As of November 12, 2017, we have a final Ways & Means Committee bill that is headed to the House floor and have the details of a Senate Finance proposal, scheduled for markup this week. If both pass, then a conference committee will try to consolidate these proposals.

On Thursday, November 17, 2017, the House’s measure passed by a vote of 227-205.  Thirteen Republicans voted with all Democrats against the bill. Remember this was only the House vote. Yet to come is a Senate vote, then a reconciliation bill from the conference committee, resulting in a final identical bill for a House and Senate vote. Passage this year would require a tight choreography of events in a narrow timetable.

Here is a scorecard of the current competing tax reform proposals. All of the provisions discussed are effective after December 31, 2017, unless otherwise noted. “Current rule” below refers to the amount or rule in effect for 2018, if reform is not enacted. All of the summaries below are necessarily brief and do not provide a discussion of every change.

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 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 Proposal Replace the seven rates with four – 12%, 25%, 35%, and 39.6%. The top rate applies at 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.
  • Senate Proposal Replace the seven rates with a different, slightly lower, seven – 10%, 12%, 22.5%, 25%, 32.5%, 35%, and 38.5%. Long-term capital gains and qualified dividends – same as current law.
  • Observation The size of the House brackets means that the cuts are more aggressive from the House and, accordingly, the revenue loss. The brackets will be indexed for inflation in the future.

 

Standard Reduction
  • Current Rule Single – $6,350; Married-filing-jointly – $12,700; Head of household –$9,350.
  • House Proposal Single or Head of household – $12,000; Married-filing-jointly – $24,000.
  • Senate Proposal Same as House.
  • 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 Proposal Repealed.
  • Senate Proposal Repealed.
  • Observation Bill-writers say that the much larger standard deduction 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 Proposal 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 Proposal Increase the credit to $1,650 per child (slightly higher) and move the phase-out starting point to $500,000 single ($1,000,000 joint). 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 Proposal 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 (limited to the first $500,000 of acquisition debt on a principal residence only – no equity loans, and no vacation homes).
  • Senate Proposal Eliminates all state and local taxes (property, income, and/or sales), personal casualty losses (unless a federal disaster), unreimbursed employee expenses, and tax prep fees. Retains medical and mortgage interest as under current law, but without a deduction for home equity interest. Senate also includes other miscellaneous expenses, like investment fees.
  • Observation Either of 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. The potential loss of the deduction for state taxes promises to be one of the most contentious issues of reform.

 

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 Proposal All are eliminated. Alimony income would not be taxable and employer moving allowances would not be excluded from income.
  • Senate Proposal 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: (1) You can claim this only once every two years. (2) The house must have been your principal residence for two of the prior five years.
  • House Proposal 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 Proposal Same as House, except that the exclusion does not phase out for upper incomes.
  • Observation The move to five-out-of-eight will keep home “flippers” from using the exclusion, but the income test will represent the first limitation on using an exclusion for upper-incomers.

 

Alternative Minimum Tax
  • Current Rule Imposed on all taxpayers.
  • House Proposal Repealed.
  • Senate Proposal Repealed.

 

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 Proposal Doubles the exemption to over $10 million, and after 2024, repeals it entirely. The gift tax remains.
  • Senate Proposal Doubles 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.

 

Business Tax Provisions

Tax Rate on Business Income from Partnerships, LLCs, and S Corporations
  • Current Rule Taxed as ordinary income at marginal tax rates.
  • House Proposal Imposes 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 service 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 Proposal These owners will get a deduction for 17.4% of their “qualified business income”, limited to wages paid to the owner. Service businesses are not eligible unless the owner’s income is under $75,000 single, $150,000 married-filing-jointly.
  • Observation Very different approaches, either of which, if enacted, would be the most complicated provision in this bill.

 

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 Proposal Taxed at a flat 20%, beginning in 2018. PSCs are taxed at a flat 25%.
  • Senate Proposal Taxed at a flat 20%, beginning in 2019. No special rate for PSCs.
  • Observation The date will be the key difference to reconcile.

 

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 Proposal Deduction increased for up to $5 million, with a phase-out beginning at $20 million.
  • Senate Proposal 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 Proposal Can deduct 100% of the cost of acquisitions after 9/27/2017. No longer required to be “new”. Effective 2018 through 2022.
  • Senate Proposal Same as House.
  • Observation Another significant tax incentive for all businesses, beginning before Taxpayers should expect that states will not follow this.

 

Some specific business tax rules set to change.

Deduction of Interest Expense
  • Current Rule No limit.
  • House Proposal 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 Proposal 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 17.4% pass-through deduction, if applicable. Does not apply to those under $15 million gross receipts.

 

Real Estate Depreciation
  • Current Rule Residential buildings – 27.5 years. Non-residential – 39 years.
  • House Proposal No change.
  • Senate Proposal Reduce the depreciable lives to 25 years.

 

Entertainment Deduction
  • Current Rule Generally 50% deductible.
  • House Proposal Not deductible.
  • Senate Proposal Not deductible.

 

Net Operating Losses (“NOLs”)
  • Current Rule Can carry back for two years and/or carry forward for up to 20 years.
  • House Proposal 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 Proposal Same as House.

 

Like-Kind Exchanges
  • Current Rule Allowed for real and personal property used for investment or in a business.
  • House Proposal Repealed for all assets except real property.
  • Senate Proposal Same as House.

 

Domestic Production Deduction
  • Current Rule Deduction of 9% of production activity income.
  • House Proposal Repealed.
  • Senate Proposal Repealed.

 

“C” Corporations Forced to Use the Accrual Method of Accounting
  • Current Rule At $5 million gross receipts.
  • House Proposal At $25 million gross receipts.
  • Senate Proposal 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 Proposal At $25 million gross receipts.
  • Senate Proposal At $15 million gross receipts.

Stay tuned as DMJ will continue 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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