Tax reform has been a hotly debated issue since the 2016 presidential campaign, where Democrats and Republicans alike advocated major overhauls to the current tax code.
Today, a little over one year since Donald Trump was elected the 45th president of the United States, where do plans for U.S. tax reform stand?
Earlier this month, the House Ways and Means Committee passed its most comprehensive tax reform proposal yet: the “Tax Cuts and Jobs Act.” Shortly after the draft bill was released, Senate Republicans unveiled the key features included in their tax plan in a report entitled Description of the Chairman’s Mark of the “Tax Cuts and Jobs Act,” before releasing the full legislative text of the bill.
Let’s take a look at some principal components of these proposals and how they could impact corporate, individual and international tax issues moving forward. Be sure to check out the infographic below for an in-depth look at how tax reform has evolved since the 2016 presidential campaign.
- Corporate tax rate: Under the House bill, C corporations would be subject to a flat 20 percent tax rate, with personal service corporations subject to a flat 25 percent tax rate starting in 2018. The Senate proposed to delay the corporate rate reduction until 2019 in an effort to comply with budget reconciliation rules.
- Pass-through tax rate: Owners of pass-through entities (partnerships and S corporations) would be subject to a maximum 25 percent tax rate on profits under the House plan. The Senate plan features a more modest tax break of a 17.4 percent deduction for qualified business income. However, under the Senate proposal pass-through owners would face a new excess business loss limitation that would strictly limit the deduction of business losses. Anti-abuse guidelines in both plans remain fluid as we await further guidance from lawmakers.
- Interest expense deductions: The House proposal limits the deduction for interest expenses of businesses that have average gross receipts in excess of $25 million to 30 percent of adjusted income. The limitation is targeted toward larger businesses. The Senate plan would apply this limitation to more businesses by exempting those with average annual gross receipts over a three-year period of $15 million or less. Real estate businesses would also be exempt from the interest limitation under both plans.
- Net operating loss (NOL) deduction: The NOL deduction is initially limited in both plans to 90 percent of taxable income, though the Senate plan limit drops to 80 percent after 2022.
- Full capital expensing: Both the House and Senate proposals would allow businesses to deduct the full cost of most capital assets in the year of the purchase. In the House version of the bill this would apply to purchases of new and used property, while the Senate would limit it to purchases of new property only.
- Contributions to capital: In the House bill, contributions to capital would be included in gross income if the contribution was not made in exchange for stock. The Senate bill does not contain a similar provision.
- Standard deduction and personal exemptions: The interplay between almost doubling the standard deduction and eliminating personal exemptions is a topic of debate in both bills. For example, let’s take a family of four whose personal exemptions would be worth $4,150 each in 2018. Under the current tax code, both parents could receive a standard deduction of $6,500 ($13,000 total) plus $4,150 in personal exemptions for each family member ($16,600 total) for a grand total of $29,600. Under both new plans, each parent would receive the increased standard deduction of $12,000 ($24,000 total) but would not be eligible for any personal exemptions, bringing their grand total to $24,000. In an effort to make up for this, both plans increase the child tax credit, with the Senate proposing to double it from $1,000 to $2,000. Additionally, the House plan features a new $300 family tax credit for each taxpayer, their spouse and non-child dependents. However, this credit phases out after five years.
- State and local deduction eliminations: One of the primary concerns expressed by many individuals and representatives is the repeal of the state and local income tax deduction and property tax deduction. All previous plans eliminated both of these, but the House bill maintained a limited deduction for property taxes – up to $10,000 per year. However, the state and local tax deduction would be fully eliminated under the Senate plan.
- Other deductions: For remaining itemized deductions, the House bill proposes eliminating deductions for medical expenses, student loan interest, moving expenses and adoption credits. Also, the above-the-line deduction for alimony would disappear. However, many of these would be preserved under the Senate plan. The mortgage interest deduction would be preserved by the House, but the indebtedness limitation would be lowered to $500,000 versus the current $1 million limit. The full mortgage interest deduction would be preserved by the Senate.
- Individual tax rate: The lowest rate now stands at 12 percent in the House bill and 10 percent in the Senate proposal. The top rate is back up to 39.6 percent from the House and 38.5 percent from the Senate. The bills also finally provided details on what levels of income would trigger each bracket.
- Alternative minimum tax (AMT), retirement plans and capital gains: Both bills eliminate the AMT through at least 2025, but spare retirement savings rules and the capital gains rates from major alterations.
- Estate tax and generation-skipping taxes (GST): Under the House bill, the estate tax and GST would be repealed for years beginning after 2023, with the rate decreasing to 35 percent and the exemption amounts doubling in the interim. The wealthiest individual Americans could have approximately $22 million in their joint estates in 2018 under the plan without paying any tax, and the exemption would continue to be indexed for inflation. The Senate would also increase the exemption amount to $22 million for married individuals in 2018, but would not lower the rate nor repeal the tax.
- Affordable Care Act (ACA): The Senate plan includes a provision to repeal the ACA individual mandate. No such provision currently exists in the House plan.
It’s worth noting that the current Senate Plan calls for most of the changes for individual taxpayers to expire (sunset) after 2025. The House Bill would make its tax cuts for individuals permanent.
- Territorial tax system: The border-adjusted tax is no longer being discussed in either proposal. The demise of the border adjustment tax has necessitated a move to a territorial tax system, which generally means companies will pay taxes wherever their income is earned.
- One-time deemed repatriation tax: In both plans, previously untaxed foreign earnings of foreign subsidiaries will be deemed repatriated and subject to a bifurcated tax rate depending on whether they are holding cash or cash equivalents. The House bill increased the rates over prior proposals to 14 percent on cash and 7 percent on cash equivalents. The Senate plan features lower rates for these provisions – a 10 percent rate for accumulated foreign earnings held in cash and cash equivalents, and a 5 percent rate for earnings held in illiquid assets. Keep in mind that that is a deemed repatriation – it doesn’t matter whether you bring the money back into the U.S. or not, you are still going to pay the tax.
- New excise tax: The House bill calls for a new 10 percent tax on the ongoing foreign-source “high-profit” returns earned by the foreign subsidiaries of a U.S. business. The Senate plan would subject U.S. shareholders of a controlled foreign corporation to a 12.5 percent minimum tax on certain intangible profits earned by the foreign corporation.