By SEMA Washington, D.C., Staff
The U.S. House of Representatives and Senate are currently pursuing separate comprehensive tax reform bills with the intention of enacting legislation by the end of 2017. The House completed action by passing a $1.5 trillion corporate and personal tax cut bill. The Senate Finance Committee passed its version of the bill with Senate floor action to take place after Thanksgiving. Both bills would permanently cut the corporate tax rate from 35% to 20%, while reducing some personal taxpayers’ rates and erasing and shrinking deductions for individuals. The House bill would collapse today's seven personal income-tax rates into four: 12%, 25%, 35% and 39.6%, while the Senate would maintain seven income tax rates: 10%, 12%, 23%, 24%, 32%, 35% and 38.5%. While the House bill’s proposed rates would be made permanent, the Senate bill’s tax rates for individuals would end in 2026 and then need to be renewed due to Senate procedural rules.
Below is a quick-read side-by-side comparison of the two bills. Following that is a comprehensive analysis published by the Small Business Legislative Council, of which SEMA is a member.
For more information, contact Eric Snyder at erics@sema.org.
Corporate Taxes
- Current law: Top corporate rate of 35% on taxable income more than $10 million a year.
- House bill: Cuts corporate tax rate to a permanent 20% immediately, taking effect in 2018.
- Senate bill: Cuts corporate tax rate to a permanent 20% one year later, taking effect in 2019.
Income Tax
- Current law: Seven individual tax rates: 10%, 15%, 25 %, 28%, 33%, 35 % and 39.6%.
- House bill: Reduces to four brackets: 12%, 25 %, 35% and 39.6%.
- Senate bill: Keeps seven brackets: 10%, 12%, 22.5 %, 25%, 32.5%, 35%, 38.5%.
Standard Deduction
- Current law: $6,350 for single filers and $12,700 for married couples.
- House bill: Raises to $12,000 for single filers, $24,000 for married couples.
- Senate bill: Raises to $12,000 for single filers, $24,000 for married couples.
State and Local Taxes
- Current law: Taxpayers can deduct both state and local income and property taxes.
- House bill: Keeps state and local property tax deduction (capped at $10,000), eliminates deduction for income taxes.
- Senate bill: Fully eliminates state and local income and property tax deduction, except for business income.
Estate Tax
- Current law: Top rate of 40%, with exemptions of up to $5.49 million for an individual and $10.98 million for a married couple.
- House bill: Doubles exemption to $11 million for an individual and $22 million for a married couple, repeals estate tax in 2024.
- Senate bill: Doubles exemption to $11 million for an individual and $22 million for a married couple, no repeal.
Mortgage Interest Deduction
- Current law: Taxpayers can deduct interest payments on up to two mortgages, worth up to a combined $1 million.
- House bill: Caps deduction for new mortgages to first $500,000 of the loan.
- Senate bill: Preserved, but repeals deduction for home equity debt.
Pass-Through Business
- Current law: Business income from partnerships, S corporations and sole proprietorship is taxed at individual tax rates.
- House bill: Creates special 25% rate for pass-through income; in many cases only 30% of business owner’s income is eligible, with other 70% classified as wage income.
- Senate bill: Creates new deduction that sets top rate for pass-through income in the low 30s.
Other Deductions
- Current law: Various deductions for student loan interest, medical expenses and adoption expenses.
- House bill: Eliminates deductions for medical expenses and student loan interest, keeps adoption credit deduction.
- Senate bill: Keeps all three tax deductions, including a number of other individual tax preferences.
Source: National Journal
Small Business Legislative Council (SBLC)
Update on House and Senate Tax Reform Proposals
On November 16, 2017, the House of Representatives passed the “Tax Cuts and Jobs Act” (H.R. 1) by a 227–205 vote and the Senate Finance Committee approved its “conceptual narrative” tax reform proposal by a 14–12 vote along party lines.
This alert will focus on the most important provisions from the viewpoint of the SBLC and its members in both the House bill and the Senate Finance proposal as they stood as of the votes on November 16 (both the House and Senate have adjourned for Thanksgiving recess, so we don’t expect to see any more big developments until next week). This alert will not cover every change in these bills, including the international tax provisions, provisions dealing with energy credits, bonds, life insurance, and excise taxes.
