How to Read Both Versions of the Tax Cuts and Jobs Act
Now that America has seen the House’s version of the Tax Cuts and Jobs Act (“the bill”), which passed on November 16, and the Senate’s version of the bill, we’re getting a clearer picture of where policymakers agree and where there’s still plenty of room for negotiations.
The real questions that still remain are:
- What will the final bill actually look like by the time it is ready to be signed into law?
- Will a final tax bill be passed before the end of 2017?
- How will this impact year-end tax planning for 2017?
- What actions will taxpayers need to take in 2018?
Key Bill Provisions Likely to Make It to the Final Bill
A few provisions have remained consistent in all the talks of tax reform throughout the last year or so, and some provisions have generated little or no controversy. For these reasons, we think the following items are likely to make it into the final bill without a lot of change. Sometimes, it will be a matter of reconciling the differences between the House and Senate versions of the bill.
Fewer Tax Brackets
The House bill reduces the number of individual tax brackets from seven to four. There are the three tax rates recommended in September’s Tax Reform Framework (12 percent, 25 percent and 35 percent), plus the highest tax rate (39.6 percent) was kept for individuals making more than $500,000 and married couples making more than $1 million. The Senate version retains all seven of the current tax brackets.
Standard Deduction, Personal Exemptions, Earned Income Tax Credit
Both bills call for increasing the standard deduction:
|Single with Child Filing||$18,300||$18,000|
Both bills would eliminate personal exemptions, which could impact families with several dependent children or others living in the household. Both bills retain the Earned Income Tax Credit for working families.
Family Tax Credits
The current House plan increases the child tax credit from $1,000 to $1,600 and increases the phase-out threshold of who can claim the credit from $115,000 to $230,000 for married filers. There’s also a new $300 non-refundable personal credit and non-child dependent credit for families taking care of dependent adult members of their households. This credit would expire after five years.
The Senate plan has a few differences. This plan increases the child tax credit to $1,650 and provides a $500 non-refundable credit for dependents other than children. The phase-out threshold for the child tax credit would be $1 million for married taxpayers and $500,000 for all others – a substantial increase compared to current or House-proposed thresholds. The maximum amount refundable ($1,000) would be indexed for inflation. The inflation increase projected for 2018 would raise the refundable amount to $1,100 under the Senate plan.
Lower Corporate Tax Rate
This point has been non-negotiable from the beginning. In the current bills, the corporate tax rate will fall from 35 to 20 percent in both versions. The biggest difference here is that the House bill would make the 20 percent rate effective in 2018, while the Senate bill would make it effective in 2019.
Pass-Through Entity Tax Rate
In the House version, owners of pass-through entities, which include a lot of small business owners and entrepreneurs, may enjoy a 25 percent maximum tax rate rather than paying a higher individual tax rate on their business income. However, anti-abuse rules are included, which can limit the applicability of the lower rate to only 30 percent of pass-through income from active businesses. There is a complex formula included in the House bill, which could raise that 30 percent limit for capital intensive businesses. Pass-through businesses in professional service industries (e.g., health, law, financial services, professional services, performing arts) are excluded from this beneficial 25 percent tax rate.
The Senate Plan presents a different system for pass-through entities. Individual taxpayers with “domestic qualified business income” from a partnership, S corporation or sole proprietorship will generally be able to deduct 17.4 percent of that income. Much like the House version, the Senate bill has exceptions for businesses offering services in fields, such as health, law, accounting, performing arts, athletics, consulting and many others. As with the House bill, there are exceptions and thresholds for applying the 17.4 percent deduction.
Capital Investment Expensing
Under both the House and Senate bills, businesses will be able to immediately expense 100 percent of the costs of equipment and machinery with expanded first-year bonus depreciation. This provision is the only one that is retroactive and applies to qualified assets acquired and placed in service after September 27, 2017. This special bonus depreciation will expire on December 31, 2022.
