An Overview of the “Tax Cuts and Jobs Act of 2017” House and Senate Versions

Prepared by FGMK Tax Partner Charles Schultz III and Senior Tax Associate Jeffrey Golds

The House and Senate have each passed separate versions of the “Tax Cuts and Jobs Act of 2017,” and both bills have gone to conference committee to be reconciled.  In conference committee, members of the House and Senate will work to reconcile differences in the bills and draft a new version which will then need to be passed by both the House and Senate again.   As there are significant differences between the House and Senate versions, it is safe to assume that the final bill, when passed, will differ in meaningful ways from the current House and Senate versions.  Furthermore, it is unclear exactly how long the process of reconciling the two bills will take.  While the summaries below should give the reader a sense of what the general framework of the final tax reform should look like, taxpayers should read below to see where there are similarities and differences between the bills to get a sense of what the final bill might look like, and should consult with a member of the FGMK Tax Practice before taking any specific tax planning steps related to tax reform.

INDIVIDUAL TAXATION

The House Bill seeks to simplify the Internal Revenue Code (the “Code”) for individuals by requiring fewer tax brackets and by consolidating various exemptions and deductions into a larger Standard Deduction.  The House Bill will not make changes with respect to the maximum rate for capital gains and qualified dividends.  The House Bill will also not repeal the 3.8% net investment income tax under the Affordable Care Act or the 0.9% additional Medicare tax on higher-income individuals.   Similar to the House Bill, the Senate Bill consolidates various exemptions and deductions into a larger Standard Deduction.  Unlike the House Bill, the Senate Bill lowers overall rates but does not reduce the number of brackets, and eliminates the 3.8% tax under the Affordable Care Act. 

TAX RATES

House Bill

  •  Fewer tax brackets: The seven current brackets are reduced to just four: 12%, 25%, 35%, and 39.6%.
    •  12% Tax Phase Out: There is to be a phase-out of the 12% tax bracket for taxpayers with adjusted gross income over $1 million ($1.2 million for joint returns).

Senate Bill

  •  Seven tax brackets: The seven current brackets are to be retained, but at lower rates: 10%, 12%, 22.5%, 25%, 32.5%, 35%, 38.5%. This change will expire and revert back to current rates in 2026.
  •  Repeal of ACA Individual Mandate: The individual mandate under the ACA is to be reduced to 0%.

STANDARD DEDUCTION

House Bill

  •  Increased Standard Deduction: In conjunction with the simplified tax rates, the Standard Deduction for individuals is to be increased as follows:
    •  For Single Individuals, to $12,000.
    •  For a Head of Household or Married Joint return, to $24,000.
  • Additionally, a Single Individual with at least one dependent child will qualify for a Standard Deduction of $18,000.

Senate Bill - Will expire and revert back to current system in 2026.

  • Increased Standard Deduction: In conjunction with the simplified tax rates, the Standard Deduction for individuals will be increased as follows:
    •  For Single Individuals, to $12,000
    •  For a Head of Household, to $18,000
    •  For Married Joint return, to $24,000

ITEMIZED DEDUCTIONS

House Bill

  • Reduction in Itemized Deductions: In concert with simplifying the tax brackets and increasing the Standard Deduction, several itemized deductions will be reduced or eliminated:
    •  Mortgage Interest Deduction: For mortgages entered into after November 2, 2017, the deduction for home mortgage interest will be limited to mortgages of $500,000 or less.
      •  Exception: Mortgages entered into before November 2, 2017, or the refinancing of such mortgages, will not be subject to this limitation.
      •  Elimination of Second Home Deductions: The mortgage interest deduction will be limited to the taxpayer’s primary residence only. No interest on mortgages used to purchase vacation or secondary homes will be allowed.
      •  Home Equity Loans: The deduction for interest on home equity loans will be eliminated.
    •  State and Local Taxes: The deduction for state and local income taxes and sales taxes will be eliminated for individuals, and the deduction for local real property taxes will be capped at $10,000.
      •  Exception for Businesses: State and local income and property taxes paid or accrued in the carrying on of a trade or business will still be fully deductible by the business.
    •  Itemized Deduction Limitation: The House Bill eliminates the overall limitation on itemized deductions for high-income taxpayers earning over $261,500 a year.
    •  Increase in Charitable Giving Deduction Amount: The limitation on the charitable giving deduction will be raised to 60% of the donor’s adjusted gross income.
    •  Deductions Eliminated: The following deductions will be eliminated:
      •  Personal exemptions and dependents
      •  Personal casualty loses (e.g. fire, storm, theft, etc.)
      •  Student loan interest payments
      •  College Stadium Seating Licenses (e. licenses which permit the purchase of season tickets at a college sports stadium)
      •  Tax preparation expenses
      •  Medical expenses
      •  Moving expenses
      •  Trade or business expenses related to being an employee (g. a teacher buying teaching supplies for their class)

Senate Bill - Will expire and revert back to current system in 2026.

