On November 9, Orrin Hatch, Chairman of the US Senate Finance Committee, unveiled the Senate's version of comprehensive tax reform. Chairman Hatch released the Senate proposal following approval of the US House of Representatives' tax reform proposal (HR 1, the Tax Cuts and Jobs Act) by the House Ways and Means Committee.
The Senate bill has many similarities to the House bill, but it differs in important ways as well.
Highlights of the Senate bill
Unlike the House bill, the Senate bill would retain the current seven-tax-rate bracket structure, although several rates would be lowered slightly. The new top individual tax rate would be 38.5 percent, slightly lower than the 39.6 percent rate retained by the House bill.
Like the House bill, the Senate bill makes no change to capital gains or dividend tax rates. It also retains the 3.8 percent tax on net investment income.
Like the House bill, the Senate bill would index the rate brackets for inflation based on the "chained" Consumer Price Index (CPI), which will generally result in smaller inflation-adjusted increases in the rate brackets and other parts of the tax law that are indexed for inflation, such as the standard deduction.
Like the House bill, the Senate bill would adopt a top corporate tax rate of 20 percent. Unlike the House bill, however, the Senate bill would tax all corporate income at the 20 percent rate and would delay the effective date of the new 20 percent rate until 2019.
The Senate bill would permit individuals to deduct 17.4 percent of their domestic qualified business income from a partnership, S corporation or sole proprietorship. The Senate bill includes limitations and restrictions to limit the deduction so that it does not apply to compensation, guaranteed payments or service providers with incomes in excess of US$150,000. This provision is in lieu of the House bill's lower rate for certain pass-through entities and owners of pass-through entities.
Similar to the House bill, the Senate bill would increase the standard deduction and child tax credit and eliminate personal exemptions. Most itemized deductions, including the deduction for state and local taxes, would be repealed, although:
- The mortgage interest deduction (other than for home equity loans) would be retained
- The deduction for charitable contributions would be retained and modified
- The deduction for investment interest expense would be retained
- The casualty loss deduction would be retained but limited to those arising in declared disaster areas
- The moving expense deduction would be retained only for members of the Armed Forces
- The wagering loss deduction would be retained but limited
Certain business losses would be limited for upper-income taxpayers.
Like the House bill, the 70 percent dividends received deduction (DRD) would be reduced to 50 percent and the 80 percent DRD to 65 percent.
Like the House bill, the Senate bill would provide full expensing of equipment acquired between September 27, 2017, and January 1, 2023. In addition, the limits on Section 179 expensing for small businesses would be increased as well. Other changes would apply to the rules for depreciable property.
For businesses with average gross receipts of more than US$15 million, business interest expense would generally be limited to 30 percent of adjusted taxable income, which is similar to earnings before interest, taxes, depreciation and amortization (EBITDA). For businesses operating as partnerships, this limitation is applied at the partnership level. Further, a taxpayer could elect for the limitation not to apply to real estate trades or businesses. The House bill has a similar limitation, although the House provision would not apply to businesses with less than US$25 million in average gross receipts.
Like the House bill, new rules would apply to:
- Net operating losses
- Like kind exchanges
- Deductions for Federal Deposit Insurance Corporation (FDIC) premiums
In addition, the Senate bill makes changes to accounting rules and depreciation periods for real property.
Existing business deductions, credits and other incentives would be repealed, including:
- The Section 199 "manufacturing" deduction
- The deduction for entertainment expenses
- The deduction for employee fringe benefits
Unlike the House bill, the Senate bill does not generally repeal or modify existing business credits. It makes changes, however, to the "orphan" drug credit and the rehabilitation credit, reducing the latter from 20 percent to 10 percent of qualified rehabilitation expenditures.
In measuring gain on the sale of stock, sellers could no longer specifically identify the stock sold and would have to use first-in-first-out or average cost basis. Partnership tax rules would be selectively tightened. New worker classification rules would be adopted.
Both the individual and corporate AMT would be repealed.
Very significant change are made to tax rules for:
- Insurance companies
- Tax-exempt entities
- Retirement savings
- Highly compensated individuals
Future advance refunding bonds would be taxable, but tax-exempt bonds fare much better in the Senate bill than in the House bill.
The estate and gift tax exemption amount would be doubled to US$10 million and indexed for inflation. Unlike the House bill, the estate tax is not repealed after 2024 and gift tax rates are not reduced.
