amount equal to the greater of the depreciation deduction that was previously claimed under section 168(n) or the property’s fair market value on the date of the deemed disposition.8
- Notably, because “nonresidential real property” has a 39-year recovery period and is therefore generally ineligible for the bonus depreciation available under section 168(k), the ability to accelerate the depreciation deduction for qualified production property is a notable addition in the House Bill. However, unless a taxpayer has sufficient taxable income to fully utilize the special depreciation deduction, taxpayers should consider whether such an election makes sense given limitations on the ability of a taxpayer to deduct NOLs under section 172 (80 percent of taxable income) and section 382 (limitation on the ability to utilize certain tax attributes after an ownership change).
Increased dollar limitation for election to expense certain depreciable business assets (Section 179)
The House Bill permanently increases the maximum deduction available under section 179 from USD1,000,000 to USD2,500,000 for tax years beginning after December 31, 2024. In addition, the House Bill also increases the amount of property that may be placed in service before the phase out begins applying from USD2,500,000 to USD4,000,000 (which will generally be adjusted for inflation for taxable years beginning after December 31, 2025).
Temporary immediate deductibility of domestic research and experimental expenditures (Section 174A)
The House Bill allows taxpayers to immediately expense domestic research or experimental expenditures incurred in tax years beginning after December 31, 2024 and before January 1, 2030. Furthermore, a taxpayer may elect to amortize such expenses over 60 months (five years) as opposed to immediately expensing such expenditures.
- Taxpayers that do not have sufficient taxable income to fully offset all of their domestic research or experimental expenditures may consider electing to amortize such expenses in order to spread the deduction over several tax years in light of certain limitations on deductibility of NOL carryforwards under the Code, including the limitation on the use of NOLs to 80 percent of a taxpayer’s taxable income and the limitation under section 382 following an ownership change. However, start-up companies intending to issue stock that qualifies for the exemption under section 1202 applicable to QSBS will also need to consider whether the election to capitalize such domestic research or experimental expenditures will cause their stock to fail to qualify as QSBS under section 1202 as a result of the sum of their cash and tax basis in their assets exceeding the USD50,000,000 threshold.
Deduction for qualified business income (Section 199A)
The House Bill makes permanent the deduction for QBI under section 199A. Furthermore, the House Bill increases the deduction percentage from 20 percent to 23 percent for tax years beginning after December 31, 2025, reducing the top marginal effective rate of U.S. federal income tax on QBI from 29.6 percent (under current law) to 28.49 percent. The House Bill also expands the definition of QBI by treating as QBI 23 percent of any dividends received from an electing business development company (“BDC”) where such dividends are attributable to net interest income of such BDC which is properly allocable to a qualified trade or business of such BDC.9
Furthermore, the House Bill allows more taxpayers to benefit from the deduction for QBI by changing how the phase-in of the W-2 wage/capital investment limitation and the specified service trade or business limitation are phased in for a taxpayer with taxable income above the “threshold amount.”10
Under the House Bill, for a taxpayer whose taxpayer income exceeds the “threshold amount,”11the amount determined under section 199A(b)(2) for each qualified trade or business will be equal to the greater of (i) 23 percent of the taxpayer’s QBI from each qualified trade or business (determined taking into account the W-2 wage and capital investment limitation and the specified service trade or business limitation), and (ii) the excess, if any, of (A) the product of (1) 23 percent and (2) the taxpayer’s QBI from each business (determined without taking into account the W-2 wage/capital investment limitation and the specified service trade or business limitation) less (B) the product of (1) 75 percent and (2) the excess of such taxpayer’s taxable income over the threshold amount.12
- The section 199A deduction for QBI was largely designed to create parity between the reduced corporate income tax rate (21 percent today) and individuals recognizing taxable income through a sole proprietorship, partnership, or S corporation. Taxpayers should consider these changes to section 199A in making initial choice of entity decisions.
Limitation on amortization for professional franchises and related intangibles (Section 197)
The House Bill limits the amount that a taxpayer may amortize with respect to (i) an acquired franchise to engage in professional football, basketball, baseball, hockey, soccer or other professional sport; and (ii) intangible assets that are acquired in connection with such a franchise (which, under current law, are generally amortizable under section 197 over 15 years) to an amount equal to 50 percent of the taxpayer’s adjusted basis in such franchise or other intangible asset.
