OBB-BA-Di, Ob-La-Da, Life Goes On, Brah? Life – and Tax Policy – Goes On

OBBBA extends many of the policies first enacted in the Tax Cuts and Jobs Act of 2017 (TCJA), rolls back several renewable energy incentives enacted under the Inflation Reduction Act of 2022, and introduces new rules that will impact individuals, domestic and multi-national businesses, business owners, and nonprofit organizations. This alert provides an overview of some of the key provisions included in OBBBA.

Business Tax Provisions

Restoration of 100% Bonus Depreciation

OBBBA permanently restores 100% bonus depreciation for qualified property (e.g., machinery and equipment) acquired and placed in service after January 19, 2025, repealing the TCJA’s phase-down that began in 2023.

Bonus Depreciation for Qualified Manufacturing Facilities

OBBBA enacts a new bonus depreciation election allowing the immediate expensing of 100% of the cost basis of “qualified production property” (e.g., manufacturing facilities placed in service in the United States), if construction commences after January 19, 2025, and before January 1, 2029, and the asset is placed in service before January 1, 2031.

Increased Limitation on Interest Deductions

OBBBA makes favorable adjustments to the interest deduction rules by permanently restoring the pre-2022 deduction cap on interest expenses with respect to debt incurred in a trade or business to generally 30% of a taxpayer’s EBITDA (as opposed to 30% of EBIT, as required under prior law).

Permanency of Qualified Business Income Deduction

OBBBA makes permanent the 20% deduction for qualified business income (QBI) (generally, business income other than employee income and income from certain service businesses) and expands the phase-in thresholds.

Immediate Research and Experimental Expensing

Since 2022, taxpayers have been required to amortize expenditures related to research and experimental (R&E) activities conducted in the United States over a five-year amortization schedule (foreign-based R&E expenses are required to be capitalized and amortized over a 15-year amortization schedule). OBBBA permanently allows taxpayers to deduct 100% of expenditures paid or incurred after December 31, 2024, with respect to research and experimental activities conducted in the United States (capitalization requirements for foreign-based R&E expenses are not modified). Certain small business taxpayers may be eligible to retroactively deduct R&E expenses for taxable years beginning after December 31, 2021. Other taxpayers may elect to deduct any remaining unamortized amount with respect to domestic R&E expenditures paid or incurred in taxable years beginning after December 31, 2021, and before January 1, 2025. Taxpayers should discuss with their tax advisors whether they qualify to retroactively expense capitalized R&E or otherwise accelerate the remaining amortizable amount of such expenses.

Increased Expensing Limitations

Under prior law, taxpayers could elect to fully expense 100% of the cost of certain qualifying property (generally, machinery and equipment), as opposed to depreciating such costs over a depreciation schedule. For 2025, this is subject to a $1,250,000 cap on such expensing and a phase-down if the qualifying property costs exceed $3,130,000. For property placed in service after December 31, 2024, OBBBA expands expensing limitations by increasing (1) the $1,250,000 cap under the TCJA to $2,500,000 and (2) the phase-down threshold under the TCJA to $4,000,000, with these numbers being subject to annual inflation adjustments.

Qualified Small Business Stock Gains

OBBBA provides a three-tiered gain exclusion for qualified small business stock (QSBS), offering (1) 50% if the stock is held for three years, (2) 75% if held for four years, and (3) 100% if held for five years. In addition, OBBBA increases the gross asset cap for QSBS issuers from $50 million to $75 million (indexed for inflation) and raises the per-issuer gain exclusion cap to $15 million (also indexed), thereby extending QSBS exclusion eligibility. These changes only apply to stock acquired after the date of OBBBA’s enactment.

Extended Limit on Excess Business Losses

Under prior law, non-corporate taxpayers were subject to disallowance of “excess business losses,” which generally are net business losses that exceed certain threshold amounts as adjusted for inflation. OBBBA makes permanent the disallowance of a non-corporate taxpayer’s excess business loss (the threshold amount for 2025 is $313,000 for non-joint filers and $626,000 for joint filers), which was scheduled to expire December 31, 2028.

