Senate Passes Landmark Tax Reform Legislation
In the early hours of this morning (December 2), the Senate passed landmark tax legislation which, if enacted into law, will impact every individual and business in America. The vote on H.R.1, the Tax Reconciliation Act, remained on party lines, 51-49. One Republican, Sen. Bob Corker of Tennessee, voted against passage of the bill.
Up to the time of the final vote, amendments were considered and voted upon. It will take some time to sort out the impact of all of the provisions, but what follows is an overview of the Senate bill that passed this morning, as well as a comparison to the House bill that passed on November 16. The Joint Committee on Taxation issued its economic analysis of the final changes this morning.
Modifying the Individual Tax Brackets
The Senate bill would retain seven tax brackets for individuals, but would lower the rates to 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. The top bracket would not be reached for married taxpayers until they have income above $1 million.
The income schedule would be as follows:
House: The House bill reduces the current number of tax brackets for individuals from seven to four. The new brackets would be set at 12%, 25%, and 35%, and 39.6%. Although most taxpayers’ income would be subject to lower tax rates under the new brackets, some in the middle would see some income shift from a top rate of 33 percent to 35 percent. The House bill retains the current top bracket; however, if would not kick in for married taxpayers until they had income above $1 million, as opposed to $480,050 as it does under the current structure. The income table for the House bill’s proposed tax rates can be viewed here.
Note: All individual changes made through the Senate bill would expire after 2025.
Increasing the Standard Deduction
Of the roughly 143 million tax filers in the U.S., about 48 million currently itemize deductions. The Senate bill would dramatically change that number. The Senate bill increases the standard deduction to $24,000 for married filing jointly and $12,000 for single taxpayers. The current standard deduction is $12,700 for married taxpayers and $6,350 for singles. For 2017, the additional standard deduction for the aged or blind is $1,250. The Senate bill leaves the additional standard deduction for the aged or blind in place. Only taxpayers with income above the standard deduction amount would be required to file a tax return.
House: The House Bill increases the standard deduction to $24,400 for those who are married filing jointly and to $12,200 for single taxpayers. The House Bill would eliminate the additional standard deduction for the aged or blind.
Eliminating the Personal Exemption
To help offset the cost of doubling the standard deduction, both the House and Senate Bills would wholly eliminate the personal exemption. This amount is currently $4,050 for each taxpayer and dependent in 2017.
Late amendments to the Senate bill would preserve the AMT for individuals and corporations, but increase exemption amounts and phase-out thresholds for individuals through 2025.
House: The House bill would eliminate the individual and the corporate AMT.
Eliminating Many Deductions
The Senate bill would eliminate a number of deductions. Specifically eliminated deductions would include:
- State and local tax deduction, except for a $10,000 state and local property tax deduction (this exception, which mirrors the one included in the House bill was added in the final hours before passage)
- Deduction for Moving Expenses
- Miscellaneous Itemized Deductions above the 2 percent floor. These include, for example, deductions for unreimbursed employee expenses, tax preparation expenses, hobby expenses, and safe deposit box rental. Personal casualty losses would not be deductible unless the loss was due to a natural disaster addressed by a Presidential disaster declaration.
The Senate bill would retain charitable contribution deductions, the deductions for medical expenses exceeding 10% of adjusted gross income, alimony, and student loan interest. A late amendment to the bill would decrease the AGI threshold for the medical expenses deduction for everyone (not just those 65 and older) to 7.5 percent for years 2017 and 2018. The Senate plan would also retain the home mortgage interest deduction at the current mortgage debt limit of $1.1 million (for original indebtedness).
House: The House plan would retain the charitable contribution, a deduction for property taxes, up to a $10,000 limit, and the home mortgage interest deduction, for new mortgage debt up to $500,000. The current home mortgage interest deduction limit is $1.1 million. The House plan would eliminate other itemized deductions, such as the those for state and local taxes (other than the $10,000 property tax deduction), medical expenses, tax preparation fees, moving expenses (except for those in the Armed Services), student loan interest, unreimbursed employee expenses, personal casualty losses, and alimony payments. Alimony payments would be treated as child support payments under the House proposal. The recipient of the alimony would be able to exclude the income from taxation. This change would impact new divorce decrees after December 31, 2017, although parties could elect to apply to the provisions to modifications of decrees already in place.
Increasing the Child Tax Credit and Creating a New Credit
To offset the considerable impact of the loss of many deductions and the $4,050 personal exemption per person upon families, the bills would significantly increase the child tax credit.
The Senate bill raises the child tax credit to $2,000 per qualifying child. It would also expand the credit to apply to children under the age of 18, instead of 17 (through 2024). Up to $1,100 of the credit would be refundable. The Senate proposal also provides a nonrefundable $500 credit for dependents who do not qualify for the child tax credit. The Senate proposal would significantly expand the phase-out threshold for credit eligibility.
