Tax Reform: Closing in on the Finish LineBy Mark R. Baran | December 11, 2017
A conference committee consisting of both House and Senate negotiators will begin work this week to reconcile differences between their respective tax measures. The House passed its version of the Tax Cuts and Jobs Act (H.R. 1) in November, while the Senate’s version was passed in early December. As Marks Paneth reported last month, both the House and Senate versions are substantially similar but contain very important differences that need to be resolved.
To the extent that the conference negotiators conclude their work quickly and both chambers of Congress approve a final reconciliation bill soon thereafter, historic tax reform may well be signed into law by the President this year.
H.R. 1 is an approximately $1.5 trillion tax measure that has, as its centerpiece, both individual and corporate tax rate reductions and reforms along with many tradeoffs. Among the many provisions in H.R. 1 that differ between the House and Senate plans, here are the ones we feel will have the broadest impact on all of our clients and industry groups:
- Corporate and individual tax rates. The proposed corporate rate in both versions is 20%. The individual tax rate regimes differ as to the highest rate, the number of brackets, and adjusted taxable income ranges. In the Senate version, the corporate rate cut is delayed to tax year 2019 (House effective date is tax year 2018), and individual rate changes sunset at the end of 2025.
- Pass-throughs. There is top rate of 25% in the House on certain pass-through income and a 23% deduction for pass-through business profits in the Senate.
- Alternative minimum tax (AMT). The House plan repeals both individual and corporate AMT, while the Senate retains the corporate AMT and provides a higher exemption amount for individual AMT.
- Limitations on net operating losses (NOLs). Both versions eliminate NOL carrybacks (with limited exceptions) and limit the NOL deduction to 90% of taxable income. The Senate reduces this amount to 80% after 2022.
- Net interest expense deduction. Both versions restrict the deduction to 30% of earnings before interest and taxes (EBIT). The House version caps the deduction at 30% of earnings before interest, taxes, depreciation and amortization (EBITDA).
- Personal income taxation. Differences remain relating to mortgage interest deductions, medical expense deductions, standard deductions, child tax credits and AMT. The individual House changes are permanent while most of the Senate changes sunset at the end of 2025.
- International tax. Both the House and Senate plans move to a territorial-based tax system but differ on base erosion rules. The deemed repatriation rate on deferred foreign profits rate is higher in the Senate for liquid assets (14.49% vs. 14%) and illiquid assets (7.49% vs 7%).
These provisions, along with other less controversial differences, must be resolved before a reconciliation bill can move forward for debate and vote in each chamber of Congress.
Our Marks Paneth practice groups are actively tracking developments and assessing the impact of many wide-ranging tax provisions on our clients’ business structures, operations and individual taxes.
While not a comprehensive list, we have compiled some major ways our clients in certain industries will be impacted:
Since most Real Estate businesses operate as partnerships or are treated as partnerships for tax purposes, the partnership tax changes would significantly impact the real estate industry, as well as limitations in the Senate version on utilizing active trade or business losses against other sources of income. For more details on how some of these changes may affect your real estate business, please click here.
In addition, Professional Services businesses (i.e. health, law, engineering, architecture, accounting, brokerage), performing arts and consulting would be disproportionately impacted. These businesses would be severely restricted from taking advantage of the lower partnership rates in the House version or the 23% deduction (limited to 50% of wage income) in the Senate version.
In addition to changes to partnership taxation and activities through the use of foreign subsidiaries, the Theatre, Media and Entertainment industry would be impacted by the proposal to allow immediate expensing of certain production costs.
Commercial Business clients who utilize a wide variety of entity structures and business operations will experience a myriad of changes. These changes include, but are not limited to, lower corporate rates, full expensing for short-lived capital investments, increases to the small business expensing cap, limits on net interest deductions and NOLs, enhanced ability to use cash accounting and inventory methods, bonus depreciation, limits on deductions such as fringe benefits, and international tax changes.
Under both plans, Tax-Exempt Organizations will face some changes to excise taxes. Colleges and universities would incur an excise tax on certain investment income exceeding thresholds. For private foundations, excise tax on investment income (currently at 2%) would be 1.4%. A proposed excise tax of 20% on exempt organization’s excess executive compensation would apply to the remuneration paid by an applicable exempt organization to a covered employee in excess of $1M plus any excess parachute payment. Exempt organizations should also be aware of the new rules requiring separate computation of unrelated business taxable income for each trade or business activity. Individuals should also be prepared for charitable donation changes.
High-Net-Worth Individuals will be impacted by the changes to their business income as noted above, AMT, possible estate tax repeal or increased exemption amounts, and many simplification measures, particularly those relating to itemized deductions, exemptions and exclusions.
While there is optimism that tax reform will become law soon, uncertainties remain because of certain high-profile provisions, sunset dates and budgetary limitations such as the Byrd rule in the Senate. Whether these uncertainties are enough to delay or – in a worst case scenario – derail enactment will largely depend on the resolution of these open issues. As the legislative process continues in the coming weeks, clients should be prepared to adapt and work closely with their tax advisors during this important year-end tax planning season.
To assist clients with their tax planning in light of potential enactment of this important tax reform legislation, we will continue to provide updated information on developments and practice group analysis specific to your industry.
For more information, please contact your Marks Paneth tax advisor or Mark Baran, Principal in our Tax Services Group, at firstname.lastname@example.org.
About Mark R. Baran
Mark Baran, JD LL.M., is a Principal in the Tax Department at Marks Paneth LLP. He has more than 25 years of specialized tax, transactional and legal experience advising publicly-traded and private companies, regulated financial institutions, investors, high net worth individuals, and government agencies. Mr. Baran provides specialized tax consulting and transactional services to a broad spectrum of clients and industries including the public sector. He routinely provides tax opinions on the tax implications of... READ MORE +