Tax Reform Bill

| 11/3/2017

The House Ways and Means Committee on Nov. 2 published its first draft of a tax reform bill that proposes a significant overhaul to the U.S. tax system. In the coming weeks, the legislation will be reviewed by a formal committee process and the House of Representatives will vote on whether to move the bill forward. If it passes the House, the bill will go to the Senate, and if the Senate passes a bill that differs from the House bill, the bills will have to go to a conference committee to reconcile any differences prior to a version being signed into law.

In general, the proposed tax provisions would become effective for taxable years beginning after 2017. A summary of some of the key proposals included in the bill is below. Note, however, that changes are likely to occur during committee markup, and the Senate likely will bring its own priorities to the process. Intense lobbying is anticipated with respect to many provisions, and it remains to be seen if some of the more controversial provisions will survive the process.

Business Tax Provisions

  • Would institute a 20 percent corporate tax rate for tax years beginning after 2017.
  • Would subject personal services corporations to a flat 25 percent corporate tax rate.
  • Would limit net operating loss (NOL) deductions to 90 percent of taxable income. Carrybacks generally would be repealed, but the bill would provide a special one-year carryback for small businesses and farms in the case of certain casualty and disaster losses. Additionally, the bill would allow NOL carryforwards that arise in tax years beginning after 2017 to be increased by an interest factor to preserve their value.
  • Would repeal Section 199.
  • Would repeal the corporate alternative minimum tax (AMT).
  • Would institute a 100 percent bonus depreciation expense for new or used assets purchased after Sept. 27, 2017, through Dec. 31, 2022. This would not apply to real estate trade or businesses or regulated utilities.
  • Would increase the Section 179 expense limit to $5 million and the phaseout amount to $20 million. These amounts would be indexed for inflation.
  • Would limit the deduction for net interest expense to 30 percent of a business’s adjusted taxable income. Adjusted taxable income is a business’s taxable income computed without regard to business interest expense, business interest income, NOLs, depreciation, amortization, and depletion. Any interest amounts disallowed under the provision would be carried forward to the succeeding five taxable years and would be an attribute of the business (as opposed to its owners). Small businesses with average gross receipts of $25 million or less would not be subject to the limitation. Additionally, the provision would not apply to certain regulated public utilities and real property trades or businesses.
  • Would eliminate like-kind exchanges with the exception of real property.
  • Would repeal the Section 118 exclusion for nonshareholder contributions to capital.
  • Would treat income from the disposition of a self-created patent, invention, model or design (whether or not patented), or secret formula or process as ordinary instead of a capital gain or loss.
  • Would repeal many credits, including:
    • Credit for clinical testing expenses for certain drugs for rare diseases or conditions.
    • Employer-provided childcare credit.
    • Rehabilitation credit.
    • Work opportunity tax credit.
    • New markets tax credit.
    • Credit for expenditures to provide access to disabled individuals.
  • Would keep the research and experimentation credit and the low-income housing credit in effect.
  • Would treat a portion of net income from a pass-through entity to an owner or shareholder as business income subject to a maximum 25 percent tax rate (instead of ordinary individual income tax rates). The rate generally would treat 70 percent as ordinary income with 30 percent eligible for the lower 25 percent rate. Professional services firms generally would be unable to use the lower 25 percent rate. Capital-intensive businesses could end up with a greater portion of pass-through entity income taxed at the 25 percent rate.
  • Would apply anti-abuse rules to prevent recharacterization of wages to business income eligible for the 25 percent pass-through rate.
  • Would accelerate the taxation of nonqualifed deferred compensation to the vesting date.
  • Would eliminate performance-based and commission exceptions for the $1 million compensation limit of Section 162(m) and also would modify the employees covered by Section 162(m) to include the CFO.

Individual Tax Provisions

  • New Individual Tax Brackets: 12 percent, 25 percent, 35 percent, and 39.6 percent
      Single Married Head of Household
    12%* >$0 >$0 >$0
    25% >$45,000 >$90,000 >$67,500
    35% >$200,000 >$260,000 >$230,000
    39.6% >$500,000 >$1 million >$500,000

    *12 percent bracket is phased out for high-earning taxpayers with income in excess of $1 million ($1.2 million for joint filers).

