On what is now a historic day, Congress fulfilled its promise of delivering comprehensive tax reform before the New Year. After some last minute glitches, the “Tax Cuts and Jobs Act” (H.R. 1) was approved in the Senate last night by a vote of 51-48. It was then approved today in the House by a vote of 224-201. The tax reform bill was passed under the special “reconciliation,” rules which provide only for a simple majority vote of 50 in the Senate and not the 60 vote hurdle that is needed with most legislation. The votes in the House and the Senate were along party lines. The tax bill now moves to President Trump who is expected to sign the bill into law soon. This is the most significant piece of tax legislation since the Tax Reform Act of 1986 brought about sweeping changes in every area of tax law and across all industries. The House-Senate Conference completed its work last week in reconciling the two separate tax reform bills passed in each chamber. The Conference Report was the compromised tax bill that was approved this week in Congress (click here to see the Conference Report).
Tax reform efforts had been brewing in Congress for several years. Following last year’s election, the political landscape changed to allow tax legislation to move forward in 2017, although there were numerous hurdles to overcome. Congressional leaders and the administration announced their plans when they introduced a “tax framework” for reform in September (please click here for our article when the tax framework was revealed). The tax framework stated goals were as follows:
- Tax relief for middle-class families.
- The simplicity of “postcard” tax filing for the vast majority of Americans.
- Tax relief for businesses, especially small businesses.
- Ending incentives to ship jobs, capital, and tax revenue overseas.
- Broadening the tax base and providing greater fairness for all Americans by closing special interest tax breaks and loopholes.
Many of these themes ended up in the final legislation, although the 1,100-page final Conference Report (which contained the legislative text of the bill) includes many complexities that might eventually lead to a poster size postcard. While there were several changes in the bill that will make tax filing simpler for many taxpayers, there are other changes that will make tax planning and filing more complicated.
Here are the key highlights in the tax bill that were the focus of much of the debate in Congress and received quite a bit of media attention:
- Corporations. The tax bill drops the top corporate tax rate from 35% down to 21% and this new rate is effective in 2018. It also removes the lower graduated corporate tax brackets, and adopts just one 21% rate for Corporations, including PSCs (Personal Service Corporations). In addition, the corporate Alternative Minimum Tax (AMT) is also repealed by the tax bill.
- Pass-Through Businesses. Congress spent much time and effort trying to address how much tax relief (and in what form) to provide to owners of pass-through businesses (Partnerships/LLCs, S Corporations, and Sole Proprietorships). The final bill produced a 20% deduction for business income. The bill added a limitation, however, that is a function of 50% of the wages paid by the business; or 25% of the wages paid by the business plus 2.5% of its cost of property used in the business. This new, and yes, complicated provision will provide a tax incentive for many small businesses.
- Individuals. The tax rates were reduced compared with current levels. The top tax rate was cut down from 39.6% to 37%. Other tax brackets were cut as well. Here is the new tax bracket in 2018 for married couples:
MARRIED INDIVIDUALS FILING JOINT RETURNS AND SURVIVING SPOUSES
|TAX BRACKET||TAX RATES|
|Not over $19,050||10% of the taxable income|
|Over $19,050 but not over $77,400||$1,905 plus 12% of the excess over $19,050|
|Over $77,400 but not over $165,000||$8,907 plus 22% of the excess over $77,400|
|Over $165,000 but not over $315,000||$28,179 plus 24% of the excess over $165,000|
|Over $315,000 but not over $400,000||$64,179 plus 32% of the excess over $315,000|
|Over $400,000 but not over $600,000||$91,379 plus 35% of the excess over $400,000|
|Over $600,000||$161,379 plus 37% of the excess over $600,000|
Additionally, there were a number of changes in deductions impacting individuals in the tax bill. The standard deduction will be doubled, and several other tax deductions will be eliminated or curtailed, including the state and local tax deduction. Further, the estate tax exemption would be doubled beginning in 2018, but the estate tax rate remains the same.
- International Taxes. The bill transitions to a new participation exemption system (“a territorial system”) from the current system and provides for a 100% deduction for distributions received from controlled foreign corporations. In addition, there will be a special tax on a repatriation of foreign earnings. It will be paid for over a number of years and the tax rate depends on the nature of the foreign assets. There are numerous other international tax provisions with various transition rules and effective dates.