The Senate Finance Committee spent last week completing its markup of the Chairman’s Mark that was originally released on November 9. This was a “conceptual markup” which means the legislation is debated and examined as a narrative rather than working with actual legislative text. There have been many amendments incorporated into this conceptual narrative since its original release. The actual text of the bill has not yet been introduced. Until now, the country has never seen major tax reform undertaken without input from both parties and numerous hearings over many years. Hearings allow major stakeholders to express their concerns and approval and the tax writing committees to take time to tweak their bills accordingly. The current process is basically tax reform on steroids. It is anticipated that the Senate will consider the bill (which at that point should be reduced to text) shortly after Thanksgiving. As we have heard, the President wants the tax bill on his desk by Christmas. Depending on when the Senate votes on its version of the bill (and if the bill passes the Senate on the first try), this schedule would leave around eleven working days for a conference committee and final approval in the House and the Senate. With all the elements and politics involved, at this point, that is looking like a very ambitious deadline.
Until last week, the prevailing opinion in Washington was that the Senate’s version would control the tax reform process. However, when looking at the two versions side by side, it becomes obvious that the House bill covers a number of provisions that the Senate Finance version does not and vice versa. Because of this, there very well may be a “real” conference—meaning that the conference committee will need to decide what to do about conflicting provisions or provisions that exist in one chamber’s version but not the other’s. Because of the limits of budget reconciliation, this conference process will be further complicated by the need to stick to strict budgetary guidelines, meaning that all the cuts in the House and Senate versions can’t simply be merged together without additional changes. Where the Senate has made a decision, it’s likely their provision will prevail. However, where the House has a provision, but the Senate does not have a corresponding provision then it is possible that the House provision will be added and vice versa. Two provisions come to mind where deference probably won’t be given to the Senate version: the pass-through provisions, which are likely to emerge in a different format from either the Senate mark or the House version, and the state and local property tax deduction, where the conferenced legislation, is likely to follow the House version (which was carefully negotiated to appease members in higher tax places).
Many of the provisions affecting individual taxpayers in the Senate mark would expire as of December 31, 2025. This is two years sooner than would be required under the law. It appears this early expiration date of many provisions was needed in order to make the entire mark revenue neutral so that the C corp rate and the repeal of the ACA individual mandate could be made permanent. Concerned senators are being told that the most popular of these provisions will be extended before they expire, but that is an expectation that may or may not be met.
Advantages and Comparisons of the House Bill and Senate Mark
While there are a number of controversial and potentially problematic provisions in both the House bill and Senate’s conceptual mark, both versions also have advantageous provisions. Below is a breakdown of the provisions that will benefit most taxpayers. The provisions of the House Bill are discussed in black and the provisions of the Senate Finance Committee’s conceptual mark are in blue.
Reduced C Corporation Tax Rates
In the House bill, the C corporate rate drops immediately and permanently to 20% (though, as noted below, this decrease exasperates the disparity between C corp and pass-through tax rates). The tax rate for personal service corporations would be 25%.
The Senate Finance mark would also provide a permanent 20% tax rate for C corps but this rate wouldn’t go into effect until tax years after 2018 (a year later than the House’s proposal). The tax rate for personal service corporations also starting in 2018 would be 20%.
AMT Repealed
The House bill repeals the alternative minimum tax (AMT), which will help many upper-middle income and wealthy taxpayers and would definitely simplify the tax code.
The Senate Finance mark has the same provision.
