Tax Reform—What Stays, What Goes, What’s Left?

tax reformIn one of the most unpredictable and hotly contested presidential races in United States history, Donald Trump promised, if elected, to pass, among other things, massive tax reform that would “simplify the tax code.”  With the U.S. House of Representatives’ recent drafting of the Tax Cuts and Jobs Act, he came one step closer to doing so, though there are challenges ahead given the enormity of the undertaking, and hurdles to clear as the Senate has just released its own version in the last week.  PYA has analyzed what each version proffers and will compare some of the notable changes in this article.

At first glance, the Act is a sweeping reform of the current Internal Revenue Code.  It appears the objective of the bill is to relieve some of the burden, both financially and administratively, for many tax-paying Americans.  We’ve broken down some of the key changes of this Act—in its current form—for individuals, businesses, and non-profits.

Individuals

The Internal Revenue Code for individual taxpayers has become an enigmatic maze of confusion and ambiguity.  The Tax Cuts and Jobs Act seeks to address this issue, and even aims to reduce the size of the physical tax return to a 15-line “postcard” for most filers.  Most higher income individuals will be pleased to hear that the bill repeals the Estate Tax, known as the “Death Tax” by opponents, and repeals the Alternative Minimum Tax.  Most taxpayers who do not itemize their deductions will likely benefit from the doubling of the standard deduction, but may be adversely impacted by the repeal of the personal exemption, along with exemptions for qualified dependents.  Some of the key changes in the proposed legislation for individuals are below.

  • Reduces the threshold that limits the deductibility of mortgage interest from mortgages of more than $1,000,000 to more than $500,000
  • Eliminates state and local income and sales tax deductions and institutes an annual cap of $10,000 on the deduction of state and local property taxes
  • Introduces some relief for owners of pass-through entities (partnerships, LPs, LLCs, LLPs, etc.) in the form of taxing 30% of the pass-through earnings at a reduced 25% rate (instead of the individual’s tax rate)–the remaining 70% of the earnings would be taxed at the owner’s individual rate.
    • A House “markup” by Representative Kevin Brady (R-Texas) proposes a 9% tax rate for the first $75,000 of income of a married active owner who has less than $150,000 of pass-through business income. This revision is supported by the National Federation of Independent Business (NFIB).  The measure would be phased in over five years.
  • Effectively doubles the standard deduction, but eliminates personal exemptions:
    • Filing single: $6,350 to $12,000
    • Married filing jointly: $12,700 to $24,000
  • Increases the child tax credit to $1,600 from $1,000, but eliminates the $4,050 per-child exemption
  • Proposes to simplify the filing process so that the form would be a simple “postcard” with only 15 lines for most Americans (yet unclear how this would be achieved)
  • Reduces the number of individual tax brackets from seven to three or four with tax rates of 12%, 25%, 35%, and a category yet to be determined, outlined respectively as follows:
    • Brackets for married filing jointly:
      • $0 – $90,000 of income – 12%
      • $90,000 – $260,000 of income – 25%
      • $260,000 – $1,000,000 of income – 35%
      • Over $1,000,000 – top rate (undetermined but likely the 39.6% Clinton era rate)
    • Brackets for single filers:
      • $0 – $45,000 of income – 12%
      • $45,000 – $200,000 of income – 25%
      • $200,000 – $500,000 of income – 35%
      • Over $500,000 – top rate (undetermined but likely the 39.6% Clinton-era rate)
  • Introduces two new “family credits” of $300:
    • Non-child dependent credit (dependent over 17 that you are supporting, ailing parent, adult child with disability, etc.)
    • Credit for each spouse, or head of household
  • Eliminates dependent care assistance account employer contributions exclusion from income
  • Eliminates the following personal deductions:
    • Student loan interest
    • Medical expense
    • Moving
    • Alimony payment
  • Eliminates ability of developers of sports stadiums and facilities to deduct the interest expense on bonds issued by local governments to fund the construction of such facilities
  • Provides a 100% tax credit on the first $2,000 of eligible higher education expenses and a 25% credit on the next $2,000, but combines the following credits into one in order to do so (would be effective for any year after 2017):
    • American Opportunity Tax Credit
    • Hope Scholarship Tax Credit
    • Lifetime Learning Credit

Businesses

As some U.S. businesses have grown and expanded globally seeking new customers and investment, many have opted to leave their profits overseas—the result of the unique tax rules and treaties that exist around the globe.  At this point, it costs companies too much in taxes to bring money earned abroad back to the U.S.  The Tax Cuts and Jobs Act seems to address this issue by reducing the tax rate that companies will pay when repatriating their earnings.

