Senate Tax Proposal Released as the TCJA Advances to the House Floor
Author: Julia Dengel
One week after releasing the highly anticipated Tax Cuts and Jobs Act of 2017 (TCJA), the House Ways and Means Committee passed the bill along party lines by a vote of 24 to 16. In the days between the bill’s initial release on November 2 and its passage through the committee, Chairman Kevin Brady offered several amendments that were included in the approved bill. Read more about some of the provisions included in the bill’s initial release in our previous alert. November 9 also saw the release of the Senate’s version of the bill, which includes several critical deviations from the House bill.
Here’s a summary of some of the most recent changes included in the House TCJA as well as those included in the Senate bill, prior to any chairman amendments or markup.
Approved House Bill Amendments
- Originally slated for repeal under the TCJA, the following current-law provisions will remain unchanged or modified by the amended House bill:
- Exclusion for dependent care assistance programs through December 31, 2022
- Credit for qualified adoption expenses
- Exclusion for qualified moving expense reimbursements, but only for active-duty members of the U.S. Armed Forces who move pursuant to a military order
- The updated House bill provides certain employees who receive stock options or restricted stock units as compensation for performance of services and later exercise these options may elect to defer recognition of income on these options for up to five years where the corporation’s stock is not publicly traded.
- Brady also clarified that all itemized deductions related to state and local income taxes would be repealed, regardless of whether those taxes relate to a trade, business or other income-producing activity.
- The estate and generation-skipping tax repeal and the drop in maximum gift tax rate to 35 percent are delayed until 2025.
- The updated House bill includes an amendment that requires a three-year holding period for certain partnership interests to qualify for long-term capital gain treatment. This provision is directed at “carried interests” received in exchange for the performance of services.
- Under current law, a corporation owning less than 20 percent of the stock of another corporation may deduct 70 percent of any dividend received. This deductible amount rises to 80 percent if a noncontrolling corporation owns at least 20 percent of the stock. The House TCJA would lower these deductions to 50 and 65 percent, respectively.
- Businesses that use “floor plan financing indebtedness” would be excluded from the TCJA provision that limits the deductibility of net business interest. This type of indebtedness is used to finance the acquisition of motor vehicles, which include automobiles, trucks, recreational vehicles, motorcycles, boats, farm machinery or equipment and construction machinery or equipment, held for sale to retail customers. Conversely, this provision also provides that any trade or business with floor plan financing that chooses to fully deduct the related interest wouldn’t be allowed the benefit of the new 100 percent bonus depreciation provision.
- The updated House bill imposes an 8 percent surtax on life insurance income.
- For tax periods beginning after December 31, 2023, certain research and experimentation expenses, including software development costs, would be required to be capitalized and amortized over a five-year period. For foreign research projects, this amortization period increases to 15 years.
- The post-amendment version of the House bill preserves the current-law tax treatment of nonqualified deferred compensation.
- Another approved amendment to the House bill provides a lowered tax rate for owners of small pass-through businesses with net active business income. Instead of the ordinary 12 percent rate, married taxpayers who actively participate in a business would receive the benefit of an 11 percent rate on the first $75,000 of allocated taxable business income for the 2018 tax year. This rate is scheduled to reduce to 9 percent by 2022. The reduced rate phases out if taxable income from the pass-through business exceeds $150,000 and is completely eliminated at $225,000.
- The updated House bill modifies the treatment of S corporations converting to C corporations. An approved amendment would treat distributions from an eligible terminated S corp as paid from its accumulated adjustments account and its E&P on a pro rata basis. It also would provide that any Section 481(a) adjustments be taken into account ratably over a six-year period.
Taxation of Foreign Income
- The House bill includes an amendment that increases the deemed repatriation rate of deferred foreign profits to 14 percent for cash or cash equivalents and 7 percent on all other illiquid assets.
- Another amendment expands the foreign tax credit to apply to 80 percent of the payments U.S. companies make to their foreign affiliates.
- The House TCJA includes a clarifying amendment that ensures all Section 501(c)(3) organizations would be allowed to engage in political speech, as long as the speech is in the ordinary course of the organization’s business and any associated expenses are minimal. This provision would be effective for tax years beginning after December 31, 2018, and expire after December 31, 2023.
- The provision assessing a 1.4 percent excise tax on the net investment income of private colleges and universities was amended to only apply to institutions with 500 or more students and assets with a value of at least $250,000 per full-time student. This is a deviation from the $100,000 per full-time student figure included in the bill’s original language. Another amendment clarified that the 1.4 percent excise tax also would apply to the net investment income on endowment assets of a private university formally held by organizations related to the university.
Due to the amendments made during the markup process, the legislation’s preliminary cost is now expected to be approximately $1.44 trillion over the 10-year budget window, which is below the $1.5 trillion limit provided in the budget resolution that passed in the House on October 26. The bill will now go to the House Rules Committee—where additional amendments are possible—and then to the House floor for debate and vote. House Speaker Paul Ryan expects the House to vote on the bill the week of November 13, prior to the Thanksgiving recess.
Senate Bill Key Features
On the evening of November 9, the Senate Finance Committee released details on its version of the TCJA. While similarities exist, the Senate version contains several major differences from the House bill, which affect both business and individual taxpayers. Some primary differences between the current House and Senate bills include:
- The Senate plan retains the current seven-bracket rate structure but adjusts the rates to 10, 12, 22.5, 25, 32.5, 35 and 38.5 percent, as well as the taxable income ranges to which each bracket applies. The top bracket would not kick in until taxable income exceeds $500,000 for single filers ($1 million for joint filers). Like the TCJA, the brackets would be adjusted for inflation using a chained measurement method of the consumer price index.