International Provisions

Foreign Derived Deduction Eligible Income

OBBBA renames “foreign-derived intangible income” (FDII) to “foreign-derived deduction eligible income” (FDDEI), lowers the Section 250 deduction rate to 33.34% (14% effective tax rate), and eliminates the 10% qualified business asset investment offset. These changes apply to tax years beginning after December 31, 2025.

GILTI (Now NCTI)

OBBBA renames “global intangible low-taxed income” (GILTI) to “net CFC tested income” (NCTI) and permanently decreases the NCTI deduction rate to 40% (from 50% under GILTI), enacting an effective rate of 12.6% (assuming NCTI is not subject to foreign tax).

Foreign Tax Credits

OBBBA increases the deemed paid credit for foreign taxes on NCTI (formerly GILTI) from 80% to 90% and limits deductions allocable to NCTI to the FDDEI deduction (see above) and directly related expenses, with all others (like interest and R&E) allocated to US-source income. For US-produced inventory sold abroad via a foreign branch, up to 50% of the income may be treated as foreign-source for foreign tax credit (FTC) purposes. These changes generally raise the FTC limitation and reduce residual US tax, effective for tax years beginning after December 31, 2025.

Controlled Foreign Corporation Downward Attribution

OBBBA eliminates the downward attribution of stock from foreign to US persons for purposes of determining controlled foreign corporation (CFC) status. In addition, a new provision (Section 951B) targets anti-deferral rules at certain foreign-controlled structures to prevent avoidance. These provisions are effective for tax years beginning after December 31, 2025.

Subpart F Pro-Rata Share Rules

OBBBA requires any US shareholder who owned CFC stock at any time during the year (while the entity was a CFC and the shareholder was a “U.S. shareholder”) to include their pro rata share of subpart F and NCTI income, closing the loophole for mid-year transfers. This applies to tax years beginning after December 31, 2025.

Real Estate

Qualified Opportunity Zones

OBBBA makes the opportunity zone (OZ) tax incentive (enacted under the TCJA) a permanent policy in the tax code. In addition, OBBBA improves on the existing OZ framework by creating an ongoing five-year deferral period for capital gains invested after December 31, 2026, in a qualified opportunity fund (QOF) (i.e., there is not a universal recognition date for all taxpayers, as was the case under the TCJA), with a 10% basis step-up at the five-year mark, and provides enhanced tax benefits to investments in QOFs that make certain qualifying investments in rural areas (e.g., the initial five-year holding period 10% step-up in basis is increased to 30%). OBBBA also enacts a new information reporting regime for QOFs and makes other changes to the (qualified opportunity zones (QOZ) program.

Adjustment to Real Estate Investment Trust Subsidiary Asset Tests

OBBBA increases the amount of taxable real estate investment trust (REIT) subsidiary stock that a REIT may own from 20% to 25% for purposes of the 75% asset value test that a REIT must satisfy. This applies with respect to taxable years beginning after December 31, 2025.

Energy and Environmental Incentives

Limitations for Clean Electricity Production Credit, Clean Electricity Investment Credit, and Advanced Manufacturing Production Credit

OBBBA terminates the relevant credits for wind and solar energy property placed in service after December 31, 2027. However, such placed-in-service requirement does not apply to property that begins construction within one year after the enactment of OBBBA. The advanced manufacturing production credit remains largely intact, with some modifications. For all these credits, however, OBBBA adopts prohibited foreign entity rules, which prevent certain entities that either are owned or have commercial ties with persons from certain nations (i.e., China, North Korea, Russia, and Iran) from claiming credits. Further, OBBBA adopts material assistance rules, which bar the availability of credits where a prohibited foreign entity materially assisted with the manufacturing or construction of a project.

Advanced Manufacturing Investment Credit

The CHIPS and Science Act of 2022 enacted a 25% tax credit to provide semiconductor manufacturers an incentive to build semiconductor manufacturing facilities in the United States. Generally, under the CHIPS Act, taxpayers may receive a tax credit for 25% of the investment cost of qualifying facilities that manufacture semiconductors, or the equipment to manufacture semiconductors. OBBBA increases this credit from 25% to 35% for property placed in service beginning in 2026.

