Keeping current with the proposed tax reform laws, from both the Senate and the House of Representatives, is a daunting task!  It seems as if they make changes daily, nonetheless we all need to pay attention to the versions as they are introduced.

Let’s begin with the House Ways and Means Committee draft for tax reform.

Of importance to most of you will be the following individual considerations:

1. Summary of Rates

The current rates are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% but the new bill would impose four tax rates on individuals: 12%, 25%, 35%, and 39.6%, effective for tax years beginning 2018.

  • The 25% bracket would start at $45,000 of taxable income for single taxpayers and at $90,000 for married taxpayers filing jointly.
  • The 35% bracket would start at $200,000 of taxable income for single taxpayers and at $260,000 for married taxpayers filing jointly.
  • The 39.6% bracket would apply to taxable income over $500,000 for single taxpayers and $1 million for joint filers.

2. Standard Deduction and Personal Exemption

The standard deduction would increase from $6,350 to $12,200 for single taxpayers and from $12,700 to $24,400 for married couples filing jointly, effective for tax years after 2017. Single filers with at least one qualifying child would get an $18,300 standard deduction. These amounts will adjust for inflation after 2019.

They would repeal most other deductions, including the medical expense deduction, the alimony deduction, and the casualty loss deduction (except for personal casualty losses associated with special disaster relief legislation).  Additionally they would eliminate the deduction for tax preparation fees.

The personal exemption would be eliminated.

The mortgage interest deduction on existing mortgages would remain the same; for newly purchased residences (that is, for debt incurred after Nov. 2, 2017), the limit on deductibility would be reduced to $500,000 of acquisition indebtedness from the current $1.1 million. The overall limitation of itemized deductions would also be repealed.

3. Charitable Contributions

Some rules would change for tax years beginning after 2017, including the current 50% limitation which would be increased to 60%.

4. Other Deductions

  • The deduction for state and local income or sales taxes would be eliminated, except that income or sales taxes paid in carrying out a trade or business or producing income would still be deductible. State and local real property taxes would continue to be deductible, but only up to $10,000. These provisions would be effective for tax years beginning after Dec. 31, 2017.
  • The deduction for interest on education loans would be repealed.
  • The deduction for qualified tuition and related expenses would be repealed.
  • The exclusion for interest on U.S. savings bonds used to pay qualified higher education expenses would be repealed.
  • The exclusion for qualified tuition reduction programs would be repealed.
  • Employer-provided education assistance programs would be repealed.

5. Changes to Credits

  • It would repeal the adoption tax credit.
  • The credit for the elderly and the totally and permanently disabled would also get repealed.
  • The credit associated with mortgage credit certificates, and the credit for plug-in electric vehicles would be repealed.
  • It would increase the child tax credit from $1,000 to $1,600, with the first $1,000 of the credit refundable.
  • It would allow a new nonrefundable “family” credit of $300 to each taxpayer (and spouse in the case of a joint return) and each dependent who is not a qualifying child.
  • The $300 credit for non-child dependents would expire after 2022
  • The American opportunity tax credit, the Hope scholarship credit, and the lifetime learning credit would be combined into one credit, providing a 100% tax credit on the first $2,000 of eligible higher education expenses and a 25% credit on the next $2,000, effective for tax years after 2017
  • Contributions to Coverdell education savings accounts (except rollover contributions) would be prohibited after 2017, but taxpayers would be allowed to roll over money in their Coverdell ESAs into a Sec. 529 plan
  • The alternative minimum tax (AMT) would be repealed

6. Estate Tax Changes

  • The estate tax would be repealed after 2023 (with the step-up in basis for inherited property retained). In the meantime, the estate tax exclusion amount would double (currently it is $5,490,000, indexed for inflation)
  • The top gift tax rate would be lowered to 35%

 

Along with individual considerations, the tax proposals have business implications as well:

  1. Pass Through Income

  • A portion of net income distributions from pass through entities would be taxed at a maximum rate of 25%, instead of at ordinary individual income tax rates, effective for tax years after 2017. Passive activity income would always be eligible for the 25% rate. The bill includes provisions to prevent individuals from converting wage income into pass through distributions.
  • Owners and shareholders generally could elect to treat 30% of the income from non-passive business activities (including wages), as eligible for the 25% rate; ordinary income tax rates would apply to the other 70% . Alternatively, owners and shareholders could apply a facts-and-circumstances formula.
  • For specified service activities defined as any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees), including investing, trading, or dealing in securities, partnership interests, or commodities, the applicable percentage that would be eligible for the 25% rate would be zero.
  1. Business Provisions and Rates

