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Press Room: Tax Release

November 03, 2017

House Releases Draft Tax Reform Legislation to Overhaul Tax Code

On November 2, 2017, the House Committee on Ways and Means Chairman Kevin Brady (R-Texas) released the latest piece in the tax reform puzzle—a draft bill to overhaul the tax code. The Tax Cuts and Jobs Act (the Brady bill) includes long-awaited specifics regarding base-broadening measures that could be part of tax reform legislation. A mark-up session on the House’s bill is scheduled to begin on Monday, November 6, 2017, with a Ways and Means Committee vote anticipated as early as the end of next week. Chairman Brady announced that he may propose modifications to his bill before the mark-up session, at which time Ways and Means Committee members will also have the opportunity to offer amendments. House Republican leaders hope the full House will approve tax reform legislation prior to the Thanksgiving recess. The Senate Finance Committee has been working on its own draft tax reform legislation in parallel with the House Ways and Means Committee. A draft of the Senate’s own bill is scheduled to be released next week, with mark-up expected to begin the following week. Given this short timeframe and the importance of year-end tax planning, it is imperative to assess the impact of these proposed changes.

Long-Awaited Specifics

The Brady bill is proposed to be generally effective for tax years beginning after 2017. Certain provisions contain separate effective dates and transition rules and select provisions are temporary. Below is a brief summary of key provisions of the Brady bill

