Late on December 1, 2017, the Senate passed their version of the “Tax Cuts and Jobs Act” (H.R. 1). Next, a conference committee will work to consolidate the House and Senate proposals, in a form that will pass both legislative bodies.

Following is a summary of the two bill versions. At this point, it is fair to assume that some combination of the proposals will be enacted. Where the two bills are substantively identical, this leads one to strongly know what the final bill will propose in that area. Unless otherwise stated, these provisions would begin in 2018.

One key difference is that Senate budget rules require that the bill either get 60 votes (not going to happen) or not increase the deficit beyond ten years. This requirement means that the individual tax provisions expire after 2025 (the corporate provisions are permanent). This sunset will have to remain in a final bill, again unless, 60 Senate votes can be obtained or the bill does not increase the deficit in the long term.

 

Individual Tax Provisions

Tax Rates
  • Current Rule For ordinary income, seven graduated tax rates apply to individuals – 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The special long-term capital gains and qualified dividends, the rate is 0% for a taxpayer otherwise in the 10% or 15% rate. For taxpayers otherwise, in the 25% to 35%, the special rate is 15%. For those in the top 39.6% rate, the special rate is 20%.
  • House Bill Replace the seven rates with four – 12%, 25%, 35%, and 39.6%. The top rate applies to approximately twice the current amount of income. Long-term capital gains and qualified dividends rates are retained, and the 20% rate would apply at current rate brackets. The benefit of the lowest rate is recaptured for those at the 39.6% rate, making that marginal rate even higher.
  • Senate Bill Replace the seven rates with a different, slightly lower, seven – 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. Greatly increase the amount of income subject to each bracket. Long-term capital gains and qualified dividends – same as current law. No recapture of the lowest rate. Again, these rates sunset after 2025, reverting to current law.
  • Observation The size of the House brackets means that the cuts are more aggressive as compared to the Senate, and accordingly, the revenue loss. House members will feel that the Senate proposal is the status quo, not reform. The brackets will be indexed for inflation in the future.

 

Standard Deduction
  • Current Rule Single – $6,350; Married-filing-jointly – $12,700; Head of household –$9,350.
  • House Bill Single – $12,200; Head of household – $18,300; Married-filing-jointly – $24,400.
  • Senate Bill Single – $12,000; Head of household – $18,000; Married-filing-jointly – $24,000.
  • Observation Bill-writers believe that the large interest in the standard deduction, coupled with the restriction on itemized deductions, will result in 90% of taxpayers being able to avoid itemizing. Also, this cushions the blow for many specific itemized deductions that have been eliminated.

 

Personal Exemptions
  • Current Rule An exemption from tax applies to $4,050 of income, for the taxpayer, spouse, and any dependents.
  • House Bill Repealed.
  • Senate Bill Repealed.
  • Observation Bill-writers say that the much larger standard deduction and an expanded child tax credit will address this loss, with simplification as a side effect. Lower to middle income taxpayers with many dependent children though will be adversely affected.

 

Child Tax Credit
  • Current Rule A credit of $1,000 per dependent child under age 17 is allowed. The credit phases out beginning at $75,000 of single income ($110,000 joint).
  • House Bill Increase the credit to $1,600 per child and move the phase-out starting point to $115,000 single ($230,000 joint). Also, an additional credit of $300 is allowed for non-child dependents through 2022 only.
  • Senate Bill Increase the credit to $2,000 per child and move the phase-out starting point to $500,000. No supplemental credit for non-children.
  • Observation The increased phase-outs and credit will make the credit much more valuable to most taxpayers than under current law.

 

Itemized Deductions
  • Current Rule Popular itemized deductions include medical expenses, state and local taxes (sales or income, but not both), real estate taxes, mortgage interest expense, charitable contributions, casualty losses, unreimbursed employee expenses, and tax preparation expenses. For mortgage interest, you can deduct interest on up to $1,000,000 of acquisition debt on a principal residence and one second home, plus interest on up to $100,000 of home equity debt from whatever source.
  • House Bill Eliminates medical, state and local income or sales taxes, casualty losses (unless a federal disaster), unreimbursed employee expenses, and tax preparation fees. Retains deductions for local property taxes (capped at $10,000), charitable contributions (some technical changes), and mortgage interest. Current mortgages for a principal residence are grandfathered, but new mortgages would be limited to the first $500,000 of acquisition debt. No deduction for equity loans, and vacation homes – without grandfathered protection.
  • Senate Bill Same as House for deduction of taxes. Retains the medical deduction, in fact, providing an improved 7.5% floor for medical expenses (currently 10%) for 2017 and 2018 only. For mortgage interest, only the home equity interest deduction would be repealed, with no other changes. Same as House for loss of miscellaneous deductions.
  • Observation These changes would greatly reduce the need and ability to itemize deductions. Depending on your specific situation, the changes can have a minor effect or dramatically impact your income tax obligation.