  • In this bill, a flat corporate rate would replace the current four-tier schedule of corporate rates with a flat 20% rate (25% for personal services corporations)
  • The bill would provide higher expensing levels resulting in 100% expensing of qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (with an additional year for longer-production-period property). It would also increase tenfold the Sec. 179 expensing limitation ceiling and phase-out threshold to $5 million and $20 million, respectively, both indexed for inflation
  • Under the new bill, the cash accounting method would be more widely available.  Increasing to $25 million the current $5 million average gross receipts ceiling for corporations generally permitted to use the cash method of accounting and extend it to businesses with inventories. Such businesses also would have exemption from the uniform capitalization (UNICAP) rules. The exemption from the percentage-of-completion method for long-term contracts of $10 million in average gross receipts would also be increased to $25 million
  • Deductions of net operating losses (NOLs) would be limited to 90% of taxable income. NOLs would have an indefinite carryforward period, but carrybacks would no longer be available for most businesses. Carryforwards for losses arising after 2017 would increase by an interest factor
  • Instead of the current provisions under Sec. 163(j) limiting a deduction for business interest paid to a related party or basing a limitation on the taxpayer’s debt-equity ratio or a percentage of adjusted taxable income, the bill would impose a limit of 30% of adjusted taxable income for all businesses with more than $25 million in average gross receipts
  • It would also include repeal of the Sec. 199 domestic production activities deduction.
  • General elimination of deductions for entertainment, amusement, or recreation activities, such as a business expense would also occur.
  • It would also eliminate employee fringe benefits for transportation and certain other perks deemed personal in nature rather than directly related to a trade or business, except to the extent that such benefits are treated as taxable compensation to an employee (or includible in gross income of a recipient who is not an employee).
  • The bill would limit like-kind exchange treatment to real estate, but a transition rule would allow completion of currently pending Sec. 1031 exchanges of personal property.
  • This would curtail business and energy credits, offsetting some of the revenue loss resulting from the lower top corporate tax rate
  • Under this bill, repeal of a number of business credits would occur, including:
    • The work opportunity tax credit (Sec. 51).
    • The credit for employer-provided child care (Sec. 45F).
    • The credit for rehabilitation of qualified buildings or certified historic structures (Sec. 47).
    • The Sec. 45D new markets tax credit. (You would still have up to seven subsequent years to us up credits allocated before 2018.)
    • The credit for providing access to disabled individuals (Sec. 44).
    • The credit for enhanced oil recovery (Sec. 43).
    • The credit for producing oil and gas from marginal wells (Sec. 45I)
  • Other modified credits include:
    • Those for a portion of employer Social Security taxes paid with respect to employee tips (Sec. 45B)
    • Those for electricity produced from certain renewable resources (Sec. 45)
    • Those for production from advanced nuclear power facilities (Sec. 45J)
    • The investment tax credit (Sec. 46) for eligible energy property.

The Sec. 25D residential energy-efficient property credit, which expired for property placed in service after 2016, would extend retroactively through 2022 but reduce beginning in 2020.

  1. Bond Provisions

Several types of tax-exempt bonds would become taxable, including:

  • Private activity bonds (The bill would include taxpayer income interest on such bonds issued after 2017).
  • Interest on bonds issued to finance construction of, or capital expenditures for, a professional sports stadium.
  • Interest on advance refunding bonds.
  • It would generally repeal current provisions relating to tax credit bonds. (Holders and issuers would continue to receive tax credits and payments for tax credit bonds already issued, but they would not issue any new bonds).

Lastly, the bill would repeal the alternative minimum tax (AMT).

The third category along with individual and business considerations is in regards to foreign income and persons considerations.

Based on the new proposed tax bill, these are key changes:

