By Phil Jelsma
A major overhaul of the nation's tax code is in the works, and we now have competing Senate and House versions of H.R.1, the Tax Cuts and Jobs Act (the "Act"). The House has passed its version and the Senate is marking up or amending its version. Eventually, the Senate and the House will have to reconcile their differences, but in the meantime, following is a comparison of the two competing bills with current law. This article compares the two competing bills with current law.
Taxation of Pass-Through Entities
Current law: Income earned through partnerships and S corporations is passed through to the partners or shareholders and taxed at ordinary income rates.
Senate bill: It would create a 17.4 percent deduction for the non-wage portion of pass through business income. The deduction would apply to non-service income with an exception for service income to taxpayers with taxable income below $150,000 for joint filers and $75,000 for others. It would be phased out at certain income levels and be limited to 50% of the W-2 wages of the business.
House bill: The bill would reduce the rate for pass through business income to 25 percent. Business owners could choose to categorize 70 percent of their income as wages, subject to ordinary rates, and 30 percent as business income, taxable at the 25 percent rate. The alternative is to set the ratio of their wage income to business income based on the level of their capital investment. Professional service firms, such as doctors, accountants, and lawyers, couldn't take the 70/30 split and could only avail themselves of the preferential rate based on capital investment. The Nov. 9 amendment includes a formula to direct the 25 percent preferential income tax rates to small-business owners.
Current law: The rate follows a graduated schedule with a maximum rate of 35 percent.
Senate bill: The Senate would drop the rate to 20 percent beginning in 2019.
House bill: The rate would drop to 20 percent beginning in 2018.
Net Operating Losses
Current law: Net Operating Losses ("NOLs") carryback 2 years and carryover 20 years.
Senate bill: NOLs would be limited to 90% of taxable income and 80% of taxable income after 2023.
House bill: NOLs would be limited to 90% of taxable income.
Current law: Section 1031 applies to personal and real property.
Senate bill: The Senate would limit Section 1031 to real property not held primarily for sale.
House bill: The House would limit Section 1031 to real property.
Current law: Fund managers must hold the partnership interest for a year for carried interest treatment. Carried interest is the portion of an investment fund's profit--usually a 20 percent share--that is paid to investment managers. Currently, tax authorities treat that income as capital gains, making it eligible for a tax rate as low as 23.8 percent--on gains from assets held for a year or more. The top tax rate for ordinary income is 39.6 percent.
Senate bill: The legislation would impose a three-year holding period requirement for partnership or LLC interests received in connection with performing services to be eligible for long-term capital gain tax rates. The change would triple the length of time an asset would have to be held to qualify for the lower rate.
House bill: The legislation would impose a three-year holding period requirement for partnership or LLC interests received in connection with performing services to be eligible for long-term capital gain tax rates. The change would triple the length of time an asset would have to be held to qualify for the lower rate.
Individual Rates & Standard Deduction
Current law: For 2017, individuals have a standard deduction of $6,350 and married couples filing jointly have a deduction of $12,700. There are seven tax brackets that start at 10 percent and top out at 39.6 percent.
Senate bill: The plan would nearly double the standard deduction to $24,000 for a couple filing jointly. It sets seven tax brackets: 10, 12, 22.5, 25, 32.5, 35 and 38.5 percent. The top bracket applies to income starting at $500,000 for individuals and $1 million for married couples. The Senate would preserve a deduction for qualified medical expenses and a tax credit for adoption.
House bill: The bill would set tax brackets at 12 percent, 25 percent, and 35 percent, and maintain the existing 39.6 percent rate for individuals earning $1 million or more. The brackets are as follows: Households with income up to $24,000 would pay no income tax. The 12 percent bracket applies to households earning up to $90,000. The 25 percent bracket applies to households earning up to $260,000. The 35 percent bracket applies to households earning up to $1 million.
State and Local Tax Deduction
Current law: Individuals who itemize can write off their property taxes and their state and local income taxes or general sales taxes.
Senate bill: The Senate would fully repeal individuals' ability to write off their property taxes as well as their state and local income taxes.
House bill: The bill would allow individuals to deduct the cost of state and local property taxes up to $10,000.
Current law: C corporations may deduct interest paid or accrued within a tax year on indebtedness.
Senate bill: The proposal would preserve interest deductibility for small businesses, limiting the deduction to 30 percent of earnings before interest and taxes.
House bill: The legislation would limit the interest deduction to 30 percent of a company's earnings before interest, tax, depreciation, and amortization (EBITDA). Businesses with average gross receipts of $25 million or less would be exempt from the interest limitation rules. The bill would provide a carve-out for car dealers to allow them to get full interest deductions, but not full expensing.
