Analysis of Chairman Camp’s Draft Tax Reform Act of 2014
Author: Robert Conner
On my way out the door this morning, my 4-year-old asked what I planned to work on today. I replied, “Son, I plan to write an article summarizing House Ways and Means Committee Chairman Dave Camp’s (R-Mich.) recently released and much anticipated discussion draft of the Tax Reform Act of 2014.” I couldn’t help but laugh when my son responded, “Dad, make sure if you tell a scary story it ends on a happy note.”
Whether the tax reform provisions included in Chairman Camp’s proposal invoke hope or fear will depend on the reader. One thing is for certain, though: If enacted, the Tax Reform Act of 2014 will represent the most comprehensive overhaul of the U.S. tax code since the Tax Reform Act of 1986.
The following is a summary of certain key provisions included in Camp’s tax reform discussion draft.
Individual Tax Reform Proposals
Tax Rates – Under current law, there are seven individual income tax brackets ranging from 10 percent to 39.6 percent. Chairman Camp’s proposal would consolidate these tax brackets into just two:
- 10 percent applied to taxable income up to $71,200 if married filing jointly ($35,600 if single). This bracket begins to phase out for married taxpayers with adjusted gross income (AGI) of more than $300,000 ($250,000 for individuals).
- 25 percent applied to taxable income in excess of $71,200 if married filing jointly ($35,600 if single)
Additional 10 Percent Surtax on High-Income Taxpayers – Certain high-income taxpayers would face a new 10 percent surtax under Chairman Camp’s proposal. The 10 percent surtax would apply to the extent the following exceeds $450,000 for married taxpayers filing jointly ($400,000 if single):
AGI plus “specific add-backs,” less “qualified domestic manufacturing income (QDMI),” less allowable charitable contributions.
QDMI generally would be net income derived from (1) any lease, rental, license, sale, exchange or other disposition of tangible personal property manufactured, produced, grown or extracted by the taxpayer in whole or in significant part within the U.S. or (2) construction of real property in the U.S. as part of the active conduct of a construction trade or business. Any net earnings from self-employment do not qualify as QDMI.
“Specific add-backs” would include tax-exempt interest; employer contributions to health, accident and defined contribution retirement plans (to the extent excluded from gross income); deduction for health premiums of the self-employed; deduction for contributions to health savings accounts and the portion of Social Security benefits excluded from gross income.
Taxing Long-Term Capital Gain & Qualified Dividends as Ordinary Income – Under current law, long-term capital gains and qualified dividends generally are taxed at a preferential rate of 15 percent for married taxpayers filing jointly with taxable income less than $450,000 ($400,000 if single) and 20 percent if taxable income exceeds those amounts. Camp proposes to do away with these preferential rates, taxing long-term capital gains and qualified dividends at ordinary income rates. To replace these preferential rates, however, Camp’s proposal would allow all noncorporate taxpayers to take an above-the-line deduction equal to 40 percent of their long-term capital gains and qualified dividends.
Elimination of Personal Exemption & Expansion of Standard Deduction – To determine taxable income under current law, an individual reduces AGI by any personal exemption deductions and either (1) the applicable standard deduction or (2) itemized deductions. Prior to any phaseouts, the 2013 standard deduction for married couples filing jointly is $12,200 ($6,100 if single) and the personal exemption is $3,900 for the taxpayer, spouse and any dependents.
Under Camp’s proposal, the deduction for personal exemptions would be eliminated, and the standard deduction would rise to $22,000 for joint filers ($11,000 if single). The standard deduction—or, in the case of itemizers, an equivalent amount of itemized deductions—would phase out by $20 for every $100 by which AGI exceeds $517,500 for joint filers ($358,750 if single).
Other Provisions Affecting Individuals – The following are other notable provisions proposed by Chairman Camp:
- Repeal of the alternative minimum tax (AMT); any unused AMT credits would be refunded
- Interest on home equity indebtedness would not be deductible and home mortgage interest would be limited to the interest paid on the first $500,000 of debt
- Charitable contributions deducted only to the extent they exceed 2 percent of the individual’s AGI; so an individual with $500,000 of AGI would not receive any tax benefit from the first $10,000 of charitable contributions
- The 2 percent floor on “other miscellaneous itemized deductions” would be repealed, and deductions would not be allowed for tax preparation fees or unreimbursed employee business expenses; also, the overall limitation on itemized deductions (PEASE limitation) would be removed
- Repeal of the itemized deduction for medical expenses, state and local income taxes and property taxes
- Repeal of the deduction and corresponding income inclusion for alimony payments
- Repeal of the deduction for moving expenses
- Elimination of income limits on Roth IRA contributions; no new contributions to traditional IRAs would be allowed
Business Tax Reform Proposals
Tax Rates – Under current law, a corporation’s regular income tax liability generally is determined by applying the following tax rates to its taxable income:
$0 - $50,000
$50,001 - $75,000
$75,001 - $10 million
More than $10 million
Due to certain phaseouts, a corporation with taxable income between $335,000 and $10 million is generally subject to a flat tax rate of 34 percent. Also under current law, a personal service corporation is not entitled to use the graduated corporate rates and instead pays a flat tax of 35 percent.
