On November 2, Republicans in the House of Representatives unveiled H.R. 1, the Tax Cuts and Jobs Act, following months of negotiations between House and Senate Republicans and the Trump Administration, and moving a step closer to a major legislative achievement for the party.
The bill, which includes both individual and business tax cuts and reforms, is now on the fast-track thanks to the FY2018 budget resolution adopted by Congress last month. The budget resolution sets the stage for comprehensive tax reform that requires only a simple majority for Senate passage and would remove the possibility of a Senate filibuster. Notably, to comport with Senate rules, the package must (1) not exceed the agreed-to $1.5 trillion in tax cuts over the 10-year budget window and (2) must not add to the deficit after the end of the 10-year window.
While House and Senate leaders would like to put a bill on the President’s desk by December, efforts to finalize a package that can pass both chambers may stretch into early 2018. Challenges remain, including intra-party disagreements on several major revenue raisers and a slim Republican majority in the Senate – not to mention a dwindling legislative calendar. Some Senate observers have suggested that the schedule for completion this year may be too optimistic.
This advisory focuses on the proposed business tax changes. The legislation also includes important individual tax changes and reforms. These proposed changes to the individual tax code are politically and substantively important to the package, but are not analyzed in this advisory. A detailed summary provided by the House Ways and Means Committee – covering both the individual and corporate reforms – is available here.
Week of November 6: On Monday, November 6, the House Ways and Means Committee began marking up H.R. 1. The markup, which is expected to continue for several days, will provide Committee Members opportunities to amend the bill and potentially resolve outstanding concerns ahead of a floor vote.
Week of November 13: House leadership has indicated the bill will be on the House floor for consideration the week before Thanksgiving. If approved, the bill would go to the Senate. (Note that Senate Republicans are working on their own bill, which could be released as early as this week and marked up by the Senate Finance the week of the 13th).
Week of November 20: The Senate could stay in session for part of the scheduled Thanksgiving recess to vote on its tax bill. Under Senate rules, debate time would be limited to 20 hours.
Late November / December: Congressional leaders and the White House will work to iron out any differences before settling on a single final bill to be voted on by both chambers and sent to the President. This part of the process could stretch into 2018.
Corporate Tax Reform Highlights.
The bill would permanently lower the corporate tax rate from 35 to 20 percent and would eliminate the Alternative Minimum Tax (AMT). The revenue necessary to pay for this considerable rate reduction comes from the modification and/or elimination of a variety of “special interest” tax provisions.
Additionally, the bill would impose a flat 25 percent rate on some pass-through business income – under current law, income from pass-through businesses such as LLCs and partnerships is treated primarily as individual ordinary income and taxed as high as 39.6 percent. The bill would allow some pass-through businesses to characterize some income (not compensation) as profit subject to the flat rate. While the compensation portion would still be taxed as ordinary individual income, the profit portion would be taxed at the new 25 percent rate. Professional service providers such as lawyers and accountants would be excluded, presuming 100 percent of earnings is wages. In addition, special rules are proposed (and likely further refined) to reduce schemes designed to take advantage of the flat rate on business income v. compensation income.
Interest Deduction Limitations.
The bill would disallow businesses’ deduction of net interest expense in excess of 30 percent of the business’s adjusted taxable income (EBITDA). Utilities and real estate businesses would be exempt from the limitation, as would businesses with average gross receipts of $25 million or less. Disallowed business interest may be carried forward for five years.
The bill would allow for full and immediate expensing of 100 percent of the cost of qualified property for five years, before reverting to current law.
For small businesses, the bill would increase the Section 179 limitation to $5 million and the phase-out amount to $20 million (both limits would be indexed to inflation beginning next year) – also for five years.
Miscellaneous Business Changes.
The transfer of patent rights would no longer be considered a sale of a long-term capital asset regardless of the form of consideration paid.
Performance-based compensation and commissions would no longer provide exceptions for excessive employee remuneration.
Net Operating Loss Carryover.
Under the bill, taxpayers would be able to carry over net operating losses (NOL) indefinitely (as compared to the 20 year window under current law) and increased by a factor reflective of inflation. Deduction of NOL carryovers would be limited to 90 percent of current year taxable income. Carrybacks would generally be precluded with the exception of a one-year carryback for small businesses and farms and in the event of disaster losses.
International Tax Provisions.
The bill would also end the current “worldwide” system of US taxation, moving to a “territorial” system more in line with most international trading partners. After 2017, foreign income earned by U.S. companies would be tax free upon repatriation. The bill does, however, impose a 10 percent minimum tax on profits (above a certain threshold) of foreign subsidiaries.
To address U.S. multinationals’ profits currently deferred, the bill provides for repatriation of those earnings at tax rates of 12 percent (cash / cash equivalent) and 5 percent (intangibles). Corporations would have eight years to complete the repatriation, with minimum annual installments of 12.5 percent of the total tax liability.
Beginning in 2019, any payments from a U.S. corporation to a foreign subsidiary would be subject to a 20 percent excise tax. The provision would only apply when payments totaled at least $100 million.
Changes to Certain Business Credits.
The bill would eliminate the following credits:
- Section 199 manufacturing credit
- Credit for clinical testing expenses for certain drugs for rare diseases or conditions
- Employer-provided child care credit
- Work Opportunity tax credit
- New Markets tax credit
- Enhanced oil recovery credit
- Credit for producing oil and gas from marginal wells
The bill would also modify several existing credits:
- The value of the Production Tax Credit would be reduced to 1.5 cents per kilowatt-hour (repealing the current inflation adjustment) and would be phased out for projects built after 2019.
- 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.
- A tax credit for advanced nuclear projects would be extended.
The tax credit for research and development would be retained.
- Under the bill, interest on newly-issued private activity bonds (PABs) would be included in income and, as a result, no longer tax-exempt.
- The bill would also repeal tax credit bonds.
- Interest on bonds issued to finance the construction of, or capital expenditures for, a professional sports stadium would be no longer be tax-exempt.
Real Estate Reforms.
- Like kind exchanges would be limited to real property not held primarily for sale.
- All nonshareholder contributions to capital (e.g., government grants) are taxable.
- Low-income housing credits are retained.
- Rehabilitation tax credits are eliminated.
- Partnership tax rules are modified to eliminate technical termination on transfers of more than 50 percent interests.
- Stepped-up basis on death is retained while estate taxes are eliminated in 2022 and overall exemption is doubled in the meantime.