The U.S. House of Representatives Issues Version of Tax Reform: Tax Cuts and Jobs Act
On September 27, 2017, the Trump Administration and Republican leaders released a unified framework for tax reform that would make changes to both individual and business taxation including suggested cuts in rates. The unified framework was a nine-page blueprint of proposals for tax relief that was not very specific or detailed. The President noted that he will leave it up to congressional committees to supply details.
On November 2, 2017, the House Ways and Means Committee released its version of the tax reform bill, The Tax Cuts and Jobs Act, which is 429 pages and contains many provisions that will affect business, personal and international taxpayers, if enacted.
Individual, Trust, and Estate Proposals
- Reduce the number of tax brackets from seven to four, with rates of 12, 25, 35 and 39.6 percent.
|Rates||Married Filing Jointly||Single and Married Filing Separately|
|12%||Zero – $90,000||Zero – $45,000|
|25%||$90,001 – $260,000||$45,001 – $130,000|
|35%||$260,001 – $1,000,000||$130,001 – $500,000|
|39.6%||Over $1,000,001||Over $500,001|
Note: Future brackets will be subject to inflation adjustments. There is also a phase-out of the 12% bracket for those single filers with taxable income in excess of $1,000,000 and married filers with taxable income in excess of $1,200,000.
- Increase the standard deduction to $24,000 for married taxpayers filing jointly; $18,000 for single filers with at least one qualifying child (Head of Household filers); and $12,000 for single filers. This is almost doubling the present standard deduction.
- Repeal personal exemptions.
- Increase the Child Tax Credit to $1,600. (Modified income limits will make the credit available to more families, but no portion of the increased amount will be refundable).
- Create two different $300 family credits, also non-refundable.
- One for nonchild dependents.
- One for each spouse, if they file jointly, or in the case of a single parent or head of household, depending on income levels.
- Repeal the Individual Alternative Minimum tax as of 2018 and provide for a refund of any Alternative Minimum Tax carryforward of 50% of remaining credits (in excess of regular tax) for years 2019, 2020, and 2021, with the balance refundable in 2022.
- Eliminate or modify most itemized deductions, such as:
- Deduction for state and local income taxes.
- Deduction for state and local property taxes in excess of $10,000.
- Deduction for personal casualty losses (except for personal casualty losses associated with special disaster relief legislation).
- Deduction of medical expenses.
- Deduction for employee business expenses.
- Deduction for mortgage interest subject to the following rules.
- Interest on acquisition debt currently in existence can be deducted under current rules.
- For debt incurred after November 2, 2017, the $1 million debt limit is reduced to $500,000 and will only include mortgage interest deduction on a principal residence. Home equity interest will be nondeductible.
- Deduction for tax preparation expenses.
- Deduction for moving expenses.
- Repeal of the overall limitation in itemized deductions, (known as the Pease Limitation).
- Eliminate many tax credits and income exclusions, including:
- Adoption tax credit.
- Plug-in electric motor vehicles credit.
- Exclusion for interest on U.S. savings bonds used to pay qualified higher education expenses.
- Exclusion from income for qualified tuition reduction programs.
- Exclusion for employer-provided education assistance programs.
- Exclusion for employer provided contributions to Archer Medical Savings Accounts.
- Deduction or alimony payments effective for any divorce decree or separation agreement executed or modified after 2017.
- Exclusion for employer provided housing for the convenience of the employer to the extent that the value of the housing exceeds $50,000 ($25,000 for a married individual filing a separate return). The amount excluded is subject to a phase-out for highly compensated individuals (income of $120,000, as adjusted for inflation).
- A phase-out of the exclusion of gain from the sale of a principal residence on a dollar-for-dollar basis, where the taxpayer’s adjusted gross income exceeds $500,000 ($250,000 for those filing married filing separate).
- Exclusion for employee achievement awards.
- Exclusion for employer dependent care assistance program.
- Exclusion for qualified moving expense reimbursement.
- Elimination of the Deduction for Domestic Production Activities.
- Credit for clinical testing expenses for certain drugs for rare diseases or conditions.
