The Senate releases its version of tax reform

Authored by Patrick Balthazor, Paul Dillon, Michelle Hobbs, Mike Schiavo and Michael Wronsky

On Thursday, the Senate released a detailed description of its initial tax reform bill, the Senate Tax Cuts and Jobs Act (STCJA). The STCJA now heads to markup by the Senate Finance Committee the week of Nov. 13. Majority Leader Mitch McConnell indicated he expects the Senate to hold a vote on the bill before Thanksgiving. If it passes, it would then go to a conference committee to negotiate differences between it and the House version.

The budget reconciliation recently passed by both houses of Congress allows for $1.5 trillion in tax revenue losses over the next 10 years. However, under budget rules, if tax cuts create a deficit beyond the 10-year budget window, they have to sunset after a decade. This is similar to the Bush tax cuts that previously expired in 2012. While the deficit can increase by $1.5 trillion under the budget resolution, revenue losses under the framework have been projected to be at least $4 trillion. Therefore, tax writers continue to debate how to bridge the revenue loss.

Significant differences exist between the Senate and House versions. In particular, the Senate proposal would delay the corporate rate reduction for one year, until 2019, as well as retain seven tax brackets for individuals rather than reducing the number of brackets to four. Other big changes from the House version include a repeal of all individual deductions for state and local income and property taxes. However, the Senate retains the deduction for medical expenses.

Further, the Senate bill differs in regard to the tax rate imposed on business conducted via pass-through entities, and that it would not repeal the estate tax.

In this alert, we compare certain provisions in the STCJA just proposed by the Senate and the TCJA currently being debated in the House.

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

 House bill (HR 1 – Tax Cuts and Jobs Act)Senate bill (Description of the Chairman’s Mark of the Tax Cuts and Jobs Act – JCX-51-17)
Corporate rates
  • 20% flat rate, beginning in 2018
  • 20% flat rate, beginning in 2019
  • Rate reduction is permanent
  • Rate reduction is permanent
  • 25% for personal service corporations
  • 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 17.4% deduction for domestic qualified business income from a partnership, S corporation or sole proprietorship
  • 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
  • Does not apply to specified services businesses, except in the case of a taxpayer whose taxable income does not exceed $150,000 (married filing joint), $75,000 for other individuals
  • 70% of active business income taxed as compensation (ordinary rates), remaining 30% eligible for special 25% flow-through rate
  • 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
  • Certain professional service businesses generally not eligible for 25% rate, including law, accounting, medicine, engineering, architecture
  • 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
  • Capital-intensive businesses may calculate a higher capital percentage based on facts and circumstances
  • Qualified business losses carry forward to next taxable year
  • 100% of passive business income is eligible for the special 25% rate
  • No specific provisions for passive income
Business interest
  • Deduction for interest expense limited to 30% of adjusted taxable income (EBITDA)
  • Deduction for interest expense limited to 30% of adjusted taxable income
  • Applies, regardless of entity form; for partnerships, limitation is at the partnership level
  • 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
  • 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)
  • Automobile dealers 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
  • No provision for auto dealers
  • Small business exception: does not apply to businesses with average gross receipts of $25 million or less
  • Small business exception: does not apply to businesses with average gross receipts of $15 million or less
 
  • Limitation does not apply to certain regulated public utilities
Net operating losses (NOLs)
  • NOLs modified – taxpayers can deduct NOLs up to 90% of taxable income
  • NOLs modified – taxpayers can deduct NOLs up to 90% of taxable income
  • Most taxpayers can no longer carry an NOL back
  • Two-year carryback repealed other than for farmers
  • NOLs can be carried forward indefinitely for most taxpayers
  • NOLs can be carried forward indefinitely
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
  • 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
  • No provision included
  • Repeal tax credit bonds
  • 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
  • 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
  • No provision for recovery periods
  • 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
  • § 179 expensing limit increased to $5 million, phaseout threshold increased to $20 million
  • § 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
  • § 199 domestic production activities deduction repealed
  • R&D credit, Low-Income Housing Tax Credit (LIHTC) retained
  • R&D credit and LIHTC are retained
  • Work Opportunity Tax Credit (WOTC), employer-provided child care credit, rehabilitation credit repealed
  • No provision for WOTC or employer-provided child care credit; rehabilitation credit is modified
  • No additional New Markets Tax Credits (NMTC) allocated after 2017
  • No provision for NMTC
  • Like-kind exchanges repealed for personal property; LKEs retained for real estate
  • 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 regarding amortization of research

