On November 2, Republican members of the House of Representatives introduced their vision of sweeping tax reform. It is massive legislation that lowers tax rates for certain taxpayers, eliminates specific tax deductions and credits, and drastically changes the landscape of international taxation by introducing a territorial based system for foreign subsidiaries of U.S. companies. In many respects, it transfers the tax burden from corporations to individuals. While there is no such person as “the average taxpayer”, since every taxpayer’s situation is different, many individuals are likely to see a tax increase, especially upper income taxpayers that live in states that have high state taxes.
Many of the provisions were expected. But, there are some that are missing. Carried interest could find its way into tax reform. The border tax adjustment was, as expected, omitted. And, recent talk of lowering the amount of pre-tax contributions to retirement plans did not materialize into proposed tax legislation either. The ACA tax of 3.8% still exists, at least for now. But, there is always the possibility of changes as the legislation proceeds through the process.
While this should be viewed only as the first salvo, as changes can be expected, it certainly provides the first concrete blueprint of what tax reform could entail. Below is a general outline of the many changes.
The bill would have four tax brackets: 12 percent, 25 percent, 35 percent, and 39.6 percent, in addition to an effective fifth bracket at zero percent in the form of the enhanced standard deduction. The income levels would be indexed for Chained Consumer Price Index for 8 All Urban Consumers (C-CPI-U) instead of CPI, a different measure of inflation.
The tax brackets for married filing jointly are as follows 12% up to $90,000; 25% up to $260,000; 35% up to $1 million; 39.6% over $1 million.
The tax brackets for single filers are as follows 12% up to $45,000; 25% up to $200,000; 35% up to $500,000; 39.6% over $500,000.
The bill would, for high-income taxpayers, impose an increase in tax at 6 percent of any excess of adjusted gross income over $1,200,000 in the case of a joint return or surviving spouses and $1,000,000 for any other individual.
The top long term capital gains tax rate is unchanged.
The bill would make this provision effective for tax years beginning after 2017.
The bill would increase the standard deduction to $24,400 for joint filers (and surviving spouses), $12,200 for individual filers, and for single filers with at least one qualifying child could claim a standard deduction of $18,300. The bill would provide that these amounts would be adjusted for inflation based on the chained CPI (C-CPI-U). The bill would make these provisions effective for tax years beginning after 2017.
Home Mortgage interest
Limited on post 11/2/17 debt limited to $500,000 of principal and ONLY on primary residence.
State and local taxes
The deduction for state and local income tax and sales tax is repealed. The real property tax deduction is capped at $10,000. Taxes paid in carrying on a trade or business are still deductible.
Personal Casualty Losses
Medical Expense deduction
Tax Preparation fee deduction
For any post 2017 decree, alimony would be neither deductible nor taxable.
Employee Business Expenses
Phase out of itemized deduction
The bill would (i) increase the AGI limitation on cash contributions from 50% to 60% and would retain the 5-year carryover, (ii) repeal the current 80% deduction for contributions made for university athletic seating rights, (iii) provide that the standard mileage rate for charitable use of an automobile would take into account the variable cost of operating an automobile rather than the current 14 cents per mile, and (iv) repeal the exception to the contemporaneous written acknowledgment requirement for contributions of $250 or more when the donee organization files the required return. The changes would apply to contributions made in tax years beginning after 2017.
The bill would repeal the deduction for personal exemptions, which would be effective for taxable years beginning after December 31, 2017.
Alternative Minimum Tax
The proposal would repeal the existing individual AMT.
Gain from Sale of a Principal Residence Exclusion
The Bill would continue to exclude from gross income up to $500,000 ($250,000 for other filers) from the sale of a principal residence, but only if the taxpayer owned and used the home as such for five out of the previous eight years. The exclusion would only be available once every five years and would begin to phase out by one dollar for every dollar by which the taxpayer’s gross income exceeds $250,000 ($500,000 for joint filers). The provision would be effective for sales and exchanges after 2017.
Enhancement of Child Tax Credit and New Family Tax Credit
Under the bill, the child credit would be increased to $1,600. Alternatively, a credit of $300 would be allowed for non- child dependents.
In addition, a family flexibility credit of $300 would be allowed with respect to the taxpayer (each spouse in the case of a joint return) who is neither a child nor a non-child dependent.
The family flexibility credit and the non-child dependent credit would be effective for taxable years ending before January 1, 2023.
The phase out for the combined child credit, the non-child dependent credit, and the credit for other taxpayers would be increased to $230,000 (for joint filers), and to $115,000 (for single filers).
The provision would be effective for tax years beginning after 2017.
