The US Congress is working diligently to pass a major tax bill sponsored and supported by the Republican Party and under intense pressure from President Trump. The House passed its version of a tax bill onNovember 16. The Senate passed a different version early in the morning,December 2(by a 51-49 vote). The bills next go to a conference committee of select members from both houses of Congress that will attempt to reconcile the two into a single new bill that can be approved by both the House and Senate. The intent is to complete this process by the end of 2017.
The fact that both the House and the Senate have passed major tax bills with much in common reflects a political imperative toward tax reform. However, there are significant differences between the bills that will make reconciliation challenging, and the challenge is heightened by close votes especially in the Senate, the need to satisfy several factions within the Republican Party and the requirements of the “budget reconciliation” process that permits passage in the Senate with just 51 votes (including the Vice President as a tie-breaker if necessary). That budget process requires that the tax bill, in total, not increase the deficit beyond a 10-year window. The Senate bill reflects last-minute changes necessitated, in part, by analyses out of the Joint Committee on Taxation (JCT) on November 30 estimating less economic growth and larger deficits than had been expected out of the bill as reported out of the Senate Finance Committee on November 16, 2017, resulting in amended bill provisions and revised estimates by the Congressional Budget Office on December 1 and by JCT on December 2.
According to Senate Majority Leader Mitch McConnell (R-KY), the Senate bill reflects an attempt to smooth conference committee approval by moving the Senate bill toward aspects of the House bill, including a limited state and local property tax deduction, a medical expense deduction and consumer price indexation of certain individual limits. Both versions of the tax bills propose a relatively small number of “headline” changes, most prominently a reduction in the corporate tax rate to 20% and some parallel shifts for unincorporated businesses and reduction of personal income taxes (the Senate’s reductions sunset after 2025). Both versions of the tax bills propose an enormous number of smaller changes, some of which appear to be policy driven but many others are budgetary, i.e., revenue raisers to comply with the budget reconciliation requirements.
Despite massive pressure to produce a tax bill, the end result is difficult to predict. There is no assurance that the reconciliation process will produce a single bill that can pass in both the House and the Senate and there are a handful of difficult reconciliation challenges. However, Sen. McConnell says it is unlikely a compromise will not be reached, Speaker Paul Ryan (R-WI) has indicated that most of the Senate bill would be acceptable to the House (a familiar pattern from past tax legislation) and there is reason to believe the stock markets have already priced in the substantial tax benefits to US corporations.
The impact of federal changes will also be felt at the state and local level. However, when and if there will be changes cannot be predicted until the federal changes are final. Many states adopt either all or some portion of the Internal Revenue Code as their own state taxing statute. Most states, unlike the federal government, are also bound by balanced budget requirements that make operating at a deficit unlawful. Despite this requirement, more than half of the states are currently facing budget deficits. This means that federal changes that jeopardize state tax revenues are likely not to be immediately adopted by the states, resulting in significant differences between federal and state taxation, as well as differences between states.
Here we list some of the more significant tax bill provisions, with commentary about differences and negotiations.
Corporate & Business
- Corporations are taxed at a 20% flat rate.
- Senate bill delays reduction for one year to 2019. To be reconciled.
- Pass-through business income taxed at reduced rates.
- Though advertised as reduced rates on pass-through income, the details make the reductions apply to fewer kinds of income in more limited circumstances than the headline may suggest.
- The differences look small on the surface but in detail are significant, affecting rates and effective years, and represent significant budget amounts that may be difficult to reconcile.
- Current 50% immediate expensing of qualified personal property is increased to 100% for five years and the definition of qualified personal property is expanded (in different ways).
- There is a difference in what happens after five years, one that appears to be important to at least one critical vote in the Senate.
- Eliminate (House) or modify (Senate) the alternative minimum tax on corporations.
- Eliminating the AMT is viewed as a high priority, but expensive for the Senate budget requirements. However, the effect of retaining the AMT (at a 20% rate) is to effectively disallow deductions and credits—including especially the R&D credit—that corporations have assumed would continue to be available. This will have to be reconciled. Early indications are that the AMT will be eliminated, which will put pressure on other provisions to meet budget requirements.
- NOLs arising after 2017 are only carried forward (indefinitely). Carry back provisions are eliminated.
- Different NOL deduction limits going forward. To be reconciled.
- Net business interest expense is limited to 30% of adjusted taxable income.
- Adjustments differ materially between the two. To be reconciled.
- Real Property depreciation.
- Senate version shortens both residential rental and non-residential real property depreciation to 25 years (from 27.5 and 29 years, respectively).
- Profits Interests/Carried Interests continue to enjoy capital gain treatment with extended three-year holding period.
- Forced repatriation of foreign untaxed E&P, subject to reduced rates of tax (different for liquid and for illiquid untaxed E&P). Taxpayers can elect to pay the resulting tax ratably over eight years.
- Different rates in the two bills. The differences may appear to be small but have a large effect on the budget process because the amounts to be repatriated are enormous.
- Going forward, dividends are exempt from US tax but will not attract deductible foreign tax credits.
- Though touted as a move to a territorial system, Sub-part F income taxation continues with added anti-tax base erosion provisions.
- US multinationals incur a minimum tax on foreign income over thresholds that differ between the bills.
- Senate bill does not contain controversial House bill excise tax on certain payments to foreign affiliates though differences exist in other base erosion provisions.
- The details differ significantly. To be reconciled.
- Double the estate tax exclusion to $10 million.
- The House bill would also phase out the estate tax entirely and adjust gift tax rates. To be reconciled subject to budget constraints.
- There are a number of changes to individual taxes, including changes in tax rates and brackets, an increase in the standard deduction, elimination of personal exemptions, elimination of the alternative minimum tax and more. The changes are not all the same in tax effect—some increase expected taxes, some decrease expected taxes—but overall, on average, the result is expected to reduce taxes.
- The changes are different in some important details and the Senate bill has the benefits expire after 2025.
- The effect on personal income tax liability is very important politically and sunset of personal tax benefits is very unpopular. At the same time, these changes have been carefully designed to comply with the budget requirements. This will be a challenge to reconcile.
- Repeal the individual state and local tax deduction, with a $10,000 exemption for property taxes.
- Unpopular but represents significant dollars that are important to the budget requirement. At the same time, this change affects different states differently and is therefore very sensitive to vote counts.
- Mortgage interest deduction is cut in half in the House bill.
- The mortgage interest deduction is popular, including with Republicans and their constituency, but costly. This becomes a budget issue.
- Eliminate the penalty for individuals who do not buy health insurance, which is viewed as critical to making the Affordable Care Act (Obamacare) work.
- This is in the Senate bill but not the House bill, so it will have to be reconciled. The politics and votes around this provision may be different than other tax provisions, making this a sensitive topic for assembling the right coalitions to pass the final bill.
You can check [here] for further updates on both the federal and state proposed revisions