The House Bill — Tax Cuts and Jobs Act — Proposes Sweeping Changes
The recently released House bill – titled the Tax Cuts and Jobs Act – includes provisions affecting virtually all taxpayers. The bill (‘Bill”) would make sweeping changes to numerous provisions of US tax law, including the tax rate structure for individuals and corporations, changes to numerous deductions, as well as significant changes to the treatment of foreign subsidiaries, with varying effective dates. The gradual repeal of estate and generation-skipping transfer taxes is in the draft Bill as well. The treatment of carried interests was not included in the original Bill, but an amendment by Ways and Means Chair Kevin Brady would impose a three-year holding period on gains derived through certain carried interests.
For Individual Taxpayers
- The reduction in tax brackets from seven to four, including 12%, 25%, 35%, and 39.6% brackets;
- A claw back of the benefit of the lower brackets for high earners (over $1 million);
- An increased standard deduction of $24,000 for joint filers and $12,000 for individual filers, coupled with the repeal of the itemized deduction limitation and the elimination of personal exemption deductions;
- A maximum tax rate of 25% on a portion of a taxpayer’s business income earned through pass through entities. Passive owners would enjoy the full 25% rate, while those active would have to allocate between labor-based and capital-based income. Note that under the Bill, the amounts allocated to labor would be subject to certain self-employment taxes;
- The elimination of the itemized deduction for state and local income taxes and the reduction of the real property tax deduction to a cap of $10,000 to the extent such taxes were not incurred in a trade or business or income producing activity;
- Further limitation of the mortgage interest deduction to interest on up to $500,000 ($250,000 for single taxpayers) of acquisition indebtedness (vs. $1 million under current law);
- Further limitations on and an income phase out for the exclusion of gain on the sale of a principal residence;
- The repeal of the personal casualty loss deduction;
- An increase in the adjusted gross income (AGI) limitation for cash charitable deductions from 50% to 60%;
- The repeal of the alimony deduction;
- The repeal of the alternative minimum tax (AMT);
- The repeal of the exclusion for employer-provided education expenses;
- Consolidation of myriad education credits;
- The repeal of the interest income exclusion on private activity bonds;
- The taxation of deferred compensation arrangements at the point there is no longer a substantial risk of forfeiture (i.e. receipt is not conditioned on the future performance of substantial services), irrespective of when payable and whether funded or unfunded; and
- The repeal of certain itemized deductions, including medical expenses as well as miscellaneous deductions such as investment and tax preparation expenses.
The Bill increases the unified estate, gift, and generation skipping tax exemption to $10 million per person and, after 2023, repeals the estate and generation skipping transfer taxes and reduces the top gift tax rate to 35% from 40%. The adjustment to fair market value of the basis of a decedent’s assets held at death remains the law.
For Corporate and Business Taxpayers
- A reduction in the corporate tax rate to a 20% flat rate (from a graduated system maxing out at 35%) effective in tax years beginning after 2017 (25% for personal service corporations);
- Immediate expensing for certain qualified property placed in service after September 27, 2017 and before January 1, 2023, and an increase in the IRS Code Section 179 maximum to $5 million (from $500,000). Property used in a real property trade or business (as defined for passive loss rules purposes) is not eligible for immediate expensing;
- Repeal of the New Markets and Rehabilitation credits;
- Modification of the like-kind exchange rules to allow gain deferral on like-kind exchanges of real property only (would affect tangible personal property such as artwork or aircraft);
- A limitation on the net operating loss (NOL) deduction to 90% of taxable income;
- A limitation on interest expense deductions to 30% of adjusted taxable income (generally, taxable income computed without interest expense, depreciation/amortization, or NOLs) with exceptions for, among others, certain real property trades or businesses (as defined for passive activity loss purposes). Disallowed interest may be carried forward for five years;
- The repeal of IRS Code Section 163(j) earnings stripping limitations;
- The full elimination of entertainment expenses;
- The repeal of the deduction for domestic production activities; and
- Certain accounting benefits for smaller businesses, including an increase of the sales threshold from $5 million to $25 million for the use of the cash method of accounting.
Selected International Provisions
- The implementation of a territorial tax system through a “participation exemption”, excluding from US taxation dividends received from a 10% or greater foreign subsidiary to the extent sourced from foreign earnings (these dividends are currently taxable in the US to the extent of post-FTC tax);
- The partial repeal of IRS Code Section 956, which taxes foreign earnings invested in US property;
- The deemed repatriation of post-1986 foreign subsidiary E&P not yet subjected to US tax, taxable at either 12% or 5% depending upon whether those earnings were retained in cash or cash equivalents or reinvested in the foreign subsidiary’s business;
- A 20% excise tax on certain deductible payments made to foreign related parties, along with an election to treat the payments as effectively connected income;
- The repeal of the indirect foreign tax credit provision (consistent with territorial tax system); and
- Current US taxation on a US parent corporation’s “foreign high returns,” measured as the excess of a foreign subsidiary’s net income over a specified AFR-based rate of return on asset basis (designed to address base erosion).
Other Provisions of Interest
- The repeal of IRS Code Section 708’s partnership technical termination rule; and
- The inclusion of capital contributions in a corporation or partnership’s gross income to the extent not contributed in exchange for stock or an additional partnership interest (targeting, apparently, state and local government concessions and incentives).
Ways and Means Committee Chair Kevin Brady’s "Chairman’s Mark", issued a day after H.R.1, removed a provision that would have limited treaty benefits for certain deductible FDAP payments, as well as a provision that delayed certain inflation indexing of tax brackets until 2023. The Chairman’s Mark also made certain technical and conforming adjustments. Brady has announced the bill will not be subject to further amendments on the House floor.
Note that this is only a proposal; it is not law. The Senate will be issuing its own bill – promised shortly – and, eventually (after each bill passes its respective chamber) negotiations will begin in committee to draft a joint bill before being presented to both chambers for a vote and, ultimately should it pass in both the House and the Senate, signature by the President. The current House timeline is for a full House vote on H.R.1 by Thanksgiving. Much can be expected to change, however, during the committee negotiations, and the shape of ultimate tax reform is still unclear.
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