House: The House bill raises the child tax credit to $1,600 per qualifying child (from the current amount of $1,000). The plan would also increase the income levels at which the child tax credit begins to phase out. The child tax credit would continue to apply only to children under the age of 17. A new nonrefundable $300 family credit would also be allowed for each spouse and non-child dependent. This family credit would be offered for five years. Up to $1,100 of the child tax credit would be refundable beginning in 2018.
Other Credits and Exclusions
The Senate bill would retain the American Opportunity Tax Credit, the Earned Income Tax Credit, and the Adoption Credit.
The Senate bill (and the House bill) would continue to allow taxpayers to exclude gain from the sale of a personal residence, but would require that the taxpayer live in the residence for five out of the past eight years, instead of the current requirement of two out of the last five years. Taxpayers could only use the IRC § 121 exclusion once every five years.
The Senate bill would preserve and increase from $250 to $500 the above-the-line deduction for educators’ out-of-pocket expenses.
Eliminated under both Senate and House bills would be the exclusion from income for employer-provided transportation fringe benefits and moving expenses. A late add to the Senate bill would provide that employee achievement awards consisting of cash, gift cards, event tickets, or other non-tangible personal property would not be considered tangible personal property "employee achievement awards." They would, therefore, not be excluded from income.
House: The House bill would also eliminate the exclusion from income for employer-provided dependent care expenses and achievement awards. The House bill would also expand the AOTC to a fifth year and apply one-half of the yearly credit amount in that fifth year.
Tax benefits permitted for retirement plans would be largely unchanged by both bills, although the Senate bill would eliminate the ability of individuals to re-characterize contributions to another type of IRA before the due date of the individual’s tax return.
Estate, Gift, and Generation Skipping Tax
The Senate bill would double the basic exclusion amount and retain basis adjustment at death. The Senate plan, however, would not repeal the estate tax and generation skipping tax for estates valued greater than the increased basic exclusion. Under this bill, every person could die with up to $11.2 million in assets in 2018 and owe no estate tax. Portability would continue to allow a surviving spouse to elect to apply the deceased spouse’s unused exclusion. If both spouses were to die in 2018, they could exclude up to $22.4 million in property from the estate tax.
House: The House proposal would initially double the basic exclusion amount allowed for each person. Under the House plan, the estate and generation-skipping tax would be repealed altogether beginning in 2024. The gift tax would remain, although the higher exclusion amounts would apply. Basis adjustment at death would continue.
Note: In 2016, there were only 5,219 estate tax returns filed for taxable estates. Only 682 of those taxable estates had any farm property (2% of total taxable assets).
Lowering the Corporate Tax Rate
The Senate bill would lower the maximum corporate tax rate from 35% to 20%, beginning in 2019. Reducing the corporate tax rate over a 10-year period would cost nearly $1.5 trillion. The House bill would implement this change beginning in 2019.
Lowering Tax Rates for Pass-Through Businesses
Since most small businesses, including farmers, conduct business through a sole proprietorship, partnership, or S corporation, lowering the corporate tax rate would not aid them. The House and Senate bills provide different ways to reduce taxes for these businesses, while at the same time trying to prevent taxpayers from abusing the special provision.
Under the Senate bill, beginning in 2018, individuals receiving income from a pass-through business could generally deduct 23 percent of qualified business income (this was a final hour increase from the 17.4 percent deduction included in the original text) from a partnership, S corporation, or sole proprietorship. “Qualified business income” would not include an S corporation shareholder’s reasonable compensation or a partner’s guaranteed payments. This deduction would generally be limited to 50 percent of W-2 wages (like the current DPAD deduction). However, the wages limitation would only apply to businesses with income greater than $500,000 (MFJ). This would ensure that small businesses without employees could still take advantage of this deduction.
Only small services businesses could take advantage of this deduction. They could use the deduction if income is equal to or below $500,000 (MFJ). The deduction would then be phased out for the next $100,000 of income (MFJ).
Special Provision for Agricultural Cooperatives
The Senate bill expanded, in the late hours of debate, the 23 percent qualifiying business income deduction to apply to specified agricultural or horticultural cooperatives. The deduction, beginning in 2019, would be applied against the lower of the cooperative’s taxable income for the taxable year, or 50 percent of the W-2 wages of the cooperative with respect to its trade or business. This provision is intended to lower taxes for these entities and offset the loss of the DPAD deduction to these cooperatives. The interplay of this deduction with the patronage dividend will be analyzed separately.
House: The House bill seeks to lower the maximum tax rate for sole proprietors, S corporations, and partnerships from 39.6% to 25%. The provisions, however, are anything but simple. The bill contains complex provisions to ensure that taxpayers can’t shift wage income to business income to take advantage of the new preferential rate. By default, 30 percent of a typical pass-thru business’s income would be considered “qualified business income” entitled to the lower rate. The other 70 percent would be considered attributable to labor and taxed at ordinary individual income tax rates. Passive business income would be wholly taxed at the lower maximum rate. Service businesses, such as those providing accounting, legal, financial, and engineering services, would not generally be entitled to have any of their income taxed at the lower rate since their income is considered attributable to the business owners' personal labor.
