- Reconciling the Differences, the Senate Tax Cuts and Jobs Act
- November 23, 2017 | Authors: Amish M. Shah; Robert S. Chase; Reginald J. Clark; Christopher W. Schoen; N. Jerold Cohen; Caroline R. Reaves; Saren Goldner; Carol P. Tello; Ellen McElroy; Benje A. Selan; Daniel R. McKeithen; Vaishali S. Puckett; Aaron M. Payne; Margaret A. Reilly
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- Reconciling the Differences, the Senate Tax Cuts and Jobs Act
On November 9, 2017, the Senate Finance Committee released a Description of the Chairman’s Mark of the “Tax Cuts and Jobs Act” and on November 14, 2017, the Senate Finance Committee released a Description of the Chairman’s Modification to the Chairman’s Mark of the “Tax Cuts and Jobs Act,” both prepared by the Joint Committee on Taxation (the Senate Plan). The Senate Plan, like the parallel Tax Cuts and Jobs Act passed by the House of Representatives (the House Plan), is far reaching and contemplates significant changes to how the US taxes individuals, domestic businesses and multinational enterprises. See the prior Eversheds Sutherland alert on the House Plan. The Senate Plan generally adopts the reductions in taxes identified in the Unified Framework released by the so-called “Big Six” on September 27, 2017, and like the House Plan includes a number of revenue raising provisions intended to pay for a portion of the cost of the tax reductions. See the prior Eversheds Sutherland alert on the Unified Framework. In many cases, the revenue raising proposals in the Senate Plan modify or eliminate long-standing tax incentives.
Eversheds Sutherland Observation: Republicans aim to pass a tax bill by the end of the year. The House Plan was passed on a party-line vote by the House Ways and Means Committee and was passed today by the full House. The Senate Plan shares many similarities with the House Plan. However, as discussed in greater detail below, there are meaningful differences in the substance of the two proposals. Additionally, Republicans have chosen to advance the Senate Plan under the budget reconciliation process, which permits certain legislation to be passed in the Senate without the possibility of a filibuster (meaning it can be passed with 50 rather than 60 votes). Under the Senate’s Byrd rule, legislation passed this way can only make changes outside the 10-year budget window (i.e., be permanent, as opposed to sunsetting) if the legislation is not projected to increase the federal deficit outside of the 10-year budget window. It is not yet clear what total impact the Byrd rule will have on the Senate Plan, but many of the modifications made on November 14 appear to have been driven by budgetary considerations. Given the extensive changes contemplated by the Senate Plan (and the parallel House Plan), individuals and businesses will need to carefully follow and consider the potential impact of proposed tax reform.
This alert summarizes the principal proposals in the Senate Plan and notes the most significant differences from the House Plan. See the Eversheds Sutherland Tax Reform Law blog for more information, including the description of the Senate Plan and the Senate Finance Committee’s section-by-section summary of the Senate Plan. The blog includes additional in-depth analysis of the provisions described below, including alerts on the accounting methods, insurance, energy and international provisions of the Senate Plan. The blog also includes in-depth analysis of the House Plan.
Proposed Taxation of Individuals:
- Retains seven brackets, but sets reduced rates for those brackets at 10%, 12%, 22%, 24%, 32%, 35% and 38.5%. These reduced rates expire for taxable years beginning after December 31, 2025.
- Eversheds Sutherland Observation: The House Plan would consolidate the current seven brackets into four and retain the top rate of 39.6%. Under the House Plan, taxpayers in the 39.6% bracket would lose the benefit of the 12% bracket, effectively subjecting a portion of their income to tax at a marginal rate of 45.6%.
- Nearly doubles the standard deduction to $24,000 for married taxpayers filing jointly (and $12,000 for other individuals), while eliminating personal exemptions.
- Eliminates most itemized deductions.
- The mortgage interest deduction on up to $1 million of acquisition indebtedness would be retained, though the deduction for interest on home equity indebtedness would be repealed.
- Eliminates the deduction for property taxes as well as state and local income taxes.
- Eversheds Sutherland Observation: The House Plan would permit up to $10,000 per year in property taxes to be deducted. House Ways and Means Committee Chairman Kevin Brady has suggested the House will not agree to the full elimination of the deduction for property taxes.
- Unlike the House Plan, the Senate Plan retains the deduction for medical expenses.
- Retains the charitable contribution deduction.
- Eliminates the alternative minimum tax (AMT). The repeal of the individual AMT expires for taxable years beginning after December 31, 2025.
- Retains the estate, gift and generation-skipping taxes, but doubles the exemption amount.
- Repeals the penalty for failure to maintain coverage under the Affordable Care Act (commonly referred to as the individual mandate).
- According to the Joint Committee on Taxation, eliminating the individual mandate will raise approximately $318 billion over 10 years.
Proposed Taxation of Domestic Businesses:
- Reduces the corporate tax rate from 35% to 20%, effective for taxable years beginning after December 31, 2018. In contrast to the reduced individual rates, the reduced corporate rate is permanent and does not sunset.
- Eversheds Sutherland Observation: The House Plan would reduce the corporate tax rate to 20% commencing in 2018. The one-year delay of the rate reduction in the Senate Plan, coupled with the fact that many other provisions in the Senate Plan are effective for taxable years beginning in 2018, may produce anomalous results (or planning opportunities) that taxpayers should closely consider.
- Personal services corporations would be subject to the same 20% corporate tax rate.
- The current 80% and 70% dividends received deductions (DRDs) would be reduced to 65% and 50%, respectively. The reductions are intended to align the DRDs with the reduction in the corporate tax rate described above so that the effective rate of tax on dividends received remains the same as under current law.