- Employer-provided child care credit.
- Rehabilitation Credit.
- Work Opportunity Credit.
- New Markets Tax Credits.
- Disabled Access Credit.
- Retain and simplify the Earned Income Tax Credit to improve efficiency.
- Changes to the rules dealing with charitable contributions effective for tax years beginning after 2017.
- The 50% adjusted gross income limit for cash contributions to public charities and certain private foundations is increased to 60%. The 5-year excess deduction carryover rule is retained.
- The charitable mileage rate is to be adjusted for inflation.
- Doubles the basic exclusion amount for gift and estate tax purposes from the current exclusion of $5.49 million in 2017, as indexed for inflation, to $10 million, which will be indexed for inflation.
- Lowers the gift tax rate to a top rate of 35%.
- Repeal the estate and generation-skipping transfer taxes, while retaining the stepped up basis rules, in 2024.
Due to the changes described above, many taxpayers will no longer opt to itemize deductions. Further, as a relief to many, there are not going to be any changes to 401K plans. The beneficial tax rates on long-term capital gains and qualified dividends continue to apply, but ordinary income from interest and short term capital gains could be taxed as high as 39.6%.
- Lower the top corporate tax rate from 35 percent to a flat 20 percent, or 25% for personal service corporations, beginning after 2017.
- Eliminate the corporate alternative minimum tax.
- Create a maximum 25% rate on “business income” from pass-through entities such as partnerships, S Corporations and Limited Liability Companies (LLCs,) as well as, sole proprietorships. Since a portion of these earnings may relate to owners’ own labor, different allocations and rates may apply:
- Where the individual is passive with respect to the activity (determined under the passive activity rules), then 100% of the income is subject to the 25% maximum rate.
- Where the individual materially participates in the activity, then either a default or elective portion of the income applies for the 25% rate.
- Default Portion: For certain service professionals (e.g., doctor, lawyer, accountant, engineering, consulting, financial service advisor, or performing artists), the default portion eligible for the 25% rate is zero (causing all of the income to be subject to regular tax rates). For other activities, the default rate is 30%, allowing this portion to be subject to the 25% rate and 70% to be treated as regular income.
- Elective Portion: All businesses (including professional services businesses) can elect to calculate a portion eligible for 25% treatment. This portion of the income is determined under a formula using the short term rate plus 7%, multiplied by the capital investments of the business. Once an election is made, it must be used for five years.
- Significant revisions to the treatment of partnership profits and S corporation profits for self-employment tax purposes. The proposal would eliminate long standing loopholes that permit limited partners and S corporation shareholders to avoid paying self-employment tax on their share of profits. The revisions would apply to taxable years beginning after December 31, 2017.
- Allow immediate expensing of the cost of new investments in depreciable assets acquired after September 27, 2017, and before January 1, 2023. (The placed-in-service date will be extended for one year for property with a longer production period).
- Unlike the present bonus depreciation rules, the asset does not have to be new property; however, the taxpayer’s business must be the first use of the property, and;
- Qualified property does not include any property used in a real property trade or business.
- Section 179 expensing is increased to $5,000,000 for years 2018 to 2022.
- Qualified energy efficient heating and air conditioning property will be included as Section 179 property.
- Every business, regardless of form, would be subject to disallowance of a deduction for net interest expense in excess of 30% of the business’ adjusted taxable interest. Net interest expense is determined at the tax filer level (e.g., the partnership versus a partner). Adjusted taxable income is business taxable income without regard to business interest expense, business interest income, net operating losses, depreciation, amortization and depletion. Disallowed interest under this rule becomes a carryover to the next five years as an attribute of the business (not its owners). Businesses with average gross receipts of $25 million or less would be exempt from the interest limitation rules.
- Eliminate the deduction under Internal Revenue Code § 199 for domestic production (DPAD) and state and local tax deductions.
- Net Operating Losses (NOLs) would generally not be eligible for a carryback, but there would be a special one-year carryback for small business and farms in the case of certain casualty and disaster losses. However, any carryback or carryover could be used only to the extent of 90% of income. This rule would apply to losses arising in tax years beginning after 2018. Additionally, NOLs arising in tax years beginning after 2017 that are carried forward are to be increased by an interest factor to preserve their value.