  • Reduction in Itemized Deductions: In concert with reducing the tax brackets and increasing the Standard Deduction, several itemized deductions will be reduced or eliminated:
    • Miscellaneous Itemized Deductions: The Senate Bill eliminates all miscellaneous itemized deductions subject to the 2% floor.
    • Mortgage Interest Deduction: The Senate Bill does not change the current deduction related to Mortgage Interest.
      •  Home Equity Loans: The deduction for interest on home equity loans will be eliminated.
    • State and Local Taxes: The deduction for state and local income taxes and sales taxes will be eliminated for individuals, and the deduction for local real property taxes will be capped at $10,000.
      •  Exception for Businesses: State and local income and property taxes paid or accrued in the carrying on of a trade or business will still be fully deductible by the business.
    • Reduction in Medical Expense Deduction Floor: The Senate Bill temporarily lowers the threshold for deducting medical expenses to 7.5% of gross income.
    • Itemized Deduction Limitation: The Senate Bill eliminates the overall limitation on itemized deductions for high income taxpayers earning over $261,500 a year.
    • Increase in Charitable Giving Deduction Amount: The limitation on the charitable giving deduction will be raised to 60% of the donor’s adjusted gross income.
    • Deductions Eliminated: The following deductions are to be eliminated:
      •  Personal exemptions and dependents
      •  Personal casualty loses (e.g. fire, storm, theft, etc.)
        •  Exception: Losses incurred in a disaster declared by the President in 2016 may be deducted.
      •  Tax preparation expenses
      •  College Stadium Seating Licenses (e. license which permit the purchase of season tickets at a college sports stadium)
      •  Trade or business expenses related to being an employee
        •  Exception: Teachers will be able to deduct up to $500 for supplies necessary for teaching
      •  Expenses for the production or collection of income (g. appraisal fees, investment fees, etc.)
      •  Repayments of income received under a claim of right
      •  Repayments of Social Security benefits
      •  Moving expenses (excluding those incurred by member of Armed Services moving due to a Military Order)

 EXCLUSIONS FOR INCOME

 House Bill

  • Employer Provided Housing: The exclusion of employer-provided housing from income will be limited to $50,000 for an individual and phased out for high-income taxpayers (those making over $120,000 a year, adjusted for inflation).
  • Gain from the Sale of a Primary Residence: The exclusion of gain from the sale of a taxpayer’s primary residence will require that the residence in question have been the taxpayer’s primary residence for five of the preceding eight years - an increase from the current requirement of two of the last five years. In addition, the exclusion will be phased out for taxpayers with $500,000 or more of adjusted gross income.
  • Exclusions Eliminated: The following exclusions from income will be eliminated:
    •  Employee Achievement Awards (e. retirement gifts)
    •  The value of employer-provided child care (will be preserved until 2023)
    •  Employer moving expense reimbursements (save for those incurred by military members related to deployment based relocation)
    •  Income on the interest of a U.S. Savings Bond which is used to pay for education
    •  Income related to Qualified Tuition Reductions made to employees of an educational institution and their spouses and dependents
    •  Income related to Employer-Provided Education Assistance

 Senate Bill - Will expire and revert back to current system in 2026.

  • Gain from the Sale of a Primary Residence: The exclusion of gain from the sale of a taxpayer’s primary residence will require that the residence in question have been the taxpayer’s primary residence for five of the preceding eight years - an increase from the current requirement of two of the last five years. In addition, the exclusion will be phased out for taxpayers with $500,000 or more of adjusted gross income.
  • Exclusions Eliminated: The following exclusions from income will be eliminated:
    •  Qualified Bicycle Commuting Reimbursements
    •  Employer moving expense reimbursements
    •  Income on the interest of a U.S. Savings Bond which is used to pay for education
    •  Income related to Qualified Tuition Reductions made to employees of an educational institution and their spouses and dependents
    •  Income related to Employer-Provided Education Assistance
    •  Employee Achievement Awards (e. retirement gifts) which are composed of cash, cash equivalents, gift coupons, vacations, meals, lodging, or tickets

TAX CREDITS

House Bill

  • Child Tax Credit Increased: The Child Tax Credit will be replaced with a new partially refundable $1,600 a year family credit. In addition, each family member will be entitled to a $300 per year nonrefundable credit.   Finally, the amount of income at which these credits begin to phase out will be raised to $230,000 a year for joint filers and $115,000 a year for single filers.
  • Credits Eliminated: The following credits currently available to individuals will be eliminated:
    •  Credit for Individuals over 65 on Disability
    •  The Adoption Credit
    •  The Mortgage Credit
    •  The Plug-In Electric Car Credit
    •  The Hope Scholarship Credit
    •  The Lifetime Learning Credit

 Senate Bill

  • Child Tax Credit Increased: The Child Tax Credit will be increased to $2,000 a year.  The amount of income at which these credits begin to phase out will begin at $500,000 a year for joint filers.  Finally, the earned income threshold for a refund of the credit is lowered to $2,500, and the $1,000 maximum refund per child will be indexed for inflation.

 CHANGES TO EDUCATIONAL INCENTIVES

 House Bill

  •  In conjunction with the increase in the Standard Deduction and the elimination of most itemized deductions, changes will be made to certain educational incentives, including an expansion of the American Opportunity Tax Credit, and the exclusion of income related to a discharge of student debt resulting from death or disability.

 Senate Bill

  •  In conjunction with the increase in the Standard Deduction and the elimination of most itemized deductions, changes will be made to certain educational incentives, including the exclusion of income related to a discharge of student debt resulting from death or disability, and allowing Section 529 accounts to be used to pay for elementary and secondary education.