Chairman Camp’s proposal would set the corporate tax rate at a flat 25 percent (which would be phased in from 2015 through 2019), and the special rule applicable to personal service corporations would be repealed. The corporate AMT also would be repealed. However, a corporate net operating loss only would be permitted to offset 90 percent of the corporation’s taxable income in the carryback or carryforward years.
Depreciation Provisions – Certain accelerated depreciation provisions allowed under current law would be repealed under the proposal. Specifically, Modified Accelerated Cost Recovery System (MACRS) recovery periods and methods would be replaced with a system that generally would mean longer asset lives and straight-line depreciation. First-year bonus depreciation, which is currently equal to 50 percent of the cost of qualifying assets placed in service during 2013, would be repealed, as would the accelerated 15-year life applied to qualified leasehold, restaurant and retail improvements.
For 2013, Section 179 allows taxpayers to immediately deduct up to $500,000 of qualifying assets in the year of acquisition. However, under current law, the Section 179 limit drops to $25,000 in 2014. The proposed plan would permit immediate Section 179 expensing on up to $250,000 of qualifying assets each year. This deduction would be phased out for every dollar by which the total qualifying asset additions exceed $800,000. The provision also would allow computer software, certain investments in real property and air conditioning and heating units to qualify for section 179 expensing.
Finally, the amortization period for Section 197 intangibles, e.g., goodwill, would be extended to 20 years from the current 15 years.
Limitation on the Use of Cash Method of Accounting – Current law provides an array of rules for determining whether a taxpayer may use the cash method of accounting for income tax purposes, with different types of businesses subject to different sets of rules. Camp proposes limiting the use of the cash method of accounting to businesses with average annual gross receipts of $10 million or less, whereas businesses with more than $10 million would be required to report taxable income using the accrual method. It appears the ability to use the cash method if a business has less than $10 million of gross receipts would apply even if a business maintains inventory.
This provision would not apply to farming businesses or sole proprietors, which would continue to be subject to current law accounting rules. However, personal service corporations and pass-through entities performing services in the fields of banking, health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting would be subject to this provision if average annual gross receipts exceed $10 million.
A taxpayer required to switch from the cash to accrual method of accounting as a result of this provision generally would be permitted to include any positive adjustment to income over a four-year period beginning in 2019 in the following amounts: 10 percent included in 2019, 15 percent in 2020, 25 percent in 2021 and 50 percent in 2022.
Pass-Through Entity Changes – Under the proposal, income passed through to owners of partnerships and S corporation interests would be classified as self-employment income. In determining net earnings from self-employment, partners and S corporation shareholders who actively participate in the entity would be permitted to treat 30 percent of their combined compensation and pass-through income as a return of capital and not subject to self-employment tax. Owners who do not actively participate would be permitted to exclude all of the pass-through income from self-employment income.
For S corporations, the recognition period for built-in gains tax would be permanently set at five years.
For partnerships, Camp proposes to shut down the so-called “carried interest” loophole by recharacterizing a portion of applicable capital gains as ordinary income. Also, basis adjustments under Section 754 would be mandatory rather than elective, and the concept of “technical terminations” would be repealed.
Other Provisions Affecting Businesses – The following are other notable business provisions proposed by Camp:
- The research and development (R&D) tax credit would be made permanent, but R&D expenses would be required to be amortized over five years
- Repeal of the Section 199 domestic production activity deduction
- The 50 percent meal and entertainment limitation under current law would only apply to expenses for food or beverages, with no deduction allowed for other entertainment expenses
- Repeal of percentage depletion deduction and passive activity exception for working interests in oil and gas property
- Repeal of like-kind exchanges
- Repeal of the Work Opportunity Tax Credit and many other business tax credits
- Repeal of the last-in, first-out (LIFO) and lower of cost or market methods of accounting for inventories
Overall, Camp’s tax reform discussion draft paves a possible path toward reducing corporate and individual tax rates while simplifying the tax code. So for those who thought this was a scary story, I'll make good on my promise to end with a silver lining. With this being an election year and with the number of “sacred cows” on the chopping block, it's not likely that tax reform legislation will make it out of committee and through both houses of Congress in 2014. If you are concerned with how certain provisions included in Camp’s tax reform discussion draft may affect you, consider providing feedback to the House Ways and Means Committee or your representative.
To learn more about how this tax reform discussion draft may affect your tax situation, contact your BKD advisor.