08 July 2025 Tax reconciliation legislation will significantly affect individual taxpayers
On July 4, 2025, President Trump signed into law H.R. 1. The Act largely serves to permanently implement TCJA tax rates and tax cuts. It also incorporates several of President Trump's campaign promises, such as no tax on qualified tips and a provision allowing for no tax on qualified overtime compensation.
Several proposals introduced by the House Bill (see Tax Alert 2025-1161) and then the first Senate Bill (see Tax Alert 2025-1350) have been abandoned or dramatically reduced in the Act.
Additionally, the Act repeals numerous clean air manufacturing and production credits. For more details, see Tax Alert 2025-1069. While countless provisions within the Act impact individual taxpayers, this Tax Alert focuses on those most applicable to high net-worth individuals. The Act makes the tax rate schedules under the TCJA permanent. The Act modifies the indexing for inflation by providing one additional year in the cost-of-living adjustment. The Act, however, does not include the one additional year in the cost-of-living adjustment for the dollar amount at which the 35% rate bracket ends and the 37% rate bracket begins (37% rate bracket threshold). Additionally, the Act effectively caps itemized deductions at 35% when offsetting ordinary income for those in the top 37% tax bracket. The cap is 19% when offsetting capital gains. Higher earners welcome the preservation of the TCJA rates; however, the corresponding limitation on itemized deductions lessens the overall benefit for those in the highest income tax bracket. Under current law, a top tax rate of 40% applies to property inherited through an estate or acquired by gift. The first $10 million (plus inflation) in transferred property (the basic exclusion) is exempt from any combination of estate, gift and generation-skipping taxes. For 2025, the exemption amount is $13.99 million. Transfers between spouses are generally exempt from these taxes, and a surviving spouse may carryover (add) to his or her own basic exclusion any portion of that spouse's basic exclusion that has not been exhausted. The Act permanently increases the estate and gift tax exemption to $15 million (indexed for inflation). The Act also permanently increases the generation-skipping transfer tax exemption to $15 million (indexed for inflation). Fewer than 1% of current taxpayers face a tax on their estate. However, the preservation of the high lifetime estate tax exemption is a welcome enhancement. Under current law, for tax years beginning after December 31, 2017, and before January 1, 2026, an individual taxpayer may deduct: (1) 20% of qualified business income from a partnership, S corporation or sole proprietorship; and (2) 20% of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. The deduction is not permitted with respect to certain SSTBs above certain income levels. The 20% deduction may not be used in computing adjusted gross income and may be utilized both by non-itemizers and itemizers. "Qualified business income" is the net amount of domestic qualified items of income, gain, deduction and loss from the taxpayer's qualified business. Qualified business income (QBI) does not include:
The Act makes the qualified business deduction permanent at 20%. The Act also increases the deduction limit phase-in range from $50,000 to $75,000 (single filers) and $100,000 to $150,000 (married filing jointly filers). In addition, the Act establishes a new minimum deduction of $400 (adjusted for inflation) for taxpayers with at least $1,000 of qualified business income from one or more active trades or businesses. Making the QBI deduction permanent is a welcome provision for owners of eligible passthrough entities, and the inflation adjustments to the phase in ranges will prevent some taxpayers from losing the benefit over time. Current law allows an individual taxpayer to claim an itemized deduction for state, local or sales taxes up to $10,000 ($5,000 if married filing separately) of the amount paid. Additionally, individuals are generally able to deduct their distributive share of state and local taxes allocable from a pass-through entity (the so-called PTET deduction). The Act increases the cap for the individual SALT deduction from $10,000 to $40,000 as it relates to a tax year beginning in calendar year 2025. It will then increase to $40,400 in any tax year beginning in calendar year 2026, and 1% annually through 2029. In 2030, a $10,000 cap would return. The cap is reduced by 30% of the taxpayer's modified adjusted gross income over $500,000 ($250,000 if married filing separately). The cap and income threshold would grow 1% each year from 2026 until 2030. While many will welcome the higher limit to the SALT deduction, the highest earners will receive little to no benefit. And unless a future Congress acts, the relief only lasts until 2029. In calendar year 2030, the SALT cap reverts to $10,000. Current law allows taxpayers to claim additional depreciation (i.e., bonus depreciation) under IRC Section 