This limitation applies to all specified intangibles acquired after the House Bill is enacted (however, a safe harbor is not provided if a taxpayer had entered into a binding contract to acquire the franchise or other intangible asset prior to the enactment of the House Bill).
- It is worth noting that the House Bill does not go as far as former section 197(e)(6).13 Former section 197(e)(6) excluded professional sports franchises and intangible assets acquired in connection with such franchises from the definition of intangible assets under section 197. The IRS took the position that sports franchises and certain other intangibles, such as broadcast rights, were also not subject to the depreciation allowance under section 167(a) because such assets had a useful life that could not be determined with reasonable accuracy, effectively eliminating all available depreciation and amortization deductions for such assets.
U.S. response to unfair foreign taxes (Section 899)
The House Bill introduces new section 899 to the Code, which (i) increases the amount of certain U.S. federal income taxes on specific payments received by persons with sufficient connections to a foreign country that has adopted an “unfair foreign tax” and (ii) modifies the application of the base erosion and anti-abuse tax (“BEAT”) to companies that are more than 50 percent owned (by vote or value), directly or indirectly, by such persons.
Section 899, if enacted in its present form, will significantly affect the U.S. tax liabilities, compliance and planning for many foreign individuals and entities that invest or do business in the United States.
General rules
Section 899 increases certain “specified tax rates” on individuals, corporations, governments and other entities that are tax residents of, or controlled by tax residents of, countries that enact “unfair foreign taxes,” which include the undertaxed profits rule (“UTPR”), digital services taxes (“DST”), diverted profits taxes (“DPT”) and, at the discretion of the Treasury Secretary, any extraterritorial tax,14 any discriminatory tax15 or any tax enacted with the intent that it be economically borne, directly or indirectly, disproportionately by U.S. persons.
Under this definition, any country that has adopted a UTPR as part of its Pillar Two legislation or that imposes a DST or DPT (these terms are not specifically defined in the House Bill) is automatically treated as a “discriminatory foreign country” without the need for further designation or action by the Treasury Secretary. However, a tax, including the UTPR, will not be an unfair foreign tax if it does not apply to either: (i) any U.S. person (including a trade or business of a U.S. person) or (ii) a foreign corporation (including a trade or business of such foreign corporation) if the foreign corporation is a “controlled foreign corporation” and more than 50 percent of such corporation’s stock is directly or indirectly owned by U.S. persons.
- It would appear that (i) non-resident capital gains taxes applicable to the direct or indirect disposition of stock of an entity organized in a particular country (other than taxes imposed under rules similar to the Foreign Investment in Real Property Tax Act (“FIRPTA”)) and (ii) taxes imposed with respect to the provision of services that are sourced based on the location of the payor or service recipient (and not where the services were performed) would each be a “discriminatory tax,” as such taxes apply more than incidentally to items of income that would not be considered to be from sources, or effectively connected to a trade or business, within the country enacting such tax under U.S. tax rules.
- Section 899 expressly provides that certain taxes are not extraterritorial taxes or discriminatory taxes, including: (i) an income tax generally imposed on citizens or residents of a foreign country (even if the computation of income includes payments that would be foreign source income); (ii) an income tax imposed on the income of nonresidents attributable to a trade or business in a foreign country; (iii) an income tax imposed on citizens or residents of a foreign country by reference to the income of a corporate subsidiary of such person;16 (iv) withholding or gross basis taxes on fixed or determinable annual or periodical (“FDAP”) income (other than taxes imposed with respect to services performed by persons other than individuals); (v) a tax on real or personal property, an estate tax, gift tax, or other similar tax; and (vi) any other taxes identified by the Treasury Secretary.
- The exclusion from the definition of “unfair foreign taxes” applicable to taxes that are not imposed on a U.S. person or a controlled foreign corporation that is more than 50 percent owned (by vote or value) by U.S. persons allows countries that have enacted a UTPR to avoid being “discriminatory foreign countries” by creating an exception for U.S.-parented groups from the UTPR under their domestic legislation.