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 to 38.5% from 39.6%; other brackets are: 10%, 12%, 22.5%, 25%, 32.5%, 35%
  • 38.5% bracket begins at taxable income of $500,000 for single filers/$1 million for joint filers
Other individual provisions
  • Standard deduction increased to $12,200 (single filers)/$24,400 (joint filers) beginning 2018
  • Standard deduction increased to $12,000 (single filers)/$24,000 (joint filers) beginning 2018
  • Personal exemptions repealed
  • Personal exemptions repealed
  • Most itemized deductions repealed, including state and local income tax
  • Most itemized deductions repealed, including all state and local taxes
  • Mortgage interest deduction retained for existing loans; for new loans after Nov. 2, 2017, deduction limited to interest on $500,000 acquisition debt
  • Mortgage cap retained at $1 million for all acquisition loans; deduction for home equity indebtedness is repealed
  • Property tax deduction retained, but limited to $10,000
  • Property tax deduction repealed entirely
  • Charitable contribution deduction retained and modified
  • Charitable contribution deduction retained and modified
  • Repeals medical expense itemized deduction
  • Retains 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)
  • 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 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
  • Child tax credit increases to $1,650 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 $1 million for joint filers and $500,000 for all other taxpayers
  • 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
  • No provision for alimony
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
  • No provision included, however, Sen. Grassley has indicated carried interests will be addressed during markup
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
  • Mandatory inclusion of pro rata share of undistributed, nonpreviously taxed post-1986 foreign earnings
  • Would be imposed on E&P as of either Nov. 2, 2017, or Dec. 31, 2017, whichever is greater
  • Imposed for the last taxable year beginning before Jan. 1, 2018
  • 14% on E&P related to cash and cash equivalent assets
  • 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
  • 7% on remaining E&P
  • Can elect to pay tax liability over eight years
  • Can be paid in eight installments
Estate and gift taxes
  • Estate/GST exemption doubles starting in 2018 (to $11.2 million from $5.6 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 (to $11.2 million from $5.6 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
  • 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
Deferred compensation
  • No provision
  • For services performed after 2017, employees are taxed on deferred compensation as soon as there is no longer a substantial risk of forfeiture; existing plans based on pre-2018 service are grandfathered until the later of the last tax year beginning before 2027 or the taxable year in which there is no substantial risk of forfeiture

 

Conclusion:

Neither the House nor Senate bills are retroactive to Jan. 1, 2017. Rather, most provisions would apply beginning in 2018. Whether or not some version of these proposals is enacted, it is highly unlikely rates will increase in 2018. Therefore, for the balance of 2017, we continue to recommend the time-honored approach of deferring income and accelerating deductions in order to reduce your current-year liability. Please see our year-end tax planning letter for additional information.

  • Defer income. For example, cash-basis taxpayers may want to postpone billing clients until January.
  • Maximize contributions to 401(k)s and other pre-tax retirement accounts in 2017. If this means saving less in 2018 so the net savings between the two years is the same, the tax savings may be worth it.
  • Postpone retirement account withdrawals. If you are retired and withdrawing money from a retirement plan, cash flow permitting, consider suspending any additional withdrawals for 2017 and catching up in 2018.
  • Accelerate state tax payments. If you have flexibility in when you can pay your real estate taxes, accelerate the payment — as well as 2017 state income tax payments — into 2017.
  • Caution: Accelerating certain deductions into 2017 could trigger the AMT, defeating the purpose of claiming the additional deductions in the first place. We recommend you meet with your tax advisor to run multiyear projections to determine the best strategy for your personal situation.

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. Differing components, such as the several individual tax brackets or the implementation of the reduced corporate rate, we expect will be the focus of debate during the conference process which will impact any final outcome. 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.


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.