Sikich Series on Tax Reform – Tax Reform Legislation Released

Ways and Means Committee Chairman Kevin Brady introduced today the long-awaited details on comprehensive tax reform. The release had been pushed back one day from the originally scheduled November 1, 2017 date. The proposed bill runs over 400 pages and involves a major overhaul of many provisions throughout the tax code.

Brady and his committee were charged with coming up with the details of a bill that fit within the Tax Framework released on September 27, 2017, which was drafted by Congressional leaders and the Administration. The framework of tax reform are to promote economic growth, help businesses be more competitive and create new jobs, provide a middle class tax cut, and make the tax laws simpler. The proposed tax bill unveiled today puts the pieces together on this framework.

A main goal of tax reform was to lower the corporate tax rate from 35% down to 20%, and provide for a 25% tax rate for owners of certain pass-through entities. To achieve these lower tax rates and other changes in the bill, there would be numerous tax incentives (special deductions, credits, etc.) that would be eliminated or curtailed. These “pay-fors” (or offsets) were included to help pay for the lower tax rates. Today we learned the details of many of these changes.

Highlights for Businesses

The tax reform framework offered several major provisions for businesses. One of which was a drop in the corporate tax rate from 35% down to 20%. Another major provision was to establish 100% expensing of capital expenditures. The framework, however, cautioned that many other deductions and incentives may be repealed or curtailed. The business provisions included in today’s proposal contained the following selected items:

  • The corporate tax rate would be cut to 20% for C Corporations. This rate would be effective in 2018.
  • In addition, the tax rate for a Personal Service Corporation (“PSC”) would be cut to 25% from the current 35%.
  • A tax rate of 25% would be established for “pass-through businesses” (S Corporations and Partnerships/LLC’s). There are several complexities with this 25% provision and the option of a safe harbor election. This new 25% rate also begins in 2018.
  • The interest deduction would not be limited for small businesses (a company with less than $25 million in revenue).
  • The interest deduction for companies with over $25 million in revenue, however, would be limited in their interest deduction based on 30% of adjusted taxable income. Any unused interest expense above this 30% threshold would be disallowed, and would then carry forward for five years. This limitation would first apply in 2018.
  • 100% bonus depreciation for additions placed in service after September 27, 2017. The provision would expand the property that is eligible for this immediate expensing by removing the requirement that the original use of the property begin with the taxpayer. Instead, the property would be eligible for the additional depreciation if it is the taxpayer’s first use of the property.
  • Section 179 provisions were also enhanced. Under the tax proposal the annual Section 179 limitation would be increased from $500,000 to $5,000,000, and the phase-out amount for annual additions would be increased from $2,000,000 up to $20,000,000.
  • Further, the new proposal would permanently modify the definition of “Section 179 Property” to include qualified energy efficient heating and air-conditioning property. This provision to modify the definition of Section 179 property would be effective for property acquired and placed in service after November 2, 2017.
  • Accounting method reforms for small businesses (companies with less than $25 million in receipts) would be adopted in 2018. These modifications would permit use of the cash method (even if the small business had inventories); it would remove the Uniform Cost Capitalization for Inventory (UNICAP) rules for small businesses; and it would permit use of the completed contract method or other method for long-term contracts for contractors.
  • Net Operating Losses (NOLs) would still be allowed, however, the NOL deduction would be limited to 90% of a company’s income before the NOL deduction. Further, NOLs would be restricted in their utilization to being carried forward only; there would be no NOL carrybacks. These new rules would apply for tax years beginning in 2018.
  • LIFO Inventory remains. There was some speculation that the LIFO inventory method would be repealed or eliminated in some fashion under tax reform. However, there was no proposed change related to LIFO in the legislative proposal released today.
  • Credits no more. The Work Opportunity Tax Credit (“WOTC,” or Jobs Credit), the New Markets Tax Credit (“NMTC”), and several other tax credits would be repealed under the proposed new law. This repeal would apply beginning in 2018.
  • The R & D Credit (Research Credit), however, would be retained.
  • Also, the tax credit for a portion of employer FICA taxes paid with respect to employee tips would be modified beginning in 2018.
  • “Like-Kind Exchanges” (Section 1031 exchanges) would be limited and only apply to real property going forward. Thus, exchanges involving personal property (e.g., equipment or vehicles) would no longer be allowed. This change would apply beginning in 2018.

