Press Room: Tax Release
House Passes and Senate Finance Committee Advances Landmark Tax Reform Legislation
The House passed its version of the Tax Cuts and Jobs Act on November 16, 2017, along a mostly party-line vote of 227-205, with 13 Republicans voting no along with every Democrat. The Senate Finance Committee approved its own version of the tax reform legislation on a 14-12 party line vote. The full Senate will begin debate on the legislation following the Thanksgiving holiday, where the path to obtaining at least 50 votes is unclear. The House and Senate bills include various differences and Republicans now face the hurdle of rallying at least 50 Senators to support the legislation and also aligning the House and Senate versions. Despite the gap between the two bills on certain measures, Republican leaders expressed confidence that final legislation would reach President Donald Trump’s desk before the end of 2017. Below is a brief discussion of some of the changes proposed in each of the tax reform bills that impact individual and business taxpayers, with particular attention paid to the important areas where the bills diverge.
In terms of business provisions, the House bill would reduce the corporate tax rate from 35% to 20% and the rate on select pass-through income would go down to 25% (with restrictions for active participants and service businesses). The House bill would fully repeal the corporate alternative minimum tax (AMT). Full and immediate expensing of capital investments would be allowed under the House proposal for capital investments placed into service after September 27, 2017 and before January 1, 2023. Various deductions and credits would be eliminated, including the Sec. 199 domestic production deduction, the work opportunity tax credit, and the new markets tax credit. The research credit and low-income housing credit would be maintained. Net interest expense would be limited to 30% of EBITDA for all trades or businesses other than real estate and small businesses. A carried-interest provision would require underlying assets to be held for three years in order to receive long term capital gains on profits interests.
The current worldwide system of taxation would be transitioned to a territorial system of taxation with an exemption system for the foreign-source portion of dividends received from certain foreign corporations by U.S. shareholders that are domestic corporations and meet certain conditions. A mandatory deemed repatriation tax, based on certain currently deferred earnings and profits, would apply to any U.S. shareholder of a foreign corporation that satisfies certain conditions. The effective tax rate on the mandatory deemed repatriation of foreign earnings would differ based on the amount of earnings invested in cash/liquid property (14%) as compared to other assets (7%). The mandatory tax would apply to individuals who owned interests in certain foreign corporations either directly or indirectly through a pass-through entity.
On the individual side, the current seven income tax rate brackets would be consolidated into four (12%, 25%, 35% and 39.6%). The AMT for individuals would also be repealed. House lawmakers voted to limit the deductibility of interest to $500,000 of debt for new mortgages and to repeal the deduction for home equity and second home mortgage interest. The exclusion of gain on the sale of principal residences would be limited for higher income taxpayers and the time of residency would be increased to five of eight years. The deduction for state and local income tax and sales tax would be repealed, while the deduction for property tax would be capped at $10,000. Itemized deductions for charitable contributions, investment interest expense, and miscellaneous itemized deductions subject to the 2% floor would remain in place. The applicable exclusionary amounts for estate tax purposes would be doubled, with a repeal of the estate tax completely in 2025.
The Senate’s proposal includes a corporate tax rate reduction to 20%, but the change would not occur until 2019. The corporate AMT would also be repealed under the Senate’s proposed legislation. Individuals would be entitled to a 17.4% deduction on qualified business income from a pass-through enterprise, limited to 50% of the taxpayer’s allocable or pro rata share of W-2 wages from the pass-through, with limitations for service businesses. The same carried-interest proposal is included as in the House bill. As with the House plan, the Senate’s reform proposal also calls for a new territorial system of international taxation, but with lower rates on the assets recaptured through the mandatory deemed repatriation (10% for cash/liquid assets and 5% for other assets).
The Senate plan contains seven tax rate brackets for individual taxpayers and lowers the top tax rate from 39.6% to 38.5%. For pass-through businesses that qualify for the special deduction on all income, the top rate would effectively be 31.8%, significantly higher than the House provision at 25%. One of the biggest differences between the House and Senate plans is that the Senate Finance Committee decided to repeal the individual mandate of the Affordable Care Act requiring that most Americans purchase health insurance or be subject to a penalty, which raises a significant amount of revenue because the government would not subsidize insurance policies that were not purchased. The state and local tax itemized deduction would be repealed entirely under the Senate bill. The Senate would retain the deduction for investment interest expense, but repeal the deduction for miscellaneous itemized deductions subject to the 2% floor. While the estate tax exemption amount would also be doubled under the Senate bill, the estate tax would not be set to repeal.
While it will be a huge challenge for Republican leaders to corral 50 Senators to vote for tax reform legislation and to resolve differences between the House and Senate proposals, momentum for tax reform is strong. It is possible that tax reform legislation could pass by the end of 2017, or in early 2018, with a 2018 effective date. Republicans propose sweeping changes that would affect the taxation of every business. Now is a critical time to evaluate the proposals and the potential impact on your businesses’ domestic and international structure. The proposed tax legislation is targeted and it is likely necessary to prepare a detailed model to understand how it would impact each taxpayer. Regardless of the outcome of the pending legislation, there are steps that should be taken now to optimize your position before the end of the year. Please contact us to discuss the proposed legislation in more detail and so that we may help evaluate how these potential changes may affect you or your business. We will continue to keep you informed as the tax reform process continues.