  • Drops the top corporate tax rate from 35% to 20%
  • Reduces the repatriation rate to 12% (tax on earnings returned home from ventures overseas)
  • Moves from current global tax system to a territorial system (similar to what you see in Europe and other places around the world)
  • Eliminates the Alternative Minimum Tax
  • Eliminates state and local tax deductions (not clear if property taxes are included in this)
  • Allows for immediate deduction of “business investments” (not clear if this just means property acquisitions or any type of business investment)
  • Increases §179 deduction limitation and phaseout to $5,000,000 and $20,000,000, respectively
  • Increases various thresholds and exemptions dictating accounting methods:
    • Cash method threshold increases from $5,000,000 average gross receipts to $25,000,000 (these businesses would also be excluded from the UNICAP rules)
    • $10,000,000 exemption from percentage-of-completion method for long-term contracts increases to $25,000,000
  • Limits Net Operating Loss (NOL) deductions to 90% of taxable income, and losses can no longer be carried back
  • Simplifies the current 163(j) rules to an interest expense limitation of 30% of adjusted taxable income for any business with more than $25,000,000 in average gross receipts (it is not clear if the calculation for “adjusted taxable income” would remain the same)
  • Eliminates the Domestic Production Activities Deduction
  • Eliminates meals and entertainment deductions and employee fringe benefits, unless the employee includes the benefit in his or her taxable income
  • Limits like-kind exchanges under §1031 to real estate (currently pending exchanges would be allowed)
  • Eliminates the following business credits:
    • Work Opportunity Tax Credit
    • Credit for employer-provided child care
    • Credit for rehabilitation of qualified buildings or certified historic structures
    • 45D New Markets Tax Credit
    • Credit for providing access to disabled individuals
    • Credit for enhanced oil recovery
    • Credit for producing oil and gas from marginal wells
    • Credit for portion of employer Social Security taxes paid with respect to employee tips
    • Credit for electricity produced from certain renewable resources
    • Credit for production from advanced nuclear power facilities
    • Investment Tax Credit
    • Credit for eligible energy property
    • 25D Residential Energy-Efficient Property Credit
  • Removes “exempt” status for the following tax-exempt bonds:
    • Private activity
    • Interest on advance refunding
    • Tax credit
  • Introduces several revenue-raising provisions that would modify the current rules as they relate to the insurance industry
  • Places limits on the deductibility of compensation of certain highly paid employees
  • Replaces the current foreign tax credit system with new dividend exemption system

Non-Profit Organizations and Universities

Traditionally, non-profit organizations, such as religious organizations, charities, and universities, have enjoyed the benefits of an exempt status.  Their immunity will be challenged, to some degree, in the new bill—not just through statutory means, but also through some indirect consequences contained in other parts of the bill.  For example, because the standard deduction will effectively double, fewer Americans are likely to take advantage of itemization, which is where charitable contributions are deducted.  This may, in turn, remove some of the incentive for contributing to charitable organizations.  Another more specific provision of the bill is the tax on large, private university endowments.  The bill contains a provision that private universities with assets greater than $100,000 per student will pay a 1.4% excise tax on their net investment income.

One week after the House passed its version of tax reform, the Senate has proposed its version of what the Internal Revenue Code should look like.  The following are some key differences of the Senate plan outlined in a comparison chart from the Tax Foundation, an independent tax policy nonprofit based in Washington, D.C.:

Individuals

  • Retains the seven brackets we currently have (instead of reducing the number of tax brackets to four) and reduces the rates such that the top rate would be 38.5% instead of 39.6%
  • Eliminates the state and local tax deduction altogether, with an exception for state and local taxes incurred in carrying on a trade or business
  • Retains the deduction for mortgage interest for acquisition debt, but eliminates the deduction for equity debt
  • Does not eliminate the estate tax, but instead doubles the current estate tax exemption amount
  • Keeps the current deduction for medical expenses that the House wishes to eliminate
  • Indexes tax brackets and other provisions of the Senate’s version of the Tax Cuts and Jobs Act to the Chained Consumer Price Index (CPI) measure of inflation

Businesses

  • Introduces a limit on the deductibility of net interest expense (total interest expense less any interest income) on any future loans to 30% of earnings before interest and taxes (EBIT)

There are other differences between the two bills, but they both seek to simplify the current tax code and move to a territorial tax system.

While the outcome of this legislation is far from decided, PYA is poised to provide our client partners with the latest information to explain how these changes may affect their future tax filings.  If you have questions about tax reform, credits and deductions, or possible impact, contact one of our PYA executives below at (800) 270-9629.

 


Eric Elliott

Eric Elliott

Principal

Greg Gates

Greg Gates

Principal

Heather Martin

Heather Martin

Senior Manager

Brad Leskoven

Brad Leskoven

Senior Manager

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