Updated: Tax Reform: What's on the Table?
Update: The House of Representatives passed H.R. 1 on November 16 by a vote of 227-205. Later that day, the Chairman's Mark cleared the Senate Finance Committee by a vote of 14-12. The Senate legislative text has been released here.
House Republicans released their detailed tax reform proposals on November 2. On November 9, an amended version of H.R. 1, the Tax Cuts and Jobs Act, passed out of the House Ways & Means Committee by a vote of 24-16. The bill will move to a vote on the House floor as early as November 16. On November 9, Senate Republicans unveiled their proposals through the Chairman’s Mark of the Tax Cuts and Jobs Act. The Chairman’s 103-page modification to the Chairman’s Mark was published on November 14. The negotiations are ongoing and the details fluid, but tax reform proponents are hoping the House and Senate can each pass a version of the Act, and that the two bodies can work out conflicting details in conference. The goal for proponents is to have a final Bill passed by both chambers and sent to the President by year end. It is too early to make predictions, but below we review many of the key provisions of the two proposals.
Modifying the Individual Tax Brackets
House: The House proposal calls for reducing 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 proposal also retains the current top bracket; however, if would not kick in for married taxpayers unless they have income of $1 million, as opposed to $480,050 as it does under the current structure. The income table for the proposed tax rates can be viewed here.
Senate: The Chairman’s Mark suggests retaining seven tax brackets for individuals, but lowering the rates to 10%, 12%, 22.5%, 25%, 32.5%, 35%, and 38.5%. Like the House proposal, the top bracket would not be reached for married taxpayers until they have income of $1 million.
Update: The Chairman’s Modification would modify rates to 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. The income schedule would be as follows:
Increasing the Standard Deduction
Of the roughly 143 million tax filers in the U.S., about 48 million currently itemize deductions. The current tax reform proposals would dramatically change that number. Aiming to “simplify” the tax code, the proposals would roughly double the standard deduction and eliminate a number of itemized deductions. As a result, fewer people would be required to file a tax return and many fewer people would benefit from itemizing deductions.
House: The House proposal increases the standard deduction to $24,400 for those who are married filing jointly and to $12,200 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 House proposal would eliminate this deduction.
Senate: The Senate proposal increases the standard deduction to $24,000 for married filing jointly and $12,000 for single taxpayers. The Senate proposal leaves the additional standard deduction for the aged or blind in place.
Under both proposals, only taxpayers with income above the standard deduction amount would be required to file a tax return.
Eliminating the Personal Exemption
To help offset the cost of doubling the standard deduction, both the House and Senate proposals would wholly eliminate the personal exemption. This amount is currently $4,050 for each taxpayer and dependent in 2017.
Eliminating Most Itemized Deductions
Both proposals would eliminate most current itemized deductions, although the plans vary slightly.
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, 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.
Senate: The Senate plan to eliminate itemized deductions is similar, except that it would completely eliminate a deduction for property taxes. The Senate plan would also retain the deductions for medical expenses exceeding 10% of adjusted gross income, alimony, and student loan interest. The Senate plan would also retain the home mortgage interest deduction at the current mortgage debt limit of $1.1 million (for original indebtedness). It would also retain the deduction for personal casualty losses if the loss was due to a natural disaster addressed by a Presidential disaster declaration.
Increasing the Child Tax Credit and Creating a New Family Credit
To offset the considerable impact of the loss of many deductions and the $4,050 personal exemption per person upon families, both proposals would significantly increase the child tax credit.
House: The House proposal 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 $1,000 of the child tax credit would be refundable in 2018.
Senate: The Senate proposal raises the child tax credit to $1,650 per qualifying child. It would also expand the credit to apply to children under the age of 18, instead of 17. Up to $1,000 of the credit would be refundable. Instead of creating a new a family credit, the Senate proposal provides a nonrefundable $500 credit for dependents who do not qualify for the child tax credit. The Senate proposal would also expand the phase-out threshold for credit eligibility.
Update: The Chairman’s Modification would increase the child tax credit to $2,000.
Other Credits and Exclusions
The House proposal would retain the American Opportunity Tax Credit and expand it to apply one-half of the yearly credit amount to a fifth year. The Senate would retain the AOTC at its current level. Both proposals would retain the Earned Income Tax Credit.
Both proposals would allow taxpayers to exclude gain from the sale of a personal residence, but they 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. They would also restrict a taxpayer from using the IRC § 121 exclusion more than once every five years.
Although the initial House proposal included eliminating the adoption credit, a late amendment restored this credit. Current House and Senate proposals would leave the adoption credit intact. Both proposals would eliminate current provisions allowing taxpayers to exclude from income employer-provided transportation fringe benefits and moving expenses. The House proposal would also eliminate the exclusion from income for employer-provided dependent care expenses and achievement awards.
Tax benefits permitted for retirement plans would be largely unchanged by both proposals, although several changes, such as the elimination of IRC § 401k catch-up contributions for high earners are introduced.
Update: The Chairman’s Modification eliminates the proposal to eliminate catch-up contributions for high earners.
Both proposals would eliminate the alternative minimum tax or AMT, both for individuals and corporations.
Estate, Gift, and Generation Skipping Tax
House: The House proposal would initially double the basic exclusion amount allowed for each person. Under this proposal, 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 deceased spouse’s unused exclusion to be used by the surviving spouse. In other words, if both spouses were to die in 2018, they could exclude up to $22.4 million in property from the estate tax.
