As expected, House Ways and Means Committee Chair Dave Camp (R-Mich.) released his long-awaited tax reform discussion draft on Wednesday, February 26, in which he seeks to lower the individual and corporate tax rates as well as broaden the tax base for each respective tax. The proposal includes significant reforms that affect industries across the economy. Some of the more significant proposed changes are outlined below.
These proposed changes would affect taxpayers in a number of ways. If you have any questions about the proposed changes, please feel free to contact the authors.
For individuals, Camp’s draft proposes:
- Establishing three rates: 10% (below $71,200 for joint filers), 25% (between $71,200 and $450,000 for joint filers), and 35% (above $450,000 for joint filers). The top 35% rate would apply to modified adjusted gross income above certain threshold amounts, which would include items currently excluded from taxable income, such as tax-exempt interest, 401(k) contributions, employer-provided health benefits, and the self-employment health deduction.
- Phasing out the standard deduction and the child tax credit for certain individual taxpayers.
- Repealing the state and local tax deduction, the personal exemption, and the individual alternative minimum tax.
- Capping new home mortgages at $500,000 for purposes of the home mortgage interest deduction (the reduction would be phased in over a four-year period).
- Converting certain 401(k) accounts into Roth-like accounts. Employees would be able to contribute half of the maximum elective deferral amount into a traditional 401(k) account. Any contributions in excess would be into a Roth account.
Camp’s draft proposes a number of changes to the taxation of businesses. Some of the more notable changes are:
- Replacing the current 35% corporate tax rate with a flat 25% rate. The rate reduction would be phased in by reducing the current rate two percentage points each year for five years.
- Eliminating the Modified Accelerated Cost Recovery System (MACRS), increasing depreciable lives of assets, and requiring straight-line depreciation. These rules would apply to property placed in service after December 31, 2016. The change would also remove bonus depreciation.
- Repealing the “last-in, first-out” (LIFO) inventory method. Taxpayers would include their LIFO reserves in income over a four-year period, retroactively taxing this inventory.
- Eliminating the Section 199 domestic production activities deduction.
- Modifying and making permanent the Section 41 research and development tax credit.
- Extending the amortization period for goodwill and certain intangibles to 20 years.
- Requiring amortization of certain business expenses. Fifty percent of certain advertising expenses would be amortized over a 10-year period. Research and experimentation expenses would be amortized over a five-year period.
- Modifying tax rules for pass-through entities, such as S corporations and partnerships. Permanently reduces an S corporation’s recognition period for built-in gains from 10 to five years. Repeals the guaranteed payment provisions applicable to partnerships. Removes the “substantial appreciation” trigger for ordinary income treatment on a distribution of inventory by a partnership to a partner.
- Lowering the corporate tax rate on all intangible income of foreign subsidiaries to 15%. The same reduced rate would apply to the foreign intangible income of U.S. parent companies.
- Imposing a one-time transition tax on all previously untaxed earnings and profits of foreign subsidiaries of U.S. corporations. The transition tax would be subject to the foreign tax credit.
- Restricting the use of the cash method of accounting. Under the proposal, businesses with $10 million or less in average annual gross receipts may continue to use the cash method. Businesses with over $10 million in average annual gross receipts would be required to use the accrual method of accounting.
Camp’s proposal includes changes that would significantly affect several important industries. Industry-specific changes are explained below.
Energy and energy-related industries would see the repeal of:
- The percentage depletion method (effective for tax years beginning after 2014);
- The “passive activity” exception for working interests in oil and gas property (for tax years beginning after 2014);
- The enhanced oil recovery credit;
- The credit for producing oil and gas from marginal wells (effective for tax years after 2014);
- The LIFO inventory method (discussed above); and
- Alternative fuel credits. Among the repealed credits are the alternative motor vehicle credit, alternative fuel vehicle refueling property credit, plug-in electric drive motor vehicle credit, and the alcohol used as fuel credit.
- Proposing new excise tax on “systemically important financial institutions.” Each of these financial institutions would be required to pay a quarterly excise tax of 0.035% of its total consolidated assets in excess of $500 billion. After 2015, the $500 billion threshold would be indexed to increases in the GDP.
- Treating carried interest as ordinary income. This change would subject certain partnership interests held in connection with the performance of services to a rule that would characterize a portion of any capital gain as ordinary income. The rule would apply to partnership distributions and dispositions of partnership interests.
- Changing the treatment of life insurance tax reserves and other insurance provisions.
- Repealing the medical device excise tax that was created by the Patient Protection and Affordable Care Act.
Transportation and Infrastructure
- Terminating private activity bonds. This change would remove the exclusion from income for interest earned on newly issued private activity bonds, effective for private activity bonds issued after 2014.
- Repealing advance refunding bonds, effective for bond issues after 2014.
- Providing $126.5B in additional funding for the Highway Trust Fund. This would maintain level funding for 10 years. Funding would be generated by a one-time transition tax on the earnings and profits of foreign subsidiaries of U.S. corporations, discussed above.
- Repealing the LIFO inventory method (discussed above).
- Repealing the percentage depletion method (discussed above).
- Eliminating MACRS and bonus depreciation (discussed above).