US Tax Reform: Senate Interpretation
This past weekend, the US Senate passed H.R. 1 – the Tax Cuts and Jobs Act – providing for the largest changes to the US tax code since 1986. The following is a list of “highlights” in the legislation (along with differences from the House bill passed on November 16, 2017):
Corporate Tax Provisions
- Much like the House bill, the US corporate tax rate will drop from the current 35 percent to 20 percent. Unlike the individual tax cuts that will expire in 2027, the cut to the corporate tax rate is permanent. The rate cut in the Senate bill starts for tax years commencing after December 31, 2018, whereas the House Bill is set to cut the corporate tax for years after December 31, 2017.
- Under both bills, the US corporate tax system shifts from a worldwide system in which companies are taxed on all income earned all over the world (if repatriated or caught by the CFC rules) to a territorial system, whereby dividends from 10 percent-owned foreign corporations are given a participation exemption and are not subject to US taxation. Note that most of the current subpart F and PFIC rules are still applicable.
- In order to transition to a shift from worldwide taxation to a more territorial system, the Senate bill allows US corporations to bring back money they have overseas at a rate of 14.5 percent (as opposed to the 14 percent rate in the House bill).
- Both bills also allow companies to fully expense new buildings and other investments for the next five years instead of subjecting them to periodic depreciation.
Individual Tax Provisions
- The Senate bill keeps seven tax brackets (as opposed to the House bill which only has four) but cuts the rates at every level and raises many of the income thresholds to qualify for the higher bracket. For example, the top rate is reduced to 38.5 percent (down from 39.6 percent) and would apply only to married individuals that earn more than $1 million (as opposed to the current top-level kicking in at $470,700). Note that this is also the level at which the highest long-term capital gains rate kicks in, resulting in further tax savings for high-income taxpayers.
- As with the House bill, the cut to individual tax rates is not permanent and unless a future Congress acts, many Americans will see their tax bills actually increase starting in 2027.
- The Senate bill eliminates the state and local tax deduction but will allow people to deduct up to $10,000 in US property taxes – this provision is similar to the House bill.
- Both bills get rid of personal exemptions and replace them with an enhanced standard deduction ($24,000 for married couples and $12,000 for individuals in the Senate bill and slightly higher amounts in the House bill).
- The Senate bill allows the child tax credit to increase from $1,000 now to $2,000, whereas the House bill allows this credit to increase to $1,600 but proposes other credits.
- Both bills eliminate the ability to deduct losses from “fire, storm, shipwreck, or other casualties, or theft” as well as various deductions such as tax preparation expenses, the deduction for people who bike to work, and the deduction for moving expenses. That said, the medical expense deduction stays and gets more generous for 2017, 2018 and 2019 (as opposed to the House bill which would eliminate such deduction).
- The Senate bill repeals the deduction for home equity indebtedness (currently up to $100,000) but appears to keep the deduction for acquisition indebtedness at the current level of up to $1 million. The House bill eliminates the distinction between home equity indebtedness and acquisition indebtedness and lowers the threshold for deductibility to $500,000 (although there are grandfather rules for indebtedness that was incurred prior to November 2, 2017).
- Both bills require taxpayers to reside in their homes five out of the last eight years (as opposed to two out of the last five years) to qualify for the exemption of the first $250,000 ($500,000 for married filers) gain on the sale of a principal residence.
Other Tax Provisions
- With respect to pass-through entities (such as partnerships, LLCs and S corporations), under the Senate bill, most pass-through businesses will not have to pay tax on 23 percent of their income (and any remaining tax is paid based on individual rates and not corporate rates). Law firms, doctor’s offices and other “service businesses” that earn over $250,000 a year will not be eligible for the deduction and other large pass-through business will have a limit on how much they can deduct. The House bill proposes a tax rate of 25 percent on pass-through businesses which would be inapplicable to service businesses.
- Unlike the House bill, which has proposed to eliminate the estate tax by 2024 (and to substantially increase the exemption amount to $10 million until then) but keep the step up in basis in estate assets, the Senate bill keeps the estate tax (and basis step up) but also increases the exemption amount to $10 million, effective for years after December 31, 2017.
- One other key difference between the two bills is that Senate bill retains the Alternative Minimum Tax (AMT) for both individuals and corporations and only increases slightly the threshold in which it kicks in for individuals, whereas the House bill eliminates the individual and corporate AMT altogether.
- With respect to “carried interest” provisions (i.e., investment management services income earned through a partnership), both bills require a three-year holding period in the partnership interest before a taxpayer can access the long-term capital gains rate (up from the current one year holding period).
The two bills will need to be reconciled but the Republicans expect this to happen soon and President Trump is expected to sign a final bill by Christmas. We will continue to monitor activity.