 CHANGES TO DEFERRED COMPENSATION

House Bill - Makes several changes to the taxation of executive compensation. This could possibly eliminate nonqualified and deferred compensation arrangements going forward, as well as adversely impact incentive plan design, nonqualified retirement benefits, and severance arrangements:

  •  Introduction of New Section 409B: All compensation will become taxable when it is no longer subject to a substantial service obligation, such that taxation will occur at vesting.
    •  Stock options and stock appreciation rights will be taxed upon vesting, whether or not exercised. In essence, the executive could be subject to an income tax without the benefit of the stock option proceeds.
    •  Similarly, SERPs and other nonqualified retirement plans will be taxed at vesting, even if distributions may not occur until many years in the future.
    •  Severance will be taxed at termination of employment, notwithstanding that it is paid over time and/or conditioned on compliance with a noncompetition covenant.
    •  Incentive awards will also be taxed upon vesting, even where payment is deferred for corporate governance or other reasons (e.g., a mandatory deferral).
    •  Existing arrangements will be grandfathered under current rules through 2025.
  •  Elimination of Limit on Contingent Compensation: The $1 million limit on deductions taken by an employer for contingent commissions or bonuses made to a Covered Employee will be eliminated.
    •  Covered Employees: The Bill will amend the definition of “Covered Employee” to mean the CEO, CFO, and the three other highest paid employees.
    •  The Section 162(m) deduction limitations will now apply to any individual deemed a covered employee for as long as they receive compensation from the company.
      •  The Bill will align the definition of “covered employee” with current SEC disclosure rules, thus subjecting the CFO to the limitation.
  •  Expansion of Executive Compensation Excise Tax: The Corporate Excise tax on Executive Compensation will be applied to Not-for-Profits as well; the excise tax will be applied to compensation paid in excess of $1M.
  •  Qualified Deferred Compensation: Generally speaking, the changes to deferred compensation plans will make it easier for taxpayers to withdraw amounts from their plan at a younger age: 
    •  Withdrawals While Still Employed: All pensions, and 401k plans provided by a state or local government, will allow the taxpayer to begin taking distributions once they are 59.5 years old, even if the taxpayer is still working.
    •  Elimination of Six Month Waiting Period for Hardship Distributions: Employees taking a hardship distribution from their 401k plan will be permitted to continue making contributions to such plan, rather than being forced to withhold contributions for six months.
    •  Inclusion of Employer Contributions in Hardship Distributions: Employees will be able to take hardship distributions from their 401k plan from all the amounts which have been contributed to the plan, not just employee-contributed amounts.
    •  Extended Rollover Period for Plan Loan Offsetting: Any employee who takes out a loan from their 401k plan and then ends their employment will have until the due date for next year’s tax filing, up from 60 days, to contribute the loaned amount to an IRA.
    •  New Rules for IRAs: Rules allowing recharacterization of IRAs as Roth IRAs (and vice versa) will be eliminated.

 Senate Bill - Makes several changes to the taxation of executive compensation and deferred compensation:

  •  Executive Compensation: Rules related to Executive Compensation will also be modified under the House Bill:
    •  Deferral of Income of Stock Options or Restricted Stock: At the Employees election, an employee who receive stock options or restricted stock as compensation for services may defer recognition of income for up to 5 years as long as stock is not publically traded.
    •  Elimination of Limit on Contingent Compensation: The $1 million limit on deductions taken by an employer for contingent commissions or bonuses made to a Covered Employee will be eliminated.
      •  Covered Employees: The Senate Bill will amend the definition of “Covered Employee” to mean the CEO, CFO, and the three other highest paid employees.
    •  Expansion of Executive Compensation Excise Tax: The Corporate Excise taxes on Executive Compensation will be applied to Not-for-Profits as well.
  •  Qualified Deferred Compensation: Generally speaking, the changes to deferred compensation plans will make it easier for taxpayers to withdraw amounts from their plan at a younger age:
    •  Disaster Distributions: Qualified Plan holders may make a 10% early distribution related to a presidentially declared disaster which occurred in 2016 and may pay income on such distribution ratably over 3 years.
    •  Extended Rollover Period for Plan Loan Offsetting: Any employee who takes out a loan from their 401k plan and then ends their employment will have until the due date for next year’s tax filing, up from 60 days, to contribute the loaned amount to an IRA.
    •  New Rules for IRAs: Rules allowing recharacterization of IRAs as Roth IRAs (and vice versa) will be eliminated.

GIFT AND ESTATE TAX

House Bill - The House Bill proposes a major overhaul of the Gift and Estate Taxes. Generally, the Estate Tax will be repealed and, though the Gift Tax will remain, the rate will be reduced:

  •  Increase in Excluded Amount for Gift and Estate Taxes: The basic exclusion amount for Gift and Estate Taxes for all gifts and bequests made by an individual, whether living or deceased, will increase to $10,000,000, adjusting for inflation beginning in 2018.
  •  Decrease in Gift Tax Rate: The Gift Tax rate for property donated by a living donor will be reduced to 35% beginning in 2024.
  •  Elimination of Estate and Generation-Skipping Taxes: As of 2024, both the Estate Tax and the Generation-Skipping Tax will be eliminated.

Senate Bill - The Senate Bill, unlike the House Bill, does not repeal the Estate or Generation-Skipping Taxes. However, the Senate Bill proposes an increase in the exclusion amount.

  •  Increase in Excluded Amount for Gift and Estate Taxes: The basic exclusion amount for Gift and Estate Taxes for all gifts and bequests made by an individual, whether living or deceased, will increase to $10,000,000, adjusting for inflation beginning in 2018.

