On November 16, 2017, the Republican-led House of Representatives passed the Tax Cuts and Jobs Act in a 227-205 vote. The Republican-led Senate passed their own version of tax reform on December 2, 2017 by a vote of 51-49.
The House and Senate must now hammer out a final bill through the budget reconciliation process before it can get to the President’s desk. The combined bills contain over 900 pages of new legislation, so this will not be an easy task. There are some similarities between the two bills, but there are also significant differences. In the end, the Senate might have more persuasion since its bill passed with such a thin margin. The President is pushing for the final bill before Christmas, but many commentators indicate a completed bill by then is only a 50/50 proposition.
One of the initial goals of the tax legislation was simplification of the tax code. These proposed bills pretty clearly indicate that while this legislation will be significant tax reform, it will not be significant simplification. Given the size and complexity of the combined tax bills and the discrepancies between the two versions, this summary only highlights a few selected items.
Proposals where the bills agree (at least in concept)
Individual tax rates: Both bills change the tax brackets. Under the House bill, the individual income tax brackets are condensed from seven brackets (10%, 15%, 25%, 28%, 33%, 35%, and 39.6%) to four brackets (12%, 25%, 35%, and 39.6%). Under the Senate bill, the number of brackets will remain at seven, but the rates are changed to 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. Additionally, the Senate bill sunsets almost all of the individual provisions after 2025, while there are no such sunsetting provisions included in the House bill. Capital gains tax rates are 15% or 20%, depending upon the rate threshold.
Personal exemptions and standard deduction: Personal exemptions are repealed under the House bill starting in 2018 and suspended for 2018 through 2025 under the Senate bill. Effectively, they are combined with increased standard deductions of $12,200 single/$24,400 married filing jointly (MFJ) under the House bill, and $12,000 single/$24,000 MFJ under the Senate bill.
State and local taxes: Both bills agree, eliminate/suspend the state and local income tax deduction starting in 2018.
Property taxes: Both bills agree, limit the deduction for state and local property taxes to $10,000.
Mortgage interest deduction: Both bills keep a version of the mortgage interest deduction. The House keeps the deduction for existing mortgages, but limits it to $500,000 for newly purchased homes (not available on second home). The Senate retains the current law of $1 million of acquisition related debt, but eliminates the deduction for home equity indebtedness.
Inflation adjustments: Both bills calculate inflation adjustments using the chained consumer price index. This index will increase at a slower rate than the consumer price index currently being used.
Corporate tax rates: Both bills reduce the current 35% maximum corporate tax rate to 20%. However, there is disagreement as to the effective date of the rate change. The House version is effective for tax years after 2017, and the Senate version is effective for tax years after 2018.
Depreciation: Both House and Senate bills provide for 100% expensing of qualified property acquired after September 27, 2017 and before January 1, 2023. The House bill also allows 100% expensing for acquisitions of used property, while the Senate bill contains no such provision.
Under the House bill, the expensing limitation and phase-out threshold for Section 179 is increased to $5,000,000 and $20,000,000, respectively for tax years 2018 through 2022. Under the Senate bill, the amounts are significantly lower at $1,000,000 and $2,500,000, respectively. It is important to note that both the House and Senate versions expand upon current 179 provisions ($510,000 and $2,030,000).
Proposals where the bills differ
Estate and gift taxes: For gifts made and decedents dying after 2017, the House bill would increase the federal estate and gift tax unified credit exclusion to $10,000,000, adjusted for inflation. The estate tax would be fully repealed for decedents dying after 2024. The Senate bill increases the credit exclusion to $10,000,000 as well, beginning in 2018. However, the Senate version does not have a full repeal, and the increase is only for decedents dying before 2026.
Alternative minimum tax: Under the House bill, individual and corporate alternative minimum tax (AMT) would be repealed beginning in 2018. AMT would not be repealed under the Senate bill.
Pass-through tax treatment: Beginning after 2017, both the House and Senate bills would make sweeping, complicated changes to the taxation of pass-through entities. Under current law, ordinary income from pass-through entities, including sole proprietorships, partnerships, and S corporations, is taxed at the taxpayer’s rate. This could be as high as 39.6%.
For most individuals, the House bill would subject distributions of “business income” to a maximum 25% rate. Owners or shareholders receiving distributions from passive business activities would be able to treat them as 100% business income. Owners of active business activities would generally treat their distributive share of income as 30% business income subject to the maximum 25% rate, and 70% subject to the personal income tax rates. The bill would provide a 9% tax rate for the first $75,000 of net business income of an active owner filing a joint return, earning less than $150,000 from a pass-through entity. The 9% rate would be phased in so that the rate for 2018 and 2019 would be 11%, and the rate for 2020 and 2021 would be 10%. Most personal service businesses would not be eligible for these special rates under the House bill.
The Senate bill would allow a new deduction of 23% for taxpayers with pass-through domestic “qualified business income” (QBI), defined as all domestic income other than investment income (e.g., dividends, interest income, capital gains, et cetera). The deduction would generally be limited to 50% of the taxpayer’s allocable portion of W-2 wages paid by the pass-through entity. The wage limit would apply to a taxpayer with taxable income exceeding $500,000 filing joint returns ($250,000 for other filers), with a phase-in for the wage limit for taxable incomes exceeding these amounts.
Depreciation – farm property: The Senate bill repeals the current requirement that property used in farming operations use a 150% declining balance. Additionally, the Senate bill would also reduce the recovery period for farm machinery and equipment from seven years to five years. The House bill contains no such provisions related to the rate or the recovery period of farm property.
Cost basis of securities: The Senate bill requires investors to use the first in, first out method after 2017 for determining the cost basis of securities sold unless the average basis method is permitted.
We will continue to update you as the bill reconciliation progress continues and when a new tax reform bill is in place.
The information presented is not intended to be a full and exhaustive explanation of the tax bills referenced as there are many more provisions. Please consult with your tax advisor regarding the policies that might be applicable to your specific situation.