Yesterday, U.S. House Ways and Means Chairman Kevin Brady (R-TX) introduced the “Tax Cuts and Jobs Act” which, for the most part, if enacted, would be effective January 1, 2018. When unveiling the act, Chairman Brady, said “… in the weeks ahead we will move this legislation forward and work with the Senate to send a unified bill to President Trump’s desk by the end of the year.”
After months of comments, general guidelines and speculation, taxpayers finally have draft tax legislation to review and factor into tax planning strategies. While it contains most of the “tax cut” measures promised by Republican congressional and administration leaders in the “Unified Framework” document published September 27, 2017, the act also includes a number of the rumored “pay-fors” and other tax changes intended to pay for the proposed tax rate cuts and reduce the impact of the act on the federal deficit, while still complying with the budget adopted by Congress last week. You can find the text of the act here, and a section-by-section summary, published by the Ways and Means Committee.
Highlights of the Act
The act proposes comprehensive tax reform including provisions that would affect not only individuals and businesses but also tax-exempt organizations including charities. To assist in understanding the effect of the act and potential tax planning opportunities, we will provide more detailed descriptions of selected provisions of the act in the near future.
But for now, the following are key provisions of the act affecting individuals and businesses:
- Provide four tax rate brackets of 12 percent, 25 percent, 35 percent and 39.6 percent. The act consolidates the current seven tax rate brackets into four. For married individuals filing jointly, the top 39.6 percent bracket kicks in for taxable income over $1 million. For single taxpayers, the top rate begins for taxable income over $500,000. The act also provides special tax brackets for heads of households.
- Increase the standard deduction to $12,000 for a single taxpayer ($24,000 for married couples filing jointly). The new amounts are nearly double the current standard deductions and should result in simplification for those taxpayers no longer needing to itemize deductions in order to minimize their tax liabilities. The standard deduction amounts are to be indexed for inflation. For example, the standard deduction for joint filers would be $24,400 in 2018.
- Eliminate personal exemptions and itemized deductions other than those for home mortgage interest, charitable donations and state and local real property taxes. Retaining any type of deduction for state and local taxes was subject to intense negotiations. Under the compromise reached, individual state and local income taxes are no longer deductible. However, individual real property taxes are still deductible up to a cap of $10,000. State and local income taxes and property taxes related to a business or other income producing activity remain deductible. Under the act, taxpayers would continue to deduct mortgage interest with respect to a principal residence, but, the debt limitation amount, used to restrict deductibility of mortgage interest, is reduced from the current $1 million amount to $500,000, effective November 2, 2017.
- Enhance the child tax credit by increasing the credit amount to $1,600 per child. The act increases the income level at which the child tax credit phases out and provides a $300 credit for costs of caring for adult dependents. In addition, a new “family flexibility credit” of $300 per taxpayer would be available for years 2018 through 2022.
- Simplify education incentives. The act consolidates existing higher education tax credits into an enhanced American Opportunity Tax Credit. It also includes provisions affecting student savings, loans and assistance.
- Retain tax incentives for retirement savings, such as IRA and 401(k) plans. However, the act repeals the special rule permitting re-characterization of Roth IRA contributions as traditional IRA contributions.
- Retain the exclusion of gain from the sale of a personal residence, but with extended ownership/use requirements. The act would also phase-out the exclusion for adjusted gross income levels above $500,000 ($250,000 for single filers).
- Repeal the estate and generation-skipping taxes after 2023. Beginning in 2018, the individual basic estate tax exclusion amount is effectively doubled from the current $5 million level (indexed for inflation) to $10 million (which is also indexed for inflation). The gift tax is retained, but at a lower 35 percent rate, and is subject to the individual basic exclusion amount of $10 million and an annual exclusion of $14,000 per donee, also indexed for inflation.
- Repeal the alternative minimum tax (AMT). However, it should be noted, special rules are provided for utilizing AMT credits from prior years.
- Retain existing special rates for long-term capital gains and net investment income.
- Reduce the top corporate tax rate to 20 percent. Personal services corporations would be subject to a special 25 percent rate under the act. In addition, the corporate AMT is repealed.
- Provide a top tax rate of 25 percent on “business income” generated by certain sole-proprietorships and pass-through entities (partnerships, S corporations and LLCs). Detailed rules are provided to limit the amount of “business income” for service businesses and to prevent active business owners from avoiding ordinary tax rates on income considered compensation.
