Tax reform: The journey continues ...

Last week, the House passed the Tax Cuts and Jobs Act (TCJA). In addition, the Senate Finance Committee completed the markup of its own version of the TCJA and sent it to the full Senate for debate after the Thanksgiving holiday.

The Senate Finance Committee made numerous substantive changes to its initial bill introduced earlier this month, including the following.

Individual rate cuts are temporary. Reduced rates for individuals would expire Dec. 31, 2025. At that time, rates and brackets would revert back to today’s structure, and the individual alternative minimum tax would be reinstated. The lower rates related to pass-through business income also would expire in 2026.

This expiration is essentially a budget gimmick in order to bring the bill into compliance with Senate rules that the bill cannot add to the deficit beyond the 10-year budget window. This is similar to the “Bush tax cuts” that ended after a decade. Potentially, this expiration could lead to another fiscal cliff in 10 years when debate begins about extending the rate reductions.

According to the Congressional Budget Office (CBO), taxpayers would see their tax bills drop by an average of 7.4 percent in 2019; however, by 2027, their taxes would rise by an average of 0.2 percent. Lower-income taxpayers would be hardest hit, with those making between $20,000 and $30,000 seeing their tax bills start to rise in 2021 and up to 25.4 percent by 2027. Those making more than $75,000 would see their taxes go down, albeit by less than 1 percent by the final year, while everyone making under $75,000 would see some level of tax increase.

Corporate rate cuts are permanent. The Senate bill would implement a permanent corporate rate reduction to 20 percent starting in 2019. The House bill cuts the corporate rate to 20 percent starting in 2018.

Affordable Care Act individual mandate is repealed. The shared responsibility payment under the Affordable Care Act (ACA) would be reduced to zero, effectively eliminating the individual mandate to purchase health insurance. The CBO estimates this repeal would save the government roughly $300 billion in subsidies it would no longer have to pay as a result of enrollment decreases.

A coalition of leading healthcare groups, including the American Medical Association and America’s Health Insurance Plans, recently urged lawmakers to maintain the individual mandate. “Eliminating the individual mandate by itself likely will result in a significant increase in premiums, which would in turn substantially increase the number of uninsured Americans,” the groups wrote. The CBO estimates that premiums would rise 10 percent without the mandate and 13 million more people would be uninsured over a decade.

Critical Senate and House differences

Where components are similar between the Senate and House versions, such as the repeal of the corporate and individual AMT, we believe there is a greater likelihood those provisions would be included in final legislation. However, significant differences exist that may lead to intense debate as to how a compromise bill can be reconciled. Voting margins are relatively tight in both houses of Congress; the House passed the TCJA with a 227-205 vote, the Senate Finance Committee markup was approved by a party line vote of 14-12. Accordingly, this is not likely to be a quick process. If the bill passes the Senate with differences from the House version, the two bills will go to a conference committee. Major areas of contention include:

  • Effective date of corporate rate reduction. The House wants the reduction in 2018 while the Senate would delay until 2019.
  • Reduced rate for pass-through businesses. Both chambers use completely different methodologies for achieving the reduced rate and disagree on the types of businesses that will be eligible. The approaches are detailed in the chart below.
  • Excess business losses. The Senate would create a new restriction for noncorporate taxpayers with “excess business losses.” For this purpose, excess business losses are the amount by which business deductions exceed gross business income. This provision would limit such losses to $500,000 (married filing jointly) and $250,000 for all other taxpayers per year. In other words, business losses cannot offset nonbusiness income by more than the allowed amounts in any taxable year. Any excess loss would be carried forward. This is a significant restriction over current law.
  • Repeal of the individual state and local tax deduction. Both the Senate and House would repeal the deduction for state income taxes. The House would preserve a limited (up to $10,000) deduction for real property taxes. The Senate would repeal the state and local tax deduction in full. Expect a large pushback from the larger higher-taxed states where any restriction on the state and local tax deduction is unpopular. Both bills preserve this deduction for corporations but disallow it for pass-through entity state income taxes.
  • Repeal of individual mandate. This was added late in the process to the Senate bill. Since the Senate failed to repeal the ACA this past summer, inclusion here could be just as divisive.
  • Home mortgage interest limitation. The House would reduce the mortgage cap to $500,000 from $1 million. The Senate would leave the $1 million cap in place. Any change to the existing rules will be met by fierce opposition from the powerful real estate lobby.
  • Private activity bonds. The House version would eliminate tax exemption for private activity bonds, used by universities, hospitals and lower-income housing, as well as advanced refunds, which is about one-quarter of municipal issuances. The Senate, however, proposes retaining the private activity bonds, about 20 percent of issuance. If enacted, this would likely lead to higher borrowing costs for municipal issuers and would increase the strain on local budgets.