Publicized and Overlooked Provisions
There were a host of other provisions in the tax bill impacting businesses, individuals, and companies with international operations. Further, there were considerable changes for tax-exempt organizations and insurance companies. Below are several selected measures for businesses and individuals in the tax reform bill, some of which have been publicized and others that may have been overlooked:
- Business Interest Expense. The Conference Report adopts a limitation on the deductibility of business interest expense. This item had been in both the House and Senate bills. The new rule would limit the deductibility of business interest to 30% of the company’s adjusted taxable income, plus any business interest income of the company. “Adjusted taxable income” is defined as the income of the company, but does not include: any business interest income of the company; any 20% deduction for pass-through business; any Net Operating Loss (NOL) of the company; any depreciation or amortization deductions of the company; and any item of income or deduction that is not part of a trade or business of the company. Special rules are adopted to reflect this business interest deduction limitation for pass-through businesses and their owners. Further, there is a general exception to these new interest limitation provisions for a small business which is defined as a business with gross receipts of less than $25,000,000.
- 100% Bonus Depreciation. The Conference Report provides that the 100% bonus depreciation is available for property placed in service after September 27, 2017. In addition, this deduction applies for property that is new to the taxpayer. Thus, “used” property acquired by the taxpayer could qualify for the 100% bonus depreciation. Previously, the “bonus depreciation” rules did not permit used property to qualify for this deduction. This is also one of few provisions in the tax bill that applies for the 2017 tax year.
- Further, the Section 179 expensing rules were also expanded up to $1,000,000 (with overall additions of $2,500,000) beginning in 2018. The Section 179 property definition also now includes property used in furnishing lodging, and certain property in roofing, air conditioning units, and other items.
- New Family Leave Tax Credit. This credit applies for tax years 2018 and 2019. It is available to companies that offer family leave to their employees. If an employer provides at least two weeks per year to a full-time employee of family leave or sick time, then a tax credit of 12.5% of their wages paid during the family leave is available if the wage paid during the family leave is at least 50% of the employee’s normal wage. This credit is increased if the wage paid to the employee is above the 50% limit. Thus, this new credit could provide significant tax benefits to businesses that offer such family leave programs.
- Excess Business Losses. This new provision would limit individual taxpayers to a loss of $500,000 for married couples (and $250,000 for single taxpayers) from businesses they own. Any excess loss is allowed to be carried forward. Previously, business losses were unlimited. This new provision applies beginning in 2018.
- Carried Interest. There has been much discussion and debate over the last several years concerning the tax rules for “carried interest.” The tax bill, however, did not fully address issues with carried interests, with the exception of extending the holding period to three years for long-term capital gain treatment for any individual who receives a carried interest in a partnership for service provided to the partnership.
- Individual AMT. There has been much discussion over the past several years about the AMT. The AMT has impacted many taxpayers and creates much complexity and confusion among taxpayers and even tax practitioners. Congress wanted to repeal the AMT, but to make many of the other final changes in the bill and to secure enough votes (especially in the Senate), the AMT was retained for individuals. The AMT exemption was enhanced in the tax bill and the point at which this exemption is phased out was significantly increased, thus the impact of AMT will be reduced. AMT was not repealed, however, and taxpayers will continue to need to deal with and file the AMT forms.
- Basis of Securities – FIFO Rules. Congress was considering a change in the tax bill in how taxpayers detained the gain or loss from the sale of securities. When taxpayers sell a stock or security now, if they have different costs for the securities for different times the stock or security was acquired they can identify which shares are being sold, and thus they can impact the gain or loss from the sale (most often to use higher cost stock/security to reduce the gain they are reporting). The tax bill would have required the taxpayer to use the “FIFO” rule (first in, first out) which would treat the taxpayer as selling the longest held stock or security first and this likely would like have resulted in higher reported gains as older stock purchases often have a lower cost than the more recently acquired shares. In the Conference Report, however, this FIFO rule was dropped. Thus, there is no change in the current rules.
What Should You Be Doing Now?
The tax bill is not enacted yet, but it will be any day now as soon as the President signs the law. With a short time period before 2018, this leaves little time to engage in some 2017 year-end tax planning. Here are a few initial observations:
- As noted above, a number of itemized deductions (mostly state and local taxes and also other miscellaneous itemized deductions) will be eliminated or curtailed beginning in 2018. Thus, to the extent an individual taxpayer incurs these items, they may want to consider paying these on or before December 31, 2017.
- As mentioned, the tax rates under the tax bill are scheduled to drop in 2018. This will apply for both individuals and businesses (whether a corporation or pass-through business). Thus, to the extent possible, income should be deferred to 2018 and deductions accelerated into 2017. The ability to do this may vary from business to business, and from individual to individual, but something to consider.
- Other analysis such as possible adoption or change of entity status (from say, S Corporation to C Corporation, or vice versa) would involve a more in-depth analysis as there are many factors to address. We at Sikich would be pleased to assist you in this process.
- These are general observations and the actual planning can vary by taxpayer based on their particular situation, assumptions used, and other factors.
If you are interested in any assistance in tax planning for 2017, or any other tax planning or analysis, please consult your local Sikich tax advisor.