 BUSINESS TAXATION

 House Bill

  • Reduced Rate for Business-Related Income: Business owners of pass-through entities (e.g. sole proprietorships, partnerships, LLCs, and S-Corporations) will have a portion of their Business-Related Income taxed at a 25% rate rather than at their individual rate.  Small businesses bringing in less than $115,000 of income a year will have the first $75,000 taxed at 9% (this rate to be phased in over 5 years):
    •  Business Related Income: Business Related Income is equal to any active business income treated as a return on capital, as well as 100% of any net business income derived from passive business activities.
      •  Passive Investors in Pass-Through Business Entities: Passive Investor partners will be taxed at the maximum rate of 25% and will still be entitled to preferential rates on long term capital gains and qualified dividend income from such business income, but will be taxed at their ordinary rates on short-term capital gains and interest payments not allocable to a trade or business.    
    •  Amount Taxed at Business Rate: The amount of income subject to this lower rate will be either:
      •  30% of the business’ income (with the remaining 70% taxed at the normal individual rate); or, at the taxpayers election.
      •  The business’ Specified Return on Capital related to the business, divided by the owner’s Net Business Income.
        •  Specified Return on Capital is defined as the business’s Deemed Rate of Return, multiplied by the Asset Balance related to the business.
          •  Deemed rate of Return is short term AFR for the month in which the taxable year ends, plus seven percentage points.
          •  Asset Balance is the adjusted basis of all property used in the business as of the end of the taxable year.
    •  Anti-Abuse: The House Bill states that special rules will be put in place to prevent individuals from treating wages as business income.
    •  Limitation on Professional Service Businesses: Professional Service businesses, such as accounting, law, or consulting firms, will only be able to use the alternative capital formula.

 Senate Bill

  •  Deduction for Business-Related Income: Business owners of pass-through entities (e.g. sole proprietorships, partnerships, LLCs, and S-Corporations) will be allowed to deduct 23% of their domestic Qualified Business Income (i.e. the net of a taxpayers items of income, gain, deduction, and loss related to such taxpayers business).
    •  Limitation for Specified Service Businesses: The deduction will not be available to Specified Service Businesses, except for taxpayers with $500,000 or less of income and will be phased in for income over $500,000 over the next $100,000 of income.
      •  Specified Service Businesses: Those in fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or any other where the principal asset is the skill or reputation of the employees or owners.
    •  Limitation on Deductible Amount: For taxpayers earning income from an S-Corporation or Partnership, deduction will be limited to 50% of their W-2 wages. This will not apply to individuals with less than $500,000 in income, and will be phased in for income over $500,000 over the next $100,000 of income.
  •  Excess Business Loss Limitation: Excess Business Losses (i.e. the excess of aggregate deductions attributable to trades or business over sum of aggregate gross income of taxpayer plus a Threshold Amount) will be carried forward as part of the taxpayers NOL.
    •  Threshold Amount: $500,000 for married individuals, $250,000 for individuals, adjusted for inflation.
  •  Substantial built in Losses: The Substantial built in loss rules will be expanded to create a Substantial Built-In Loss where a partner will be allocated a net loss in excess of $250,000 were such partner to transfer their interest.
  •  Basis Limitation on Partner Losses: The basis limitation of losses will apply to a partner’s distributive share of charitable contributions and foreign taxes.

CARRIED INTEREST

  • House and Senate Bill - In both the House and Senate Bills, Partnership interests received in connection with the performance of services will be subject to a 3 year holding period in order to be treated as long-term capital gains.

SELF-CREATED INTELLECTUAL PROPERTY

House Bill - The sale of a self-created patent (other than a musical work) will be ordinary income rather than capital.

 Senate Bill - Not addressed.

RESEARCH AND EXPERIMENTATION EXPENDITURES

House and Senate Bill - Under both Bills, Certain research or experimentation expenditures will be capitalized and amortized over 5 years.

LIKE-KIND EXCHANGES

 House Bill - Like-kind exchanges will only be allowed for real property not held primarily for sale.

 Senate Bill - Like-kind exchanges will only be allowed for real property not held primarily for sale.

TECHNICAL TERMINATION RULES ELIMINATED

 House Bill - The Technical Termination rules for partnerships (treating a transfer in a year of 50% or more of the total interest in partnership capital and profits as a liquidation of the partnership and formation of a new partnership) will be eliminated.

Senate Bill - Not addressed.

CONTRIBUTIONS TO A BUSINESS IN EXCESS OF VALUE OF SHARES

House Bill - Contributions of capital to a business will be taxable as income if the contributions exceed the fair market value of the stock or partnership interest received in exchange.

 Senate Bill - Not addressed.

ALTERNATIVE MINIMUM TAX

 House Bill - The House Bill eliminates the Alternative Minimum Tax (the “AMT”).

  • Refunds of Unused AMT Credits: Taxpayers who have AMT credits that they have carried forward will be able to claim a 50% refund for any remaining credits in 2019-2021, and then a full refund for any unused credits in 2022.

Senate Bill - The Senate Bill retains the AMT for both individuals and corporations.

  •  Threshold for Individuals: The Senate Bill increases the threshold for application of the AMT for individuals.
    •  Note: We would expect a change to the corporate AMT rate before final passage of the bill.  As currently written, the Senate Bill includes a 20% regular corporate rate, and a 20% corporate AMT.  This would result in the application of the AMT to all corporate taxpayers, and essentially result in the de facto revocation of numerous corporate deductions and credits.  It is highly unlikely that this is the intended result.

CORPORATE TAXATION

CORPORATE TAX RATE

 House Bill - The current tiered corporate tax rate will be replaced with a flat 20% rate.

  •  Exception for Personal Service Corporations: Personal Service Corporations will be subject to a flat 25% rate.

 Senate Bill - The current tiered corporate tax rate will be replaced with a flat 20% rate.

  •  Personal Service Corporations: Personal Service Corporations will not be subject to a different rate.
  •  Effective Date: The new rate will not be effective until 2019.

 ACCELERATED COST RECOVERY

 House Bill

  •  Depreciable Property: Depreciable property placed in service between September 27, 2017, and January 1, 2023, could, at the taxpayer’s election, be 100% deducted the year it is placed in service, rather than depreciated. The property need not be new property but must not be previously used by the taxpayer.
    •  Exception: This change excludes property used by a public utility or in a “real property business.” 
  •  Section 179 Property: Up to $5 million in Section 179 property could be immediately expensed, with a phase-out beginning when over $20 million of Section 179 property is placed in service in a given year. These limitations will be indexed for inflation beginning for years after 2017.

