By Phil Jelsma
Following the Senate's recent vote on the Tax Cut and Jobs Act (the "Act") -- the most ambitious tax overhaul in decades -- the Act is now headed to a reconciliation committee that will produce a conference report for approval by the House and the Senate. While the two bills are close, key differences still remain.
At the last minute, the Senate decided to retain the state and local property tax deduction capped at $10,000 and expands the Section 529 college savings account to both primary and secondary education expenses.
While legislators continue to work to merge the Senate and House versions of this massive tax bill, it is important to understand the variations between the two, as well as the last minute changes.
Following is a brief summary of the differences to date:
Individual Tax Rates
House Version: Consolidates the current seven rates into four, retaining the highest marginal rate of 39.6%.
Senate Version: Retains the seven rates but reduces the highest marginal rate from 39.6% to 35%. The individual income tax cuts sunset at the end of 2025.
Medical Expense Deduction
House Version: The House Bill repeals the medical expense deduction.
Senate Version: The Senate Bill retains the medical expense deduction for 2017 and 2018 if eligible expenses exceed 7.5% of adjusted gross income ("AGI") rather than 10% of AGI.
Mortgage Interest Deduction
House Version: The House Bill limits the mortgage interest deduction to the first $500,000 in principal indebtedness.
Senate Version: Keeps a home mortgage interest deduction for acquisition debt but eliminates the deduction for home equity indebtedness.
Taxation of Pass-through Income
House Version: Caps the pass-through rate at 25% and sets a rebuttable presumption that 70% of pass-through income is wage income, and 30% is business income subject to the lower rate. Excludes most professional service companies from the preferential rate.
Senate Version: Adopts a 23% deduction for pass-through income but limits it to 50% of W-2 wage income paid by the pass-through entity. Includes a slightly broader provision of ineligible service providers. The provision expires at the end of 2025.
Corporate Tax Rates
House Version: Cuts the corporate tax rate to 20% effective January 1, 2018.
Senate Version: Cuts the corporate tax rate to 20% beginning January 1, 2019.
House Version: Allows full expensing of short-term capital investment such as machinery and equipment over five years. Increases the Section 179 small business expensing cap from $500,000 to $5 million with a phase out beginning at $20 million. Maintains the current depreciation for real property.
Senate Version: Allows full expensing of short-lived assets such as machinery and equipment over five years. Raises the Section 179 small business expensing cap to $1 million with a phase out starting at $2.5 million. Shortens the depreciable life of real property to 25 years.
Alternative Minimum Tax
House Version: Repeals both the individual and corporate alternative minimum taxes.
Senate Version: Retains the corporate minimum tax and the individual alternative minimum tax with a higher exemption amount.
Taxation of Interest Expense
House Version: Caps the net interest deduction at 30% of earnings before interest, taxes depreciation and amortization.
Senate Version: Caps a net interest expense at 30% of earnings before interest and taxes.
Net Operating Losses (NOLs)
House Version: Eliminates net operating loss carrybacks while allowing indefinite net operating loss carryforwards. Current year NOLs are limited to 90% of taxable income.
Senate Version: Eliminates net operating loss carrybacks while eliminating NOL carryforwards to 80% of taxable income.
Cash Method of Accounting
House Version: Increases small business eligibility from $5 million of gross receipts to $25 million of gross receipts.
Senate Version: Increases small business eligibility from $5 of gross receipts million to $15 million of gross receipts.
House Version: Moves to a territorial system with base erosion rules including the inclusion of 50% of excess returns by controlled foreign corporations and an excise tax on payments made to foreign firms unless claimed as effectively connected income.
Senate Version: Moves to a territorial system with certain anti-abuse rules and a base erosion minimum tax of the excess of 10% of modified taxable income over a regular tax liability.
Deemed Repatriation of Foreign Profits
House Version: Enacts a deemed repatriation of currently deferred foreign profits at a rate of 14% for liquid assets and 7% for liquid assets.
Senate Version: Enacts a deemed repatriation of currently deferred foreign profits at a rate of 14.49% for liquid assets and 7.49% for illiquid assets.
House Version: Increases the exemption to $10 million indexed for inflation with repeal after six years.
Senate Version: Doubles the current estate tax exemption.
While Republicans are inching closer to achieving tax reform, their bill still has some hurdles to overcome.
A conference committee comprised of members of both Houses must approve a report which addresses all the differences. The conference report must then be approved by both the House and the Senate. It is certainly more likely that the provisions included in the Senate version will be included in the conference report --- versus the House provisions.
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.