Comparison of major components (not an all-inclusive list)

 House bill (H.R. 1 – Tax Cuts and Jobs Act)Senate bill (approved Senate Finance Committee version)
Corporate rates
  • 20% flat rate, beginning in 2018
  • Rate reduction is permanent
  • 25% for personal service corporations
  • 20% flat rate, beginning in 2019
  • Rate reduction is permanent
  • The special rate for personal service corporations would be eliminated
Pass-through business entities
  • Business income from pass-through entities, including sole proprietorships eligible for a maximum rate of 25%; however, there are “reasonable compensation” limitations
  • Provides for a reduced 9% rate in lieu of the ordinary 12% rate for first $75,000 of net business income for an active owner or shareholder earning less than $150,000 in taxable income through a pass-through business; benefit is phased out as income increases above $150,000
  • 70% of active business income taxed as compensation (ordinary rates), remaining 30% eligible for special 25% flow-through rate
  • Certain professional services businesses generally not eligible for 25% rate, including law, accounting, medicine, engineering, architecture
  • Capital-intensive businesses may calculate a higher capital percentage based on facts and circumstances
  • 100% of passive business income is eligible for the special 25% rate
  • No sunset provision
  • Provides for a 17.4% deduction for domestic qualified business income from a partnership, S corporation or sole proprietorship
  • Does not apply to specified services businesses, except in the case of a taxpayer whose taxable income does not exceed $500,000 (married filing joint), $250,000 for other individuals; benefit of deduction for services businesses phases out over the next $100,000 of taxable income for joint filers or $50,000 for other individuals
  • A specified service business means any business activity involving health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any trade where the principal asset is the reputation or skill of one or more of its employees
  • Qualified business income does not include any amount paid by an S corporation as reasonable compensation to the taxpayer or as a guaranteed payment for services to a partner
  • Deduction generally limited to 50% of the taxpayers pro rata share of W-2 wages of the partnership, S corporation or sole proprietorship
  • Qualified business losses carry forward to next taxable year
  • No specific provisions for passive income
  • Deduction for pass-through business would sunset after Dec. 31, 2025
Business interest
  • Deduction for interest expense limited to 30% of adjusted taxable income (EBITDA)
  • Applies regardless of entity form; for partnerships, limitation is at the partnership level
  • Does not apply to real property trades or businesses, certain regulated public utilities
  • Certain business would be allowed a full deduction of interest related to "floor plan financing indebtedness"; however, full expensing of assets would not be allowed to any business that has floor plan financing debt
  • Small business exception:  Does not apply to businesses with average gross receipts of $25 million or less
  • Deduction for interest expense limited to 30% of adjusted taxable income
  • Applies regardless of entity form; for partnerships, limitation is at the partnership level
  • Real property trades or businesses can elect out of this limitation; however, the trade-off is a longer depreciation period for real property (i.e., ADS); ADS life for residential rental property decreases to 30 years
  • No provision for floor plan financing
  • Limitation does not apply to certain regulated public utilities and electric cooperatives
  • Small business exception:  Does not apply to businesses with average gross receipts of $15 million or less
Net operating losses (NOL)
  • NOLs modified – taxpayers can deduct NOLs up to 90% of taxable income
  • Most taxpayers can no longer carry an NOL back
  • NOLs can be carried forward indefinitely for most taxpayers
  • NOLs modified – taxpayers can deduct NOLs up to 90% of taxable income; 90% limit is further reduced to 80% for tax years beginning after Dec. 31, 2022; would be repealed effective for tax years beginning after Dec. 31, 2025, if Oct. 1, 2017-Sept. 30, 2026, revenue targets are met
  • Two-year carryback repealed for most taxpayers
  • NOLs can be carried forward indefinitely
Limitation on losses for non-corporate taxpayers
  • No provision
  • Would limit “excess business losses” of a taxpayer other than a C corporation to $500,000 per year (joint filers)/$250,000 per year (single filers)
  • An excess business loss for the tax year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer, over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount ($500,000 for married taxpayer filing jointly; $250,000 for other individuals, adjusted for inflation)
  • The limitation would apply at the partner or S corporation shareholder level
  • Disallowed losses are carried forward and treated as part of the taxpayer’s NOL