Senate Bill

  • Recovery Period for Real Estate: The recovery period for nonresidential real property and residential rental property shortened to 25 years. In addition, qualified leasehold improvements, qualified restaurant property and qualified retail improvement property all consolidated as “qualified improvement property” and given 10 year recovery period.  These changes would only apply to property placed in service beginning in 2018.
  • Depreciable Property: Property which is currently permitted bonus depreciation under 168(k) which is placed in service between September 27, 2017, and January 1, 2023, could, at the taxpayer’s election, be 100% deducted the year it is placed in service, rather than depreciated from September 27, 2017 until January 1, 2023.  Thereafter, the amount of basis which can be immediately expensed will decrease by 20% every year from January 1, 2023 through January 1, 2027.
    •  Exception: This change excludes property used by a public utility or in a “real property business.” 
  • Personal Automobiles and Computers: Deduction limitations for automobiles increased.  Rules treating computers as special property removed.
  • Farm Equipment: Recovery period shortened to 5 years at taxpayer’s election.
  • Section 179 Property: Up to $1 million in Section 179 property could be immediately expensed, with a phase-out beginning when over $2.5 million of Section 179 property is placed in service in a given year. These limitations will be indexed for inflation beginning for years after 2017.
    •  Expanded Definition: Section 179 will include personal property used to furnish lodging, as well as property used in a qualified film, television, and live theatrical production. Will also expand definition of Qualified Real Property eligible for Section 179 expensing to include improvements to nonresidential real property including roofs, HVAC, fire, alarm, and security systems.

BUSINESS DEDUCTIONS

House Bill

  • Reduction in Dividends Received Deduction: The 80% and 70% dividends received deductions will be reduced to 65% and 50% respectively.
  • Limitation on Deductible Interest: All businesses (other than those with less than $25 million in gross receipts, public utilities, and real estate businesses) will suffer the disallowance of interest deductions in excess of 30% of “adjusted taxable income” (e. taxable income before interest expense, interest income, depreciation, and amortization. Pre-existing loans will not be grandfathered and will be subject to the limitation).
  • Limitation on Carryforward of Net Operating Losses (“NOLs”): NOLs which are carried forward will only be allowable up to 90% of a taxpayer’s taxable income.  Such NOLs could be carried forward indefinitely.
    • Increase in NOL Carryforward Amount: After 2017, NOLs carried forward will be increased by the short term AFR plus 4 percentage points.
    • Changes to Timing of NOLs: Businesses generally will not be able to carry back NOLs; however, certain qualifying small businesses and farms will be allowed a one-year carryback of their NOLs.
  • Deductions Eliminated: The following business deductions will be eliminated:
    •  Local lobbying expenses
    •  FDIC Premiums
    •  The Domestic Production Activity Deduction
    •  The Entertainment Expense Deduction (other than costs spent on meals or beverages)
    •  Certain unused business credits
    •  Employer deductions for fringe benefits provided to employees

Senate Bill

  • Limitation on Losses: For taxpayers other than a corporation, excess business losses will be limited.  This limitation will expire and revert back to the current rule in 2026.
    •  Adjusted Taxable Income: Defined as taxable income calculated without regard to any item of income, gain, deduction, or loss which is not properly allocable to a trade or business, any business interest or business interest income, any NOL under section 172, and any deduction allowed under section 199 or 199A.)
  • Limitation on Deductible Interest: All businesses (other than those with less than $15 million in gross receipts, public utilities, certain electric cooperatives, and real estate businesses) will suffer the disallowance of interest deductions in excess of the sum of 30% of adjusted taxable income, business interest income, and floor plan financing interest.  This means that, unlike the House Bill, “adjusted taxable income” is determined after taking depreciation, rather than before.
  • Reduction in Dividends Received Deduction: The 80% and 70% dividends received deductions will be reduced to 65% and 50% respectively.
    • Excess Business Losses: The excess of aggregate deductions of the taxpayer attributable to a trade or business over the sum of aggregate gross income or gain of the taxpayer, plus a threshold amount ($500,000 for married taxpayers).
  • Limitation on Carryforward of Net Operating Losses (“NOLs”): NOLs which are carried forward will only be allowable up to 90% of a taxpayer’s taxable income until 2023, and 80% thereafter.  Such NOLs could be carried forward indefinitely.
    •  Changes to Timing of NOLs: Businesses generally will not be able to carry back NOLs; however, certain farms will be allowed a two-year carryback of their NOLs.
    •  NOLs of Property and Casualty Insurance Companies: The current rules allowing 2 year carry back and 20 year carry forward will remain.
  • Inclusion in Charitable Contributions and Foreign Taxes: A partner in a partnership may include in losses their share of charitable contributions and foreign taxes paid by the partnership.
  •  Worker Safe Harbor: A safe harbor will be created to provide certainty as to whether a service provider is an employee of a business or not.
  • Deductions Eliminated: The following business deductions will be eliminated:
    •  Local lobbying expenses
    •  Amounts paid under a settlement subject to a non-disclosure agreement in connection with sexual harassment or sexual abuse
    •  FDIC Premiums
    •  The Domestic Production Activity Deduction
    •  Beginning in 2023, the Entertainment Expense Deduction
    •  Employer deductions for fringe benefits provided to employees

TAX CREDITS

 House Bill

 Although the House Bill explicitly states that it will retain the R&D Tax Credit and the Low Income Housing Tax Credit, the House Bill eliminates or modifies several of the credits which are currently available in order to balance the reduced corporate tax rate.