Estate and Gift Tax and GST Provisions
The House bill will increase the federal unified estate and gift tax exemption (as well as the generation-skipping transfer tax exemption) in 2018 for single individuals from $5.6 million to $11.2 million and for married couples from $11.2 million to $22.4 million. This doubling of the current federal estate and gift and generation-skipping transfer tax exemptions will be a major help for those small business owners who have a larger estate than the current exemption amounts. Starting in 2023, the estate tax and the generation-skipping transfer tax are scheduled to be repealed in their entirety. The gift tax would remain in place but the gift tax rate would be reduced from 40% to 35%, effective for gifts made after 2024. The step-up in basis is preserved in this bill which will help the heirs of any deceased person who had assets that appreciated significantly during the deceased person’s life. The increase in the exemption amounts culminating with repeal will be of some help to those upper-middle income taxpayers or those in the lower range of wealthy whose estates exceed the amount of the exemption today. Repeal of the estate tax will be greatly beneficial to the extraordinarily wealthy.
The provisions in the Senate Finance conceptual mark on the unified estate and gift and generation-skipping transfer tax exemption are the same as in the House bill except that there is no repeal of the estate and generation-skipping transfer tax at any point in the future and no change to the gift tax rate. Unlike the House bill, this change would sunset in 2025, so the exemptions would revert back to an indexed $5 million amount after December 31, 2025. (In 2017, the $5 million amount indexed is $5.49 million for a single person). However, the indexing occurring thereafter will continue to be based on the chained CPI that begins to apply in 2018 under both the Senate and House tax bills.
Increased Bonus Depreciation
Under the House bill, companies would be able to immediately write off the full cost of investments in their businesses, starting with assets purchased and placed in service after September 27, 2017 and before January 1, 2023.
The Senate Finance mark’s provision is basically the same as in the House bill.
Section 179 Deduction Expanded
Under the House bill, effective for tax years 2018 through 2022, the Section 179 deduction would be expanded dramatically from $500,000 to $5 million with an increased phase-out threshold at $20 million.
Under the Senate mark, the provision is similar to the House bill, except the $5 million limit would be decreased to $1 million and the phase-out threshold would be $2.5 million. The definition of qualified real property would also be expanded to include improvements made to nonresidential real property, including roofs, heating and air-conditioning property.
Research and Development Credit and Low-Income Housing Credit Retained
Under the House bill the research and development credit is retained as is the low-income housing credit.
The Senate Finance mark would also preserve the research and development credit as well as the low-income housing credit. A number of additional provisions would be added to the low-income housing credit.
Expanded Availability of Cash Method of Accounting
The House tax bill would increase the availability of the cash method of accounting by raising the current $5 million average gross receipts for corporations and partnerships with corporate partners ceiling to $25 million (indexed for inflation). This would also be extended to farming entities.
The Senate Finance mark also raises the current ceiling but only to $15 million instead of $25 million. This would also be extended to certain farming entities as well but with more restrictions than the House bill.
New Employer Credit for Paid Family and Medical Leave
No provision in the House bill.
In the Senate mark there is a new credit for wages paid to employees on FMLA if certain conditions are met. This credit is effective only for 2018 and 2019.
Potentially Problematic Provisions
A variety of think tanks and experts, as well as the Joint Committee of Taxation, have shown that a number of taxpayers will either immediately get a tax hike under the tax reform plans or, by 2027, will pay more taxes than they do today. Most of the models reflect that taxpayers making between $200,000 and $500,000 are the most likely to see a tax increase. The most recent data published in The Wall Street Journal indicates that in 2019 nearly 25% of taxpayers in this group would pay more in taxes under the tax reform plans than they would under the existing tax laws. As discussed in prior Alerts, a major goal of the tax reform legislation has been to have lower rates while broadening the tax base (by eliminating tax credits and deductions). However, for some taxpayers, the loss of some of the deductions below will not be offset by the lower rates and/or the increase in the standard deduction. Additionally, in the long term, and as mentioned above, a significant number of the individual tax provisions are not permanent but rather sunset within eight years which would, at best, put some taxpayers in much the same place as they were pre-tax reform.
As a bottom line, if an individual or a married couple has a significant amount of medical expenses, mortgage interest (under the House bill, existing loans would be grandfathered and subject to the old rules), real estate taxes (under the House bill, the deduction would be capped at $10,000, with no deduction in the Senate bill), and/or state and local income taxes, they could either immediately, or sometime within the next 10 years, end up worse off under the House or Senate version (or a hybrid thereof).