American Opportunity Tax Credit
Under the bill, the three existing higher education tax credits (American Opportunity Tax Credit (AOTC), Hope Scholarship Credit (HSC), and Lifetime Learning Credit (LLC)) would be consolidated into a new, enhanced AOTC.
The new AOTC, like the current AOTC, would provide a 100- percent tax credit for the first $2,000 of certain higher education expenses and a 25-percent tax credit for the next $2,000 of such expenses.
The AOTC would also be available for a fifth year of post- secondary education at half the rate as the first four years, with up to $500 of such credit being refundable.
The provision would be effective for tax years beginning after 2017.
Consolidation of Education Savings Rules
Under the bill, new contributions to Coverdell education savings accounts after 2017 (except rollover contributions) would be prohibited, but tax-free rollovers from Coverdell accounts into section 529 plans would be allowed.
Elementary and high school expenses of up to $10,000 per year would be qualified expenses for section 529 plans.
The provision would be effective for contributions and distributions made after 2017.
Reforms to Discharge of Certain Student Loan Indebtedness
Under the bill, any income resulting from the discharge of student debt on account of death or total disability of the student would be excluded from taxable income.
The provision would be effective for discharges of indebtedness received after 2017 and amounts received in taxable years beginning after 2017.
Repeal of Other Provisions Relating to Education
Under the bill, the deduction for interest on education loans and the deduction for qualified tuition and related expenses would be repealed. The exclusion for interest on United States savings bonds used to pay qualified higher education expenses, the exclusion for qualified tuition reduction programs, and the exclusion for employer-provided education assistance programs would also be repealed.
The exclusion for education assistance programs would be effective for amounts paid or incurred after 2017. The other provisions would be effective for tax years beginning after 2017.
Exclusion for Qualified Moving Expense Reimbursements
Effective after December 31, 2017 the Bill would repeal the exclusion for qualified moving expense reimbursements – such reimbursements would constitute taxable income.
Exclusion for Adoptions Assistance Programs
Effective after December 31, 2017, the Bill would repeal the exclusion for adoption assistance programs.
Estate and Gift Taxes
The bill would increase the federal estate and gift tax unified credit applicable exclusion amount to $10,000,000 (as indexed for inflation), effective for decedents dying and gifts made after 2017. The bill would repeal the federal estate tax, effective for estates of decedents dying after 2023. The bill would lower the federal gift tax rate from 40% to 35%, effective for gifts made after 2023. The bill retains the “step-up” in basis for assets passing from a decedent’s estate, even after repeal.
Generation- Skipping Transfer Tax
The bill would increase the federal GST exemption amount to $10,000,000 (as indexed for inflation), effective for generation-skipping transfers made after 2017. The bill would repeal the federal generation-skipping transfer tax, effective for generation-skipping transfers made after 2023.
Corporate Tax Rate
Beginning in 2018, 20% flat corporate tax rate; 25% flat rate for personal service corporations.
Alternative Minimum Tax
Beginning in 2018, would repeal alternative minimum tax. In 2019, 2020, and 2021, if taxpayer would have AMT credit carryforward, taxpayer would be able to claim a refund of 50% of remaining credits (to extent credits exceed regular tax for year). For 2022, taxpayer would be able to claim a refund of all remaining credits.
Cash Method of Accounting
The $5 million average gross receipts threshold for corporations and partnerships with corporate partners that are not allowed to use the cash method of accounting would be increased to $25 million (indexed for inflation) and would be extended to farm corporations and farm partnership with a corporate partner, as well as family farm corporations) for tax years beginning after 2017. The requirement that such businesses satisfy the requirement for all prior years would be repealed.
Exemption from UNICAP for such business entities would apply to real and personal property acquired or manufactured by such business.
Accounting for Long-term Contracts
The $10 million average gross receipts exception to the requirement to use the percentage-of-completion accounting method for long-term contracts would be increased to $25 million for tax years beginning in 2018, and businesses that meet such exception would be permitted to use the completed-contract method (or any other permissible exempt contract method).
Expenditures for fixed assets other than assets used in real property trades or businesses would be eligible for 100% immediate expensing, if acquired between 9/28/17 and 12/31/22.
Section 179 Expensing
Effective for tax years 2018 through 2022, the Bill would increase the small business expensing limitation to $5 million and the phase out amount to $20 million. The new limitations would be adjusted for inflation. Effective beginning after November 2, 2017, section 179 property would include qualified energy efficient heating and air- conditioning property.
Local Lobbying Expenses
The bill would eliminate the deduction for lobbying expenses for legislation before local government bodies, including Indian tribal governments, effective for amounts paid or incurred after 2017.