Although the House and Senate bills contain many similar features, the Senate bill would make more extensive changes to the US international tax rules than would the House bill. The Senate bill borrows more heavily from former Ways and Means Committee Chairman Dave Camp's 2014 tax reform bill as well.
Like the House bill, the Senate bill would adopt a 100 percent exemption for dividends from foreign subsidiaries and a "deemed repatriation" provision. The 100 percent dividend exemption is limited to domestic corporations which hold a 10 percent or greater interest in a foreign corporation. It applies only to foreign-source dividends and does not apply to income earned directly by a domestic corporation, for instance, through a branch. The Senate bill also includes special rules dealing with the sale of stock of foreign subsidiaries to take into account the 100 percent dividend exemption.
Like the deemed repatriation provision in the House bill, the deemed repatriation provision in the Senate bill:
- Applies to all US shareholders, including individuals which are not eligible for the 100 percent dividends exemption
- Has a two-tiered rate structure for liquid and illiquid earnings
- Allows for payment of the deemed repatriation tax in installments over eight years
- Allows S corporations to defer payment of the repatriation tax
- Applies at the end of 2017
In some ways, however, it is harsher than the deemed repatriation provision in the House bill: It applies to all foreign corporations in which a US shareholder owns 10 percent, whether a controlled foreign corporation or not. In other ways, it is more favorable than the House bill:
- The deemed repatriation rates are five percent for illiquid assets and 10 percent for liquid assets
- The "post-1986 earnings" subject to the deemed repatriation are limited to the period in which a US person held a 10 percent interest in the foreign corporation
- The eight-year installment payments are back-loaded (eight percent in the first five years, 15 percent in year six, 20 percent in year seven and 25 percent in year eight)
The Senate bill does not have the "foreign high returns" provision in the House bill, but it has a similar provision which taxes foreign earnings that exceed 10 percent of the aggregate of depreciable property used in a trade or business. Like the House provision, the "global intangible low-taxed income" (GILTI) provision applies to all US shareholders, including individuals. The Senate bill pairs this provision with new incentives to develop (or bring back) intellectual property and export its usage.
The Senate bill does not have the provision in the House bill that imposes an excise tax on payments by domestic corporations to foreign affiliates, with an election by the foreign corporation to avoid the excise tax by paying US corporate income tax. However, the Senate bill has a provision intended to reach a similar result: the "base erosion minimum tax." This base erosion minimum tax effectively requires a domestic corporation that makes deductible payments to a foreign affiliate to pay the higher of (a) a tax equal to 10 percent of its income without any deduction for such otherwise deductible payments to its foreign affiliate ("base erosion payments") and (b) its regular corporate tax liability (reduced only by the R&D tax credit). The base erosion minimum tax applies to domestic corporations that have annual gross receipts in excess of US$500 million and that have a "base erosion percentage" of four percent or higher for the taxable year (the "base erosion percentage" is the domestic corporation's total base erosion payments divided by its total deductible payments).
The Senate bill includes many of the changes to Subpart F made by the House bill, but adds new ones as well. One of the more significant of the new provisions is that the Senate bill would subject to Subpart F all foreign corporations in which a US shareholder owns a 10 percent or greater interest.
Like the House bill, the Senate bill would limit interest deductions of multinational groups. The Senate bill also includes provisions to expand the taxation of cross-border transfers of intellectual property and to address hybrid transactions and entities. It also terminates the domestic international sales corporations (DISC) rules.
The foreign tax credit rules would be loosened in some ways (such as acceleration of the election to allocate interest expense on a worldwide basis) and tightened in other ways (such as a new separate foreign tax credit limitation for foreign branch income and repeal of the fair-market-value interest expense apportionment method).
Passenger cruise ship income would become subject to US tax, as would sales of interests in partnerships engaged in a trade or business in the United States.
The Senate Finance Committee plans to begin consideration, or "markup," of its proposal on November 13. Unlike this week's markup in the House Ways and Means Committee, the Senate will work from descriptions of the specific proposals rather than actual legislative text. So, until the Finance Committee finishes the markup process and issues its committee report with legislative language, there will be some uncertainty as to specific details of the provisions in the Senate bill.
The next step for the bill approved by the Ways and Means Committee on November 9 is the House Rules Committee. House Republican leaders are still counting votes but hope to have the bill on the House floor next week. Few, if any amendments, are likely to permitted during House consideration.