Section 899 applies to all “applicable persons,” which include: (i) governments of any discriminatory foreign country; (ii) individuals (other than U.S. citizens and residents) who are tax residents in a discriminatory foreign country; (iii) foreign corporations (other than those in which a U.S. person (as defined in section 7701(a)(30)), directly or indirectly, owns at least 50 percent of the vote or value), which are tax residents in a discriminatory foreign country; (iv) privately-held foreign corporations in which more than 50 percent of the vote or value is owned, directly or indirectly, by applicable persons; (v) private foundations (within the meaning of section 4948) created or organized in a discriminatory foreign country; (vi) trusts the majority of the beneficial interests of which are held, directly or indirectly, by applicable persons; and (vii) foreign partnerships, branches and other entities that may be identified by the Treasury Secretary with respect to a discriminatory foreign country.
- Notably, a foreign subsidiary that is directly or indirectly owned 50 percent or more (by vote or value) by a U.S. multinational is not an applicable person.
- It is unclear how section 899 is intended to apply to foreign partnerships, which are not taxpayers. For example, it is unclear why all partnerships, including those organized in jurisdictions that have not enacted unfair foreign taxes, should be treated as applicable persons. Furthermore, it is unclear why a partnership that is wholly owned by U.S. persons is treated as an applicable person.
- Private corporations, including many common investment vehicles, receiving U.S.-source income will need to consider establishing procedures for determining (i) whether they are directly or indirectly owned by applicable persons and (ii) whether future investors are applicable persons (or directly or indirectly owned by applicable persons). Such private companies will also need to consider whether it makes sense to form parallel vehicles through which applicable persons invest.
- Investors in private corporations should also consider asking the private corporation about its current ownership by applicable persons and its procedures for identifying whether current or future investors are or may be applicable persons (or directly or indirectly owned by applicable persons) as part of their due diligence into the private corporations.
- As a practical matter, in addition to its direct impacts on investors, section 899 may impact certain common investment structures, particularly those involving both U.S. and foreign investors.
- For example, a joint venture (“JV”) between a U.S. investor and an investor resident in a “discriminatory foreign country” may face complexities in allocating the burden of increased U.S. withholding taxes. This could create potential tension among JV partners, especially when the increased tax is triggered solely by the presence of a foreign investor. In such cases, JVs with mixed U.S. and foreign ownership might consider proactively addressing the allocation of increased U.S. withholding tax burdens in their governing documents to ensure that the economic consequences of section 899, if enacted, are allocated in a manner consistent with the parties’ expectations.
For all applicable persons, section 899 increases each “specified rate of tax” by an applicable number of percentage points. Among the tax rates identified as “specified rates of tax” are the 30 percent tax on U.S.-source FDAP income, the individual income tax rate imposed on gains from the disposition of a U.S. real property interest, the 21 percent corporate tax rate on effectively connected income (“ECI”) of foreign corporations, the 30 percent branch profits tax, and the 4 percent excise tax on U.S.-source gross investment income of foreign private foundations.
The rate increase starts at 5 percentage points in the first year and rises by 5 percentage points each subsequent year, up to a maximum of 20 percentage points above the statutory rate. Furthermore, if a rate of tax applies in lieu of a statutory rate, including pursuant to a treaty obligation of the United States, such other rate is increased by the applicable number of percentage points.
- For example, if the withholding tax rate on U.S.-source dividends paid to an applicable person is otherwise 5 percent, such rate is increased by 5 percentage points for each year the country remains classified as a discriminatory foreign country, up to a maximum of 50 percent.
- Individuals who are applicable persons and plan to acquire an interest in a partnership or other pass-through entity that will be generating ECI (other than ECI from disposition of a U.S. real property interest) should consider owning such interest directly rather than through a corporate blocker. This is because ECI recognized by a non-resident individual that does not arise from the disposition of a U.S. real property interest is not subject to the increased rate of tax under section 899.
If a person either becomes an applicable person in the middle of its taxable year or ceases to be an applicable person during its taxable year, the applicable number of percentage points is determined using a weighted average rate based on each applicable number of percentage points in effect during such taxable year and the number of days during which it was in effect.
- For example, if the applicable number of percentage points applicable to a calendar year taxpayer for the portion of its taxable year from January 1 through June 30 was 5 percent, and the applicable number of percentage points was reduced to zero percent for the portion of the taxable year from July 1 through December 31 (because the taxpayer ceased to be an applicable person as of July 1), the applicable number of percentage points for the entire taxable year would be 2.5 percent.