  •  Credits Eliminated: The following credits available to businesses will be eliminated:
    •  The credit for Testing of Certain Drugs for Rare Disease or Conditions (the “Orphan Drug Credit”)
    •  The credit for Employer-Provided Child Care
    •  The Historic Rehabilitation Credit, with a 180-day window for certain planned projects
    •  The Work Opportunity Credit
    •  The New Markets Tax Credit
    •  The Credit for Expenditures to Provide Access to Disabled Individuals
    •  The Enhanced Oil Recovery Credit
    •  The Credit for Producing Oil and Gas from Marginal Wells
  •  Modification to Energy Credits: Various credits related to renewable energy will be modified. The most notable changes are extensions of the Renewable Energy Tax Credit and Residential Energy Efficient Property Credit.

Senate Bill

Although the Senate Bill retains the Low-Income Housing Tax Credit, the Work Opportunity Tax Credit, and R&D Tax Credit, the Senate Bill eliminates or modifies several of the credits which are currently available in order to balance the reduced corporate tax rate. 

  • Low Income Housing Credit: Adds that a building which restricts residency to veterans would not fail the general public use requirement.
  • Orphan Drug Credit: The credit for Testing of Certain Drugs for Rare Disease or Conditions (the “Orphan Drug Credit”) will be limited to 27.5% of the qualified clinical tests expenses in taxable year over the average qualified clinical tests expenses for the preceding three years. If there are no expenses in a preceding year, then limited to 25% of current year.
  • Rehabilitation Credit: The 10% rehabilitation credit will be eliminated, and the 20% rehabilitation credit will now be claimed ratably over 5 years.
  • Credit for Wages Paid under FMLA: Employers will be able to take credit on 12.5% on 50% of the wages paid to an employee under FMLA, increased .25% for each 1% of wages paid above 50%.
  • New Market Tax Credits: The Senate Bill is silent as to the NMTC but creates a Qualified Opportunity Funds which will invest in Qualified Opportunity Zones will be created. Income from investments in these Qualified Opportunity Funds will be deferred, with the amount of gain recognized reduced the longer the investment is held.

 TAX EXEMPT BOND INTEREST

 House Bill - Eliminates the tax free nature of interest for several government issued bonds issued beginning in 2018, specifically:

  •  Interest on Private Activity Bonds
  •  Interest on Advanced Refunding Bonds
  •  Interest on bonds used to finance professional stadiums
  •  Additionally, Tax Credit Bonds will be eliminated entirely

 Senate Bill - Eliminates the tax free nature of interest for several government issued bonds, specifically:

  •  Interest on Advanced Refunding Bonds

CHANGE TO ACCOUNTING METHOD RULES

 House Bill

  • Small Corporations: A corporation with $25 million in gross receipts will be permitted to use the cash method of accounting for books, even if such business has inventories. In addition, corporations with $25 million or less in gross receipts will be exempt from the UNICAP rules, and will be able to use the completed-contract method for long term contracts. Finally, businesses with $25 million or less in gross receipts will be exempt from the interest expense limitation rules noted above.

 Senate Bill

  • Small Corporations: A corporation with $15 million in gross receipts will be permitted to use the cash method of accounting for books, even if such business has inventories. In addition, corporations with $15 million or less in gross receipts will be exempt from the UNICAP rules, and will be able to use the completed-contract method for long term contracts.  Existing exceptions for Personal Service Corporations and taxpayers other than C Corporations are retained.
  •  Income Timing: A taxpayer will have to recognize income no later than the taxable year in which such income is taken into account on a financial statement.
  • Advanced Payments for Goods or Services: Rules under Rev. Proc. 2004-34 will be codified.
  • OID: Income included on financial statements related to OID will be included in year of statement, rather than ratably over the life of the loan.
  • Sale of Securities: Basis must be determined based on first in, first out.  This means taxpayers will no longer be able to specifically designate lots of securities based on basis when selling.
  • CRAFT Beverages: Aging period for beer, wine, and distilled spirts excluded from UNICAP production period.

OTHER CHANGES

 House Bill - The House Bill also proposes the following miscellaneous changes to the Code, including:

  • Small Business Investment Corporations: The rules allowing a roll-over of gain from the sale of stock if the proceeds are invested in Small Business Investment Corporations will be repealed.
  •  FICA Taxes on Tips: The Credit for FICA taxes attributable to tips in restaurants will be updated to reflect the current minimum wage.
  •  Insurance Companies: In addition to the broad changes to the taxation of businesses described above, the House Bill and Senate Bill also contains a number of changes specific to insurance companies. The details of these changes are beyond the scope of this summary.

 Senate Bill - The senate bill lowers the excise taxes on beer, wine, and spirits.

INTERNATIONAL TAXATION

 SUBSIDIARY DIVIDENDS

House Bill - All dividends from a 10% or more owned foreign subsidiary owned for at least a six month period will be tax exempt. To conform to this change, the tax on Controlled Foreign Corporation earnings invested in U.S. property under Section 956 will be eliminated with respect to domestic corporate taxpayers.

  •  Reduction in Basis of Subsidiary Stock: The basis of stock in a 10% foreign subsidiary will be reduced by exempt dividend income received from that subsidiary, but only for the calculation of any loss on disposition.
  •  Recognition of Deferred Foreign Income: Any U.S. shareholder owning 10% or more of a foreign subsidiary will include in its last tax year prior to 2018 the earnings and profits (“E&P”) of such subsidiary to the extent such profits have not yet been included in U.S. income.
    •  S-Corporation and REIT Exception: This provision will not apply if the U.S. Shareholder is an S-Corporation or REIT.  In the case of an S-Corporation, tax on repatriation may be deferred until the entity ceases to be an S-Corporation or otherwise liquidates; however, if such tax is deferred, the S-Corporation must be made jointly and severally liable for the tax.
    •  Foreign Tax Credit: The Foreign Tax Credit will be partially disallowed for dividends exempt under the House Bill to the extent of E&P not subject to the tax.  The Foreign Tax Credit will still be available with respect to Subpart F income, but only to the extent such income is included in a U.S. Shareholder’s gross income.  The Foreign Tax Credit will be available for the taxes related to affiliated payments and foreign affiliates’ routine returns.
  •  Apportionment of Gain Based on Production Location of Property: Income from the sale of property produced within the U.S. and sold outside (or vice versa) will be sourced exclusively based on production location.