Current law: The cost of capital investments generally is deducted from income over multiple years through a depreciation deduction. Taxpayers, other than trusts or estates, may elect to treat up to $510,000 (in 2017) of the aggregate cost of qualified property placed in service during the tax year as a current expense rather than as a capital expenditure.
Senate bill: Full expensing for capital investments would be permitted for five years. The plan increases Section 179 expensing to $1 million and sets the phase-out amount at $2.5 million. The depreciable life for residential rental property would be shortened from 27.5 years to 25 years and the depreciable life for nonresidential real property would be shortened from 39 years to 25 years.
House bill: Businesses would be able to fully and immediately deduct the expenses of new equipment for five years. The tax break would apply to property placed in service beginning on Sept. 27, 2017, and before Jan. 1, 2023. This excludes property used by a regulated public utility or a real estate trade or business.
Other Business Tax Breaks
Current law: The tax code includes dozens of tax breaks for businesses. Some, such as the research and experimentation credit, can be used by companies across industries. Others, such as the reduced tax rate for nuclear decommissioning funds, only apply to specific industries.
Senate bill: The Senate version preserves the research and experimentation credit and the low-income housing tax credit.
House bill: The bill would preserve the research and experimentation credit, the low-income housing tax credit, and the deduction for advertising. It also extends tax credits for nuclear power production, and the Section 48 credits for renewable energy.
Current law: Corporations are taxed on their worldwide income. There is no provision related to repatriation.
Senate bill: It would move to a territorial system and create a 10 percent deemed repatriation rate for cash assets and a 5 percent rate for noncash.
House bill: The bill would set a 10 percent tax on high-return profits, which is likely to apply to multinationals that store intellectual property overseas. There would be a two-tiered repatriation rate of 14 percent for cash held offshore and 7 percent for noncash. The legislation would impose a 20 percent excise tax on deductible payments from a U.S. company to a foreign affiliate. Ways and Means amended the initial version of the bill to limit the scope of the excise tax and the 10 percent tax on high-return profits after criticism from multinationals.
Retirement Savings Tax Provisions
Current law: In 2018, individuals younger than age 50 can put up to $18,500 into a tax-deferred 401(k) account annually.
Senate bill: It would preserve retirement account tax treatment.
House bill: The bill wouldn't change pre-tax levels for retirement accounts. Republicans have considered taxing more retirement savings upfront as a pay-for.
Mortgage Interest Deduction
Current law: Individuals who itemize can deduct mortgage interest paid on up to $1 million of mortgage debt principal.
Senate bill: The proposal preserves the mortgage interest deduction for first and second homes.
House bill: The bill would preserve the deduction for existing mortgages and set it at $500,000 for newly purchased homes, lower than current law.
Child Tax Credit
Current law: There is a $1,000 credit for each qualifying child under the age of 17, which phases out at certain income levels. A portion of the credit may be refundable. A credit for dependent care expenses varies depending on the amount of expenses, income, and number of dependents.
Senate bill: It would increase the credit value to $1,650.
House bill: The bill would increase the child tax credit to $1,600 per child younger than 17, and would include an additional $300 credit for each parent as part of a consolidated family tax credit.
Current law: The rate is 40 percent for 2017, and applies to estates valued at more than $5.49 million for individuals and $10.98 million for married couples.
Senate bill: The plan would double the size of estates that qualify for an exemption.
House bill: The bill would phase out the estate tax over six years, a compromise Republicans had to make because of revenue considerations.
Current law: Nonprofit college endowment income isn't currently taxed.
Senate bill: The proposal would set a 1.4 percent excise tax on the net investment income of private university and college endowments. The tax applies to schools with assets of more than $250,000 per student.
House bill: The bill would set a 1.4 percent excise tax on the net investment income of private university and college endowments. The tax applies to schools with assets of more than $250,000 per student. It mirrors the Senate plan.
Given there are two different versions of the tax cut proposals, it appears the two bills will be headed for a conference committee for reconciliation. Currently it is impossible to determine which proposals will be in the final tax bill to be passed by Congress. Stay tuned.
Phil Jelsma is a partner and chair of the tax practice team at Crosbie Gliner Schiffman Southard & Swanson LLC (CGS3), a San Diego-based commercial real estate law firm with offices in Los Angeles. He is recognized as a leading joint venture and tax attorney, with a 30-year background in real estate exchange transactions, syndications, nonprofit corporations and international tax planning.