  Provision Comments
Individual Income Tax Rates The current seven tax brackets would be consolidated into four tax brackets: 12%, 25%, 35% and an additional top tax rate for the highest-income taxpayers of 39.6%. The 39.6% bracket threshold would be at $1 million for married filing joint taxpayers and $500,000 for unmarried individuals and married individuals filing separately. The brackets are indexed for inflation using a chained-CPI, which will result in a slower increase in bracket thresholds over time. At a top rate of 39.6%, many higher-income taxpayers may see a net tax increase due to repeal of most itemized deductions.
Individual AMT The alternative minimum tax (AMT) would be repealed. Rules are provided whereby AMT credit carryforwards can be utilized by 2022.
Individual State and Local Tax Deduction The itemized deduction for state and local income or sales taxes would be repealed. Taxpayers would be permitted to deduct up to $10,000 of real property taxes as an itemized deduction. A deduction for state and local income and property taxes related to business income would continue to be allowed. The repeal of the itemized deduction for state and local income or sales taxes continues to be a hot issue and further revisions to this policy are possible.
Individual Mortgage Interest Deduction and Sale of Principal Residence The home mortgage interest deduction for existing mortgages would be preserved and the home mortgage interest deduction would apply for new mortgage debt up to $500,000 for primary residences. The exclusion of gain from the sale of a principal residence would be phased out for taxpayers with adjusted gross income (AGI) over $500,000 married filing joint ($250,000 single). The reduced threshold from $1 million to $500,000 on new mortgage debt is a significant reduction to the home interest mortgage deduction available to higher-income taxpayers. The effective date for the reduced threshold is November 2, 2017.
Personal Casualty Loss Deduction The itemized deduction for personal casualty losses would generally be repealed. The deduction for personal casualty losses associated with special disaster relief legislation would not be affected. Taxpayers that incur personal losses not connected with a trade or business or entered into for profit, including property losses arising from fire, storm, shipwreck, or theft, would no longer be allowed an itemized deduction for the casualty loss.
Charitable Contributions The itemized deduction for charitable giving would be retained and the AGI limitation on contributions made to public charities and certain private foundations would be increased from 50% to 60%.  
Other Individual Deductions and Credits The overall limitation on itemized deductions would be repealed. The personal exemption and all other itemized deductions would also be repealed. The standard deduction would roughly be doubled (creating a larger zero-tax bracket). The earned income tax credit (EITC) would be preserved and additional child tax credits would be provided. The proposed changes to the personal exemption and standard deduction would greatly simplify tax filings for many middle and lower-income taxpayers. The proportion of taxpayers who itemize deductions is projected to decrease from 30% to less than 10%.
Investment Income No change from the present top capital gain rate of 20%. The present law retirement plan participation would be maintained, including 401(k) plans and Individual Retirement Accounts.  
Carried Interest No provision. It is possible that carried interest legislation will be proposed as an amendment or as part of legislation in the Senate.
Net Investment Income Tax (NIIT) No change. Any elimination of the NIIT would be part of separate healthcare legislation which is currently stalled in the Senate.
Estate Tax, Generation-Skipping Transfer Tax, and Gift Tax The bill would double the estate tax exclusion amount from $5.6 million to $11.2 million and repeal the estate tax and generation-skipping transfer tax after six years (2024). The top gift tax rate would be lowered to 35%. Although repealed beginning in 2024, beneficiaries would still receive a stepped-up basis in the estate’s property under the proposal.
Tax-Exempt Organizations The excise tax on private foundations would be modified to a flat 1.4% rate. A new excise tax on certain private universities would be imposed and excise tax would be applied to excess compensation received by tax-exempt organization executives. Additional changes are proposed to unrelated business income tax provisions. Many of these provisions were included in former Ways and Means Committee Chairman Camp’s draft for tax reform.
Pass-Through Businesses Net income derived from passive business activity would be treated entirely as business income and subject to a maximum 25% rate. Net income from active business income would be subject to a special rule to prevent recharacterization of compensation as business income. Owners could generally elect to either treat 30% of income as subject to the maximum 25% rate, or to apply a formula based on returns to capital assets of the business. Income from personal services businesses (e.g., law, accounting, consulting, financial services) are generally exempted from the maximum 25% rate and can qualify only by applying the formula based on returns to capital assets of the business.
C Corporations The corporate tax rate would be lowered to a flat 20% rate beginning in 2018. The corporate AMT would be eliminated.  
Capital Expensing The bill provides for expensing of 100% of new investments in depreciable assets other than structures placed in service after September 27, 2017 and before January 1, 2023. The effective date of September 27, 2017 is intended to prevent businesses from delaying on making investments while the tax reform process continues.
Repeal of Net Interest Expense Deduction The deduction for net interest expense for all businesses would be limited to 30% of adjusted taxable income, regardless of business form, with an exception for small businesses. An additional limitation on net interest expense would apply to U.S. corporations that are part of multinational group. The U.S. corporation’s interest deduction would be limited based on the U.S. corporation’s share of earnings before interest, taxes, depreciation, and amortization (EBITDA) compared to global EBITDA. Any interest disallowed would be carried forward to the five succeeding taxable years. For pass-through entities, the limitation would apply at the entity level rather than the individual level.
Net Operating Loss (NOL) Deduction NOL carryover would offset only 90% of taxable income and carryforwards would be increased for an interest factor. Generally all carrybacks would be repealed. The provision would conform the regular tax NOL utilization to the current AMT rule limited to only 90% of taxable income.
Like-Kind Exchanges of Real Property The like-kind exchange rules would be modified to allow for like-kind exchanges with respect to real property only. A transition rule would apply to like-kind exchanges of personal property if completed prior to December 31, 2017. Taxpayers that have deferred tax on the recognition of built-in gains in property would no longer be able to achieve this deferral on personal property.
Other Business Tax Base Broadeners Most tax preferences would be eliminated except the research credit and low-income housing credit. The domestic production deduction under Sec. 199 would be eliminated along with numerous other special exclusions and deductions. Additional changes regarding the treatment of insurance and other special industry items are included. Details of the bill single out the research credit and the low-income housing credit for retention. Most other credits would be repealed.
Executive Compensation The proposal would modify the tax treatment of nonqualified deferred compensation arrangements. The performance-based pay exception to the Sec. 162(m) disallowance for covered employees would be repealed. These proposals were included in former Ways and Means Committee Chairman Camp’s draft for tax reform.
International A territorial system (100% dividend exemption system) would apply for multinational corporations that own at least 10% of the foreign corporation. A one-time deemed repatriation would be included at a two-tiered reduced tax rate – 12% rate for cash and cash equivalents and 5% rate on any remaining E&P, payable over 8 years at election of the taxpayer. An excise tax of 20% would be imposed on certain payments to foreign related parties, unless the foreign related party elects to treat such payments as effectively connected income. Current inclusion of 50% of a U.S. parent corporation’s income for “foreign high returns” would be required. Limitations on the deductibility of interest expense (discussed above) are aimed at multinationals.

The Takeaway

The release of the Brady bill provides long-awaited specifics with respect to base-broadening provisions that Republicans are considering as a part of tax reform legislation. The Brady bill provides a starting point, and amendments are expected to occur as the legislation moves through the House Ways and Means Committee. The Senate legislation is likely to have additional differences, which would ultimately have to be reconciled to pass a final tax reform bill. Due to the short time frame between potential enactment of tax reform legislation and targeted effective dates, taxpayers need to act quickly and begin planning for these possible changes. With the potential for reduced tax rates for businesses as early as next year, taxpayers should consider measures to accelerate deductions and push income into later years. Multinational corporations in particular need to take significant steps to prepare for a likely shift to a territorial tax system with a deemed repatriation tax. Please contact us to discuss what to do now to ensure you and your businesses are in the best position for the potential changes ahead. We will continue to keep you informed as the tax reform process continues.

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