168(k) in the year in which qualified property is placed in service through 2026 (with an additional year to place the property in service for qualified property with a longer production period, as well as certain aircraft). It also allows taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for certain qualified property with a longer production period, as well as certain aircraft). Bonus depreciation phases down to 80% for qualified property placed in service before January 1, 2024; 60% for qualified property placed in service before January 1, 2025; 40% for qualified property placed in service before January 1, 2026; and 20% for qualified property placed in service before January 1, 2027. Qualified property is defined as tangible property with a recovery period of 20 years or less under the modified accelerated cost recovery system, certain off-the-shelf computer software, water utility property or certain qualified film and television productions, as well as certain qualified theatrical productions. Certain trees, vines, and fruit-bearing plants also are eligible for bonus depreciation when planted or grafted. Property is generally eligible for bonus depreciation if the taxpayer has not used the property previously (i.e., it is the taxpayer's first use of the property), provided the taxpayer does not acquire the "used" property from a related party or in a carryover basis transaction). The Act permanently extends bonus depreciation. It allows taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after January 19, 2025, as well as specified plants planted or grafted after that date. In addition, the Act modifies IRC Section 168(k)(10) to give taxpayers the option to elect to claim 40% bonus depreciation (or 60% for longer production period property or certain aircraft) in lieu of 100% bonus depreciation for qualified property placed in service during the first tax year ending after January 19, 2025. Newly enacted IRC Section 168(n) provides taxpayer's with the ability to elect to take 100% depreciation on "qualified production property," which is defined as that portion of any nonresidential real property that is used by the taxpayer as an integral part of a qualified production activity; for which construction begins after January 19, 2025, and before January 1, 2029; and which is placed in service within the United States (or any possession of the United States) before January 1, 2031, provided that original use of the property resides with the taxpayer. Qualified production property does not include any portion of nonresidential real property used for offices, administrative activities, lodging, parking, sales activities, software development or engineering activities, or other functions unrelated to manufacturing, production or refining of tangible personal property. The change generally applies to property acquired and placed in service after January 19, 2025, as well as to specified plants planted or grafted after that date. As stated above, the qualified production property deduction only applies to certain nonresidential real property which begins construction during an applicable window. A permanent 100% bonus depreciation for eligible property acquired after January 19, 2025 is a welcome change for taxpayers and its expansion to qualified production property may drive rapid investments into US manufacturing facilities. IRC Section 163(j) limits the business interest expense that may be deducted in a tax year to the sum of (i) the taxpayer's business interest income, as defined in IRC Section 163(j)(6), (ii) 30% of the taxpayer's adjusted taxable income (ATI), as defined in IRC Section 163(j)(8), and (iii) the taxpayer's floor plan financing interest, as defined in IRC Section 163(j)(9). For tax years beginning before January 1, 2022, a taxpayer's ATI was based on earnings before interest, taxes, depreciation and amortization (EBITDA). Thereafter, a taxpayer's ATI is computed with regard to any deduction allowable for depreciation, amortization or depletion (i.e., the IRC Section 163(j) limitation is generally based on earnings before interest and taxes (EBIT)). Further, while IRC Section 163(j)(8) does not address a US shareholder's treatment of CFC income inclusions under IRC Sections 78, 951(a) or 951A(a), the final IRC Section 163(j) regulations provide that such amounts (referred to as "specified deemed inclusions") are not included in the determination of the US shareholder's ATI. However, under proposed IRC Section 163(j) regulations, which taxpayers may have been applying prior to finalization, a US shareholder may be able to effectively include in ATI a portion of the specified deemed inclusions to the extent there is CFC excess taxable income as defined in the proposed regulations. In general, under the final IRC Section 163(j) regulations, IRC Section 163(j) applies after the application of provisions that subject business interest expense to disallowance, deferral, capitalization, or other limitation. More specifically, under the final IRC Section 163(j) regulations, IRC