The Senate released the basic structure of its tax plan on November 9 as the House Ways and Means Committee was making changes to the House bill. The House’s changes come in preparation for a floor vote that could come as early as next week. The Senate Plan was not released as legislative text, and instead provides descriptions of the features included with their tax plan. The Senate’s draft legislation will be introduced once the House bill has cleared that chamber, and prompt action is expected in the Senate to pass its version. This will enable the two chambers to advance to a conference committee, where the differences between the two chambers’ versions of the Tax Cuts and Jobs Act would be reconciled. However, the following differences are widely expected to slow this breakneck pace.
The differences start on the business side with a delay proposed by the Senate of the GOP’s signature tax cut—the corporate rate reduction to a flat 20 percent. The corporate rate reduction would be delayed to 2019, an effort made to comply with the Senate’s budget reconciliation rules. The House’s plan called for the corporate rate reduction to be effective in 2018. Under the plans of both chambers, there is no sunset contemplated for the proposed 20 percent rate. Additionally, the alternative minimum tax (AMT) for businesses (and for individuals) would be repealed under both plans.
The Senate Plan also features a more modest tax break for pass-through entities (partnerships and S corporations) and sole proprietorships, with mechanics simpler to implement in some respects. Under the Senate Plan, owners of such businesses would be allowed a 17.4 percent deduction for qualified business income from the business. The deduction for owners of pass-through entities would be limited to 50 percent of W-2 wages attributable to the business. Qualified business income would not include any amounts received (or income allocated) in exchange for services, or certain investment-related income. The deduction would be phased out for businesses in the service industry (accountants, lawyers, etc.) where the individual’s taxable income exceeds $200,000 for married couples ($100,000 for single filers). The House plan called for a special 25 percent tax rate, attributable to all business income passed through to passive investors, and attributable to 30 percent of income passed through to active participants in the business. Special rules would apply to professional service businesses under the House plan.
The Senate Plan also features full capital expensing provisions for new property placed in service beginning Sept. 27, 2017 and before Jan. 1, 2023. While this is similar to the House plan, under the Senate Plan the expensing provision applies only to “original use” (brand new) property. Under both plans, the provision would not apply to property used by a regulated public utility, though the Senate Plan would allow the provision to apply to property used in a real property trade or business (the House plan would not).
After that, the Senate’s smaller expansion of the section 179 deduction would apply. The Senate Plan calls for an increase to $1 million for the section 179 expense limit (with an investment limitation of $2.5 million), compared to the House’s plan that calls for an increase to $5 million for the expense limit (with an investment limitation of $20 million). However, the Senate Plan would make its section 179 changes permanent, whereas the House plan would make them effective through 2022.
The Senate Plan would shorten the depreciation recovery period to 25 years for real property, and 10 years for qualified improvement property. The House plan would not change current law in these regards.
The 30 percent cap on the net interest deduction is also slightly more restrictive in the Senate Plan, as earnings are determined before interest and taxes (EBIT), while the House’s plan uses earnings before interest, taxes, depreciation, and amortization (EBITDA). Furthermore, the Senate Plan would apply this limitation to more businesses than under the House plan by exempting businesses with average annual gross receipts over a three-year period of $15 million or less (the House plan would set the threshold at $25 million). Real property businesses and regulated public utilities would be exempt from the limitation under both plans.
Both tax plans would impose a new limitation on net operating losses by limiting the deduction for net operating loss carryforwards to 90 percent of taxable income, generally eliminating the ability to carry back net operating losses to prior tax years, and establishing an unlimited carryforward period for net operating losses incurred after 2017. However, the Senate Plan boldly limits the ability of individuals to deduct a new category of “excess business losses.” The House plan contains no such provision. Under the Senate Plan, business losses stemming from any business (including losses passed through from partnerships or S corporations that are not otherwise limited) would not be deductible to the extent they exceed $500,000 for married couples ($250,000 for single filers).
Both tax plans also would expand the availability of the cash method of accounting, even where inventories are maintained. However, the Senate Plan would be less aggressive in the enhanced eligibility, limiting the cash method to businesses (which otherwise must use the accrual method) having average annual gross receipts over a three-year period of no more than $15 million. The House plan would set this limit at $25 million. Both tax plans would also exempt businesses from complying with uniform capitalization rules at these respective levels.
Finally, the Senate Plan preserves most business credits, including the Research and Experimentation Credit and the Work Opportunity Credit. The House plan would preserve the Research and Experimentation Credit, but would repeal the New Markets Credit, the Work Opportunity Credit, and certain other credits. Additionally, the orphan drug credit would be curtailed under the Senate Plan to limit qualifying expenditures to only those that exceed a three-year average and where a reduced ratio applies in cases where there were no qualifying expenditures in at least one of the three prior years. The House plan would repeal the orphan drug credit completely.