 Senate Bill - The foreign source portion of all dividends from a 10% or more owned foreign subsidiary (which is not a PFIC which is also a CFC) owned for at least 365 of the prior 731 days. The deduction is not available for hybrid dividends (amounts received which also received a deduction of other benefit from foreign taxes paid). The foreign tax credit will be disallowed for amounts that qualify for dividend deduction.  This rules will not apply to dividends received from a surrogate foreign corporation.

  •  Foreign Source Portion: The amount of the dividend which bears the same ratio to the divided and the undistributed foreign earnings bear to the total undistributed earnings.
  •  Sale of Subsidiary Stock: The amount of income received by the selling corporation which is treated as dividends under Section 1248 will be eligible for the deduction.
    •  Exception: The sale of lower tiered CFC stock by a higher tier CFC will be treated as Subpart F income.
  •  Reduction in Basis of Subsidiary Stock: The basis of stock in a 10% foreign subsidiary will be reduced by exempt dividend income received from that subsidiary, but only for the calculation of any loss on disposition.
  •  Inclusion of Transferred Loss in Income: If a 10% owned subsidiary acquires substantially all the assets of a foreign branch, the domestic owner will include in income the Transferred Loss Amount
    •  Transferred Loss: The excess of losses of the foreign branch over income of the foreign branch.
  •  Recognition of Deferred Foreign Income: Any U.S. shareholder of a foreign corporation which has one or more U.S. shareholders will include as Subpart F income in its last tax year prior to 2018 such shareholders pro rata share of the earnings and profits (“E&P”) of such subsidiary to the extent such profits have not yet been included in U.S. income.  An amount of such income will be deductible, with the deductible amount depending on whether the earnings are held in cash (deductible to extent needed to result in 14.5% effective rate) or other assets (7.5% effective rate).  Taxpayers could recognize such income over an eight year period.
    •  PFICS: This provision will not apply to PFICS that are not also CFCs.
    •  S-Corporation and REIT Exception: This provision will not apply is the U.S. Shareholder is an S-Corporations or REIT.  In the case of an S-Corporation, tax on repatriation may be deferred the entity ceases to be an S-Corporation or otherwise liquidates; however, if such tax is deferred, the S-Corporation must be made jointly and severally liable for the tax.
    •  Foreign Tax Credit: The Indirect Foreign Tax Credit will be repealed.  The Determination of the Foreign Tax Credit under Section 960 will be on a current-year basis.  A separate foreign tax credit limitation basket will be added for foreign branch income.  The effective date of worldwide interest allocation election will be accelerated by 3 years.
  • Apportionment of Gain Based on Production Location of Property: Income from the sale of property produced within the U.S. and sold outside (or vice versa) will be sourced exclusively based on production location.
  • Sale of Partnership Interest: Gain or loss from sale or partnership interest is ECI to extent the transferor will have had ECI had the partnership sold all its assets for FMV.
    •  Withholding: Transferee of interest must withhold 10% of amount realized in sale unless transferor certifies they are not a nonresident alien or foreign corporation.

 SUBPART F INCOME

 House Bill - In addition to the changes discussed with respect to dividend income, changes are also being which will expand Subpart F income:

  • Deemed Ownership of Foreign Held Stock: S. corporations will be treated as owning stock in a subsidiary which is held by foreign shareholders. 
  • Elimination of Timing Exception for Controlled Foreign Corporations (“CFCs”): A U.S. corporation will be taxed on a CFC’s Subpart F income even if the corporation has not held stock in the CFC for more than 30 days during the year in which the Subpart F income was earned by the CFC.
  • Limitations on Subpart F Income: New rules will help to limit Subpart F income, including eliminating U.S. taxed foreign base oil income, and making the “look-through” rule related to exclusion of income on payments made from one foreign subsidiary to another permanent.

 Senate Bill - In addition to the changes discussed with respect to dividend income, changes are also being which will expand Subpart F income:

  • Deemed Ownership of Foreign Held Stock: S. corporations will be treated as owning stock in a subsidiary which is held by foreign shareholders. 
  • Definition of U.S. Shareholder for Subpart F: A U.S. shareholder is any U.S. person who owns 10% or more of the total value of share of a foreign corporation.
  • Elimination of Timing Exception for Controlled Foreign Corporations (“CFCs”): A U.S. corporation will be taxed on a CFC’s Subpart F income even if the corporation has not held stock in the CFC for more than 30 days during the year in which the Subpart F income was earned by the CFC.
  • Limitations on Subpart F Income: New rules will help to limit Subpart F income, including eliminating U.S. taxed foreign base oil income, tying the $1,000,000 de minimis amount for foreign base company income to inflation, repeal of inclusion based on withdrawal of previously excluded subpart F income from qualified investment, and making the “look-through” rule related to exclusion of income on payments made from one foreign subsidiary to another permanent.

 BASE EROSION

 House Bill - The House Bill seeks to reduce base erosion through the use of transfer pricing and tax treaty shopping.