Section 899 explicitly overrides the tax exemption on certain investment income earned by foreign governments (including, for example, sovereign wealth funds) under section 892.
- Section 899 does not appear to impact other statutory tax exemptions under the Code (including the portfolio interest exemption, the exemption for bank deposit interest, the exemption for interest-related dividends and the FIRPTA exemption for qualified foreign pension funds).
- Furthermore, it is not clear whether tax rate increases apply to income that is exempt from tax under a tax treaty (e., where the tax treaty does not provide for a reduced rate of tax but instead grants to the residence country the exclusive right to tax such items of income).
- S. borrowers and lenders with withholding tax gross-up provisions in their respective credit agreements should carefully monitor the developments related to new section 899 to understand how it could impact the withholding tax gross-up obligations due by borrowers under such credit agreements. Such withholding tax gross-up obligations will be more broadly implicated if section 899 is amended to provide that the tax rate increases apply to amounts that are otherwise exempted from U.S. federal income tax under the portfolio interest exemption or an applicable income tax treaty.
Withholding taxes
As discussed above, the increased rates of tax under section 899 also increases the applicable rates of withholding tax, including those rates under sections 1441, 1442, 1445, and 1446. The increased rate of withholding tax under section 899 is subject to two safe harbors.
First, the increased withholding tax rate does not apply if the country with respect to which a person is an applicable person is not listed in the guidance issued by the Treasury Secretary and, for foreign corporations or trusts that become applicable persons as a result of the ownership by applicable persons, the increased withholding tax rate does not apply until the discriminatory foreign country appears in the guidance for at least 90 days.
Under the second safe harbor, no penalties or interest will be imposed on a person as a result of its failure to withhold the additional taxes at any time before January 1, 2027 provided that such person demonstrates to the Treasury Secretary’s satisfaction that it made its best efforts to comply with the new requirements in a timely manner.
- S. persons will need to closely review whether any non-U.S. person to which they make a payment subject to withholding qualifies as an applicable person (including as a result of being controlled by one or more applicable persons).
Changes to the BEAT
Section 899 also modifies the application of the BEAT for privately-held corporations that are more than 50 percent owned (by vote or value), directly or indirectly, by applicable persons. For these entities, the BEAT applies regardless of whether such entities meet the average annual gross receipts and base erosion percentage tests. Furthermore, the BEAT rate is increased from the new proposed 10.1 percent rate to 12.5 percent for such entities and, in computing the base erosion minimum tax amount, the regular tax liability is reduced by all credits allowed under chapter 1 of the Code.
Section 899 also eliminates certain exceptions from base erosion payments, including the exceptions for payments subject to withholding or eligible for the services cost method, and treats certain capitalized amounts as deductions for BEAT purposes. Consequently, the BEAT automatically applies to such entities, and it is more likely that they would owe a base erosion minimum tax amount due to their BEAT liability exceeding their regular tax liability (after all tax credits).
Applicability dates
The effective date for section 899 is the date of enactment of the legislation. However, the increased tax rates and BEAT modifications generally apply to taxable years beginning after the later of (i) 90 days after enactment of section 899, (ii) 180 days after the enactment of the unfair foreign tax or (iii) the first date the unfair foreign tax applies. In light of the applicability dates for the rate increases, given the adoption of the UTPR and other per se “unfair foreign taxes” in 2025 or earlier by many foreign countries, if new section 899 is adopted before November 2, 2025, applicable persons with respect to such foreign countries may be subject to the rate increases as early as January 1, 2026.
Regulatory authority
The Treasury Secretary is directed to issue regulations and guidance to implement section 899, including quarterly publication of the list of discriminatory foreign countries and their applicable dates, and to provide exceptions or adjustments as necessary to prevent avoidance or double counting for BEAT purposes.
FDII and GILTI (Section 250)
Under the House Bill, for taxable years beginning after December 31, 2025, the deduction for FDII is permanently set at 36.5 percent17 (resulting in an effective rate of U.S. federal income tax on FDII of 13.335 percent) and the deduction for GILTI is permanently set at 49.2 percent18 (resulting in an effective rate of U.S. federal income tax on GILTI of 10.67 percent). As is the case under current law, the combined rate of U.S. and foreign income tax on GILTI and FDII will be the same amount – i.e., 13.335 percent (assuming full credibility of foreign income taxes deemed paid under section 960(d)).