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. Most significantly, the House proposal would retain the current basis adjustment at death. This allows heirs to receive appreciated assets with the basis adjusted (usually stepped-up) to current fair market value.
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).
Senate: The Senate proposal would also double the basic exclusion amount and retain the step-up in basis. The Senate plan, however, would not repeal the estate tax and generation skipping tax for estates valued greater than the increased basic exclusion.
Lowering the Corporate Tax Rate
The most costly change in both proposals is to lower the maximum corporate tax rate from 35% to 20%. The House proposal would implement this change beginning in 2018. The Senate plan would delay the reduction until 2019. Reducing the corporate tax rate over a 10-year period would cost nearly $1.5 trillion.
Lowering Tax Rates for Pass-through Businesses
Since most small businesses, including farmers, operate as sole proprietors or as pass-through entities such as partnerships or S corporations, lowering the corporate tax rate would not aid them. The House and Senate proposals, however, provide different ways to reduce taxes for these businesses, while at the same time trying to prevent taxpayers from abusing the special provision.
House: The House proposal 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 proposal 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-through 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.
Last minute revisions to the House plan would ensure that even small businesses could benefit from the provisions. Under the revised proposal, 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 current proposal would leave the self-employment tax statute unchanged.
Senate: Under the Senate proposal, taxpayers could generally deduct 17.4 percent of “domestic qualified business income” from a partnership, S corporation, or sole proprietorship. “Domestic qualified business income” would not include an S corporation shareholder’s reasonable compensation. The provision would also limit this deduction for S corporations and partnerships to 50 percent of W-2 wages. This is similar to the wages restriction currently applying to the domestic production activities deduction. The wages limitation would not apply to sole proprietorships.
Update: The Chairman’s Modification would apply the W-2 wage limitation to sole proprietors as well. However, the Modification provides that the wage limitation would apply only to businesses with income greater than $500,000 (MFJ). This would ensure that small businesses without employees could still take advantage of this deduction.
Service businesses would not be able to take advantage of this new 17.4 percent qualified business income deduction, except where income is less than $150,000 (for MFJ). The deduction would be gradually phased out for incomes between $50,000 and $150,000.
Update: The Chairman’s Modification increases the taxable income limit for service businesses to take advantage of the qualified business income deduction to $500,000 (MFJ). The deduction would phase out for the next $100,000 of income (MFJ).
House: The House proposal calls for 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.
Senate: The Senate proposal also expands current expensing options; however, not as significantly. The Senate would allow 100 percent bonus depreciation for five years beginning with property placed into service on September 27, 2017. It would not expand bonus depreciation, however, 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 proposal 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).
Also Significant for Agriculture
Both proposals would retain IRC §1031 like-kind exchange treatment for real property, but eliminate it for personal property, such as farm equipment or breeding heifers. The proposals also eliminate the domestic production activities deduction (DPAD), which is frequently used by agricultural producers, beginning in 2018.
Although both provisions restrict business interest deductions, those restrictions would not apply to businesses with revenue below $25 million (House) and $15 million (Senate). Consequently, most farm businesses could continue to deduct business interest without restriction.
Update: The Chairman’s Modification 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 proposals would also leave intact the current capital gains system, cash accounting (actually expanding it to more businesses), the conservation easement deduction, and income averaging.
Update: The Chairman’s Modification would disallow an employer’s deduction for expenses associated with meals provided for the convenience of the employer on the employer’s business premises
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 alloted for farm program benefits, in 2018 alone.
Other Changes in the Chairman’s Modification (Senate)
The Chairman’s Modification makes a number of changes to the Senate's original proposal, many of them directed toward narrow provisions in the tax code, such as reducing excise taxes on beer and wine or denying deduction for settlements subject to a nondisclosure agreement paid in connection with sexual harassment or sexual abuse. Among the more generally applicable proposals included in the Modification are the following:
- Eliminating the Individual Shared Responsibility Payment.
- Increasing the Educator’s Expense Deduction from $250 to $500.
- Expressing “the sense of the Senate that politically motivated budget cuts are counterproductive to deficit reduction, diminish the IRS's ability to adequately serve taxpayers and protect taxpayer information, and reduce the IRS's ability to enforce the law.”
- 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.
- Extending from nine months to two years the period for returning the monetary proceeds from the sale of property that has been wrongfully levied upon and the period for bringing a civil action for wrongful levy.
- Requiring IRS to publish a simplified income tax return form designated a Form 1040SR, for use by persons who are age 65 or older by the close of the taxable year. The form is to be as similar as possible to the Form 1040EZ.
- Eliminating the ability of individuals to re-characterize contributions to another type of IRA before the due date of the individual’s tax return.
- Imposing a new due diligence requirement on tax professionals when making head of household determinations.
- Limiting the net operating loss deduction to 80 percent of taxable income (determined without regard to the deduction) in taxable years beginning after December 31, 2023 (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.).
The House will likely vote on H.R. 1 this week. The Senate Finance Committee will continue its markup of the “Chairman’s Mark." It is impossible to predict what will happen with tax reform. There will no doubt be many further revisions to these proposals as House and Senate Republicans attempt to successfully enact a common plan. With a few exceptions, proposals would not be retroactive. Consequently, any legislation would impact taxpayers for tax years 2018 and later. As year end approaches, however, taxpayers will be well served by planning with tax reform in mind. If changes are implemented, 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.
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.