This year presents an unusual convergence of events in the tax world. We do not actually know the full complement of tax rules that will apply in 2014. As Congress continues its gridlock, nothing is being done about taxes (other than discussions).
Over 50 provisions of the U.S. Tax Code expired at the end of 2013. Normally, most of those provisions would have been extended at the end of 2013 or very early in 2014. This year, however, the extenders are not likely to be agreed to, if at all, until late in the calendar year, probably November at the earliest, after the mid-term elections.
Given this uncertainty, tax planning is a little more difficult this year. Part I of our mid-year tax planning update considers the uncertainty in more detail, while Part II will discuss some of the tax planning considerations that you should keep in mind as the year progresses.
A Sense of Uncertainty
As of right now, there is no research credit, no exclusion for the discharge of indebtedness on principal residences; no deduction for state and local general sales taxes; no new markets tax credit; no work opportunity tax credit; no bonus depreciation; no increased expensing limitation; no exception under subpart F for active financing income; no look-through treatment of payments between related controlled foreign corporations under the foreign personal holding company income rules; no special rules for qualified small business stock; and no Section 25C nonbusiness energy property credit (or several other energy-related credits). These are just a few of the many provisions that have expired.
A bill, the Expiring Provisions Improvement Reform and Efficiency Act of 2014 (or EXPIRE), has been introduced to extend at least some of the expired provisions. Whenever a bill or proposal on taxes is announced, the revenue impact of the bill (both the revenue to be gained and lost) is calculated by the Joint Committee on Taxation (“JCT”). The revenue impact is called “scoring” the bill and is an important part of the legislative process.
EXPIRE has been “scored” to cost about $85 billion, under the mark of Chairman Camp of the Committee on Ways and Means. While there has been general agreement that it would be reasonable to enact some sort of extending legislation, the exact provisions that will be extended are still subject to negotiation between Republicans, Democrats and the Administration. In addition, the timing of any extender bill is anybody’s guess.
In the meantime, Representative Pat Tiberi (R-Ohio), has introduced a bill, H.R. 4718, that would extend bonus depreciation permanently. The House passed this bill on July 11, 2014; it now moves to the Senate for consideration. The bill has been scored at a cost of $262.9 billion (from 2014 through 2024) and no offsetting revenue provisions were offered. Given the cost and lack of revenue offset, there is little chance that the bill will be enacted as a standalone provision.
In addition to EXPIRE and H.R. 4718, the Administration has put out a Fiscal Year 2015 budget proposal (the “Administration Proposal”) with a great many changes to the Tax Code. Overall, the Administration Proposal is scored to raise about $887 billion over the period from 2014 to 2024. The Administration Proposal includes changes to the U.S. international tax regime and higher tax rates on the top end of the income-earners, including the so-called Buffett Rule. Overall, the Administration Proposal has relatively modest expenditures including extending and making permanent the earned income tax credit, providing some incentives for manufacturing, research, clean energy and job creation, and giving small businesses some additional tax breaks. The bulk of the Administration Proposal raises revenue.
Representative Dave Camp has introduced a rival plan, the Tax Reform Act of 2014 (“TRA 2014”), which has been scored to raise about $3 billion over the period from 2014 to 2023. TRA 2014 attempts to simplify the current income tax regime, rather than create a new tax system, and includes reducing the top corporate tax rate to 25% and eliminating most credits and many deductions, both at the individual and business levels, creating a flatter income tax system. Both the Administration Proposal and TRA 2014 eliminate the last-in, first-out (LIFO) inventory method and make changes to the like-kind exchange provisions of Section 1031. TRA 2014 eliminates the tax benefits associated with like-kind exchange, while the Administration Proposal limits the capital gain deferral for any one taxpayer to $1 million per tax year.
Both proposals address the currently muddled imposition of self-employment taxes on LLC members and limited partners (the media usually refer to this as the Edwards S Corporation loophole or something similar). TRA 2014 would treat 70% of allocated income to members of LLCs, limited partners and S corporation shareholders as subject to the self-employment tax.The Administration Proposal includes a provision that would eliminate differences in self-employment tax based on the type of entity and ownership, but leaves the details to regulation by the Treasury department. Given that both sides of the aisle appear to agree that a fix is needed (and given a positive revenue generation score by the JCT), some sort of fix is likely to be enacted sooner rather than later.
A full discussion of the Administration Proposal and TRA 2014 is beyond the scope of this article, but what is important to take from the proposals is the list of revenue generators. Some of these revenue generators are very likely to be utilized in whatever extender legislation is enacted. The score of the revenue generators is critically important, as the extender legislation is likely to have to be revenue neutral (meaning that it will have to pay for itself), so the provisions that are extended depend, to large extent, on the score of the revenue generators chosen.
Following is a list of “scores” from the JCT for a few of the more interesting revenue generators in TRA 2014:
|Repeal of deduction for personal exemptions
|Repeal of deduction for interest on education loans
|Modification of earned income credit
|Repeal of dependent care deduction
|Changes to itemized deduction
|Determination of net earnings from self-employment
|Changes to depreciation (elimination of bonus and most accelerated depreciation
|Phase-out and repeal of the domestic production activities income
|Repeal of like-kind exchange
|Repeal of LIFO
Following is a list of “scores” from the JCT for a few of the more interesting revenue generators in the Administration Proposal:
|Repeal of LIFO
|Modification of like-kind exchange
|Implement the “Buffet Rule” for high income earners
|Restore the estate, gift and generation-skipping to 2009 levels
|Impose a “too big to fail” fee on banks/td>
|Tax carried interests as ordinary income
|Conform self-employment taxes for professional service businesses
Again, it is worthwhile to consider the revenue generators in both proposals, especially the specific issues that are included in both (e.g., LIFO repeal and like-kind exchange). These “common ground” revenue generators are likely to be considered for offsetting the cost of the provisions that are extended. It is also important to keep in mind that while major tax reform is extremely unlikely in 2014, there is a small window for tax reform before the 2016 election and there will be an even bigger need for revenue generators should there be major tax reform.
Types of income that are not currently subject to self-employment tax would also be excluded under TRA 2014. This would include “rentals from real estate in certain circumstances, dividends and interest, and gains or loss from the sale or exchange of a capital asset, or gains or losses from other property that is neither inventory nor held primarily for sale to customers.” JCT Technical Explanation of Title 1 of the Tax Reform Act of 2014, a discussion draft prepared by the Chairman of the House Committee on Ways and Means, page 83.
TRA 2014 is based on 9 years or through 2023.
The Administration Proposal is based on a 10-year period, or through 2024.
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