The much-anticipated tax reform bill was released November 2, 2017 by the House Committee on Ways and Means. The Bill is 429 pages long and referred to as H.R. 1 Tax Cuts and Jobs Act and touches many areas of the existing tax code for both businesses and individuals. Generally, this bill is effective for years after December 31, 2017. The following summary addresses certain key provisions of the bill but certainly not all.
Corporate and Business Provisions
Tax rates – Beginning in 2018, C corporations would have one flat rate of 20%. For personal service corporations, the flat rate would be 25%. The current rate structure has graduated rates of 15% to 35% with a flat rate of 35% for personal service corporations (medical, lawyers, accountants, architects, engineers…).
Alternative Minimum Tax (AMT) – The AMT would be repealed.
Accounting Methods – For C corporations, the gross receipts threshold for using the cash basis of accounting would be increased from $5 million to $25 million. The $10 million gross receipts exception to the requirement to use the percentage-of-completion method of accounting for long-term contracts would increase to $25 million. Companies meeting this exception would be allowed to use the completed contract method of accounting or any other permissible method of accounting.
The $25 million threshold would also apply to the Uniform Capitalization provisions under §263A.
Contributions to Capital – Contributions to capital of a corporation would be included in the corporation’s gross income unless it is in exchange for stock. Therefore, contributing to paid-in-capital would likely be taxable.
Cost Recovery – “Bonus” depreciation deduction under §168(k) would increase from 50% to 100% for equipment placed in service after September 27, 2017 and before January 1, 2023. Also, the current requirement that an asset be new in order to qualify for “bonus” depreciation would be eliminated.
Qualified property would not include any property used in a real property trade or business.
Also, the bill would eliminate a taxpayer’s election to use the minimum tax credit in lieu of the additional depreciation.
The election to expense certain depreciable property under §179 would be increased from $500,000 to $5,000,000 with a phase-out amount of $20,000,000 for total asset additions. Also note that §179 would apply to certain qualified energy efficient heating and air conditioning property.
Interest Expense Deduction – The bill would limit the deduction for net interest expense (interest expense less interest income) to 30% of the business adjusted taxable income. Adjusted taxable income is generally taxable income before interest income or expense, depreciation, amortization and gains and losses not allocable to business income.
Please note that this limitation on interest expense deduction does not apply to companies with average gross receipts of $25 million or less, nor to real property trades or businesses.
Like-Kind Exchanges – The bill would limit the deferral of gain under §1031 to real property only.
Domestic Production Activities Deduction (DPAD) – Under H.R. 1, the DPAD would be eliminated. This deduction currently provides a % deduction for certain producers such as farmers and manufacturing businesses.
Entertainment Expenses – Entertainment expense deduction would be generally eliminated unless the amounts are included as taxable compensation to the employee. This would not apply to meals. Currently, 50% of these costs are generally deductible.
Credits – A number of tax credits would be repealed by this bill including:
⦁ Employer provided childcare credit
⦁ Rehabilitation credit
⦁ Work opportunity credit
⦁ New markets tax credit
Energy tax credits have been modified with a phase out in 2022 and 2027.
Passthrough Entities (Partnerships, LLCs, S Corporations or Proprietorships)
Tax Rates – If the bill passes, in general, the tax rate would be capped at 25% for income allocated to the owners of these businesses. However, if the business is considered active, the income would be allocated as 30% business income and 70% as wage income. If passed, this means that with an active operating business the 25% tax rate would apply to only 30% of the pass-through income.
Under the proposed bill, owners of passive investments would generally get the 25% maximum rate on 100% of the pass-through income.
Pass-through income from service businesses would not eligible for the lower 25% rate.
Contribution to Capital – As with the corporate provisions discussed earlier, contributions to partnership or LLC capital would be taxable gross income unless exchanged for an interest in the entity.
Technical Termination of a Partnership – Under current law, if there is a change in ownership of a partnership or LLC of 50% or more, the partnership is technically terminated. This technical termination provision would be repealed with this bill.
Tax rates – The bill proposes four rates: 12%, 25%, 35% and 39.6%.
For high-income taxpayers, the bill would impose an increase in tax at 6% on adjusted gross income over $1.2 million for joint filers or surviving spouses and $1.0 million for all other individual filers.
For capital gains, the rate would be 0%, 15% or 20% depending on the income levels of the taxpayer.
Standard Deduction – The standard deduction would nearly double to $24,000 for joint taxpayers, $12,000 for individuals and $18,000 for a single filer with at least one qualifying child.
Personal Exemptions – All personal exemptions would be repealed under the bill.
Alternative Minimum Tax (AMT) – This bill would eliminate AMT for individuals.
Mortgage Interest Deductions – The bill would limit the mortgage interest deduction based on $500,000 of any new debt incurred and would only be deductible on a taxpayer’s principal residence. The current limitation is based on $1,000,000 of debt.
State and Local Tax Deduction – The bill would eliminate the itemized deduction for state and local income and sales tax.It would also limit the deduction for state and local real property taxes to $10,000.
Medical Expense Deduction – The bill would eliminate the itemized deduction for medical expenses.
Charitable Contributions – The deduction for payments to charity are untouched by the bill except that the limitation for cash contributions of 50% of adjusted income would increase to 60%.
Alimony Payments Deduction – The bill would eliminate the current above-the-line deduction for alimony payments and the payee would not be required to report the alimony income. This provision would be effective for divorce decrees, separation agreements and modifications entered into after 2017.
Gain on Sale of Personal Residence – The bill would continue to exclude from gross income up to $500,000 of gain on the sale of a principal residence for joint filers or $250,000 for other filers. However, to qualify for this exclusion the taxpayer would have to live in the residence for five of the last eight years. As a result, this gain exclusion would only be available every five years.
Further, this exclusion would phase out dollar for dollar when the taxpayer’s gross income exceeds $500,000 for joint filers and $250,000 for all others.
Tax Credits – The Child Tax Credit would be increased from $1,000 to $1,600.The adoption credit would be repealed.
Estates, Gifts and Trusts
Estate and Gift Taxes – The bill would increase the federal lifetime exclusion to $10 million for decedents dying and gifts made after 2017.
Further, the bill would repeal the estate tax for decedents dying after 2023 while allowing for a “stepped-up” (fair market value) income tax basis.
The gift tax would remain, but the rate would be reduced from 40% to 35% effective for gifts made after 2023.
Nonqualified Deferred Compensation – Employees would be taxed on compensation as soon as there is no substantial risk of forfeiture, which is defined to include only future performance of substantial services. Short-term deferral exceptions similar to those in §409A would exist. Existing plans based on pre-2018 service would be grandfathered until the last tax year beginning before 2026.
International – Accumulated foreign earnings held in cash or cash equivalents and in illiquid assets deemed repatriated would be taxed at 12% and 5%, respectively. A taxpayer could elect to pay the resulting liability over eight years.
Further, there would be a shift to a territorial income tax system away from the current US system which taxes world-wide income and provides a credit for foreign taxes paid in other countries.
Tax-Exempt Organizations – The bill would impose a 20% excise tax on compensation in excess of $1 million paid to any of its five highest paid employees. This would not apply to qualified retirement plan payments or amounts that are excludible from gross income.
The bill would provide that churches could make political statements in the ordinary course of activities in carrying out exempt purposes if the incremental expenses incurred are de minimis.
What is Next?
This bill is a long way from becoming law and will likely see political and other opposition. The Senate is currently in the process of marking its bill, and we may see the senate version within the next few days or week. We will keep you up to date.
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