  • Foreign High Returns Tax:  The House Bill will require a taxpayer to include in income 50% of their “foreign high returns in CFCs”.  The “minimum rate” on such “foreign high returns” will be 10%.
    •  Foreign High Returns: The aggregate net income of a CFC, less ECI, Subpart F income, certain commodities, income excepted from Subpart F under Code Section 954(c)(6), less filing months short term AFR plus seven percent.
    •  Foreign Tax Credits: Foreign Tax Credits will be available for 80% of the income included in “foreign high returns.” However, such “foreign high return” amounts will be treated as a separate basket.  Certain exceptions for local active financing and extraction activities will be clarified.
  • Limitation on Interest Deductions: The deductible interest of a U.S. corporation that is a member of an “International Financial Reporting Group” (i.e. groups with consolidated/audited financial statements and average gross receipts greater than $100 million) will be limited to the excess of the corporation’s share of the interest over 110% of the corporation’s share of the group’s global earnings, before taxes, depreciation, etc.
  • Excise Tax on Payments to Foreign Affiliates: Payments by a U.S. corporation to a related foreign corporation that are deductible, includable in the cost of goods sold, or includable in the basis of a depreciable or amortizable asset, will be subject to a 20% excise tax, unless such payments are treated as effectively connected income.  Alternatively, the foreign related party may elect to report the income in question as U.S. Effectively Connected Income, and pay tax thereon.  The Chairman’s Mark introduced the possibility that foreign tax credits will be available to offset in part the U.S. tax under that election.

Senate Bill - The Senate Bill seeks to reduce base erosion through the use of transfer pricing and tax treaty shopping.

  • Global Intangible Low-Taxed Income:  S. shareholders of CFCs will be taxed currently on 50% of all GILTI, with a 37.5% deduction for all foreign-derived intangible income (reduced to 21.875% after 2025).
  • Limitation on Interest Deductions: The deductible interest of a U.S. corporation that is a member of an “International Financial Reporting Group” (i.e. groups with consolidated/audited financial statements and average gross receipts greater than $100 million) will be limited to the excess of the corporation’s share of the interest over 110% of the corporation’s share of the group’s global earnings, before taxes, depreciation, etc.
  • Hybrid Transactions: Related party deductions related to hybrid transactions or hybrid entities will be denied.
  • Domestic International Sales Corporations (DISCs): Rules related to DISCs will be repealed.
  • “Base Erosion Minimum Tax”: Tax imposed on “base erosion payments” paid by a taxpayer to a foreign related person.  Tax will be excess of 10% (increased to 12.5% after 2025) of the modified taxable income of taxpayer, reduced by excess of credits allowed under Chapter 1 of the Internal Revenue Code over general business credits allocable to research credit.
    •  Exception: Base erosion payments won’t include payments made for services under section 482.  

 FOREIGN INVESTMENT INCOME

 House Bill

  • Insurance Company Exception on PFICs: The exception from the Passive Foreign Investment Corporation “(PFIC”) rules excluding income earned in the active sale of insurance are amended so that such income will only be excluded if the PFIC will be treated as an insurance company under U.S. law.
  • FDAP Treaty Rules: The statutory 30% withholding tax on income related to Fixed, Determinable, Annual, or Periodical (“FDAP”) income will not be waived by reason of a tax treaty unless such tax will also be waived if the payment were made to a foreign parent of the foreign subsidiary.

 Senate Bill

  • Insurance Company Exception on PFICs: The exception from the Passive Foreign Investment Corporation “(PFIC”) rules excluding income earned in the active sale of insurance are amended so that such income will only be excluded if the PFIC will be treated as an insurance company under U.S. law.
  • Transportation Income: The Senate Bill will provide rules for determining whether cruise income earned by a foreign corporation or national is effectively connected to the U.S.

 TAX EXEMPT ENTITIES

House Bill - The House Bill proposes several changes to Not- for-Profit entities (“NFPs”). Generally, the changes increase the instances in which a NFP will incur the Unrelated Business Income Tax (“UBIT”) and investment income.

  • Expansion of UBIT Income: All tax-exempt entities will be potentially subject to UBIT.
  • Standardizing Investment Income Excise Tax: Private Foundations will be subject to a 1.4% excise tax on investment income, rather than the 2% or 1% variable system currently in place.
  • University Endowment Taxation: Private colleges and universities having at least 500 students and assets (excluding those used directly in carrying out its exempt purpose) worth at least $250,000 per student will be subject to the 1.4% excise tax on investments.
  • Taxation of Fringe Benefits: NFPs will be taxed on fringe benefits provided to employees.
  • Political Speech by 501(c)(3)s: All 501(c)(3)s will be allowed to make statements related to political campaigns as long as in ordinary course of business and costs associated with statements are de minimis.

Senate Bill - The Senate Bill proposes several changes to Not- for-Profit entities (“NFPs”). Generally, the changes increase the instances in which a NFP will incur the Unrelated Business Income Tax (“UBIT”) and investment income.

  • UBIT Income: UBIT will be calculated separately for each trade or business of the NFP.
  • Standardizing Investment Income Excise Tax: Private Foundations will be subject to a 1.4% excise tax on investment income, rather than the 2% or 1% variable system currently in place.
  • University Endowment Taxation: Private colleges and universities having at least 500 students and assets (excluding those used directly in carrying out its exempt purpose but including those held by third parties for the university) worth at least $500,000 per student will be subject to the 1.4% excise tax on investments.

 The summary information in this document is based on pending legislative proposals and is being provided for educational purposes only.  These proposals are subject to change, and it is believed likely will change from the contents noted herein.  Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice.  We encourage any recipients to contact the authors for any inquiries regarding the contents.  FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.

 

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