Republicans in the U.S. House Propose Sweeping Tax Reform

by The ARB Team

On November 2, 2017, House Republicans released the details of their much anticipated tax reform proposals. The bill is over 400 pages and impacts virtually every individual and business. The proposal’s fate is uncertain. Several Republicans from highly populated states are unhappy with the elimination of the state and local income tax deduction. Most commentators believe the proposal’s provisions and scope of the changes could be significantly altered in the legislative process.

The following summarizes some of the notable proposals in the bill, which would generally be effective in 2018.

INDIVIDUALS:

TAX RATES: The current seven brackets (10%, 15%, 25%, 28%, 33%, 35%, and 39.6%) would be reduced to four (12%, 25%, 35%, and 39.6%). For married taxpayers filing jointly, the 25% bracket would begin at $90,000, 35% at $260,000, and 39.6% at $1 million. For unmarried individuals and married filing separately, the bracket thresholds would be half the thresholds for married taxpayers filing jointly, except the 35% bracket for unmarried individuals would begin at $200,000, not $130,000.

MAXIMUM RATE ON CERTAIN BUSINESS INCOME OF INDIVIDUALS: A portion of flow-through entity income would be treated as “business income” and subject to a maximum rate of 25%. Passive income would be fully eligible for the special rate. Active business owners could generally elect to treat 30% of their income as being subject to the 25% rate, or would use a defined formula approach (binding for a five year period) to obtain a percentage greater than 30%. Attempts would be made to curtail abuse by preventing re-characterization of compensation as business income. In general, flow-through income from certain personal services businesses (law, accounting, consulting, engineering, financial services, or performing arts) would not be eligible for the 25% rate.

ENHANCED STANDARD DEDUCTION: Under the current law, an individual reduces adjusted gross income by any personal exemption deduction and either the applicable standard deduction or his itemized deductions to determine taxable income. Under the proposal, the standard deduction would be increased to $24,000 for joint filers and $12,000 for individual filers. Single filers with at least one qualifying child would claim a standard deduction of $18,000. The personal exemption would be eliminated.

DEDUCTIONS: Many deductions for individuals would be repealed. Most notably, the state and local income tax itemized deduction would be eliminated. The deduction for real estate taxes would be preserved, but capped at $10,000. Other deductions proposed for elimination include medical expenses, alimony, most casualty losses, tax preparation fees, moving expenses, the teachers’ classroom expense, and employee business deductions.

The mortgage interest deduction would be retained; however, for home mortgage debt incurred after November 2, 2017, only interest on up to $500,000 of acquisition indebtedness would be deductible, a sizable reduction from the current debt limit of $1.1 million. Charitable deductions would generally be preserved.

The so-called Pease Limitation, which reduces itemized deductions for higher income individuals, would be repealed.

CREDITS: Various credits would be repealed, including the adoption credit, the credit for the elderly and the totally and permanently disabled, the credit associated with mortgage credit certificates, and the credit for plug-in electric vehicles.

The child tax credit would be increased to $1,600, and a credit of $300 per individual would be allowed for the taxpayer, a spouse, and non-child dependents. These credits would generally phase out to zero for higher income taxpayers.

HIGHER EDUCATION INCENTIVES: The American Opportunity, Hope Scholarship, and Lifetime Learning Credits would be combined in a single American Opportunity Credit. The maximum credit available for the first four years of post-secondary education would be $2,500, and up to $1,250 would be available for a fifth year. The Hope and Lifetime Learning Credits would be repealed. New contributions to Coverdell Education Savings Accounts would be prohibited, and the interest deduction for student loans, the tuition and fees deduction, the U.S. Savings Bond interest exclusion, and employer-provided educational assistance programs would be repealed.

ALTERNATIVE MINIMUM TAX (AMT): The AMT would be repealed.

RETIREMENT INCENTIVES: 401(k) contribution rules would generally be retained, but conversions into and re-characterizations of Roth IRAs would generally be repealed.

ESTATE AND GIFT TAX: The proposal would double the lifetime gift and estate tax exemption after 2017. In 2023, the estate and generation-skipping transfer taxes would be repealed and stepped up basis for beneficiaries would be retained. The gift tax rate would be reduced to 35%.

BUSINESSES

FLAT CORPORATE INCOME TAX RATE: The bill would replace the current four tier system with a single 20% tax rate. Personal service corporations would be subject to a flat 25% tax rate. The corporate AMT would be repealed.

INCREASED EXPENSING: The bill would allow for 100% expensing of qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. Unlike the current bonus depreciation provisions, this proposal would not require personal property to be “new,” only new to the taxpayer. The bill proposes to increase the Section 179 expensing limitation to $5 million.

ACCOUNTING METHODS: The proposal would allow more businesses to use the cash and completed contract methods of accounting for tax purposes. It would also expand exceptions to the so-called UNICAP rules of Section 263A.

NET OPERATING LOSSES (NOLs) & OTHER DEDUCTIONS ELIMINATED OR LIMITED: The proposal would eliminate carrybacks of most net operating losses and would limit the amount that could be used in a particular year to 90% of taxable income. Carryforwards arising after 2017 would also be increased by an interest factor.

The proposal subjects every business, regardless of its form, to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. The disallowance would be determined at the entity level. Adjusted taxable income is a business’s taxable income computed without interest expense, interest income, net operating losses, and depreciation & amortization. Disallowed amounts would be carried forward for 5 years. Opportunities for members in a flow-through entity to utilize amounts disallowed at the entity level may exist. Businesses with less than $25 million of average gross receipts would be exempt from this interest expense disallowance, as would real property trades or businesses.

Other deductions affected in the proposal include:

  • The domestic production activities deduction would be repealed
  • Deductions for entertainment, amusement, or recreation activities would be eliminated
  • Deductions for reimbursements to employees for travel, meals, and certain other perks deemed personal in nature rather than directly related to a trade or business, except to the extent that such benefits are treated as taxable compensation to the employee, will be eliminated

LIKE-KIND EXCHANGES: The bill would limit the tax deferral on a like-kind exchange to real estate transactions only.

BUSINESS AND ENERGY CREDITS: The bill would repeal the following tax credits:

  • The Work Opportunity Tax Credit
  • The credit for Employer-Provided Child Care Tax Credit
  • The credit for rehabilitation of qualified historic buildings or historic structures
  • The Sec 45D new markets tax credit – credits allocated before 2018 could still be used in up to seven subsequent years
  • The credit for providing access for disabled individuals

The proposal would also modify certain tax credits, including the Social Security Tax Tip Credit, the Renewable Resources Electricity Credit, the investment tax credit for eligible energy property, and the Section 25D residential energy efficient property credit.

BONDS: Interest income on several types of bonds currently treated as tax-exempt would become taxable, including interest on private activity bonds and bonds related to professional sports stadiums.

NON-QUALIFIED DEFERRED COMPENSATION: The proposal would subject non-qualified deferred compensation to income tax as soon as there is no substantial risk of forfeiture with regard to the compensation, effective for amounts attributable to services performed after 2017.

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