- The permanent reduction to the effective rate of tax on U.S. corporations’ FDII is expected to make the United States a far more attractive jurisdiction for holding companies, as the 13.335 percent rate is lower than the 15 percent rate imposed under the IIR under Pillar Two and may become even more advantageous if the UTPR is eliminated or modified.
- Furthermore, such a permanent reduction to the FDII rate may reduce the incentive for U.S. taxpayers to move IP offshore and perhaps even encourage taxpayers that have been waiting for clarity about the future of FDII to repatriate IP to the United States.
- However, even with these positive developments should the House Bill, as drafted, become law, we acknowledge that there is still some risk that a future Congress could alter the baseline corporate tax rate or eliminate FDII entirely.
BEAT (Section 59A)
The House Bill permanently sets the BEAT rate to 10.1 percent for most taxpayers and 11.1 percent for certain banks and security dealers. Under current law, these rates are scheduled to increase to 12.5 percent and 13.5 percent, respectively, for taxable years beginning after December 31, 2025.
The House Bill also repeals provisions that, for taxable years beginning after December 31, 2025, reduce a taxpayer’s regular tax liability by all income tax credits for purposes of computing such taxpayer’s base erosion minimum tax amount, rather than the excess of all income tax credits over certain section 38 credits.
As a result, under the House Bill, taxpayers could continue to benefit from certain section 38 credits in determining their regular tax liability for BEAT comparison purposes, making it less likely that such taxpayers’ BEAT liability exceeds their regular tax liability. Together, aside from a 0.1 percent tax rate difference, these changes are expected to maintain the status quo for taxpayers that are in scope of the BEAT rules.
Modification of excise tax on investment income of private colleges and universities (Section 4968)
For taxable years beginning after December 31, 2025, the House Bill increases the excise tax on the net investment income of certain private colleges and universities, replacing the existing uniform 1.4 percent rate with rates ranging from 1.4 percent to 21 percent based on the institution’s “student adjusted endowment” such that the higher rates apply to institutions that have larger endowments as measured on a per student basis.
As under current law, the excise tax applies to private higher educational institutions only if they have at least 500 tuition-paying students, more than half of whom are located in the United States, and have a student adjusted endowment of at least USD500,000. Qualified religious institutions will be exempt from the tax, and state colleges and universities remain exempt from the excise tax.
Under the new rate structure, institutions with a student adjusted endowment between USD500,000 and USD750,000 remain subject to the 1.4 percent rate, while those with a student adjusted endowment above USD750,000 face higher rates: 7 percent for student adjusted endowments between USD750,000 and USD1,250,000; 14 percent for student adjusted endowments between USD1,250,000 and USD2 million; and 21 percent for student adjusted endowments exceeding USD2m.
The House Bill changes the calculation of net investment income to include interest received with respect to student loans made by the institution (and certain of its affiliates), and certain federally subsidized royalty income. For these purposes, “federally subsidized royalty income” includes income where any Federal funds were used in the research, development or creation of the relevant intellectual property.
The Secretary is directed to prescribe regulations to prevent the avoidance of the excise tax through the restructuring of endowment funds or other arrangements designed to reduce or eliminate the value of assets or income subject to this tax. Covered institutions are also subject to increased reporting requirements with respect to the calculations taken into account for these purposes.
Increase in tax on net investment income of certain private foundations (Section 4940(a))
The House Bill increases the tax on net investment income of certain private colleges and universities and certain private foundations, replacing the current uniform 1.39 percent rate with a tiered system based on the foundation’s total assets. Under the new rate structure, private foundations with less than USD50m in assets remain subject to the 1.39 percent rate, while those with USD50m or more face higher rates: 2.78 percent for assets of at least USD50m and less than USD250m; 5 percent for assets of at least USD250m and less than USD5 billion; and 10 percent for assets of USD5bn or more.
For these purposes, the assets of certain related organizations are included in the calculation of any private foundation’s total assets, and such calculation is performed as of the close of each taxable year. The changes would be effective for taxable years beginning after the date of enactment of the legislation, with no specified sunset provision.