Deduction for Business Interest
Under the House bill, effective 2018, businesses would only be able to deduct net interest expenses incurred by a business up to 30% of the business’s adjusted taxable income.
The Senate mark would impose the same limit on the interest deduction.
Small Business Exception from Limitation on Deduction of Business Interest
Under the House tax bill, effective 2018, companies with average annual gross receipts of $25 million or less would be able to continue to deduct business interest.
The Senate mark similarly increases the threshold except that $15 million is substituted for $25 million. If the Senate version prevails, this will hurt those businesses who have average annual gross receipts between $15 million up to $25 million.
Note under the House tax bill, it appeared that a business with average annual gross receipts of $25 million or less was deemed to be a small business which was far better than today’s $10 million cut off found throughout the tax code. Unfortunately, the Senate plan drops that number to $15 million.
Increased Standard Deduction, Repeal of Personal Exemptions and Increased Child Tax Credit
The House tax bill would increase the standard deduction next year from $13,000 to $24,400 for a joint return or a surviving spouse, $18,300 for an unmarried taxpayer with at least one qualifying child and $12,200 for single filers. This standard deduction would be indexed to a measure of inflation known as the “chained CPI”, which will grow more slowly than the inflation factor utilized today. While the standard deduction is increased, with that would come the repeal of the personal exemption that in the past was claimed for each member of the household. The loss of the personal exemption could hurt families with even just two children. For example, under current law, in 2018 a married couple with two children would receive a $13,000 standard deduction with four personal exemptions of $4,150 for a total exemption of income from federal income taxes of $29,600, whereas under the House bill only $24,400 would be exempt from federal income tax. Obviously, the more children a middle to upper-middle income family has, the more the loss of the personal exemption would hurt. The loss of personal exemptions is offset at least somewhat, but not entirely, by an increase in the child tax credit from $1,000 to $1,600 and an increase in the income limits where the child tax credits phase out to $115,000 (up from $75,000) for single taxpayers and $230,000 (up from $110,000) for married taxpayers. There is also a new credit for non-child dependents and a new “family flexibility credit” (available to the taxpayer or his/her spouse who is not a child or a non-child dependent) of $300 but both of these credits will sunset in 2022.
It is anticipated that the increase in the standard deduction will prove to greatly simplify figuring out taxes for many taxpayers with lesser amounts of income.
The Senate Finance mark has the same provisions as the House bill with respect to the standard deduction except the amounts are $24,000, $18,000 and $12,000 respectively and it also eliminates personal exemptions. The Senate Finance mark would increase the child care credit to $2,000 and, among other changes, would increase the threshold for the phase-out up to $500,000 for married taxpayers. The plan would also provide a $500 non-refundable tax credit for dependents other than qualifying children. All of the Senate Finance mark’s provisions would expire after December 31, 2025, except that the new (slower) index factor for the standard deduction would continue to apply. Otherwise all of these provisions would revert to the law as it stands today.
Also on the child and dependent front, the ability of employers to offer tax-advantaged dependent care Flexible Savings Accounts was initially eliminated immediately under House bill until an early amendment modified the bill to provide for such FSAs to continue until 2022.
The Senate mark has no provision for tax-advantaged dependent care Flexible Savings Accounts.
The bottom line is that, middle to upper-middle income taxpayers with children would see a lot of changes under this proposal.
Elimination of Individual Deductions
Both the House bill and the Senate mark eliminate a number of individual deductions and exclusions. One of the most controversial ones, contained in the House bill but not the Senate proposal, would repeal the exclusion for graduate and undergraduate tuition waivers or assistance and require students to report the value of the waiver as part of their income. This provision has been facing serious criticism for the fact that it would actually make it more difficult to pursue higher education, which would seem to be counter to what is best for our country in the long term.