- Eliminates the corporate AMT, although amendments would be made to limit the use of carryforward net operating losses (NOLs) to 90% of the taxpayer’s taxable income in a manner similar to the current corporate AMT through taxable years beginning before December 31, 2023.
- For taxable years beginning after December 31, 2023, taxpayers would only be permitted to offset 80% of their taxable income (determined without regard to the deduction). However, if cumulative aggregate on-budget federal revenue from all sources for the period beginning October 1, 2017, and ending September 30, 2026, exceeds certain thresholds, this 80% limitation would be repealed for taxable years beginning after December 31, 2025.
- Generally eliminates the ability to carry back NOLs (present law allows a two-year carryback); however, NOLs could be carried forward indefinitely (present law permits NOLs to be carried forward 20 years).
- Limits the ability to deduct net business interest expense to 30% of adjusted taxable income.
- Adjusted taxable income generally is taxable income determined without regard to any business interest income, the 17.4% deduction for certain pass-through income (discussed below) or any deduction for NOLs. Unlike the parallel provision in the House Plan, depreciation and amortization are not reversed in determining adjusted taxable income, meaning depreciation and amortization reduce the amount of allowable interest expense. This is particularly significant in light of increased expensing provisions under the proposed legislation.
- In the case of a US consolidated group, this limitation applies at the consolidated return filing level. In the case of a partnership, this limitation applies at the partnership level.
- This provision does not apply to certain regulated utilities or real property trades or business.
- Any disallowed deduction may be carried forward indefinitely, which is a departure from the House Plan that permits disallowed deductions to be carried forward only for five years.
- As discussed below, US corporations that are members of a worldwide affiliated group are potentially subject to an additional limitation on their ability to deduct interest expense and, to the extent both rules apply, whichever rule allows the lower amount of interest expense to be deducted controls.
- Permits full expensing for five years.
- Taxpayers would be permitted to fully and immediately deduct 100% of the cost of qualified property (i.e., other than real estate) acquired or placed into service after September 27, 2017, and before January 1, 2023.
- Allows like-kind exchange treatment only with respect to real property (i.e., an exchange of intangibles or tangible personal property would no longer be eligible for such treatment).
- Permits individuals to deduct 17.4% of domestic qualified business income from pass-through entities, reducing the amount of such income that would be subject to tax at the taxpayer’s applicable rates.
- Qualified business income generally means the net amount of income, gain, deduction, and losses with respect to the taxpayer’s qualified businesses (generally, trades and businesses other than services in the fields of health, law, engineering, architecture, accounting and other services businesses).
- The amount of the 17.4% deduction is generally limited to 50% of the taxpayer’s allocable or pro rata share of W-2 wages of the partnership, S corporation or sole proprietorship.
- The benefit of the 17.4% deduction is phased out for taxpayers whose taxable income exceeds $500,000 for married individuals filing jointly or $250,000 for other individuals.
- This reduced rate differs significantly from the parallel provision in the House Plan, which creates a maximum 25% (or 9% for certain taxpayers) tax rate for qualified business income.
- For taxable years beginning after December 31, 2025, requires research or experimental expenditures to be capitalized and amortized ratably – in the case of research conducted in the US, over a five-year period, and in the case of research conducted outside the US, over a 15-year period.
- However, if cumulative aggregate on-budget federal revenue from all sources for the period beginning October 1, 2017, and ending September 30, 2026, exceeds certain thresholds, this proposal would be repealed effective for taxable years beginning after December 31, 2025 (i.e., this proposal would never take effect given its effective date).
Proposed Taxation of Compensation and Benefits:
- Neither the Senate Plan nor the House Plan now includes a provision changing deferred compensation. Each proposal originally included such a provision, and in each case, the provisions were removed.
- Both the Senate Plan and the House Plan include an expanded section 162(m) deduction disallowance for compensation in excess of $1 million. The proposals eliminate the exception for performance-based compensation and expand the group of executives to which the deduction limitation applies. The Senate Plan includes a transition rule under which certain compensation that is fully vested by December 31, 2016 will not count against the $1 million limit.
- Both the Senate Plan and the House Plan would impose a new 20% excise tax payable by tax-exempt employers on compensation in excess of $1 million and separation pay in excess of three times average annual compensation, in each case for the five highest-paid employees.
- The Senate Plan would aggregate 457(b) plans with 401(k) and 403(b) plans in determining whether an individual reaches the deferral limit ($18,500 for 2018), while the House Plan would lower the earliest normal retirement age for defined benefit plans to age 59-1/2.
Eversheds Sutherland Observation: The big news in the compensation and benefits area is (i) that 401(k) deferrals have not been “Rothified” as was being proposed in the earlier stages of the tax reform process this fall, and (ii) the removal of the changes to deferred compensation in both the House Plan and Senate Plan.
Proposed Taxation of the Insurance Industry:
- The House Plan approved by the Ways and Means Committee on November 9, 2017, excluded a number of provisions applicable to insurance companies that had originally been included and added an 8% surtax on life insurance companies. The Senate Plan’s insurance company provisions, including the modification to the insurance company exception to the passive foreign investment company (PFIC) rules, are similar to those in the House Plan approved by the Ways and Means Committee.
- The Senate Plan, however, does not include the 8% surtax but includes (i) a deferred acquisition costs provision that was eliminated from the Ways and Means Markup and (ii) new reporting provisions on stranger-owned life insurance.
- Senator Tim Scott of South Carolina has introduced an amendment to the Senate Plan with respect to life insurance companies (Scott Amendment), which has not yet been incorporated into the Senate Plan. The Scott Amendment would make more changes to the taxation of life insurance companies, which are described in detail in the November 14, 2017, Eversheds Sutherland alert. The November 2, 2017, Eversheds Sutherland alert details the House Plan insurance company provisions.