State and Local Tax Cap and Other Provisions

Increased State and Local Tax Cap

OBBBA increases the current $10,000 cap on the deductibility of state and local taxes (SALT) (set to expire on December 31, 2025) to $40,000 for 2025. For tax years after 2025 and through 2029, the SALT cap will nominally adjust upward by 1% every year. Beginning in 2030, the SALT cap will revert to $10,000. In addition, OBBBA enacts a modified adjusted gross income (MAGI) threshold, whereby taxpayers with MAGI over $500,000 (also adjusted upward by 1% each year) are generally subject to a phase-down of the SALT deduction. OBBBA does not impose restrictions on pass-through entity tax (PTET) regimes enacted by states and approved by the US Department of the Treasury in Internal Revenue Service (IRS) Notice 2020-75.

Modifications to Deductions for Charitable Contributions by Individuals

With respect to taxable years beginning after December 31, 2025, OBBBA allows individuals who do not itemize their deductions to once again claim a deduction for charitable donations of up to $1,000 for single filers and $2,000 for joint filers. Additionally, with respect to taxable years beginning after December 31, 2025, OBBBA allows individuals who itemize their deductions to claim a deduction for charitable donations only to the extent that the total contributions exceed 0.5% of an individual taxpayer’s adjusted gross income.

Limitation on Itemized Deductions

With respect to taxable years beginning after December 31, 2025, OBBBA provides that the total of itemized deductions a taxpayer may claim is reduced by 2/37 of the lesser of (1) the total itemized deductions otherwise allowable, or (2) the amount by which the taxpayer’s taxable income (before this limitation and increased by itemized deductions) exceeds the threshold where the 37% tax bracket begins for their filing status.

1% Floor on Corporate Charitable Giving

With respect to taxable years beginning after December 31, 2025, OBBBA allows corporations to claim a deduction for charitable donations only to the extent that the total contributions exceed 1% of the corporation’s taxable income.

Deduction for Tip Income Received

For taxable years 2025 through 2028, OBBBA provides up to a $25,000 federal income tax deduction for qualified tips received by an employee or independent contractor in certain occupations in which tips are customarily and regularly received. The deduction phases out beginning when the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return). The deduction is available to individuals who itemize deductions and individuals who do not itemize deductions. The IRS is expected to provide guidance and transition relief for individuals and their employers and payors on accounting for the deduction and related withholding and reporting changes.

Deduction for Overtime Pay

For taxable years 2025 through 2028, OBBBA provides a $12,500 federal income tax deduction ($25,000 in the case of a joint return) for qualified overtime compensation received by an individual. Qualified overtime compensation is defined as overtime compensation paid to an individual in excess of the regular rate paid to such individual. The deduction phases out beginning when the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return). To be eligible for the deduction, gross overtime pay must be reported separately on the employee’s Form W-2. The deduction is available to individuals who itemize deductions and individuals who do not itemize deductions. The IRS is expected to provide guidance and transition relief for individuals and their employers and payors on accounting for the deduction and related withholding and reporting changes.

Employer Credit for Paid Family and Medical Leave

For taxable years beginning after December 31, 2025, OBBBA made permanent the paid family and medical leave (FMLA) credit, which was scheduled to sunset at the end of 2025. With three modifications, (1) the credit would be available in all states (regardless of whether leave is required in such state), (2) the minimum employee work requirement could be reduced (at the election of the employer) from one year to six months, and (3) the credit could be claimed for an applicable percentage of FMLA insurance premiums paid or incurred by an eligible employer during a taxable year (i.e., an employer may elect between premiums paid or wages paid, but not both).

COVID-Related Employee Retention Credits

OBBBA disallows employee retention credit claims for the third and fourth quarters of 2021 filed after January 31, 2024. Further, the statute of limitations on assessments for those claims is extended to six years. OBBBA also imposes penalties and reporting requirements on employee retention credit promoters (i.e., persons who aid, assist, or advise taxpayers filing an employee retention credit claim and derive a significant portion of their revenue from such assistance).

Lastly, we note that numerous tax policies were considered during the OBBBA legislative making process that did not ultimately become law. We note specifically that OBBBA did not change the carried interest rules or taxation of social security benefits.

If you have any questions about the tax provisions highlighted above or OBBBA, please do not hesitate to contact our AFS Tax team.