Special Report: Senate completes the next step toward Tax Reform
On Saturday morning, the Senate passed their version of the Tax Cuts and Jobs Act by a vote of 51-49. This paves the way for the House and Senate versions to head to conference to work out the differences between the two packages. Once a final bill is reached, it will need to pass both houses of Congress prior to heading to the White House for signature. The following are some of the key differences that remain to be worked out.
Business Deductions and Credits, Tax Rates
Section 179 Expensing:
- House: For years 2018 through 2022, the expensing limitation would increase to $5 million and the phase out amount to $20 million. The new limitations would be adjusted for inflation.
- Senate: The expensing limitation would increase to $1 million and the phase out amount to $2.5 million. The new limitations would be adjusted for inflation. The bill would further expand the definition of section 179 property, and the definition of qualified real property for improvements made to non-residential real property.
Deductions for Income Attributable to Domestic Production Activities (DPAD):
This is repealed in both bills, however, the Senate repeal does not begin until 2019.
Net Operating Loss (NOL) Deduction:
- House: Beginning in 2018, would allow a taxpayer to deduct an NOL carryover or carryback of up to 90% of the taxpayer’s taxable income.
- Senate: Beginning in 2018, would limit the NOL deduction to 90% of the taxpayer’s taxable income and, while amounts may be carried forward indefinitely, the carryback provisions have been eliminated. Beginning in 2023, the 90% limitation would be replaced with an 80% limitation to be repealed for tax years beginning in 2026, if October 1, 2017 – September 30, 2026 revenue targets are met.
Corporate Tax Rate:
- House: Beginning in 2018, 20% flat corporate tax rate; 25% flat rate for personal service corporations.
- Senate: Beginning in 2019, 20% flat corporate tax rate; eliminate the special tax for personal service corporations.
Corporate Alternative Minimum Tax (AMT):
The House Bill repeals the AMT beginning in 2018, however, the Senate Bill leaves the AMT in place. The House Bill includes provisions which allow for the AMT credit carryforward amounts to be refundable over a period of years.
Research and Experimentation (R&E) Credit:
This credit is preserved in both bills. However, by leaving the AMT in place, companies that are not eligible small businesses (those with average gross receipts of less than $50 million over prior three years) will likely see little to no benefit from the credit.
Pass-Through Tax Rate:
Both bills provide for a reduced rate on pass-through income, however, they approach the issues in different ways. The House Bill provides for a reduced tax rate on a portion of the income flow-through, while the Senate Bill provides for a deduction of 23% of the qualified business income; essentially creating a lower effective rate on pass-through income. The Senate Bill also provides that its provision would expire after 2025.
Accumulated Foreign Earnings:
Both bills require companies to pay a one-time tax on accumulated foreign earnings. The House Bill provides for a tax of 14% on cash assets and 7% on non-cash assets (e.g. equipment abroad in which profits were invested) while the Senate Bill provides for a slightly higher tax rate of 14.5% and 7.5%, respectively. Both bills allow for an election to pay the tax over an eight-year installment period. The Senate Bill provides some additional provisions, such as an extended statute of limitations period with respect to the mandatory inclusions of six years, and recapture tax rate of 35% if the entity expatriated within 10 years of enactment. Various other special provisions related to Real Estate Investment Trusts (REITs) and transition rules related to net operating losses, overall dual consolidated losses, and foreign tax credit carryforwards are included in the Senate Bill.
Dividends From Foreign Subsidiaries:
Both bills provide for a 100% deduction for the foreign source portion of dividends received from “specified 10-percent owned foreign corporations.” This deduction will not be available to Passive Foreign Investment Companies (PFICs). No foreign tax credit would be allowed for foreign taxes paid or accrued with respect to a qualifying dividend. The Senate Bill provides that no deduction would be available for “hybrid dividends.” The House Bill has a six-moth holding period, and the Senate Bill has a one-year holding period.
Base Erosion Provisions:
Both bills include a new Section of Subpart F related to intangible income earned in low-taxed foreign jurisdictions. While the proposed regulations of both bills is complex, both bills subject US shareholders of controlled foreign corporations to current US taxation on 50% of “global intangible low-taxed income,” with a deduction of 37.5% of foreign derived intangible income. The Senate Bill also provides for basis adjustment rules for transfers of intangible property from controlled foreign corporations to US shareholders.
The House Bill imposes a 20% excise tax on certain payments made by a US corporation to a related foreign corporation, unless a US corporation elects to treat the payments as effectively connected income. Payments that are deductible, could be included in cost of goods sold or in the basis of a depreciable or amortizable asset, would be subject to the excise tax. The Senate Bill includes a more complicated base erosion minimum tax on similar payments. Both bills allow a foreign tax credit for a portion of foreign taxes paid overseas against the tax imposed.
The Senate Bill denies a deduction for related party amounts paid or accrued to foreign subsidiary, which is not included in income of the related party under the tax laws where the foreign subsidiary is located.
Both bills also include additional limitations related to the deduction of interest of a US corporation that is a member of a worldwide affiliated group.
Individual Deductions, Credits and Tax Rates
Income Tax Rates:
The bills vary in the number of tax brackets with the House at four and the Senate at seven. What they do have in common is that they significantly increase the amount of income covered by each bracket so that the highest rates are not reached for a married couple filing jointly until their taxable income reaches $1.0 million.
The AMT is repealed in the House Bill, however, the Senate Bill left the AMT in place and slightly increased the threshold where AMT begins to kick in.
The House sets the standard deduction at $24,400 for married couples, $18,300 for unmarried individuals with at least one qualifying child, and $12,200 for all other taxpayers (subject to inflation), but repeals personal exemptions. The Senate raises the deduction to amounts similar, but slightly lower than, the House and repeals the personal exemptions. However, the Senate also preserves the enhanced deduction for the blind and elderly.
- Mortgage Interest: The House reduces the mortgage interest by limiting it to interest on mortgages of up to $500,000. The Senate, however, left the cap at $1.0 million but eliminates the deduction for home equity lines of credit.
- State and Local Taxes: Both houses repeal the deduction for state and local income taxes and state and local sales taxes; and allow a deduction of up to $10,000 for state and local real property taxes.
- Medical Expenses: The House Bill repeals the deduction for medical expenses, however, the Senate preserves this deduction.
- Teacher Expense Deduction: The above-the-line deduction is eliminate in the House bill, however, the Senate Bill increases the deduction from $250 per year to $500 per year.
- Child Tax Credit: Both bills increase the child credit, with the House Bill increasing the credit to $1,600 while the Senate increases the child credit to $2,000. The bills each have varying provisions related to phase outs and the ability of the credit to be generate a refund.
Estate and Generating Skipping Transfer Tax
- The House Bill would increase the amount exempted from estate, gift and generation-skipping taxes from $5 million to $10 million for gifts made, and decedents dying, after 2017. This House Bill would repeal both the estate tax and the generation-skipping transfer tax, effective for deaths and transfers made after 2024. The rules providing for a fair-market-value income tax basis at death would remain in place. The gift tax would also stay in place for gifts made after 2024, but the rate would be reduced from 40% to 35% at that time.
- The Senate Bill, like the House Bill, would double the estate, gift and generation-skipping tax exclusion amount to $10 million, effective for decedents dying and transfers made after 2017. However, the Senate Bill would not repeal the estate tax or the generation-skipping transfer tax as the House Bill would. The Senate Bill also would not modify the gift tax rate, leaving all of these taxes at their current 40% rate.
As we approach the end of the legislative session for the year, there are many differences still to be reconciled. We will continue to keep you updated as we learn more. If we can be of assistance with any of your questions or concerns, please reach out to us.