 

Other Deductions
  • Current Rule Deductions allowed without the need to itemize for alimony, student loan interest, an educator deduction (up to $250), and moving expenses. Employer moving allowances are not included in income.
  • House Bill All are eliminated. Alimony income would not be taxable, and employer moving allowances would not be excluded from income.
  • Senate Bill The educator deduction is not only retained but doubled. Only the moving expense and allowance is eliminated, the others retained.
  • Observation A further move towards simplicity, again with winners and losers, depending on your facts.

 

Gain on Sale of a Residence
  • Current Rule A single taxpayer can exclude up to $250,000 of gain from the sale of a principal residence. Joint filers get up to $500,000 if both meet the requirements. Two key rules. One – you can claim this only once every two years. Two – the house must have been your principal residence for some two of the prior five years.
  • House Bill The two-out-of-five rule is replaced with a five-out-of-eight rule. The exclusion is available once every five years. Also, once income exceeds $500,000, the maximum exclusion phases out. The end result is that a married couple making $1 million is not eligible for an exclusion, regardless of other facts.
  • Senate Bill Same as House, except that the exclusion does not phase out for upper incomes.
  • Observation The move to five-out-of-eight rule will keep home “flippers” from using the exclusion, but the House income test would represent the first limitation on using a home sale exclusion for upper-incomers.

 

Alternative Minimum Tax
  • Current Rule Imposed on all taxpayers.
  • House Bill Repealed.
  • Senate Bill Retained with an increase in the exemption of about 40%.
  • Observation Repealing the AMT is stalwart GOP position, but the Senate bill found it too expensive to get enough votes to pass. This will surely disappoint House members, who campaigned on AMT as a core belief. Expect them to fight to keep a full repeal.

 

Estate and Gift Tax
  • Current Rule Estates over $5.5 million ($11 million married) are taxed at 40% of the excess. Lifetime gifts are taxed against this same limitation.
  • House Bill Doubles the exemption to over $10 million, and after 2024, repeal it entirely. The gift tax remains.
  • Senate Bill Double the exemption for both the estate and gift tax, without future repeal.
  • Observation The estate tax currently affects only 0.2% of taxpayers under the present system.

 

Some other specific personal tax rules

  • Roth IRA Recharacterizations Currently, income from the conversion of a regular IRA to Roth is taxable income. However, by October 15 of the subsequent year, the taxpayer can change his/her mind and return the IRA to its regular status, and amend their tax return to remove the income. This “undoing” is known as a recharacterization.
    • House Bill Repeals the right to a recharacterization.
    • Senate Bill Same as House.
  • Graduate Student Income Currently, tuition waivers are not taxable income.
    • House Bill Taxes the value of the tuition waiver.
    • Senate Bill No change from current law.
  • Cost Basis of Securities Sold Currently, the taxpayer can use the FIFO method to account for which securities were sold (“first-in, first-out”), or the taxpayer can specifically identify which securities were sold. OR, in the case of a mutual fund only, average cost can be used.
    • House Bill No change from current law.
    • Senate Bill Would require the use of the FIFO method.

 

Business Tax Provisions

Corporate Income Tax
  • Current Rule Taxed at graduated rates from 15% to 35%. Personal service corporations (“PSCs”) are taxed at the top marginal rate.
  • House Bill Taxed at a flat 20%, beginning in 2018. PSCs are taxed at a flat 25%.
  • Senate Bill Taxed at a flat 20%, beginning in 2019. No special rate for PSCs.
  • Observation The date will be the key difference to reconcile.

 

Tax Rate on Business Income from Partnerships, LLCs, and S Corporations
  • Current Rule Taxed as ordinary income at marginal tax rates.
  • House Bill Impose a maximum tax rate of 25%, where the income is based on capital investment. Where the income is also compensatory in nature, some ratio of income will qualify for the 25% while the rest is taxed at top marginal rates. Owners of PSC-type businesses will be considered entirely compensation and thus not eligible for this break. Smaller businesses could be taxed as low as 9% if the taxpayer was otherwise in the new 12% rate.
  • Senate Bill These owners will get a deduction for 23% of their “qualified business income”, limited to 50% of the wages paid by the business to its employees. PSC-type businesses are eligible to the extent that taxable income does not exceed $250,000 single, $500,000 married-filing-jointly. Note that this is a generalized response to a complicated concept.
  • Observation Very different approaches, either of which, if enacted, would be one of the most complicated provisions in this bill.