Banking provisions
  • Deductions for FDIC premiums would be limited for institutions with consolidated assets in excess of $10 billion and eliminated for institutions with consolidated assets in excess of $50 billion
  • Private activity bond - The proposal would repeal the tax-exempt status for qualified activity bonds and terminate the qualified bond classifications
  • Repeal tax credit bonds
  • Deductions for FDIC premiums would be limited for institutions with consolidated assets in excess of $10 billion and eliminated for institutions with consolidated assets in excess of $50 billion
  • No provision included
  • No provision included
Other business provisions
  • 100% expensing for qualified property placed in service after Sept. 27, 2017, and before Jan. 1, 2023; property used in a real estate trade or business, or by certain regulated public utilities, is not eligible for 100% expensing
  • No provision for recovery periods
  • § 179 expensing limit increased to $5 million, phaseout threshold increased to $20 million
  • § 199 domestic production activities deduction repealed
  • R&D credit, Low-Income Housing Tax Credit (LIHTC) retained
  • Work Opportunity Tax Credit (WOTC), employer-provided child care credit, rehabilitation credit repealed.
  • No additional New Markets Tax Credits (NMTC) allocated after 2017
  • Like-kind exchanges repealed for personal property; LKEs retained for real estate
  • Certain research or experimental expenditures are required to be capitalized and amortized over five years (15 years for research outside of the U.S.)
  • No provision
  • 100% expensing for qualified property placed in service after Sept. 27, 2017, and before Jan. 1, 2023; property used by certain regulated public utilities is not eligible for 100% expensing
  • Recovery period for both residential and nonresidential real property reduced to 25 years; also, a 10-year recovery period is established for qualified improvement property
  • Taxpayers in real property trades or businesses that elect out of the interest limitation are required to use ADS recovery periods; the ADS recovery period for residential real property would be reduced to 30 years
  • § 179 expensing limit increased to $1 million, phaseout threshold increased to $2.5 million; expands the definition of § 179 property to include improvements to nonresidential real property:  roofs, heating, ventilation, and air-conditioning property, fire protection and alarm systems, and security systems
  • § 199 domestic production activities deduction repealed
  • R&D credit is retained LIHTC is modified
  • No provision for WOTC or employer-provided child care credit; rehabilitation credit is modified
  • No provision for NMTC
  • LKEs repealed for personal property; LKEs retained for real estate
  • Certain research or experimental expenditures incurred in taxable years beginning after 2025 are required to be capitalized and amortized over five years (15 years for research outside of the U.S.)
  • Creates new family and medical leave credit equal to 12.5% of wages paid to qualifying employees, subject to restrictions
Individual rates
  • Four brackets: 12%, 25%, 35%, 39.6%
  • 39.6% bracket begins at taxable income of $500,000 for single filers/$1 million for joint filers
  • 12% rate phased out for AGI over $1 million (single filers)/$1.2 million (joint filers)
  • Maintains seven brackets: lowers the top rate from 39.6% to 38.5%; other brackets are:  10%, 12%, 22%, 24%, 32%, 35%
  • 38.5% bracket begins at taxable income of $500,000 for single filers/$1 million for joint filers
  • Rate structure sunsets after Dec. 31, 2025
Other individual provisions
  • Standard deduction increased to $12,200 (single filers)/$24,400 (joint filers) beginning 2018
  • Personal exemptions repealed
  • Most itemized deductions repealed, including state and local income tax
  • Mortgage interest deduction retained for existing loans; for new loans after Nov. 2, 2017, deduction limited to interest on $500,000 acquisition debt
  • Property tax deduction retained, but limited to $10,000
  • Charitable contribution deduction retained and modified
  • Repeals medical expense itemized deduction
  • Exclusion of gain on sale of principal residence – retained and modified; exclusion phases out for taxpayers with average annual AGI over $250,000 ($500,000 for joint filers)
  • Child tax credit increased to $1,600; family tax credit of $300 and nonchild dependent credit of $300 added; income levels for credit phaseout increased to $115,000 (single filers)/$230,000 (joint filers); the family tax credit and the nonchild dependent credit expire after 2022
  • Alimony payments would no longer be deductible by the payor or included in the income of the recipient; this repeal would apply to any divorce or separation decree executed after 2017 as well as any modification to an existing agreement made after 2017 if the modification expressly provides for this section to apply