Highlights for Individuals

  • The tax reform framework offered several major provisions for individuals. These included a doubling of the standard deduction; repeal of the Alternative Minimum Tax (“AMT”); and elimination of the estate tax. The framework, however, indicated that several deductions and incentives may be eliminated as part of tax reform. Some of the individual provisions included in today’s proposal contained the following selected items:
  • The tax reform framework indicated it would adopt tax rates of 12%, 25%, and 35%, with the possibility of a higher top tax rate. The tax proposal revealed today would introduce tax brackets of 12%, 25%, 35%, and also retain the current 39.6% rate. This top rate of 39.6%, however, would apply at taxable income over $1,000,000.
  • As part of tax reform, the standard deduction would be doubled to $24,000 for a married couple filing jointly and to $12,000 for a single taxpayer.
  • Further, the personal exemption of $4,050 for a taxpayer, spouse, and children, would be repealed.
  • The child credit of $1,000 would be increased to $1,600. The income levels this credit is phased out at would be significantly increased (more than doubled for married taxpayers). This would apply beginning in 2018.
  • The itemized deduction for property taxes would be retained, but limited to $10,000.
  • The itemized deduction for state income taxes would no longer be allowed (unless incurred in carrying on a trade or business, although it is unsure what this entails).
  • Charitable contributions. This itemized deduction would mostly be kept intact. A few minor changes, however, would involve, (1) an increase in the AGI threshold for charitable contributions to 60% up from 50%; and (2) a repeal of the special 80% deduction for the amount paid for the right to purchase tickets for college sporting events.
  • The itemized deduction for casualty losses would be repealed under this proposal. This repeal, however, would not apply to casualty losses from specified disasters such as the hurricanes this year.
  • The itemized deduction for medical expenses would be repealed beginning in 2018 under this tax proposal.
  • The deduction for alimony by the payor would be repealed as would the income inclusion to the recipient. This alimony change would apply for divorce decrees executed after 2017.
  • The AMT would be repealed beginning in 2018.
  • The contribution limits for 401(k) plans and other retirement plans were generally left unchanged by the tax proposal.
  • Under current law, a taxpayer can convert a traditional IRA into a Roth IRA and pay tax on the amount from the traditional IRA that is converted. This conversion option would no longer be available under the tax reform proposal beginning in 2018.
  • Under the tax reform proposal, the estate tax exemption would be doubled to $10,000,000 beginning in 2018 and indexed for inflation. In addition, after 2023, the estate tax and Generation Skipping Tax (GST) would be repealed. There would also be some basis step up provisions for beneficiaries.

Highlights for International

The tax reform framework offered several major provisions for international businesses. The goal was to make the tax rate for U.S. companies more competitive with the rest of the world and offer an incentive to repatriate money back into the U.S. The international provisions included in today’s proposal contained the following selected items:

  • Under the tax reform proposal, the present system of taxing U.S. corporations on the foreign earnings of their foreign subsidiaries when these earnings are distributed would instead be replaced with a “dividend-exemption system.” Under this system, 100% of the foreign-source portion of dividends paid by a foreign corporation to a U.S. corporate shareholder that owns 10 percent or more of the foreign corporation would be exempt from U.S. taxation. No foreign tax credit or deduction would be allowed for any foreign taxes (including withholding taxes) paid or accrued with respect to any exempt dividend. This change would be effective for distributions made after 2017.
  • Another proposal relates to the imposition of U.S. tax on U.S. corporate shareholders; untaxed foreign subsidiary earnings which are reinvested in United States property would be repealed. The provision would be effective for tax years of foreign corporations beginning after 2017.
  • Under the provision, U.S. shareholders owning at least 10 percent of a foreign subsidiary, generally, would include in income for the subsidiary’s last tax year beginning before 2018; the shareholder’s pro rata share of the net post-1986 historical Earnings and Profits (E&P) of the foreign subsidiary to the extent such E&P has not been previously subject to U.S. tax, determined as of November 2, 2017, or December 31, 2017 (whichever is higher). Deeming un-repatriated foreign earnings to be repatriated would eliminate any tax advantage to keep these earnings off-shore.

For your reference, please review the following resources:

Next Step and Outlook

Please keep in mind – this proposal is not final. The tax reform proposal released today will be part of the Ways and Means Committee mark-up hearing next week and the legislation could be modified then. In addition, the Senate Finance Committee will release its tax bill next week. These two bills will be worked out almost side-by-side in the House and Senate over the next several weeks, and there will likely be differences between these two plans that will need to be ironed out. The House is still hoping to have its tax package through the House by the Thanksgiving recess. We will keep you posted as the process picks up speed. Please consult your Sikich tax professional with any questions you may have.

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