Interest Expense Deduction
Effective for tax years beginning after 2017, the Bill would limit the deduction for net interest expenses incurred by a business in excess of 30 percent of the business’s adjusted taxable income.
Small Business Exception from Limitation on Deduction of Business Interest
Under the Bill, businesses with average gross receipts of $25 million or less would be exempt from the interest limitation rules (described in section 3301 of the Bill). This provision would be effective for tax years beginning after December 31, 2017.
The Bill would allow a taxpayer to deduct an NOL carryover or carryback of up to 90 percent of the taxpayer’s taxable income. Additionally, the Bill would generally repeal all carrybacks but for a special one-year carryback for small businesses and farms in the event of certain casualty and disaster losses arising in tax years beginning after 2017. Under the Bill, any net operating loss, specified liability loss, excess interest loss, or eligible loss, carryback would be permitted in a taxable year beginning in 2017, unless the NOL is attributable to the increased expensing allowed under section 3101 of the Bill. The Bill would also allow NOLs arising in tax years beginning after 2017 that are carried forward to be increased by an interest factor.
Like-Kind Exchanges of Real Property
The Bill would limit deferral of gain on like-kind exchanges after 2017 to real property.
Deductions for Income Attributable to Domestic Production Activities
Effective for tax years beginning after 2017, the Bill would repeal the deduction allowed for domestic production activities.
Entertainment, etc. Expenses
The Bill would disallow deductions for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes. No deduction would be allowed for transportation fringe benefits, benefits in the form of on-premises gyms and other athletic facilities, or for personal amenities provided to an employee that are not directly related to the employer’s trade or business, except to the extent that the benefit is treated as taxable compensation to the employee. The Bill would also disallow deductions for reimbursed entertainment expenses paid as part of a reimbursement arrangement involving a tax-indifferent party. This provision would be effective for amounts paid or incurred after 2017.
Rollover of Publicly Traded Securities Gain
Effective for sales after 2017, the Bill would repeal the rule permitting gains on publically traded securities to be rolled over to an SSBIC.
Self-Created Property not Treated as a Capital Asset
The Bill would treat gain or loss from the disposition of a self-created patent, invention, model or design, or secret formula or process as ordinary in character. The Bill would also repeal the election to treat musical composition and copyright in musical works as a capital asset. This provision would be effective for disposition of such property after 2017.
Sale or Exchange of Patents
Effective for dispositions after 2017, the Bill would repeal the special rule treating the transfer of a patent prior to its commercial exploitation as long-term capital gain.
Research and Development Credit
The House Ways and Means talking points explicitly preserve the research and development credit.
Low Income Housing Credit
The House Ways and Means talking points explicitly preserve the low-income housing tax credit.
The bill would repeal the historic rehabilitation tax credit, which provides an incentive for the rehabilitation of certain real property.
The bill would provide a transition rule for expenditures that are incurred through the end of a 24-month period, which is required to begin within 180 days after January 1, 2018.
Work Opportunity Tax Credit
The bill would repeal the work opportunity credit, which is a non-refundable tax credit for a portion (40 percent) of wages paid to certain employees who qualify as members of disadvantaged groups.
Unused Business Credits
The bill would repeal the deduction for unused business credits that may currently be carried back one year and forward 20 years.
New Markets Tax Credit
The bill would terminate the new markets tax credit, which is a credit available for taxpayers investing in qualified community development entities. The program was extended to 2019, but the bill would end the program at the end of 2017.
The bill would permit the usage of credits that have previously been allocated for up to seven years.
Modification of the Energy Investment Tax Credit
The bill would harmonize the expiration dates and phase-out schedules for different properties.
Under the bill, the 30 percent investment tax credit (ITC) for solar energy, fiber-optic solar energy, qualified fuel cell, and qualified small wind energy property is available for property the construction of which begins before 2020 and is then phased out for property the construction of which begins before 2022, with no ITC available for property the construction of which begins after 2021.
Additionally, the 10 percent ITC for qualified microturbine, combined heat and power system, and thermal energy property is made available for property the construction of which begins before 2022.
Finally, the permanent 10 percent ITC available for solar energy and geothermal energy property are eliminated for property the construction of which begins after 2027.
Extension and Phaseout of Residential Energy Efficient Property
Under the bill, the credit for residential energy efficient property would be extended for all qualified property placed in service prior to 2022, subject to a reduced rate of 26 percent for property placed in service during 2020 and 22 percent for property placed in service during 2021.
The provision would be effective for property placed in service after 2016.