  • Standard deduction increased to $12,000 (single filers)/$24,000 (joint filers) beginning 2018
  • Personal exemptions repealed
  • Most itemized deductions repealed, including all state and local taxes
  • Mortgage cap retained at $1 million for all acquisition loans; deduction for home equity indebtedness is repealed
  • Property tax deduction repealed entirely
  • Charitable contribution deduction retained and modified
  • Retains medical expense itemized deduction
  • Exclusion of gain on sale of principal residence – retained and modified; extends the length of time a taxpayer must use a house to qualify for the exclusion and taxpayers may use the exclusion once every five years; no phaseout for AGI
  • Child tax credit increases to $2,000 per qualifying child and increases the age limit so that it can be claimed for any child under 18; credit is phased out beginning at $500,000 for married filing joint taxpayers
  • No provision for alimony
  • Most of these individual provisions sunset after Dec. 31, 2025
Carried interests
  • Long-term capital gain from carried interests held less than three years will be treated as short-term capital gain (i.e., taxed at ordinary rates)
  • Recharacterization rule applies to the performance of substantial services related to securities, commodities, real estate held for rental or investment, cash or cash equivalents, options or derivatives, partnership interests
  • Exception for capital interests
  • Senate provision similar to the House proposal
Accounting for long-term contracts
  • The $10 million average gross receipts exception to the requirement to use the percentage-of-completion accounting method for long-term contracts to be completed within two years would be increased to $25 million (indexed for inflation) for contracts entered into after 2017, and businesses that meet such exception would be permitted to use the completed-contract method (or any other permissible exempt contract method)
  • The $10 million average gross receipts exception to the requirement to use the percentage-of-completion accounting method for long-term contracts to be completed within two years would be increased to $15 million (indexed for inflation) for contracts entered into after 2017, and businesses that meet such exception would be permitted to use the completed-contract method (or any other permissible exempt contract method)
International
  • 100% deduction for foreign-source portion of dividends received from “specified 10-percent owned foreign corporations” after 2017
  • No foreign tax credit or deduction allowed for dividends that qualify for 100% deduction
  • 100% deduction for foreign-source portion of dividends received from “specified 10-percent owned foreign corporations” after 2017
  • No foreign tax credit or deduction allowed for dividends that qualify for the deduction
Repatriation
  • One-time mandatory “deemed repatriation” tax
  • Would be imposed on E&P as of either Nov. 2, 2017, or Dec. 31, 2017, whichever is greater
  • 14% on E&P related to cash and cash equivalent assets
  • 7% on remaining E&P
  • Can elect to pay tax liability over eight years
  • Mandatory inclusion of pro rata share of undistributed, non-previously taxed post-1986 foreign earnings
  • Imposed for the last taxable year beginning before Jan. 1, 2018
  • A portion of the mandatory inclusion is deductible, resulting in a 10% rate on E&P related to cash/cash equivalents and a 5% rate on remaining E&P
  • Can be paid in eight installments
Estate and gift taxes
  • Estate/GST exemption doubles starting in 2018 (from $5.6 million to $11.2 million per person)
  • Estate/GST tax fully repealed after 2023; beneficiaries retain stepped-up basis
  • No changes to gift taxes
  • Estate/GST exemption doubles starting in 2018 (from $5.6 million to $11.2 million per person)
  • Estate/GST tax is maintained with above-mentioned exemptions
  • No changes to gift taxes
AMT
  • AMT repealed beginning in 2018 for both individuals and corporations
  • Taxpayers can claim 50% of remaining AMT credit carryforwards in 2019-2021 and all remaining credits in 2022
  • AMT repealed beginning in 2018 for both individuals and corporations; repeal of the individual AMT would expire after Dec. 31, 2025
  • AMT credits are refundable for any taxable year beginning after 2017 and before 2022 based on a formula
Exempt organizations
  • 1.4% excise tax on net investment income of certain private universities
  • 20% excise tax on compensation in excess of $1 million paid to any of the exempt entity’s five highest-paid employees for the tax year
  • 1.4% excise tax on net investment income of certain private universities
  • 20% excise tax on compensation in excess of $1 million paid to a covered employee

We continue to monitor the legislative process and will publish insights and analysis as negotiations move through Congress.

For related insights and in-depth analysis, see our tax reform resource center.

For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.


The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.