- The Senate bill would expand on the House’s enhanced child tax credit by raising the credit to $1,650 with $1,100 refundable in 2018, increasing the age limit for a qualifying child to 18 and modifying existing phase-out limits.
- Deductions for medical expenses and the enhanced standard deduction for the blind and elderly would be preserved by the Senate bill.
- The Senate bill retains the current law’s rules on deducting mortgage interest on up to $1 million of acquisition indebtedness. However, it repeals the deduction for interest on home equity loans.
- Itemized deductions for state and local property, income or sales tax would no longer be allowed under the Senate bill.
- The itemized deduction for personal casualty losses would be restricted to losses incurred in a presidentially declared disaster area.
- Similar to the House bill, the Senate bill modifies the exclusion for gain from sale of a principal residence to only include homes owned and used as a principal residence for at least five of the prior eight years. However, the Senate bill does not include a phaseout for high-income taxpayers.
- The Senate bill limits the amount of nonpassive losses from a flowthrough entity an individual may deduct to $250,000 for single filers ($500,000 for joint filers). Any excess loss is treated as part of the taxpayer’s net operating loss carryforward to subsequent years.
- Unlike the House bill, the Senate version of the TCJA doesn’t repeal the estate tax or change the current 40 percent tax itself. However, it does provide a similar expansion to twice the current exemption amount.
- Carried interests aren’t addressed in the Senate version of the bill.
- Similar to the House bill, the Senate version lowers the corporate rate to a flat 20 percent but delays the effective date until 2019 and eliminates the special tax rate on personal service corporations.
- The Senate bill also provides a benefit for pass-through income; however, instead of a reduced tax rate, the Senate version allows taxpayers to deduct 17.4 percent of domestic qualified business income from a partnership, S corp or sole proprietorship. The deduction doesn’t apply to certain professional service businesses, e.g., services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services or brokerage services, except for taxpayers with taxable income under $75,000 for single filers ($150,000 for joint filers), with a phaseout beginning at the $75,000/$150,000 level. For qualified business income from partnerships or S corps, the deduction is limited to 50 percent of the taxpayer’s W-2 wages.
- The Senate bill increases the Section 179 limit to $1 million with phaseout starting at $2.5 million of additions. It also expands the definition of qualified property to include certain improvements to nonresidential real property, including roofs, HVAC systems, fire protection and alarm systems and security systems.
- The Senate bill increases bonus depreciation to 100 percent through 2022 but retains the current law requirement that property must be new to qualify.
- The Senate bill contains similar provisions to the House bill related to the expansion of the cash method of accounting, accounting for inventories and accounting for long-term contracts, but uses a $15 million gross receipts test instead of $25 million in the House version.
- The Senate bill includes a similar 30 percent limitation calculation on net interest expense as the House bill; however, the gross receipt exception in the Senate bill is lowered to $15 million and any excess interest is carried forward indefinitely.
- The Senate bill includes similar changes to the net operating loss (NOL) rules to limit the deduction to 90 percent of taxable income and only allow NOLs to be carried forward. However, the Senate bill doesn’t provide any interest factor adjustment to the NOL carryforward amount.
- The Senate bill shortens the depreciation recovery period for nonresidential real and residential rental property to 25 years and qualified improvement property to 10 years.
- Nonqualified deferred compensation would be includable in gross income of the service provider when there’s no substantial risk of forfeiture of the service provider’s rights to such compensation.
- The Senate bill provides safe harbor rules on when a service provider is treated as an employee or an independent contractor.
- The Senate bill provides a similar transition as the House bill from taxing companies on a worldwide income basis to a territorial tax system and a deemed repatriation of undistributed foreign earnings. However, the Senate bill accomplishes the deemed repatriation through a deduction of a portion of the mandatory foreign income inclusion amount. The amount of the deduction is meant to achieve an effective rate of 10 percent for cash and cash equivalent assets and 5 percent on illiquid assets. Any net tax liability resulting from the deemed repatriation may be paid over an eight-year period.
- The Senate bill repeals the special rules for domestic international sales corporations (DISC) and IC-DISCs for tax years beginning after December 31, 2018. Any deemed or actual distributions after termination of the DISC election wouldn’t be eligible for the qualified dividend tax rate.
The next step for the Senate bill will be the Finance Committee markup process, which is expected to begin November 13. Similar to the House bill, there likely will be changes made to the Senate bill during the markup session. Changes seem particularly likely, as the Joint Committee on Taxation’s estimates for the bill show it increasing the budget deficit beyond the 10-year budget window, which would require a supermajority of 60 votes to pass the legislation versus only the simple majority allowed under the expedited budget reconciliation procedures.
What’s the Outlook on Tax Reform?
Republican leadership in Washington remains committed to passing tax reform legislation in Congress and delivering the bill to President Donald Trump for signature by the year’s end. While differences exist, the overall themes of both the House and Senate bills are to provide tax relief to middle-class taxpayers and reduce the tax burden on small businesses while stimulating the international competitiveness of American-based companies. This common ground may be helpful in moving toward the goal of enactment; however, closely monitoring the legislation in the coming weeks and discussing possible planning opportunities with your tax advisor will be important to understanding how the legislation may affect your situation.
Additional BKD Thoughtware® and Simply Tax podcasts are forthcoming to help provide further details on provisions included in the Senate bill as well as updates on the TCJA’s progression as it moves through the legislative process.