- After 2017, like-kind exchanges will apply only to real property, subject to a transition rule to allow an exchange for personal property if there was a disposition of relinquished property or acquisition of replacement property by December 31, 2017.
- Gross income of a corporation will include a contribution to its capital to the extent that the fair market value of property or money contributed exceeds the fair market value of stock that is issued. (A similar rule will apply for other non-corporate entities).
- The technical termination rule for partnerships will be repealed.
- No deduction will be allowed for entertainment, amusement or recreation activities, facilities or membership dues relating to such activities or other social purposes. However the current deduction for business meals (subject to the 50% limitation) will be retained.
- The bill will repeal Section 409A and replace it with a new Section 409B. 409A includes a complicated set of rules related to the taxation of non-qualified deferred compensation. Failure to comply with Section 409A may result in penalties and income inclusion. New Section 409B, effective for services after December 31, 2017, will require non-qualified deferred compensation to be included in income when vested, regardless of payment date. This is more onerous than 409A.
- Section 162(m), related to non-deductible limitations of compensation in excess of $1,000,000 paid to executives of publicly traded companies, will be repealed effective for years beginning after December 31, 2017.
Based on the above summary, many current business benefits will face repeal, but the framework specifically retains the R&D Credit and the Low Income Housing Tax Credit. It appears that no new rules will apply with respect to carried interests, except the bill makes it clear that such income will not be subject to the 25% maximum tax rate on business income.
International Tax Proposals
- U.S. shareholders owning at least 10 percent of a foreign subsidiary, generally, would include in income for the subsidiary’s last tax year beginning before 2018, the shareholder’s pro rate share of the net post-1986 historical earnings and profits (E&P) of the foreign subsidiary, to the extent such E&P has not been previously subject to U.S. tax, determined as of November 2, 2017, or December 31, 2017 (whichever is higher).
- Provide for 100% exemption on the foreign sourced portion of dividends paid by foreign subsidiaries owned at least 10% by a U.S. parent, effective for years after 2017.
- Foreign subsidiaries of U.S. companies with “foreign high returns” based on the subsidiaries’ foreign activities will subject the U.S. parent to current tax on fifty percent of such income on a current basis over specified thresholds, effective for years after 2017.
- Excise tax of 20% on certain deductible payments by U.S. corporations to foreign related corporations, unless the foreign corporation elects to treat the payment as effectively connected with a U.S. trade or business, effective for years after 2017.
- No foreign tax credit or deduction would be allowed for any foreign taxes (including withholding taxes) paid or accrued with respect to any exempt dividend.
- The imposition of current U.S. tax on U.S. corporate shareholders with respect to untaxed foreign subsidiary earnings reinvested in United States property would be repealed. The provision would be effective for tax years of foreign corporations beginning after 2017.
- A U.S. parent will reduce the basis of its stock in a foreign subsidiary by the amount of any exempt dividends received by the U.S. parent from its foreign subsidiary – but only for purposes of determining the amount of a loss (but not the amount of any gain) on any sale or exchange of the foreign subsidiary stock by its U.S. parent. The provision would be effective for distributions made after 2017.
- Where a U.S. corporation transfers substantially all of the assets of a foreign branch to a foreign subsidiary, the U.S. corporation will be required to include in income the amount of any post-2017 losses that were incurred by the branch. The provision would be effective for transfers made after 2017.
- The bill provides for limitations on utilization of foreign tax credits paid or accrued for certain dividend income.
- The deductible net interest expense of a U.S. corporation that is a member of an international reporting group would be limited to the extent the group’s global net interest expense exceeds 110% of the U.S. corporation’s share of the groups global earnings.
At this time, the Tax Cuts and Jobs Act is still in the proposal process, with lawmakers attempting to simplify the tax code and provide relief to the American middle class. Many details are expected to be challenged by political opposition and economists and those residing in high-tax states.
Your Marcum Tax Advisor will keep you posted on any revisions to these proposals or the finalization of the new law.