Limitations on Mortgage Interest Deduction
Another big change that taxpayers would see under the House bill is the reduction of the mortgage interest deduction to $500,000 for debt incurred after November 2, 2017 on the principal residence only. This provision is one of the reasons that the Home Builders Association is opposed to the House bill. They view this as a provision that will stop people from being able to enter the housing market. This provision would also significantly increase the cost of higher-end homes or homes in more expensive regions. It is not hard to imagine this provision triggering a housing crash or a loss of value with respect to these types of homes and/or people shifting to renting high-end homes rather than purchasing them. There is also a provision in the House bill that would continue to allow the exclusion from gross income the proceeds of the sale of a principal residence but only if the taxpayer owned and used the home for five out of the previous eight years. This exclusion would be phased out for joint filers with income over $500,000 and single filers with income over $250,000. This is perceived as an anti-growth provision since people who might prefer to move up to a larger home sooner will not do so in order to receive this exclusion from gross income.
The Senate Finance mark has basically the same exclusion for sale proceeds as the House bill but includes an exception to the five year exclusion requirement for changes of employment, health or unforeseen circumstances. The Senate Finance plan would eliminate the deduction for home equity loans but, unlike the House bill, leaves the current $1 million mortgage deduction intact. Both of these provisions would sunset on December 31, 2025, and the law would revert back to as it stands today (which is less restrictive so this would be a change that taxpayers would want).
Controversial and Complex Pass-Through Provisions
One of the most controversial and complex provisions in the House tax bill is the new pass-through business income tax rate. For owners in a pass-through entity who actually work in the business, the default provision is that 30% of the income is deemed to be attributable to the capital of the business and thus taxed at a new 25% tax rate while the remaining 70% is subject to the normal income tax rates. There is a far more complicated formula for small business owners who choose to apply a facts and circumstances test to show that more than 30% of the income from the business is attributable to capital they have invested and thus will be taxed at the 25% tax rate. For owners of personal service organizations, such as lawyers, doctors, accountants, engineers, actuaries and consultants, the default presumption for active business income would be 0% not 30%. There is also a 9% tax rate for the first $75,000 ($37,500 for unmarried individuals, $56,250 for heads of household) of net business taxable income of an active owner or shareholder earning less than $150,000 ($75,000 for unmarried individuals, $122,500 for heads of household) in taxable income from a pass-through business. For taxable income over these levels, there is a phase out of the reduced tax rate which would be totally phased out at $225,000. The 9% tax rate would be phased in over the next four years and would be fully effective in 2022.
Not only will these provisions add tremendous complexity to the tax code but they also create a new major disparity in tax rates between C Corps (20%) and pass-through entities (a blend of 25% and the owner’s personal income tax rate). This differential is far worse than what exists today. Thus, instead of closing the gap between the C corp and pass-through entities, the House tax bill will make the gap far worse. This provision is why many small business owners who work in their own businesses believe that the bill discriminates against them. Meanwhile folks who do not work in the pass-through, so-called “passive” owners, will receive the 25% rate on all income from the business. This provision does appear to penalize owners who actually work in their business. Much of the complexity found in these new provisions is a direct result of trying to prevent individuals from gaming these provisions.
The Senate mark has a very different approach. Again, the Senate’s proposal hasn’t been boiled down to legislative language yet, but right now the mark contemplates giving the individual taxpayer a 17.4% deduction on qualified business income from a partnership, S corporation or sole proprietorship, up to 50% of the W-2 wages of the taxpayer who has qualified business income from a partnership or S corp (with some exclusions and phase in for couples less than, or slightly more than, $500,000 or individuals making less than, or slightly more than, $250,000). Qualified business income would not include income from specific service trades or businesses, including not only those involved in the performance of services in the typical personal service fields such as health, law, engineering, etc., but also those involved in financial services, brokerage services or “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, except in the case of a taxpayer whose taxable income does not exceed a threshold amount.” This deduction would expire after December 31, 2025.