 

Section 179 – Depreciation Expensing
  • Current Rule Can deduct up to $500,000 per year, but it cannot create a loss. Begin to lose the ability to claim the deductions at $2 million of eligible additions in that year.
  • House Bill Deduction increased for up to $5 million, with a phase-out beginning at $20 million.
  • Senate Bill Deduction increased for up to $1 million, with a phase-out beginning at $2.5 million.
  • Observation A significant tax incentive for small to medium-sized businesses, with a very different scope between the two bills. Taxpayers should expect that states will not follow this.

 

Section 168(k) – “Bonus” Depreciation
  • Current Rule Can deduct 50% of the 2017 cost of certain “new” additions per year, no cap. Phases down to 40% in 2018, and ends with 30% in 2019.
  • House Bill Can deduct 100% of the cost of acquisitions after 9/27/2017. No longer required to be “new”. Effective 2018 through 2022.
  • Senate Bill Same as House except that provision phases out by 20% a year beginning in 2023. Also, the Senate does not change the current “new” requirement.
  • Observation Another significant tax incentive for all businesses, beginning before Taxpayers should expect that states will not follow this treatment.

 

Some specific business tax rules set to change

  • Deduction of Interest Expense
    • Current Rule No limit.
    • House Bill Limited to 30% of EBITDA, with the excess available for up to five years. Does not apply to small taxpayers under $25 million gross receipts.
    • Senate Bill Limited to 30% of “adjusted taxable income”, with a non-expiring carryover of the excess. The 30% is applied to net business income before NOL and the 23% pass-through deduction, if applicable. Does not apply to those under $15 million gross receipts.
  • Alternative Minimum Tax
    • Current Rule Imposed on corporations.
    • House Bill Fully repealed.
    • Senate Bill No change from current law.
  • Entertainment Deduction
    • Current Rule Generally 50% deductible.
    • House Bill Not deductible.
    • Senate Bill Same as House.
  • Real Estate Depreciation
    • Current Rule Residential real estate is depreciated over 27.5 years; commercial over 39 years.
    • House Bill No provision.
    • Senate Bill Life reduced to 25 years, allowing for a faster recovery of the investment.
  • Net Operating Losses (“NOLs”)
    • Current Rule Can carry back for two years, and/or carry forward for up to twenty years.
    • House Bill No further carrybacks after 2017. Carryforwards are limited to 90% of income (still must pay tax on 10% even if you have plenty of NOLs).
    • Senate Bill Same as House, except the limit, becomes 80% after 2022.
  • Like-Kind Exchanges
    • Current Rule Allowed for real and personal property used for investment or in a business.
    • House Bill Repealed for all assets except real property.
    • Senate Bill Same as House.
  • Domestic Production Deduction
    • Current Rule Deduction of 9% of production activity income.
    • House Bill Repealed after 2017.
    • Senate Bill Repealed after 2017 for pass-throughs, after 2018 for others.
  • “C” Corporations Forced to Use the Accrual Method of Accounting
    • Current Rule At $5 million gross receipts.
    • House Bill At $25 million gross receipts.
    • Senate Bill At $15 million gross receipts.
  • Required to Comply with Section 263A Capitalization Rules
    • Current Rule At $10 million for resellers, no threshold for manufacturers.
    • House Bill At $25 million gross receipts.
    • Senate Bill At $15 million gross receipts.
  • Local Lobbying Expenses
    • Current Rule Deductible.
    • House Bill Deduction repealed.
    • Senate Bill Same as House.
  • Work Opportunity Tax Credit
    • Current Rule Provides a tax credit for a percentage of the wages paid to certain disadvantaged groups.
    • House Bill Repealed.
    • Senate Bill No provision.
  • Technical Termination Rule
    • Current Rule A partnership (or an entity taxed as a partnership) is considered terminated and a new partnership started where there is a sale or exchange of more than 50% of the ownership interests in a 12-month period.
    • House Bill Repeal the rule.
    • Senate Bill No provision.

Stay tuned as DMJ continues to follow these developments.

R. Milton Howell III, CPA, CSEP
R. Milton Howell III, CPA, CSEP

Milton is a tax partner experienced in taxation issues including, tax research for both open and closed transactions, structuring complex tax transactions, estate and income tax planning, and representing clients before tax authorities. Milton regularly writes and reviews articles in local, regional, and national publications on tax matters and spends significant time monitoring current tax issues and legislation.

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