On the international side, the Senate Plan features lower rates for its one-time deemed repatriation provisions. The Senate Plan calls for a 10 percent tax rate to be applied against accumulated foreign earnings held in cash and cash equivalents, with a 5 percent rate for earnings held in illiquid assets. The Senate Plan would require this tax to be paid in the last taxable year that begins before Jan. 1, 2018, with an election available to pay the tax over eight installments, with the first installment due in the same year. The House plan proposes a similar one-time repatriation tax but using respective tax rates of 14 percent and 7 percent. The tax rates proposed by the House reflect an increase from its original draft legislation, in response to a loss of revenue from their changes to the anti-base erosion provisions initially proposed.
The Senate Plan would subject 10 percent-U.S. shareholders of a controlled foreign corporation to a 12.5 percent minimum tax on certain intangible profits earned by the foreign corporation. The House plan would impose a 10 percent minimum tax on foreign “high return” profits of a controlled foreign corporation.
Furthermore, the Senate Plan would treat the sale or exchange of a partnership interest by a nonresident individual or foreign corporation as effectively connected income to the same extent that such transferor would have effectively connected income had the partnership sold all of its assets at fair market value. The Senate plan would also require the transferee of a partnership interest to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that the transferor is not a nonresident individual or foreign corporation.
The House plan would impose a 20 percent excise tax on certain payments to foreign affiliates. The Senate Plan would impose a tax on certain base erosion payments to foreign affiliates. Both plans would provide for a 100 percent dividend exemption on foreign-source dividends paid to U.S. corporate shareholders (who own at least 10 percent of the foreign subsidiary). The Senate Plan would also terminate the special rules applicable to IC-DISCs and would also specifically include goodwill and going concern value as “intangible property” for purposes of gain recognition on an outbound transfer to a foreign affiliate.
On the individual side, the much vaunted simplification from the reduction in the number of tax brackets is not part of the Senate Plan. Instead, the current 7 brackets are modified and the income thresholds for each are adjusted. The tax rates and brackets under the Senate Plan would be as follows:
- A 10 percent rate would apply for incomes up to $9,525 ($19,050 for married couples);
- A 12 percent rate would apply for incomes up to $38,700 ($77,400 for married couples);
- A 22.5 percent rate would apply for incomes up to $60,000 ($120,000 for married couples);
- A 25 percent rate would apply for incomes up to $170,000 ($290,000 for married couples);
- A 32.5 percent rate would apply for incomes up to $200,000 ($390,000 for married couples);
- A 35 percent rate would apply for incomes up to $500,000 ($1 million for married couples); and
- A 38.5 percent would apply for incomes in excess of $500,000 ($1 million for married couples).
Although the House plan originally proposed no changes for carried-interest taxation, the House plan was amended to require certain conditions for preferential tax treatment to be received by investment fund managers and certain real estate investors. For instance, such persons would be required under the House’s amended plan to hold partnership interests that are treated as a carried interest for a three-year holding period before long-term capital gains tax rates could apply. In stark contrast to the House amended plan, the Senate Plan includes no proposed changes for carried interests.
The postcard idea also does not seem to fit into the Senate Bill; even though the standard deduction is roughly doubled under both plans, many of the deductions that would be eliminated or limited in the House bill would be preserved under the Senate Plan. These include the full mortgage interest deduction, the deduction for medical expenses, and the student loan interest deduction. However, the state and local tax deduction would be fully eliminated under the Senate Plan, instead of the limited state property tax deduction of $10,000 in the House’s bill. As mentioned previously, the AMT for individuals would be repealed under both plans.
Both plans would preserve popular retirement savings provisions under current law for section 401(k) plans. Both plans would also change the tax treatment of deferred compensation plans drastically, by requiring income inclusion at the moment when a substantial risk of forfeiture is removed. Under both plans, this would accelerate the timing of income recognition for traditional deferred compensation arrangements, for most stock options and for equity awards.
The Senate also features a $50 per child increase in the child tax credit (up to $1,650) over the House plan’s proposal. However, it does not contain the $300 family tax credit proposed in the House.
Other Tax Provisions
Another major difference between the two chambers’ tax plans is the estate tax. The House’s plan would eliminate the estate tax after 2023, would lower the tax rate to 35 percent for 2018-2023, and would also double the exclusion amount to $10 million during 2018-2023. On the other hand, the Senate Plan would double the exemption in the same regard, but would not lower the rate or repeal the tax.
Both plans call for a new 1.4 percent tax to be applicable to not-for-profit organizations operating private colleges and universities. This tax would apply to the net investment income of such educational institutions having assets of more than $250,000 per student. However, under the Senate Plan, royalty income received for licensing an organization’s name or logo would be taxable as unrelated business income for all not-for-profit organizations. This provision was not part of the House plan.
The immediate question is whether these differences can be reconciled before the President’s suggested Christmas deadline. The particularly difficult differences arising from the Senate’s proposal appear to be the delay in the corporate tax cut, the complete elimination of the state and local tax deduction, and the failure to provide a complete repeal of the estate tax. However, the Senate merely provided an outline of the basic structure of their plan, and it is expected to change before they begin the task of drafting legislation.
For more information on tax reform please contact your local CBIZ MHM tax professional.
Copyright © 2017, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.
CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).