The GOP issued its long-awaited tax bill, H.R.-1 theTax Cuts and Jobs Act, on November 2, 2017, and theChairman’s Mark-upof the bill on November 3. The House bill goes next to the Ways and Means Committee, which is likely to make further changes to reflect, in part, public reaction to many of the changes proposed. Upon release, the Tax Bill was accompanied by asection-by-section summary, a Joint Committee explanation, andrevenue impact analysisandparallel analysesaccompanied the chairman’s markup. These are the first steps in the tax writing process.
The House Ways and Means Committee has scheduled the mark-up of the bill beginning at noon, Monday, November 6, 2017, and throughout the week as necessary, and it is being reported that the mark-up bill is expected to be ready for full House consideration the week of November 13.
The Senate Finance Committee is reporting that its members are close to finalizing the Senate’s tax proposal with an expectation of publication in the second week of November.
The tax bills are so far proceeding on the assumption that they will comply with the Congressional “budget reconciliation” process that permits passage in the Senate with just 51 votes (including the vice president as a tie-breaker). The reconciliation process limits the changes possible in the legislative process by requiring that the tax bill, in total, not increase the deficit beyond a 10-year window. This requirement is putting stress on what already is a complicated effort to meet all of the stated goals of Congress and the president while staying within the $1.5 trillion budgeted deficit approved by the House and the Senate in a joint budget resolution in October.
Once the House and Senate have voted on and approved their separate bills, the bills are sent to a conference committee where they are reconciled in a new bill that both the House and Senate have to pass (unless one chamber can agree to pass the other’s without change).
We are working with our clients to plan ahead and navigate these waters. The Tax Bill represents a relatively small number of fundamental changes, most prominently a reduction in the corporate tax rate to 20% and some parallel shifts for unincorporated businesses, and an enormous number of smaller changes, some of which appear policy driven but many others of which appear to be budgetary, i.e., revenue raisers to comply with the budget reconciliation requirements. Summaries and tables of comparisons abound. We have not tried to duplicate or copy, but here provide some preliminary observations.
Individual Business Owners
- The 39.6% rate is retained as the maximum individual rate for income over $1 million but the introduction of reduced rates of 25% for some business income and 20% for corporate income may create planning opportunities and change organizational choices.
- In something of a reversal of prior distinctions between passive and active business income, passive business income would generally be taxed at a 25% rate and active business income would be taxed 30% at the 25% rate and the balance at ordinary individual rates. This can be expected to encourage a shift toward passive ownership.
- Personal service corporations are also eligible for the flat 25% rate but restrictions on these vehicles as workarounds for retirement savings and continued high individual tax rates make it unclear whether these vehicles will actually be more attractive for those involved in providing health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting services.
- Capital gains and qualified dividends are generally excluded from the Bill’s special rate regimes but continue to enjoy existing preferential rates.
- Current 50% immediate expensing of qualified personal property is increased to 100%, beginning September 27, 2017, and before January 1, 2023.
- What constitutes qualified personal property is relaxed, dropping the original use requirement so that both investments in new and used property are eligible.
- Net Operating Losses (NOLs) generated before 2018 may be carried back (as long as not attributable to immediate expensing provision above), but post-2017 NOLs are limited to 90% of taxable income (the way Alternative Minimum Tax NOLs are currently limited) and may only be carried forward. The proposed carryforward is not time limited and is enhanced with an interest factor to retain value.
Interest Deduction Limitation
- Net business interest expense is limited to 30% of adjusted taxable income (adjusted to be essentially EBITDA).
Corporate and International Provisions
- Corporations are taxed at a 20% flat rate.
- Forced repatriation of foreign untaxed E&P as of the end of 2017 is taxed at two rates: 12% for cash and cash equivalents, with the remainder taxed at 5%. Taxpayers can elect to pay the tax ratably over eight years.
- Going forward, dividends are exempt from US tax but will not attract deductible foreign tax credits.
- In addition to continued inclusion of Sub-part F income, US corporations will be required to include 50% of “high foreign returns” (income exceeding a base return on asset basis), effectively subjecting it to a 10% US rate.
- US corporations generally will be required to pay an excise tax of 20% on payments (other than interest) to a related foreign corporation unless the related foreign corporation elects to treat the payments as income effectively connected with the conduct of a US trade or business. The provision effectively taxes the foreign corporation on US sourced related party payments.
- Nonqualified deferred compensation provision is repealed to require recognition upon vesting. Performance-based compensation exception for compensation in excess of $1 million to covered employees is eliminated. (see our separate discussion of Proposed Changes to Executive Compensation)
State Tax Impact
Deductibility of state and local taxes for federal income tax purposes is significantly limited under the Tax Bill. This and other changes at the federal level will impact state tax laws as well beginning in 2018. Given the extent and timing of the federal changes, we look for a possible patchwork of state tax schemes and responses as diverse as the states themselves.
There is tremendous pressure for something to be done at the federal level, but we expect some of these provisions to face intense pressure for change. The end result is very difficult to predict.