Section 163(j) applies after the application of provisions that require the capitalization of interest, such as IRC Sections 263A and 263(g). As a result, capitalized interest expense under those sections is not treated as business interest expense for purposes of IRC Section 163(j). The Act amends IRC Section 163(j)(8)(A)(v) to provide that ATI is once again computed without regard to any deduction allowable for depreciation, amortization or depletion (i.e., based on EBITDA), and this reversion is now permanent. The Act amends IRC Section 163(j)(8)(A) to adjust the ATI calculation of a US shareholder by fully excluding CFC income inclusions under IRC Sections 78, 951(a), and 951A, consistent with the final IRC Section 163(j) regulations but contrary to the proposed IRC Section 163(j) regulations. The Act also modifies interest deductibility under IRC Section 163(j) by providing that the IRC Section 163(j) limitation is generally applied before interest capitalization provisions, thus making business interest expense that might otherwise be capitalized subject to the IRC Section 163(j) limitation. However, the Act provides that any interest that is required to be capitalized under IRC Sections 263(g) or 263A(f) is not treated as business interest expense for purposes of the IRC Section 163(j) limitation, consistent with the treatment of such interest amounts under the final IRC Section 163(j) regulations. The provisions relating to CFC income inclusions and the coordination with capitalization provisions would be effective for tax years beginning after December 31, 2025. The permanent addback of depreciation and amortization to ATI (in conjunction with the potential return of 100% bonus depreciation) will provide significant relief to certain taxpayers by reducing the amount of interest limited under IRC Section 163(j). However, certain taxpayers with foreign operations may see this benefit eroded (starting in tax years beginning after December 31, 2025) by the exclusion of Subpart F and GILTI (and any associated IRC Section 78 gross up) from ATI. Due to the proposed IRC Section 163(j) ordering rule, taxpayers that remain IRC Section 163(j) limited (even after the reversion to EBITDA) in tax years beginning after 2025 would have a more limited opportunity to reduce the impact of the IRC Section 163(j) limitation through elective interest capitalization. Current law allows taxpayers who itemize deductions to receive a deduction for charitable contributions. The deduction amount is subject to a specified limitation based on the type of contribution gifted. The Act creates a permanent deduction for taxpayers who do not itemize their deductions. For tax years beginning after December 31, 2025, the Act permanently allows non-itemizers to claim a deduction of up to $1,000 if a single filer ($2,000, married filing jointly) for certain charitable contributions. For those who itemize, the Act imposes a 0.5% floor on any charitable contribution otherwise allowable for tax years beginning after December 31, 2025. This change reduces a taxpayer's charitable contributions for a tax year by 0.5% of the taxpayer's contribution base for that tax year. The Act also permanently extends the increased contribution limit for cash gifts to qualified charities. High net-worth individuals who routinely give to charity will see the corresponding value of that deduction decrease in 2026. This new "floor" on the deduction applies in addition to the limitation on the value of itemized deductions for the highest earners. Taxpayers who are planning large charitable gifts may consider moving those donations into 2025 rather than future years (if practicable). IRC Section 1202 provides an exclusion of gain from the sale of QSBS that is held for more than five years. The exclusion is 100% for stock acquired after September 27, 2010, and either 50% or 75% for stock acquired in earlier periods. The gain excluded under IRC Section 1202 is not treated as a preference item for purposes of the alternative minimum tax (AMT) under IRC Section 57(a)(7) for post-2010 acquisitions. The exclusion is subject to a per-issuer cap, which is generally the greater of $10 million or 10 times a taxpayer's basis in the subject stock. The exclusion does not apply if a corporation's aggregate gross assets exceed $50 million at any time from the corporation's date of formation through the moment immediately after the stock is originally issued to the taxpayer. The Act establishes a tiered gain exclusion for QSBS: 50% for QSBS held for at least three years, 75% for QSBS held for at least four years, and 100% for QSBS held for at least five years. This change applies to stock originally issued after the enactment date of the Act. The gain excluded under the three- and four-year rules is not treated as a preference item for purposes of the AMT under IRC Section 57(a)(7) if the stock was acquired after September 27, 2010. The per-issuer cumulative exclusion limitation increases from $10 million to $15 million, subject to an annual inflation adjustment increase. If