On Thursday, the House Ways and Means Committee released details of the long-awaited tax reform bill which will be formally known as “The Tax Cuts and Jobs Act.”
The key components of the plan include the following tax rate reductions:
- Corporate rate would fall to 20%.
- “Small business” income rate falls to 25%. This will apply to certain types of income from pass-through entities.
- Top individual rates would remain at 39.6%, but the number of tax brackets would shrink from 7 to 4 and push income into lower tax brackets for many individuals.
- Tax rate reduction: Four tax brackets would apply for individuals – 12%, 25%, 35%, and 39.6%
|$0 – $45,000||12%|
|$45,001 – 200,000||25%|
|$200,001 – $500,000||35%|
|$0 – $90,000||12%|
|$90,001 – 260,000||25%|
|$260,001 – $1,000,000||35%|
- Standard deduction for individuals would rise to $12,200 for single taxpayers and $24,400 for married couples. Personal exemptions would be eliminated.
- Most itemized deductions, including those for medical expenses, state and local income taxes, sales taxes (for taxpayers in states without income tax), employee business expenses, and tax preparation fees would be eliminated.
- Alimony payments and moving expenses would no longer be deductible.
- The charitable contribution deduction would be retained and the limitation would be raised to 60% of AGI.
- The deduction for property taxes would be limited to $10,000.
- Mortgage interest would be deductible only for loans up to $500,000. A grandfather rule would apply to pre-November 2, 2017, indebtedness.
- 401(k) contribution limits would be unchanged.
- Deductions and exclusions for contributions to medical savings accounts would be eliminated.
- Capital gains rates of 15% would apply up to a threshold income amount of $77,200 for joint filers and half that amount for single filers. A 20% rate would apply with a threshold of $479,000 for joint filers and $425,800 for single filers.
- Child tax credit would be increased from $1,000 to $1,600 per child under 17 and a $300 “Family Tax Credit” for non-child dependents would be added.
- Roth IRA re-characterization rule would be repealed; this is the provision that currently allows an individual to re-characterize a contribution to a traditional IRA as a contribution to a Roth IRA (and vice versa) and may also re-characterize a conversion of a traditional IRA to a Roth.
- Section 529 account distributions expanded – the bill would allow up to $10,000 per year for elementary and high school expenses to be treated as “qualified expenses” from Section 529 plans.
- Exclusion for gain on sale of principal residence – the 2-year and 5-year rules currently in place will be changed to 5 years and 8 years, respectively; exclusion will only be available for 1 sale or exchange every 5 years.
- Exclusions from income for employee achievement awards, dependent care assistance, moving expense reimbursements, and adoption expenses would be repealed.
- Alternative Minimum Tax (AMT) for individuals would be repealed.
- The estate tax exemption would double to approximately $11 million up from the present $5.49 million. Estate tax and generation-skipping tax will be repealed in 2024.
- Corporate tax rate would drop from today’s top rate of 35% to 20%.
- AMT for corporations would be repealed.
- “Qualified Business Income” of individuals, including income from pass-through entities such as partnerships and S-corporations, would be subject to a special rate of 25%.
- Not all pass-through income will benefit from the 25% rate; owners or shareholders may elect to apply a “capital percentage” (effectively a safe harbor) of 30% to the net business income to determine the amount eligible for the 25% rate. The remaining 70% would be subject to ordinary income tax rates. Alternatively, they may elect to use a formula based on a facts-and-circumstances approach. For certain types of personal services businesses (such as health, law, accounting, and engineering services, among others) the capital percentage which would be eligible for the 25% rate is zero.
- Deductions for entertainment expenses and certain fringe benefits would be non-deductible.
- Expansion of Section 179 deduction
- 100% bonus deprecation would be allowed generally for tax years until 2023, and certain used property may be eligible.
- Section 199 Domestic Production Activities Deduction repealed.
- Net Interest expense for “C” corporations limited with an exception for small businesses
- Like-kind exchanges under Section 1031 would be limited to real property.
- Net operating loss carrybacks would be repealed, except in the case of 1-year carryback of eligible disaster losses; bill would permit indefinite carryforward of NOLs.
- Base erosion prevention –50% of the “Foreign High Return Amount” of a controlled foreign corporation would be included in current taxable income of the U.S. shareholder. A limited foreign tax credit is allowed with respect to the “foreign high return income.”
- Establishment of a participation exemption system for taxation of foreign income, essentially a territorial tax system for international companies
- Dividends from foreign subsidiaries (where the U.S. parent owns at least 10%) would be exempt from tax.
- Minimum tax of 10% on a global basis on the foreign profits of U.S. multinationals to prevent shifting of income to low or no tax foreign jurisdictions.
- R&D credits and low-income housing credits would be preserved.
- A new provision would cause contributions to the capital of any entity to be treated as taxable income; an exception is made for certain contributions in exchange for stock or for interests in other types of entities.
- Repatriation of accumulated foreign earnings at 12% (liquid assets) or 5% (illiquid assets) rate to incentivize U.S. companies to onshore foreign cash. Foreign tax credits triggered by the repatriation would be partially available to offset the U.S. tax. An election is available to spread the tax liability over a period of eight years.
- Excise tax on payments from U.S. corporation to related foreign corporation – a 20% excise tax would be imposed on certain payments made that are deductible, includible in cost of goods sold, or includible in the basis of a depreciable or amortizable asset, unless the related foreign corporation elects to treat the payment as income effectively connected with a U.S. trade or business. Certain exceptions would apply, including payments for commodities and payments intercompany services where the U.S. company pays with no mark-up. Also, the excise tax applies only to groups with payment to foreign affiliates totaling at least $100 million annually (looking at the average of the three preceding years).
Previous Tax Proposals Not Addressed in Draft Bill
The draft bill did not address several previous proposals so there is some uncertainty as to the future of these items:
- 3.8% Net Investment Income Tax
- Affordable Care Act taxes
- LIFO inventory method for tax purposes
- Carried interest legislation
In addition to the highlights above, the bill contained numerous other provisions. If you have questions about how the proposed tax reform plan might impact you, please contact your Elliott Davis tax advisor.