Rollover of Publicly Traded Securities Gain into SSBICs
For sales after 2017, repeal of rule permitting rollover of gains on publicly traded securities to an SSBIC.
Employer Social Security Taxes Related to Employee Tips
The bill would modify the credit to align with current minimum wage. The bill would also impose reporting requirements for restaurants that claim the credit.
100% Deduction for Foreign-Source Portion of Dividends & Repatriation
100% deduction for foreign-source portion of dividends received from “specified 10-percent owned foreign corporations” by U.S. shareholders. Accumulated foreign earnings held in cash or cash equivalents and in illiquid assets are deemed repatriated and taxed at 12% and 5% respectively. Taxpayer may elect to pay resulting liability over 8-year period in equal annual installments of 12.5% of the total tax liability due. Effective for distributions made after 2017.
Foreign Tax Credit
Repeal of indirect foreign tax credit under §902. No foreign tax credit or deduction permitted for taxes paid or accrued with respect to exempt dividends. Income from sale of inventory sourced based solely on basis of production activities. Effective for tax years beginning after 2017.
Repeal of current taxation of investments in U.S. property by U.S. corporate shareholders under Sec. 956. Effective for tax years beginning after 2017. Repeal of foreign base company oil related income as subpart F income under §954.Effective for years beginning after 2017. Inflation adjustment of de minimis exception threshold for foreign base company income. Effective for years beginning after 2017. CFC look-through exception made permanent. Effective for years beginning after 2019. Stock attribution rules for determining CFC status modified to treat a U.S. corporation as constructively owning stock held by its foreign shareholder. Effective for years beginning after 2017.Elimination of 30-day rule in §951(a)(1). Effective for years beginning after 2017.
U.S. shareholders of CFCs subject to current U.S. taxation on 50% of “foreign high return amounts.” Deductible net interest expense of a U.S. corporation that is a member of an “international financial reporting group” limited based on a U.S. corporation’s share of group’s EBITDA. Excise tax of 20% imposed on certain payments made by a U.S. corporation to a related foreign corporation, unless a U.S. corporation elects to treat the payments as effectively connected income. Payments (other than interest) that are deductible, includible in costs of goods sold, or includible in the basis of a depreciable or amortizable asset subject to the 20% excise tax. Effective for tax years effective after 2017.
Limitation on Losses on Sale of 10 percent Owned Foreign Corporations
A U.S. parent must reduce the basis of its foreign subsidiaries (by the amount of any exempt dividends (as under new law) for purposes of determining the amount of loss (but not gain).Effective for transfers after 2017.
PFIC insurance exception restricted to foreign corporations that would be taxed as an insurance company if they were U.S. corporations and if loss and loss adjustment expenses, unearned premiums, and certain reserves exceed 25% (or 10% in certain circumstances) of the foreign corporation’s total assets. Effective for years after 2017.
Limitation on Treaty Benefits
Reduced rate of withholding under an income tax treaty not permitted with respect to a “deductible related-party payment” unless the withholding tax would be reduced by a treaty if the payment were made directly to the foreign parent. Effective for payments made after the date of enactment.
Archer Medical Savings Accounts (Archer MSAs)
Beginning in the 2018 tax year, no deduction would be allowed for contributions to an Archer MSA, and employer contributions to an Archer MSA would not be excluded from income. Existing Archer MSA balances could continue to be rolled over on a tax-free basis to an HSA.
Recharacterization of Certain IRA and Roth IRA Contributions
Would disallow recharacterizations of contributions to traditional IRAs as contributions to Roth IRAs, or vice versa, and conversions of traditional IRAs to Roth IRAs. Proposed to be effective for tax years beginning after 2017. Would be effective for plan years beginning after 2017.
Hardship Distributions from Retirement Plans -- Employee Contributions
No later than 1 year after date of enactment, IRS would have to amend its guidance that currently does not allow an employee to make contributions for 6 months after receiving a hardship distribution, to allow an employee taking a hardship distribution to continue making contributions to the plan.
Hardship Distributions from Retirement Plans -- Amounts Eligible for Withdrawal
Plan sponsors would be able to allow employees to take hardship distributions from a plan using account earnings and employer contributions, in addition to employee contributions. Applicable to plan years beginning after December 31, 2017.
Rollovers of Plan Loan Offsets
An employee who has taken a plan loan would have until the due date for filing the employee’s tax return for that year to contribute the loan balance to an IRA (instead of the current 60 days) to avoid having the loan amount treated as a taxable distribution. This rule would apply to employees whose plans terminate or who separates from employment while having a plan loan outstanding. Applicable to taxable years beginning after December 31, 2017.