In addition, the House bill raises the expensing threshold of Internal Revenue Code (“IRC” or “tax code”) Section 179 from $500,000 to $5 million. The phase-out threshold increases from $2 million to $20 million. The House wants to add qualified energy-efficient heating and air conditioning property to the list of qualified expenses. The expensing limits wouldn’t be as high under the Senate bill. The expense limit would be $1 million and the phase-out threshold would be $2.5 million. The Senate would like to expand the definition of property in this section to include depreciable real property, such as property used to furnish lodgings. Their plan would also expand the definition of qualified real property for improvements to nonresidential real property to include improvements to roofs, heating, ventilation, air-conditioning equipment, fire protection and alarm systems, and security systems.
Interest Expense Deduction
In a change from the Tax Reform Framework released earlier in the year, deductions for interest wouldn’t go away entirely under either House or Senate bills. The House version limits a business’s interest expense deductions when the expense exceeds 30 percent of the business’s adjusted taxable income. The Senate version is similar. It retains the 30 percent threshold found in the House plan. The Senate plan specifies that the limit would be applied at the taxpayer level (or at the consolidated tax return level for affiliated corporations filing a consolidated return). Any interest not allowed as a deduction could be carried forward indefinitely. The House plan would allow a five-year carryforward period.
Small Business Exception: Under the House bill, businesses with average gross receipts of $25 million or less ($15 million in Senate plan) would be exempt from the interest expense deduction limitation rule.
Net Operating Losses (“NOLs”)
The House and Senate bills have similar NOL provisions that would allow for these losses to be carried forward indefinitely and also increased by an interest factor to account for inflation in later years. Deducting NOLs would be restricted to 90 percent of current year taxable income. No more NOL carrybacks would be permitted with the exception of one-year carrybacks for defined disaster losses.
Research and Development (“R&D”) Tax Credit
This tax credit can be worth a lot of money to some companies. It includes special incentives for startups, particularly those organizations that don’t earn revenues in their first few years of existence. It also encourages innovation across industries by providing credits for money invested in developing, inventing or improving products and processes. Because this credit is seen as an economic driver that encourages business growth and job creation, we expect to see it remain in the final versions of the bill. Both Chambers include this credit intact in their bills.
Low-Income Housing Tax Credit
This credit is also preserved in both the House and Senate bills, which is important to the real estate, construction and development industries. For more in-depth insights about the implications of this credit, we encourage you to reach out to our Real Estate and Construction team.
Tax Simplification Measures
The House and Senate bills include provisions to reduce complexity in the tax code, such as:
- Repealing the corporate and individual Alternative Minimum Tax (“AMT”)
- Expanding availability of the cash method of accounting and the completed contract method of accounting, and easing requirements for accounting for inventory for taxpayers with annual gross receipts of $25 million or less ($15 million or less in the Senate version)
- Repealing the Domestic Production Activities Deduction (“DPAD”)
- Consolidating three current education related tax credits for individuals into one enhanced American Opportunity Tax Credit
What’s Likely to Change before a Bill Is Final
The items discussed above have generated little conversation, debate and negotiation, but the items below seem to be more controversial, have more critics or have more interested parties lobbying for change.
State and Local Tax (“SALT”) Deductions
One of the House bill surprises that survived a vote of the whole House is the elimination of itemized deductions for state and city income tax, sales and use tax, personal property tax and some real property taxes. The House bill does retain a limited itemized deduction for real property taxes up to $10,000. The Senate plan would eliminate all SALT deductions except for taxes paid in connection with a business or assessed on business assets.
Representatives and Senators from states with higher state income tax rates and higher property taxes, such as New York and California, have already declared that they will work to change this provision.
End of Many Itemized Deductions in Favor of Higher Standard Deduction
Both the Senate and House plans end or limit most personal itemized deductions. The bills propose to limit mortgage interest deductions and eliminate deductions all together for:
- Tax preparation fees
- Moving expenses in excess of compensation received
- Unreimbursed job expenses
- Personal casualty losses not covered by disaster relief provisions
The House bill also eliminates the itemized deduction for medical expenses and alimony payments. The Senate bill retains the current provision for deducting medical expenses and does not address alimony payments. With all these proposals gaining attention, it’s hard to say which deductions will be sacrificed and which might gain enough support to survive.
Estate Tax Update
Right now, both the House and Senate bills increase the lifetime exclusion amount for Estate and Generation-Skipping Transfer (“GST”) taxes to $10 million, indexed for inflation going forward. In the House version, the Estate Tax and GST tax would be repealed all together after six years. The Senate version does not repeal the taxes.
