With a December 22, 2017 signing date and an effective date just nine days later, the IRS has been rushing to implement the Tax Cuts and Jobs Act so that taxpayers can make necessary changes in planning and reporting for 2018. Three items of guidance came out of the IRS in April that should answer some key questions about blended corporate tax rates, alimony trusts and contributions to Health Savings Accounts (HSAs).
Blended Rate for Fiscal Year Corporations
Because the corporate tax rate was lowered in 2018 from 35% to a flat 21%, fiscal year corporations that straddle two calendar years will use a blended rate for their fiscal year which includes January 1, 2018 (see Notice 2018-28). These corporations will not get the flat 21% rate for their entire fiscal year, but instead must prorate their tax based on the number of days the different rates were in effect.
To calculate the blended rate taxes, a corporation should first calculate its tax for the entire year using the tax rate in effect prior to the TCJA. Then, the corporation calculates its tax again for the entire year using the new 21% rate. Finally, the corporation apportions the tax amounts based on the number of days in each taxable year that the different rates were in effect. The sum of these two amounts is the corporation’s federal income tax for the fiscal year.
Example: Corporation X, a C corporation, uses a June 30 fiscal year. For its taxable year beginning July 1, 2017 and ending June 30, 2018, X’s taxable income is $1,000,000. According to the IRS, Corporation X’s blended tax is computed as follows:
1) Total taxable income (Line 30, Form 1120) $ 1,000,000
2) Tax amount using rates before the Act 340,000
3) Number of days in Corporation X’s taxable year before January, 1, 2018 184
4) Multiply Line 2 by Line 3 62,560,000
5) Divide Line 4 by total number of days in the taxable year (365) to get 2017 tax $ 171,397
6) Tax amount using new 21% rate 210,000
7) Number of days in the taxable year after December 31, 2017 181
8) Multiply Line 6 by Line 7 38,010,000
9) Divide Line 8 by total number of days in the taxable year (365) to get 2018 tax $ 104,137
10) Add the tax shown on lines 5 and 9 ($171,397 + $104,137) $ 275,534
Corporation X’s total tax for its taxable year ending June 30, 2018 (Sum of Line 8 and Line 9) $ 275,534
Amended Returns, AMT: Fiscal year corporations that have already filed their federal income tax returns without using a blended rate may want to consider filing an amended return. Also, as a transition to the repeal of the corporate alternative minimum tax (AMT), fiscal year corporations will have to prorate the AMT owed for the part of their fiscal year that occurs before the TCJA took effect on January 1, 2018. The Notice gives guidance on this computation as well.
Alimony Trusts Grandfathered In
The TCJA changed alimony taxation to take away the deduction for the spouse paying alimony and to make alimony not taxable to the recipient. This provision has a prospective date, to apply only to agreements or orders that become effective after 2018.
The IRS has indicated in a recent Notice that it intends to issue regulations explaining that alimony trusts set up before 2019 are grandfathered in under the old rules unless the instrument creating the trust is modified after that date and the modification adopts the TCJA changes.
An alimony trust is a legal arrangement where the spouse required to pay alimony sets up a trust with the income from the trust going to the payee spouse as alimony. Under the pre-TCJA rules, the payor spouse cannot claim an alimony deduction on the income but is not taxed on that income. The recipient spouse is taxed on the income but not on the principal.
High Deductible Health Plan HSAs
Finally, the IRS has granted relief to taxpayers with family coverage under a High Deductible Health Plan who contribute to a Health Savings Account (HSA). For 2018, taxpayers with high-deductible family coverage may contribute $6,900 as the maximum deductible HSA contribution. A change in the inflation adjustment calculations for 2018 to chained CPI under the TCJA reduced the maximum deductible HSA contribution for these taxpayers by $50 to $6,850. Although the new chained CPI requires a lower amount, the IRS will keep its pre-TCJA calculation of $6,900 for 2018.