During the evening hours of November 9, Senate Finance Committee Chairman Orrin Hatch (R-UT) released the “Chairman’s mark” of the Senate’s initial version of tax reform. The Senate proposal, like the recent House version of tax reform introduced last week (the “Tax Cuts and Jobs Act” – see our Insight here) proposes to lower individual and business tax rates, simplify the tax code and revise U.S. international tax rules. A 253-page detailed description of the Senate proposal, furnished by the Joint Committee on Taxation, can be found here. The actual bill, in legislative language, will be released later.
Key Differences – Senate vs. House
While many of the Senate’s tax reform provisions closely mirror the House bill, there are distinct differences. The more significant differences in the Senate proposal include:
- Tax rates – The Senate proposal includes seven tax rate brackets ranging from 10 percent to a top rate of 38.5 percent. The House bill proposes four brackets ranging from 12 percent to 39.6 percent.
- Itemized deductions – The Senate proposes to retain the deduction for medical expenses but eliminate any deduction for individual state and local taxes. The House bill would retain a deduction for state and local real property taxes up to $10,000. Like the House bill, the Senate would continue allowing taxpayers to deduct home mortgage interest on their principal residences. However, the Senate retains the current $1 million debt limitation amount; the House bill reduced this limitation to $500,000. The Senate also proposes to provide a deduction for personal casualty losses if the losses are incurred in a presidentially declared disaster area. Both the Senate and House retain the itemized deduction for charitable donations.
- Child tax credit – The Senate proposal increases the child tax credit to $1,650 (compared to the House bill amount of $1,600).
- Adoption credit – The Senate proposal retains the current adoption tax credit that would be repealed by the House version.
- Exclusion of gain on sale of a personal residence – The Senate does not appear to phase-out this exclusion for higher income taxpayers (as proposed in the House bill). It does, however, provide extended ownership and use requirements.
- Estate tax – The Senate proposal would not repeal the estate tax; the House bill repeals the estate tax after 2023. However, the Senate would double the basic estate tax exemption amount similar to the House bill.
- Corporate tax rate – Like the House bill, the Senate proposes to reduce the top corporate tax rate to 20 percent. Rather than be effective beginning in 2018, the Senate would delay implementation until 2019.
- Special tax rate on “business income” of sole proprietorships and pass-through entities – The approach taken in the House bill of setting maximum rates on business income of certain sole proprietorships and pass-through entities was not followed by the Senate. The Senate proposal provides for a 17.4 percent deduction on “domestic qualified business income” passed through to owners. The deduction would generally not be available to certain service businesses and would be subject to a limitation based on wages. Effectively, this deduction would reduce the top rate on qualifying income from the newly proposed 38.5 percent, to 31.8 percent.
- Use of cash method of accounting – The Senate proposal would extend use of the cash method of accounting to businesses with gross receipts of $15 million or less. This compares to a $25 million threshold in the House bill.
- Business tax credits – The Senate proposes to retain, with modifications, both the credit for rehabilitation of historic structures and the so-called “orphan drug credit.”
- Deferred compensation – The Senate proposal includes a provision that would modify the taxation of nonqualified deferred compensation to recognize compensation income when there is no substantial risk of forfeiture. A similar provision was dropped from the House bill.
- International operations – The Senate proposal, like the House bill, proposes a one-time tax on the deemed repatriation of foreign earnings invested overseas, but with slightly lower rates. In the Senate bill, foreign earnings invested in “cash assets” would be taxed at 10 percent and the remaining foreign earnings would be taxed at 5 percent. These rates are lower than the 14 percent applied to “cash assets” and the 7 percent to be paid on any remaining amount as proposed by the House.
House Bill Amendments
Earlier in the day on November 9, the House Ways and Means Committee passed, on a party-line vote, its version of tax reform after important amendments by Chairman Kevin Brady (R-TX). This bill will now proceed to the House Rules Committee that will establish the rules for consideration by the full House of Representatives. Based on comments by House Majority Leader Kevin McCarthy (R-CA), the House expects to vote on the bill the week of November 13.
Chairman Brady’s amendments made significant changes to the House bill that include:
- Reducing the tax rates on active business income of certain sole proprietorships and pass-through entities that would otherwise be taxed in the 12 percent tax bracket.
- Eliminating the provision that would have expanded application of the self-employment tax to active owners of pass-through entities and to rental income.
- Reducing the current law dividends received deduction for corporations.
- Eliminating the nonqualified deferred compensation provision in the original House bill.
- Excluding “floor plan financing” from the limitation on deductibility of net business interest expense; vehicle dealers with floor plan financing would not be eligible for full expensing of purchases of depreciable assets.
- Increasing the tax rates on the deemed repatriation of foreign earnings to 14 percent on earnings held in liquid assets and 7 percent on illiquid assets (from 12 percent and 5 percent, respectively).
- Providing a three-year holding period requirement for long-term capital gain treatment for partnership interests received for services (so-called “carried interests”).
The Path Forward
Senate Republican leaders are proceeding to have the Senate Finance Committee and the full Senate complete action on its version of tax reform by Thanksgiving. House leaders are working toward the same timeline. However, considering the diversity in expectations related to tax reform now apparent in both the House and the Senate, delays are to be anticipated in passing a full House and full Senate tax reform bill, particularly over the next few weeks as Congress begins, or continues, to hold hearings, debates and votes.
If both houses of Congress approve their respective bills, they will then need to reconcile the differences and vote on the final tax reform bill. Considering the political and procedural challenges facing Congress and the already intense lobbying efforts from constituents and trade groups, completing this process by year-end will become increasingly more difficult with each delay.
Contact your Eide Bailly LLP professional should you have questions concerning either the tax reform legislation or tax planning alternatives.