The House bill also has special provisions to ensure that even small businesses could receive a tax cut. A new bottom tax rate of 9% (instead of 12%) would apply to the first $75,000 of income for married taxpayers with business income of $150,000 or less. This lower rate would phase out completely for taxpayers with income at or above $225,000 (married filing jointly). This provision would apply to service businesses as well. The lower rate provisions, however, would not be fully implemented immediately, but would be phased in over a period of five years.
The initial House proposal had suggested significant changes to the current self-employment tax statute, including a requirement that all “labor income,” including some rental income, would be subject to self-employment tax. In response to immediate concerns raised from a number of constituencies, these provisions were scrapped. The House bill leaves the self-employment tax statute unchanged.
First-Year Bonus Depreciation and Expensing
The Senate bill expands current cost recovery options for businesses. The Senate would allow 100 percent bonus depreciation for five years beginning with property placed into service on September 27, 2017 (taxpayers could elect to use 50 percent bonus for 2017 purchases). After five years of 100 percent bonus, the bill would then allow one year of 80 percent bonus, one year of 60 percent bonus, one year of 40 percent bonus, and one year of 20 percent bonus. The Senate bill does not expand bonus depreciation to used property. The Senate would expand Section 179 to provide an immediate $1 million deduction with a $2.5 million phase-out threshold.
The Senate bill would also allow farm equipment to be depreciated over a period of five years, instead of seven years. It would also remove the requirement that farm property is depreciated using the 150 percent declining balance method (except for 15 or 20-year property).
House: The House bill also provides five years of 100% bonus depreciation, which would include used, in addition to new property. This provision would apply to property placed into service on September 27, 2017, or later. The Section 179 deduction would be expanded to $5 million, with a phase-out threshold of $20 million.
Also Significant for Agriculture
Both the Senate and House bills retain IRC §1031 like-kind exchange treatment for real property, but eliminate it for personal property, such as farm equipment or breeding heifers. The increase in expensing options lessens the impact of this change.The bills also eliminate the domestic production activities deduction (DPAD), which is frequently used by agricultural producers and cooperatives, beginning in 2018. The new deduction for pass-thru businesses is intended to replace the need for that deduction.
Although both bills restrict business interest deductions generally to 30 percent of adjusted gross income, those restrictions would not apply to businesses with revenue below $25 million (House) and $15 million (Senate). The Senate bill also revises the limitation on the deduction of business interest to allow a farming business (as defined in IRC § 263A(e)(4)) to elect not to be subject to the business interest limitation. Such farming businesses would then be required to use the alternative depreciation system to depreciate any property used in the farming business with a recovery period of ten years or more.
The Senate and House bills would also leave intact the current capital gains system, cash accounting, the conservation easement deduction, and income averaging.
The Senate bill would disallow a deduction for expenses associated with meals provided for the convenience of the employer; however, this would not appear to kick in until after 2025.
Note on Sequestration: One concern raised by both proposals is the impact on the deficit. The Congressional Budget Office has stated that because the proposals would increase the deficit by $1.5 trillion over the next ten years, sequestration would be triggered. In 2018, that would require $111 billion to be sequestered from mandatory accounts, including those allotted for farm program benefits, in 2018 alone. This could mean a decrease in farm program payments, beginning in 2018, absent further action by Congress.
Individual Shared Responsibility Payment
The Senate bill would set the Individual Responsibility Payment to $0, beginning in 2019, meaning that individuals who do not have health insurance will not be liable for the penalty.
House: The House bill does not reference the individual shared responsibility payment.
The Senate bill includes a number of other specific tax provisions, some of which are listed below.
- Allowing an employer to take a general business credit of 12.5 % of the amount of wages paid to qualifying employees during periods of FMLA leave if the rate of payment is 50 % of the wages normally paid to the employee.
- Expanding the use of ABLE accounts.
- Imposing a new due diligence requirement on tax professionals when making head of household determinations.
- Eliminating the two-year carryback of net operating losses, except for some farming businesses and limiting the net operating loss deduction to 90 percent of taxable income (determined without regard to the deduction) (80 percent in taxable years beginning after December 31, 2022) (The House proposal limits the NOL deduction to 90 percent of taxable income and restricts all carrybacks, with the exception of one-year for small businesses and farms with some casualty and disaster losses.).
- Allowing 529 plans to be used to finance private elementary and secondary education (Cruz Amendment)
The passage of the Senate bill virtually guarantees tax reform by year end. Although differences in the House and Senate bills must be resolved through a conference process, it is clear that the majority of each chamber is set on reaching a common resolution. It would seem that a final law would look more like the Senate bill, rather than the House bill, given the slim margin of victory in the Senate. Both chambers must again approve changes to a final bill, before it would go to the President for his signature.
We will continue to provide updates as this expedited process unfolds.Some year-end actions (i.e. making larger charitable donations, selling a personal residence, moving now instead of later, evaluating business structures, etc.) may be advisable depending upon how these provisions shake out. More should be known soon.
We will keep you posted!
The Center for Agricultural Law and Taxation does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. The Center's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.