Tax Credits and Deductions Eliminated in House Bill
In the House bill, certain tax credits and deductions that would disappear in 2018 (or a later year) include the Work Opportunity Tax Credit, employer-provided dependent care assistance, and deductions for business entertainment. The Senate bill as a whole either does not address some of these credits and deductions or appears to preserve more of the current tax code’s deductions and credits.
Repeal of Individual Mandate
Another important development worth mentioning is that Orrin Hatch (R-Utah) has released his own set of revisions. He has put forth the idea of repealing the Affordable Care Act (“ACA”) individual mandate in this tax bill. Repealing the ACA individual mandate would save the government an estimated $338 million, according to the Congressional Budget Office (“CBO”). The CBO also projects that as many as 13 million people would lose or drop their health insurance coverage by 2027 and that individual policy premiums may only go up about 10 percent in the years after repeal.
Nonqualified Deferred Compensation
Another area being debated is nonqualified deferred compensation arrangements. The original House bill included provisions that would have virtually eliminated the use of nonqualified deferred compensation plans and would have accelerated the recognition of income by employees and executives benefited by these plans. However, the version of the bill that the House actually passed removed this provision. The Senate bill currently retains provisions that would accelerate tax for these plans. The venture capital and start-up business communities have raised concerns over the Senate bill provisions. This area should be watched closely.
Not-for-profit entities should look at new provisions that could have a significant impact on them, including:
- Expanding income items and nondeductible fringe benefits that may be included in unrelated business taxable income
- A 20 percent excise tax on compensation in excess of $1 million paid to the organization’s five highest paid employees
- Reducing the rate from 2 percent to 1.4 percent for the excise tax on investment income of private foundations
- Provisions that raise taxes and focus attention on private foundation distributions and the endowments of private colleges and universities
Multinational Corporations and International Taxes
The U.S. taxation of foreign income and of foreign persons receives a major overhaul in the House bill. These provisions are complex and the comments below do not capture the breadth and reach of these new provisions. For U.S. corporate taxpayers with foreign operations or entities, we highly encourage a conversation with our International Tax Group.
If one goal of this new taxing regime is to repatriate funds to the U.S. from offshore companies, then the centerpiece of the House and Senate bills may be the provisions establishing a proposed IRC Section 245A. In accordance with these provisions:
- A U.S. corporate taxpayer would receive a 100 percent deduction for foreign-source dividends received from their 10 percent or more owned foreign corporations; and
- No foreign tax credits would be permitted for taxes paid in connection with the dividend.
To facilitate the transition to this new system, the bills introduce a one-time tax on foreign earnings. The accumulated earnings and profits of the foreign-owned corporation would be deemed paid to the U.S. shareholder corporation immediately. They would also generate immediate tax liability for the U.S. corporation. However, this deemed repatriation would be taxed at rates lower than the proposed 20 percent corporate rate (i.e., 5-14 percent). The bills permit payment of this tax liability over an eight-year period.
Other provisions would make changes to Subpart F and PFICs, repeal the indirect foreign tax credit under IRC Section 902, and apply other new rules to foreign tax credits.
Will This Act Become Law?
The House has passed its version of the tax bill. The Senate has greater hurdles to overcome to pass its version. Once both bills have passed, the differences between versions also have to be negotiated and reconciled before a final version can be sent to President Trump. The House bill moved fairly quickly to a vote. We’ll see how the Senate fares in this process.
What Can You Do for Now?
Taxpayers should be engaging in preliminary planning discussions and analysis based on the best information available, but no final actions should be taken until we have more definitive answers in a final law.
We are actively monitoring the tax reform situation closely as it unfolds. We regularly brief our accounting professionals and our specialty tax teams to provide insight and planning strategies. Tax professionals throughout the Firm know what to expect and how to advise clients. The specialty tax teams include:
- State and Local Tax (“SALT”)
- Credits and Accounting Methods
- International Tax
- Estate, Gifts and Trust Services
- Nonprofit Tax
- Compensation and Benefits
Now is a great time to take a moment and get a fresh review of your unique tax situation. For specific questions, the best thing to do is to start a conversation now with a Cherry Bekaert advisor in your area, so you know if you’re prepared if and when there are major changes to the tax code.