Qualified Plan Nondiscrimination Rules
Would allow employers sponsoring closed/frozen defined benefit plans to more easily meet applicable nondiscrimination requirements that they might otherwise violate, especially with respect to cross-tested plans. Generally effective on the date of enactment.
Credit for Social Security Taxes Paid on Restaurant Tips
Credit for portion of employer social security taxes paid with respect to restaurant employee tips would be modified to reflect current minimum wage. Restaurants with less than 10 employees would now be required to report tip allocations. Effective for tips received for services performed after 2017.
Nonqualified Deferred Compensation
Existing plans based on pre-2018 service would be grandfathered until last tax year beginning before 2026. Employees would be taxed on compensation as soon as there is no substantial risk of forfeiture, defined to include only future performance of substantial services. Non-compete covenants and conditions that do not relate to future performance of services would not be treated as substantial risks of forfeiture. Short-term deferral exceptions similar to those under §409A would exist. Effective for amounts attributable to services performed after 2017.
Deduction for Excessive Employee Remuneration
The $1 million yearly limit on the deduction for compensation with respect to a covered employee of a publicly traded corporation would be modified. The exceptions for commissions and performance-based compensation would be repealed. “Covered employees” would include the CEO, CFO and the 3 highest paid employees. Once an employee qualifies as a covered employee, the deduction limitation would apply to that person so long as the corporation pays remuneration to that person (or to any beneficiaries). Applicable to taxable years beginning after December 31, 2017.
Unrelated Business Taxable Income
The bill would increase unrelated business taxable income by the amount of certain fringe benefit expenses for which a deduction is disallowed, effective for amounts paid or incurred after 2017.
Excise Tax on Tax Exempt Organization Executive Compensation
The bill would impose a 20% excise tax on compensation in excess of $1 million paid to any of its five highest paid employees. The tax would apply to all remuneration (including non-cash benefits) except for payment to tax- qualified retirement plans and amounts that are excludible from the executive’s gross income. This provision would also apply to parachute payments made to such individuals. The changes would apply to tax years beginning after 2017.
Private Foundation Excise Tax on Investment Income
The bill would simplify the private foundation excise tax on investment income and would reduce the rate from 2% to 1.4%, effective for tax years beginning after 2017.
Private Foundation Excise Tax on Failure to Distribute Income
For purposes of the private foundation excise tax on failure to distribute income, the bill would exclude organizations operating art museums from the definition of operating foundations, unless the museum is open for at least 1,000 hours during the tax year, effective for tax years beginning after 2017.
Excise Tax on Investment Income of Private Colleges and Universities
The bill would impose a 1.4% excise tax on certain private colleges and universities. This provision would apply only to private institutions that have more than 500 students and assets of at least $100,000 per full-time student (not including assets used directly by the institution in carrying out the institution’s educational purpose). The changes would apply for tax years beginning after 2017.
Exception From Excess Business Holding Tax for Independently- operated Philanthropic Business Holdings
The bill would exempt certain private foundations (PFs) from the 10% excise tax for holding a 20% interest in a for- profit business, as well as the 200% excise tax for PFs that do not divest itself of the holding by the close of the subsequent tax year. To qualify for the exception, the PF would have to satisfy the following four conditions: (i) the PF must own 100% of the for-profit business’ voting stock, (ii) the PF must not have acquired the for-profit business by a means other than purchasing the business, (iii) the for-profit business must distribute all of its net operating income for any given tax year to the PF within 120 days of the close of the tax year, and (iv) the for-profit business’ directors and shareholders cannot be substantial contributors nor make up a majority of the PF’s board of directors. The changes would apply for tax years beginning after 2017.
Churches Permitted to Make Statements Relating to Political Campaign in Ordinary Course of Religious Services and Activities
The bill would provide that churches (and their integrated auxiliaries and conventions or associations of churches) could make political statements in the ordinary course of activities in carrying out exempt purpose if the incremental expenses incurred are de minimis, effective for tax years ending after the date of the enactment.
Additional Reporting Requirements for Donor Advised Fund Sponsoring Organizations
The bill would require donor advised funds to annually disclose (i) the average amount of grants made from their donor advised funds, and (2) their policies on inactive donor advised funds for frequency and minimum level of distributions, effective for returns filed for tax years beginning after 2017.
The Citrin Cooperman Federal Tax Policy Team will follow the legislative process closely and you apprised of the potential changes and consequences of the tax proposals. If you have any questions regarding current or proposed policy, please do not hesitate to reach out to a FTPT advisor.