The House Committee on Ways and Means released today its proposed legislative language (the “House Proposal”) implementing, in large part, the framework for tax reform issued by the so-called “Big Six” on September 27, 2017. This client alert summarizes the key income, estate and gift tax provisions of this proposal.
The House Proposal generally would be effective for taxable years beginning on or after January 1, 2018. Portions of the House Proposal may be revised by Chairman Brady over the coming days or weeks. A Committee hearing on tax reform is scheduled for November 6. The House Proposal faces a number of significant legislative hurdles prior to being signed into law. We expect to provide a more detailed analysis of the proposal in a follow-up client alert in the coming days.
|Summary of House Proposal
- Reduces number of tax brackets from 7 to 4
- Top tax bracket remains at 39.6%, which applies to adjusted taxable income of more than $1 million (compared to the current level of more than $470,700) for married taxpayers filing jointly
- Roughly doubles the standard deduction from $12,700 per year to $24,400 per year for married taxpayers filing jointly
- Eliminates personal exemptions
- Eliminates most itemized deductions (including for state and local income taxes and medical expenses) other than deductions for mortgage interest (for new loans with a principal amount of $500,000 compared to the current grandfathered level of $1,000,000), property tax deductions (although capped at $10,000 per year), and charitable donations
- Repeals the individual alternative minimum tax (AMT)
- Doubles the estate tax exemption starting in 2018 and eliminates the estate and generation-skipping transfer tax starting in 2024
- No modification to the current rules that provide a step- up in tax basis to fair market value for assets owned at death
- Reduces the highest marginal gift tax rate to 35% beginning in 2024 and retains the annual exclusion of $14,000 (indexed for inflation)
- No modification to 401(k), traditional IRA, or Roth IRA contribution limits
- No elimination of the 3.8% net investment income tax
- No modification of the reduced tax rate on long-term capital gains and certain types of investment income
- Corporate tax rate is reduced from 35% to a flat 20% (with no phase-in)
- Repeals the corporate AMT
- NOL usage limited to 90% of taxable income; new NOL carryforwards increased by interest factor to preserve value; carrybacks of NOLs eliminated
- Repeals the $1 million deduction limitation for commissions and performance based compensation
|Other Business Provisions
- Limits interest deductions to 30% of earnings before interest, taxes, depreciation and amortization for businesses with gross revenues exceeding $25 million (applies to both corporations and pass-through entities); real estate firms exempt from this limit; repeals current section 163(j) limitations
- 100% expensing for certain acquired property until January 1, 2023, but excludes real property
- Eliminates the current-law domestic production deduction, but preserves the research and development credit and the low-income housing credit
|Business Income of Individuals (i.e., Special Rate for Pass- Through Income)
- Caps at 25% the tax rate applicable to qualified business income of individuals derived from businesses conducted as sole proprietorships, partnerships, limited liability companies (taxed as partnerships) and S corporations
- Passive business activity: Individuals for whom a particular business is a passive business activity generally are eligible for the maximum 25% rate with respect to all income from that business
- Active business activity: Individuals who do not qualify as “passive” with respect to a business are entitled to choose either:
- Default Option: Categorize 70% of business income as ordinary income and 30% of business income as qualified business income eligible for the capped 25% rate
- Alternative Option: Elect to establish ratio of compensation income to qualified business income based on a deemed rate of return (AFR plus 7%) on the amount of capital invested; election binding for 5 years
- Active or passive business activity determination based on current passive activity loss rules (section 469)
- Certain types of businesses generally are not eligible for the reduced 25% rate under the “Default Option,” including medical offices, law firms, and accounting firms (“Professional Service Firms”); “Alternative Option” described above is available to Professional Service Firms (subject to limitations)
- Self-employment tax: Repeals limited partner exception
- Repeals “technical termination” of partnerships
- No carried interest reform
- Partial shift from a worldwide tax system to a “territorial” tax system
- Establishes a new “Participation Exemption System” that exempts from US tax dividends paid by foreign corporations out of foreign-source earnings to their 10-percent US shareholders.
- Repeals the section 956 “deemed dividend” tax on US shareholders of foreign subsidiaries that invest earnings in US property
- As a transition measure, the House Proposal imposes a one-time tax on existing foreign profits held offshore: A 12% tax rate on accumulated foreign earnings held in cash and cash equivalents and a 5% tax rate on accumulated foreign earnings held in other assets
- The one-time tax will be payable over 8 years,in equal annual installments
- Retains subpart F income rules, with certain limited modifications
- Implements a new minimum tax on 50% of “foreign high returns,” which represent the aggregate income of foreign subsidiaries that exceeds a return of 7% plus short-term AFR on the subsidiaries’ aggregate basis in depreciable tangible property, adjusted downward for interest expense
- “Foreign high returns” exclude income effectively connected with a US trade or business, subpart F income, and insurance and financing income that satisfies the active financing exemption under subpart F and certain other income
- Limits the foreign tax credit associated with foreign high returns to 80% of foreign taxes paid
- Foreign taxes paid on “foreign high returns” cannot be used to offset tax on other foreign-source income, and cannot be carried forward or carried back
- Limits interest deductions for US corporations that are members of international groups with gross receipts of more than $100 million to the extent the US corporation’s share of global net interest expense exceeds 110% of its share of the group’s global earnings
- Generally imposes a 20% excise tax on payments (other than interest) from a US corporation to a related foreign corporation, subject to certain exceptions
- Restricts section 1031 exchanges to like-kind exchanges of real property
- Imposes a 1.4% tax on net investment income of university endowments that have assets of more than $100,000 per full-time student
There has been much discussion by GOP leadership in Congress and the White House on their goal to enact tax reform legislation by the end of 2017. However, the House Proposal faces a number of significant obstacles prior to enactment into law.
House Ways and Means Committee Chairman Brady announced this week that the Committee remains on schedule to take action and approve a bill during the week beginning November 6. If the House Ways and Means Committee can agree on legislative text, the Committee would vote on the bill that would be released to the full House of Representatives. Chairman Brady has stated that he would like to have the Committee bill completed and approved by the full House of Representatives prior to the Thanksgiving holiday recess.
Senator Patrick Toomey has stated that the Senate Finance Committee expects to release its tax reform legislation the week of November 6. In the Senate, a bill can pass with simple majority through the reconciliation process. Reconciliation allows the bill to pass with only 50 votes (with Vice President Pence casting a tie-breaking vote), rather than 60 votes, but is only permitted for bills that do not add to the deficit beyond a ten-year window after passage. The budget resolution approved by Congress in October allows a tax bill that adds as much as $1.5 trillion during the ten-year window to the federal deficit to pass without 60 votes in the Senate.
Given potential differences in approach between the Trump Administration and Congress, the expectation of significant opposition to certain elements of the House Proposal, and the complexity of such proposal, the passage of a comprehensive tax reform bill into law by the end of 2017 will likely face significant hurdles.