- Expand application of the self-employment tax. Income not eligible for the 25 percent rate, described above, for active owners of business interests—including schedule K-1 income of S corporation owners, limited partners and LLC members—would be subject to self-employment tax. The computation of self-employment income would change for all taxpayers. Rental income may also be subject to self-employment tax under changes made by the act.
- Allow full expensing of purchases of depreciable assets, other than structures, for five years effective September 27, 2017. Under the act, qualifying business property acquired and placed in service after September 27, 2017, and before January 1, 2023, would qualify for 100 percent expensing. In addition, another provision in the act increases the section 179 expensing limits and expands the definition of section 179 property to include qualified energy efficient heating and air-conditioning property effective for property acquired and placed in service after November 2, 2017.
- Extend use of the cash method of accounting to businesses with gross receipts of $25 million or less. This provision also makes changes to simplify certain accounting methods.
- Disallow a deduction for net interest expense in excess of 30 percent of a business’s “adjusted taxable income.” Adjusted taxable income is defined as a business’s taxable income, regardless of the business’s form of organization, computed without regard to business interest expense, business interest income, net operating losses, and depreciation, amortization and depletion. Businesses with average gross receipts of $25 million or less are exempt from this provision.
- Modify the net operating loss deduction by limiting it to 90 percent of taxable income and restricting carryback periods. Net operating losses generated after 2017 and carried forward would be increased by an interest factor.
- Limit like-kind tax deferred exchange treatment to real property.
- Repeal most business tax credits other than the research and development and low income housing tax credits. Popular credits such as the work opportunity tax credit, rehabilitation tax credit and new markets tax credit are repealed.
- Eliminate or limit the deductions for domestic production activities, entertainment expenses and fringe benefits, and FDIC insurance premiums paid by large banks. In addition, significant modifications are proposed for the treatment of deferred compensation and limitations on compensation expense of corporate officers. Also, the act includes a number of changes to the taxation of insurance companies.
- Revise the current “tax-free” treatment of contributions to capital of corporations and partnerships to recognize income when the value of the property contributed exceeds the value of the stock or partnership interest issued in exchange.
- Revamp taxation of businesses with international operations by providing for a:
- 100 percent deduction for dividends received from foreign subsidiaries that are at least 10 percent owned (move to a “territorial” tax system),
- Tax on a U.S. parent company’s foreign “high returns,” and
- One-time tax, payable over a period of up to eight years, on the deemed repatriation of corporate foreign earnings held or invested overseas. Repatriated earnings invested in cash and cash equivalents” would be taxed at the rate of 12 percent and repatriated earnings, invested in property, plant and equipment, would be taxed at the rate of 5 percent. The amount of repatriated earnings subject to the one-time taxing system would be determined as of November 2, 2017, or December 31, 2017, utilizing whichever calculated amount is higher.
What Happens Next?
Under the budget passed by the House and Senate, Congress is authorized to pass a tax bill that results in a 10-year net reduction in taxes of up to $1.5 trillion. The budget also allows the Senate to use the budget reconciliation process for tax reform. Reconciliation permits the Senate to avoid a filibuster and pass a tax reform bill with a simple majority of 51 votes.
While Chairman Brady may still make changes to the act released yesterday, the full Ways and Means Committee will begin working on the act next week. During this “mark-up” process, the committee will debate provisions of the act, propose amendments and, if there is sufficient agreement, accept a final version for consideration by the House of Representatives.
This process is expected to take up to two weeks; however, the timeline is aggressive and subject to political and procedural delays.
Senate Action Next
U.S. Senate Finance Committee Chairman Orrin Hatch (R-UT) has targeted next week for release of a separate Senate version of tax reform legislation. Senate Republican leaders hope that the Senate Finance Committee and the full Senate can complete their work on tax reform legislation and pass a bill by Thanksgiving.
Then Comes Reconciliation
Once the Senate offers up their version of tax reform legislation, a committee of select House and Senate leaders will come together and debate the two versions and propose a final reconciled version for final passage and presentation to the President for signature.
Clearly, tax reform legislation still faces a difficult path. There remain many challenges to Congress enacting comprehensive tax reform legislation yet this year.
Want More Details?
Should you have questions or want to explore tax planning alternatives in light of the act, contact your Eide Bailly LLP professional.