Tax Reform Watch: A Deeper Look at the House and Senate Tax Bills– November 10, 2017 by Tracy Monroe

The long-awaited House tax reform bill, the Tax Cuts and Jobs Act, was released last week and approved yesterday, November 9th. Also yesterday, the Senate Finance Committee released the highlights of what its tax reform plan will entail.

The good news? There are more similarities than differences between the two bills. The bad news? The differences that exist likely will be grounds for much contention between legislators, such as the number of tax brackets each proposes and the varying perspectives on the small business deduction. Below is a look at some of the most significant provisions.

Individuals

The changes for individuals would go into effect beginning January 1, 2018. As mentioned, tax brackets will be a hot issue between the House and Senate.

Under the existing tax system, the brackets for taxpayers married filing jointly are as follows: 

2017 IRS Tax Rate Married & Filing Jointly Income
10% $0 - $18,650
15% $18,651 - $75,900
25% $75,901 - $153,100
28% $153,101 - $233,350
33% $233,351 - $416,700
35% $416,701 - $470,700
39.6% $470,701 and above












 




Under the proposed House system, there would be four brackets: 

HOUSE Proposed 2018 IRS Tax Rate Married & Filing Jointly Income
12% $0 - $90,000
25% $90,001 - $260,000
35% $260,001 - $1 million
39.6% Greater than $1 million




 









Under the proposed Senate system, there would still be seven brackets, but they would be different than the current structure:

 
SENATE Proposed 2018 IRS Tax Rate Married & Filing Jointly Income
10% $0 - $19,050
12% $19,050 – $77,400
22.5% $77,401 - $120,000
25% $120,001 – $290,000
32.5% $290,001 - $390,000
35% $390,001 - $1 million
38.5% Greater than $1 million











 






As I said in Sunday’s Cleveland Plain Dealer, taxpayers with taxable income of $260,000 or less would likely fare better under the House Bill versus today’s system due to the reduction in rates and increased credits and standard deduction amounts.

The bills vary on which deductions are eliminated and which should stay. For example, the House bill would get rid of the medical expense deduction while the Senate bill would retain it. The House bill would cap the mortgage interest deduction limit at $500,000 of debt while the Senate bill would keep the current limit of $1 million. The House bill would eliminate the current personal exemptions but nearly doubles the standard deduction to $12,000 for single filers ($24,000 for joint filers), which, for many taxpayers, would remove the incentive to itemize deductions. The Senate plan would do the same but includes an $18,000 standard deduction for head of household filers. 

The alternative minimum tax (AMT) system would be eliminated in both proposals; however, with the removal of many itemized deductions in the proposals, the new model would be very similar to current-day AMT. And surprisingly, both proposals retained the net investment income 3.8% tax to support healthcare. 

Another key area of these proposals that would impact individual taxpayers involves the estate tax. The House bill would essentially double the gift, estate and generation-skipping transfer (GST) tax exemptions to $10 million. Furthermore, the estate tax is proposed to be eliminated in its entirety after 2023 while maintaining beneficiaries’ stepped-up basis in the estate property. The Senate bill would double the exemptions, similar to the House provision. But unlike the House, the Senate doesn’t propose repealing the estate tax or GST tax or reducing the gift tax rate at any point. 

Businesses

Both the House and the Senate proposed reform of the corporate tax system was consistent with what was released earlier in the Unified Framework, including a flat 20% tax rate for C Corporations. The rate change under the House plan would go into effect beginning in 2018 but the Senate plan would delay the change until 2019.

As promised, significant changes were proposed to the taxing of foreign income of U.S. corporations. Under the House bill, the current-law system of taxing U.S. corporations on the foreign earnings of their foreign subsidiaries when the earnings are distributed would be replaced with a dividend-exemption system. That means 100% of foreign-sourced dividends paid by a foreign corporation to a U.S. shareholder owning at least 10% would be exempt from U.S. taxation. Additionally, historical foreign earnings and profits (E&P) would be taxed at a reduced rate of 12% for cash and cash equivalents, with the remaining E&P taxed at 5%. Foreign tax credit carryforward would be fully available and foreign tax credits triggered by the deemed repatriation would be partially available to offset the U.S. tax.

Also as expected, the House bill would allow companies to immediately expense capital investments — except buildings — acquired and placed in service after September 27, 2017, and before January 1, 2023. In addition, under the House bill, the limit on Section 179 expensing for pass-through entities would rise to $5 million, with the phaseout threshold increasing to $20 million but only for five years. The Senate plan would also allow for full and immediate expensing of qualifying assets acquired and placed in service before January 1, 2023, though there would be some differences in which assets would qualify. The Senate bill also would increase the Section 179 expensing limit, but only to $1 million, and would increase the phaseout threshold, but only to $2.5 million. The higher limits would, however, be permanent.

A hot topic for many, the House bill offers a deduction of interest for every business, regardless of the type of entity, for net interest expense as long as it does not exceed 30% of the business’ adjusted taxable income. It would provide an exemption from this rule for businesses with gross receipts of less than $25 million. Net operating loss carrybacks would be disallowed and net operating loss carryforwards would be subject to a limit of 90% of taxable income. The Senate proposal allows for a similar indefinite carryforward of disallowed interest expense.

One of the most interesting provisions, particularly to our client base, is the proposed reduced rate for business income of individuals. The House bill would tax pass-through owners on business income at a maximum rate of 25%, rather than at their individual income tax rate. Those “actively involved” in their businesses would pay their individual rate on 70% of their income (which would be deemed wages) and the 25% rate on the remaining income. It introduced a facts-and-circumstances formula that calculates the amount of wage income based on their capital investment in the business. This option might be especially appealing for capital-intensive businesses. Personal services businesses wouldn’t be eligible for the 25% rate at all.

The Senate bill would provide tax relief to owners of pass-through entities by establishing a deduction for pass-through businesses of all sizes. The deduction would amount to 17.4% for certain pass-through income, with phase outs.

On November 9 an amendment to the House bill was introduced that would provide relief to some small business owners. The amendment eventually would provide a 9% tax rate, in lieu of the ordinary 12% tax rate, for the first $75,000 in net business taxable income of an active owner or shareholder earning less than $150,000 in taxable income through a pass-through business and married filing jointly. As taxable income exceeds $150,000 for married joint filers, the benefit of the 9% rate relative to the 12% rate is reduced, and it’s fully phased out at $225,000 for such filers. Businesses of all types would be eligible for the preferential 9% rate. The proposed 9% rate would be phased in over five tax years.

2017 Planning Items

Regardless of how tax reform develops for the 2018 tax season, there are still items to consider for 2017:

  1. Individuals should evaluate whether or not they would receive any benefit from paying state taxes, miscellaneous itemized deductions or medical expenses before year-end since those deductions could possibly be eliminated January 1, 2018. 
  2. Businesses should consider any fixed-asset additions before year-end. Under the PATH Act, those additions should qualify for 50% bonus depreciation or increased Section 179. Under provisions of the Tax Cuts and Jobs Act, any additions placed in service after September 27, 2017, qualify for the increased expensing under immediate expensing and increased section 179.

Obviously, there’s still a long way to go before a law is passed. The goal is to have legislation signed before the end of the year, but given what we’ve seen so far, don’t hold your breath.

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Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.