On Friday December 15, 2017, members of the House of Representative and Senate reached an agreement on the final terms of the Tax Cuts and Jobs Act of 2017. The two houses of Congress had been negotiating the fine details and terms in conference committee since the Senate passed its version of tax reform in the early hours of December 2, 2017.
The new legislation, if passed and signed into law by President Trump, will affect significant changes that pervade many aspects of the Internal Revenue Code. Most, if not all, taxpayers will be affected by these changes. The legislation is 1000 pages and has much for different industries.
In light of these changes and their significance, we are drafting a series of articles aimed at preparing our readers and clients for the new U.S. tax regime. The first article, found here, provided a summary of the initial tax reform legislation introduced in the House of Representatives. This article provides an overview of the income tax rate changes. Subsequent articles will cover various other changes to our current regime of U.S. taxation.
As was anticipated, the corporate income tax rate was reduced. The top marginal rate fell from 35% to 21%. This was a bit of a surprise as both the House and Senate bills has proposed a top corporate income tax rate of 20%. In any event, this will likely make traditional corporate entity structures (with two levels of taxation) advantageous for more business owners than such a structure had been in recent years.
The individual tax rates were changed as well, but more modestly. The new regime will have seven tax brackets, see chart below. Most individual filers will see some reduction, albeit only a few percentage points. The top marginal rate dropped from 39.6% to 37%, which was lower than the 38% proposed by the Senate.
For income received from “pass through entities” such as LLCs, S-Corps, and partnerships, taxpayers will now get a 20% deduction, which brings the effective top marginal income tax rate on pass-through income to 29.6%. The deduction begins to phase out at $315,000 of pass through income for married couples. This provision is complex and you will need to get with your tax advisors to walk through the many steps to assure the application in your situation.
For example, if a married couple received $100,000 in pass through income on a Schedule K-1, then the couple would receive a deduction of $20,000 leaving $80,000 of pass through income subject to taxation. Assuming the married couple was otherwise subject to the top individual rate of 37%, then the taxpayers would owe $29,600 in tax ($80,000 x 37%) resulting in an effective rate of 29.6% on the $100,000 they received on the Schedule K-1, which is a 10% rate cut compared to how similar pass through income is currently taxed.
This was also more modest of a tax cut than the Senate proposed, which would have provided a 23% deduction phased out at $500,000 for married couples.
Subsequent articles will address other important, forthcoming changes to the U.S. tax regime as a result of the Tax Cuts and Jobs Act of 2017.