A number of small business groups are upset with these provisions in the Senate mark because they contend that when this provision is combined with the loss of deductions the effective rate for pass-through entities will only decrease by a minimal amount. They also question why the 17.4% deduction only applies to “domestic” income and why only somewhere between 18% and 25% of all of the tax benefits going to corporations will go to pass-through businesses. A number of tax experts think that, until this provision is put down in legislative language, it is impossible to figure out how it will work because the provision is so bare bones at this point. For instance, there are some experts who believe that because of a possible technicality in the law (depending upon how these provisions are finally drafted) that S corporations would have a significant tax advantage over partnerships and sole proprietorships. Finally, they are upset that the C corporate tax rate deduction is permanent, while the deduction for the pass-through entities under the Senate mark would expire in 2025. It has been explained that C corporations need permanency in order to plan properly. Implicit in this statement is the converse—that pass-through entities do not need this permanency. Many owners of successful pass-through entities would disagree with that sentiment.
State and Local Tax Deduction
The House bill would eliminate the deduction for state and local income and sales tax. It would allow individuals to deduct up to $10,000 in state and local property taxes.
The Senate mark eliminates the deduction for state and local income and sales tax as well as state and local property taxes for individuals. Businesses would, however, be allowed to deduct these expenses. The elimination of these deductions would expire after December 31, 2025, and the deductions would revert back to the law as it stands today.
Contributions to Capital
One of the stranger provisions in the House bill deals with contributions to capital of a partnership and would require that contributions in excess of fair market value of the interest received would be included in gross income. Thus, two individuals could contribute say $10,000 to a new LLC to run a business. Due to discounts for lack of control and lack of marketability, let’s say the value of each interest is $7000. Under this provision the LLC has received $20,000 of value and the two members have received $14,000 of value, resulting in $6,000 of income, which is taxable one half to each individual. This is the first time an individual could be taxed in this situation!
The Senate mark has no corresponding provision.
Hopefully, the Senate mark will control with this provision.
The ACA Element
Perhaps the biggest amendment that was made to the Senate mark last week was the addition of provisions to repeal the Affordable Care Act’s (ACA) individual mandate that requires most Americans to buy health insurance. The primary reason this was included was because it serves as a sizable revenue raiser (because the elimination of the mandate cuts down on the number of individuals whose health insurance will be subsidized by the government). However, the discussion over the millions more uninsured and higher premiums that would result from this change has taken the Senate mark into the dangerous territory. Again, this is another example of how using the reconciliation process forces the lawmakers to try to include politically riskier provisions in order to raise money.
Interestingly, the individual mandate was not a popular provision with either Republicans or Democrats, but was considered necessary by the insurance industry. The health insurance carriers did not think it was possible to cover individuals with pre-existing conditions (a popular provision) while being limited as to what they could charge older or sicker individuals (another popular provision) without having the risk pool expanded by healthier and younger individuals. By removing the mandate, the insurance carriers are adamant that premiums will have to rise because of the belief that the younger, healthier individuals will leave the pool.
Ultimately, there is a relatively good chance that this provision will be removed in order to shore up the necessary votes in the Senate. This weekend, Budget Director Mick Mulvaney stated that the White House wouldn’t oppose the removal of this provision to help pass the bill. However, getting rid of the provision would mean a loss in revenue for the bill that would likely need to be made up elsewhere.
Major Provisions Left Unchanged
Non-qualified Deferred Compensation
After amendment to the original versions in both the House bill and the Senate Finance plan, the non-qualified plan provisions remain unchanged. In other words, Section 409A remains unchanged in both versions.
Capital Gain and Dividend Rates
Capital gains and dividend tax rates are unchanged under both the House bill and the Senate Finance bill, with the exception of some changes that are due to changes in the tax brackets.
Qualified Retirement Plans
By and large, retirement plans sponsored by businesses were not adversely affected by either the House bill or the Senate mark.
Conclusions
As we saw with the health care fight earlier this year, the passage of tax reform will largely hinge on whether the Republican leadership can assemble sufficient support in the Senate, not just for the latest Senate version of the bill but on the bill as reconciled with the House version. While there is a great deal of momentum behind tax reform at this point, there have also been some significant groups, including the home builders, mortgage brokers and voters from places with high state and local income taxes (whose constituents are likely to be negatively impacted by tax reform), who have raised concerns about the bill. Further, the current proposal would significantly increase the federal deficit, which may pose some concern for the budget hawks.