  • Standard Deduction
    • Would be increased from $6,350 to $12,000 for individual filers.
    • Would be increased from $12,700 to $24,000 for joint filers (and surviving spouses).
    • Would be increased from $9,350 to $18,000 for head of household filers.
  • Personal Exemptions
    • Would repeal personal exemptions, effective for tax years beginning after 2017.
  • AMT
    • Would repeal the AMT.
    • For tax years beginning in 2019, 2020, or 2021, taxpayers would be able to claim a refund of 50 percent of the remaining credits (to the extent the credits exceed regular tax for the year).
    • Taxpayers would be able to claim a refund beginning in 2022 of all remaining AMT credits in the tax year.
  • Mortgage Interest Deduction
    • Would retain the deduction for mortgage interest on acquisition indebtedness with respect to a principal residence but reduce the current $1 million limitation to $500,000 for debt incurred after Nov. 2, 2017.
    • Would eliminate the itemized deduction for mortgage interest paid for residences other than a taxpayer’s primary residence.
    • Would eliminate the itemized deduction for interest on home equity indebtedness.
  • Other Itemized Deductions
    • Would repeal the overall limitation on itemized deductions.
    • Would retain the itemized deduction for real property taxes but would cap the allowable deduction at $10,000.
    • Would retain the itemized deduction for charitable contributions with some changes.
    • Would eliminate the following itemized deductions:
      • Deduction for state and local income or sales tax unrelated to carrying on a business or producing income.
      • Deduction for personal casualty losses (with exceptions for losses associated with special disaster relief legislation).
      • Deduction for tax preparation services.
      • Deduction for medical expenses.
      • Deduction for unreimbursed employee expenses.
  • Other Deductions and Exclusions
    • Would repeal the deduction for interest on student loans and the deduction for qualified tuition and related expenses.
    • Would repeal the exclusion for employer-provided education assistance programs.
    • Would repeal the above-the-line deduction for alimony payments and exclude alimony from income of the recipient.
  • Estate, Gift, and Generation-Skipping Transfer Tax
    • Would increase the threshold for imposing the estate tax from $5 million to $10 million.
    • Would repeal the estate and generation-skipping transfer taxes for decedents dying after Dec. 31, 2023.

International Tax Provisions

  • Would adopt a territorial-based tax system. Under the territorial-based system, income is not taxed when it’s distributed from a foreign subsidiary to a U.S. corporate shareholder who owns at least 10 percent of the foreign subsidiary. A foreign tax credit or a deduction for foreign income or withholding taxes would not be available. It does not appear that foreign subsidiary corporations of pass-through entities and foreign branches would be eligible for relief from worldwide taxation under the territorial system.
  • Would institute deemed repatriation of foreign subsidiary profits earned before adoption of a territorial system. The deferred foreign income would be included in U.S. taxable income in 2017 for calendar year taxpayers, and the tax liability would be payable over eight years. The portion of the earnings and profits comprising cash or cash equivalents would be taxed at a reduced rate of 12 percent, while any remaining earnings and profits would be taxed at a reduced rate of 5 percent. Some foreign tax credits would be available to offset the income from deemed repatriation. Special provisions would apply to S corporations.
  • Would add an anti-base erosion provision to tax income from certain foreign subsidiaries whose income exceeds a specified rate of return (foreign high returns). This provision could have significant transfer pricing implications.
  • Would eliminate the Section 163(j) interest-stripping provisions as a result of the new overall limitation on net interest expense.
  • Would repeal Section 956, but it is unclear if the Subpart F provisions would remain in place for all taxpayers.
  • Would subject certain deductible payments made by a U.S. corporation to a related foreign corporation to a 20 percent excise tax, unless the foreign corporation elected to be subject to U.S. tax.

Exempt Organization Provisions

  • Would subject a tax-exempt organization to a 20 percent excise tax on compensation in excess of $1 million paid to any of its five highest-paid employees for the tax year.
  • Would extend the imposition of unrelated business income tax to public pension plans.
  • Would impose a 1.4 percent excise tax on private foundations’ net investment income. Under the current law, some private foundations pay a 2 percent excise tax and some pay a 1 percent excise tax.
  • Would impose a new 1.4 percent excise tax on the investment income of educational institutions with at least 500 students and investment assets totaling at least $100,000 per full-time student.
  • Would allow private foundations to hold up to 100 percent of a for-profit business if the business distributes all of its annual income to the private foundation.

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Howard Wagner
Partner, Washington National Tax
Brianne DeSellier