in any tax year a taxpayer fully utilizes the inflation adjusted per-issuer limitation, the taxpayer is no longer eligible for additional inflation adjustments. The Act also makes conforming amendments to ensure married filing separately taxpayers are able to benefit from the inflation adjusted per-issuer limitation. Finally, the Act increases the "aggregate gross asset" calculation under IRC Section 1202(d) to $75 million, which would also be subject to an annual inflation adjustment. Amendments made by the Act are generally effective for stock issued or acquired, and to tax years beginning after July 4, 2025, unless otherwise stated above. The Act's expansion of IRC Section 1202 represents a much-needed change to the statutory framework to achieve the incentives' original purpose of encouraging high-risk, long-term, growth-oriented investments. The expansion will also likely become a significant factor in choice of tax entity considerations (e.g., whether to do business as an S corporation, partnership, or C corporation). Generally, to obtain a QSBS exclusion the business must either (i) begin operations as a C corporation and issue stock or (ii) convert to a C corporation and issue stock at some point prior to the entity exceeding the aggregate gross asset threshold. The choice to operate a business taxed as a partnership or S corporation effectively takes the QSBS exclusion benefit off the table upon a later sale, unless affirmative steps are taken to preserve the benefit (e.g., through a conversion transaction). The Act, however, extends the window for a business to become a C corporation and issue stock by increasing the aggregate gross asset ceiling to $75 million (indexed for inflation). This change has the implicit effect of allowing a business to satisfy the "qualified small business" requirement for a longer period in its life cycle. Accordingly, the Act provides some favorable relief should a business decide instead to begin its operations as a tax classification other than a C corporation and later convert. To circumvent the $10,000 individual SALT cap enacted by the TCJA, many states adopted PTET regimes that allow a partnership or S corporation to pay state taxes at the entity level, with each participating owner receiving a credit against their state tax liability. In Notice 2020-75, the IRS provided that these PTET payments may be deducted as business expenses of the partnership or S corporation. This final resolution on PTET is significantly more favorable than the House proposal, which excluded SSTBs, or the Senate proposal, which capped the benefit at a percentage. Prior to the TCJA, IRC Section 958(b)(4) provided that the downward attribution provisions of IRC Section 318(a)(3)(A), (B), and (C) did not apply to treat a US person as owning the stock owned by a foreign person, thus generally limiting US shareholder status of CFCs. The TCJA repealed IRC Section 958(b)(4), resulting in US persons being treated as US shareholders and foreign corporations being treated as CFCs, when they had not previously been considered as such. The Act reinstates IRC Section 958(b)(4), limiting the attribution from foreign persons under the general attribution rules under IRC Section 318(a)(3)(A), (B), and (C) for purposes of Subpart F and GILTI inclusions. However, IRC Section 951B limits the impact of the reinstatement of IRC Section 958(b)(4) by requiring downward attribution in certain structures, causing certain foreign controlled foreign corporations to be treated as CFCs. The reinstatement of IRC Section 958(b)(4) may alleviate income tax implications and reporting of certain US taxpayers. However, care should be taken with new IRC Section 951B, which limits the applicability of IRC Section 958(b)(4). The Act includes a variety of necessary extensions to avoid large tax increases on individual earners and small businesses that were slated to come into effect at the end of 2025 because TCJA provisions were due to expire. Many of these extensions were also made permanent under the Act, with some notable exceptions (e.g., the $40,000 SALT cap decreases to $10,000 in 2030). However, some of the Act's provisions do affect the value of deductions for high net-worth individuals. The impact of the limit on not only itemized deductions but also the charitable contribution deduction, while modest, will be felt next year and beyond. With respect to small business investment, the Act should provide long desired certainty. This is because of the tax rate extensions and favorable amendments to the "Big Three" TCJA business tax provisions (immediate domestic research & development expensing, full capital expensing (i.e., "bonus depreciation"), and pro-growth interest deductibility under IRC Section 163(j)). The Act also significantly expands the QSBS tax exclusion, which will encourage prospective capital investments into high-growth start-ups. As with any major tax legislation, it is often prudent to consider the tax changes in a holistic manner on a case-by-case basis.
Document ID: 2025-1394 | ||||||||