Excessive employee remuneration (Section 162(m))
Section 162(m) caps at USD1m the allowable deduction for “applicable employee remuneration” with respect to each covered employee of a publicly held corporation. The House Bill extends this cap to the aggregate remuneration paid to each covered employee by the controlled group of which a publicly traded corporation is a member, such that the compensation paid by all members of the controlled group is treated as if it were paid by a single employer.
This means that if multiple related companies pay a specified covered employee, the USD1m limit is allocated among them, preventing the group from circumventing the cap by splitting compensation across entities. The changes would be effective for taxable years beginning after December 31, 2025, with no specified sunset provision.
Renewal and enhancement of QOZ program (Sections 1400Z-1 and 1400Z-2)
The Qualified Opportunity Zone program was introduced in the TCJA to attract investment in, and encourage entrepreneurs to start up, businesses located in economically distressed communities by (i) allowing investors to defer, and to some extent eliminate, capital gains from the sale or exchange of property to unrelated persons by investing corresponding amounts in such businesses through qualified opportunity funds (“QOFs”), and (ii) exempting from income tax these investors’ gains from the direct or indirect disposition, after a ten year minimum holding period, of investments in such businesses. Market observers have estimated that the amounts invested in QOFs total between USD40bn and USD150bn.
The House Bill triggers a “new round” of Opportunity Zone (“OZ”) designations based on updated economic data for a new iteration of the QOZ program that begins with taxable years after January 1, 2027 and ends with December 31, 2033, narrow the definition of low-income communities eligible to be designated, increase the proportion of OZs that are rural, enhance the benefits for investments in rural areas, and modify the tax incentives for investments.
The zones eligible to be designated as OZs would be census tracts with a poverty rate of at least 20 percent or a median family income below 70 percent of the area median, excluding tracts with median family incomes at or above 125 percent of the area median. Contiguous tracts are not eligible to be designated under this new definition. At least 33 percent of designated OZs must be “entirely rural” (as determined by the Treasury Secretary in consultation with the Secretary of Agriculture).
The House Bill modifies the tax incentives for investors by providing that investments in QOFs made before December 31, 2028 receive a single 10 percent step-up in basis after five years, while investments in new Rural Qualified Opportunity Funds (“RQOFs”) made before December 31, 2028, receive a 30 percent step-up; in each case, the amount of the step up is the relevant percentage of the capital gain deferred by the investor upon investing in the QOF.
The House Bill also allows a taxpayer to defer up to USD10,000 of ordinary income in each year through investments in QOFs or RQOFs and lowers the substantial improvement threshold for existing property in rural areas.
The new QOZ provisions are effective as early as taxable years beginning after the date of enactment of the legislation, but generally apply only to investments in QOFs made on or after January 1, 2027 and on or before December 31, 2033.
Changes to percentage of REIT assets that consist of stock of taxable REIT subsidiaries (Section 856(c)(4)(B)(ii))
The House Bill increases the allowable percentage of assets that a Real Estate Investment Trust (“REIT”) may hold in the securities of taxable REIT subsidiaries from 20 percent to 25 percent; 25 percent was the limit in place prior to 2018.
- This increase could potentially add flexibility to REIT structures, allowing for a broader range of businesses to be held by REITs. The change would be effective for taxable years beginning after December 31, 2025, with no specified sunset provision.
Footnotes
1. Pub. L. No. 115-97.
2. Unless otherwise indicated, all “section” references contained herein are to sections of the Code.
3. Pub. L. No. 117-169.
4. A detailed overview of the changes to the clean energy credits will be described in a separate publication.
5. However, miscellaneous itemized deductions would only be allowed to the extent they exceeded two percent of a taxpayer’s adjusted gross income.
6. The Joint Committee on Taxation explanation suggests that it may have been intended that state, local and foreign, income, war profits, excess profits, and general sales taxes paid by a partnership or S corporation in carrying on a qualified trade or business under a PTET regime would be excluded from the definition of substitute payments. In particular, in explaining the substitute payment concept, the Joint Committee explanation provides: “[l]ikewise, if a partnership not engaged in a qualified trade or business pays a gross receipts tax or personal property tax imposed on the partnership by a State, and by reason of such payment the partnership’s partners receive credits against their State personal income tax liabilities, the partnership tax payment is a substitute payment and is included in the partnership’s aggregate of specified taxes.” Joint Committee on Taxation, Description of the Tax Provisions of the Chairman’s Amendment in the Nature of a Substitute to the Budget Reconciliation Legislative Recommendations Related to Tax (JCX-21-25), May 12, 2025 (emphasis added). It is unclear why the “if a partnership not engaged in a qualified trade or business” language would be necessary if these businesses were also subject to the substitute payment rule.