  • For deductions for foreign-source dividends received by 10% U.S. corporate owners, the bill would add a new section to the Code, Sec. 245A, replacing the foreign tax credit for dividends received by a U.S. corporation with a dividend-exemption system. This provision would take effect for distributions made after 2017.  The design aims to eliminate the “lock-out” effect that encourages U.S. companies not to bring earnings back to the United States.
  • The bill would also repeal the indirect foreign tax credit provision, and amend Sec. 960 to coordinate with the bill’s dividends-received provision. It would not allow for foreign tax credit or deduction for any taxes (including withholding taxes) paid or accrued with respect to any dividend to which the dividend exemption of the bill would apply
  • Under the new law, there would be the elimination of U.S. tax on reinvestments in U.S. property. Under current law, a foreign subsidiary’s undistributed earnings that they reinvest in U.S. property are subject to current U.S. tax. The bill would amend Sec. 956(a) to eliminate this tax on reinvestments in the United States for tax years of foreign corporations beginning after Dec. 31, 2017 and would remove the disincentive from reinvesting foreign earnings in the United States.
  • The proposed tax would include a limitation on loss deductions for 10%-owned foreign corporations, amending Sec. 961 and adding Sec. 91 to require a U.S. parent to 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. This would apply only for determining loss, not gain. The provision also requires a U.S. corporation that transfers substantially all of the assets of a foreign branch to a foreign subsidiary to include in the U.S. Corporation’s income the amount of any post-2017 losses that the branch incurred. The provisions would take effect for distributions or transfers made after 2017.
  • There will be a repatriation provision, amending Sec. 956 to provide that U.S. shareholders owning at least 10% of a foreign subsidiary will include income for the subsidiary’s last tax year beginning before 2018 the shareholder’s pro rata share of the net post-1986 historical earnings and profits (E&P) of the foreign subsidiary to the extent that E&P have not been previously subject to U.S. tax, determined as of Nov. 2, 2017, or Dec. 31, 2017 (whichever is higher). The portion of E&P attributable to cash or cash equivalents would be taxed at a 12% rate; the remainder would have a tax rate of 5%. U.S. shareholders can elect to pay the tax liability over eight years in equal annual installments of 12.5% of the total tax due.
  • The bill would amend Sec. 863(b) to provide that income from the sale of inventory property produced within and sold outside the United States (or vice versa) is allocated solely on the basis of the production activities for the inventory.
  • The bill would repeal the foreign shipping income and foreign base company oil-related income rules. It would also add an inflation adjustment to the de minimis exception to the foreign base company income rules and make permanent the look through rule, under which passive income one foreign subsidiary receives from a related foreign subsidiary generally is not includible in the taxable income of the U.S. parent, provided that income was not subject to current U.S. tax or effectively connected with a U.S. trade or business.
  • We would treat a U.S. corporation as constructively owning stock held by its foreign shareholder for purposes of determining CFC status.  While also eliminating the requirements that a U.S. parent corporation must control a foreign subsidiary for 30 days before Subpart F inclusions apply.
  • A U.S. parent of one or more foreign subsidiaries would be subject to current U.S. tax on 50% of the U.S. parent’s foreign high returns—the excess of the U.S. parent’s foreign subsidiaries’ aggregate net income over a routine return (7% plus the federal short-term rate) on the foreign subsidiaries’ aggregate adjusted bases in depreciable tangible property, adjusted downward for interest expense.
  • The deductible net interest expense of a U.S. corporation that is a member of an international financial reporting group would be limited to the extent the U.S. corporation’s share of the group’s global net interest expense exceeds 110% of the U.S. corporation’s share of the group’s global earnings before interest, taxes, depreciation, and amortization (EBITDA).
  • Payments (other than interest) made by a U.S. corporation to a related foreign corporation that they can deduct, includible in costs of goods sold, or includible in the basis of a depreciable or amortizable asset, would be subject to a 20% excise tax, unless the related foreign corporation elected to treat the payments as income effectively connected with the conduct of a U.S. trade or business. Therefore, the foreign corporation’s net profits (or gross receipts if no election is made) with respect to those payments would be subject to full U.S. tax, eliminating the potential U.S. tax benefit otherwise achieved.

To complicate matters, the Senate has drafted its own version of a tax proposal. Understanding the proposed changes offered by the House of Representatives, here are the main differences between the Senate and the House Ways and Means Committee:

  • The House has four income brackets: 12%, 25%, 35% and 39.6%; the Senate keeps the original seven categories but lowers them all to 10%, 12%, 22.5%, 25%, 32.5%, 35% and 38.5%.
  • The child tax credit increases from $1,000 to $1,600 in the House bill.  But rises to $1,650 per child in Senate bill.
  • The House would lower the top corporate tax rate from 35% to 20% next year; the Senate would enact the change commencing 2019.
  • The House would double the current Estate Tax exemption to apply only to estates worth more than $10 million next year, and phase the tax out completely over six years; the Senate would double the exemption next year but otherwise keep the tax.
  • The House would eliminate the deduction for major medical expenses that exceed 10% of a taxpayer's income; the Senate version does not change this deduction.
  • For new mortgages, only interest on the first $500,000 borrowed for a primary home would be deductible under the House bill.  Additionally interest on mortgages for second homes and home equity loans would no longer be deductible.  The current limitfor the first $1 million borrowed would not change with the Senate.  However they would end the deduction for home equity loans.
  • The House bill would allow a deduction for up to $10,000 in property taxes, but end deductions for income or sales taxes; the Senate would eliminate all of these state and local taxes.
  • The House bill would eliminate student loan interest deductions; however the Senate would leave this intact.

These eight points represent the most significant differences between the two tax reform proposals. As they announce more changes we will continue to update you.