7. The requirements in clauses (iii) and (iv) will be deemed to be satisfied if a taxpayer acquires the property after January 1, 2025 and before January 1, 2029 (for this purpose, property is treated as acquired not later than the date on which the taxpayer enters into a written binding contract for such acquisition) and such property was not used in qualified production activity by any person at any time during the period beginning on January 1, 2021 and ending on May 12, 2025.
8. The House Bill directs the Treasury Secretary to issue regulations or other guidance addressing the application of this recapture rule where the property is transferred in a partial or fully tax-deferred transaction and the transferee ceases to use the property in a use that is not an integral part of a qualified production activity. Taxpayers disposing of property for which a deduction has been claimed under section 168(n) in non-recognition transactions should consider obtaining representations, covenants and indemnities from the transferor regarding the post-transfer use of the property.
9. This change reduces effective U.S. federal income tax rate on qualifying interest income earned through a BDC from 37 percent to 28.49 percent.
10. Under current law, the W-2 wage/capital investment limitation and the specified service trade or business limitation are each phased in over a fixed range of taxable income.
11. For 2025, the “threshold amount” is USD394,600 for married taxpayers filing jointly and USD197,300 for all other taxpayers. Under currently law, the W-2/capital investment limitation and specified service trade or business limitation would completely phase in at USD494,600 for married taxpayers filing jointly (and USD247,300 for all other taxpayers).
12. For example, assume that a taxpayer (married filing jointly) has USD525,000 of taxable income, USD500,000 of QBI derived from one specified service trade or business and the “threshold amount” applicable to such taxpayer is USD394,600.
Under current law, such taxpayer would not be entitled to claim a deduction for any QBI under section 199A because all of the taxpayer’s QBI is from a specified services trade or business and the taxpayer completely phased in at USD494,600 of taxable income.
However, under the House Bill, the taxpayer would be entitled to deduct USD17,200 under section 199A with respect to such specified service trade or business (23 percent of USD500,000 less 75 percent of USD130,400 (USD525,000 – USD394,600)).
13. Section 197(e)(6) was removed from the Code in 2004. Pub. L. No. 108-357.
14. An extraterritorial tax is any tax that is imposed by a country on a corporation, where such tax is determined by reference to any income or profits received by any person by reason of such person being connected to such corporation through any chain of ownership (determined without regard to the ownership interests of any individual), but would not include any tax that is imposed by reason of such corporation having a direct or indirect ownership interest in such person.
15. A discriminatory tax is defined as: (i) a tax that applies more than incidentally to items of income that would not be considered to be either (A) from sources within such country or (B) effectively connected to a trade or business within such country, in each case, applying U.S. tax rules; (ii) a tax that is imposed on a base other than net income and is not computed by permitting recovery of costs and expenses; (iii) a tax that is exclusively or predominantly applicable, in practice or by its terms, to nonresident individuals and foreign corporations or partnerships because of the application of revenue thresholds, exemptions or exclusions for taxpayers subject to such foreign country’s corporate income tax, or restrictions of scope that ensure that substantially all residents supplying comparable goods or services are excluded from the application of such tax; or (iv) a tax that is not treated as an income tax under the laws of such foreign country or is otherwise treated by such foreign country as outside the scope of any income tax treaties.
16. This exception would appear to carve-out from the definition of an unfair foreign tax: (i) controlled foreign company tax regimes similar to the U.S. subpart F and GILTI regimes and (ii) the “income inclusion rule” (“IIR”) under Pillar Two.
17. The FDII deduction is currently 37.5 percent, but the deduction is currently set to decrease to 21.875 percent for taxable years beginning after December 31, 2025.
18. The GILTI deduction is currently 50 percent, but the deduction is currently set to decrease to 37.5 percent for taxable years beginning after December 31, 2025.