As a follow up to my prior blog post entitled “New Tax Legislation”, last Thursday, November 9, 2017, the House Ways and Means Committee voted along party lines (24-16) in favor of passing the amended Tax Reform Bill to the full House. Since its unveiling on November 2, 2017, however, the House Ways and Means Committee made several amendments to the original legislation. In addition, Senate Republicans released their own proposed legislation on tax reform. In this blog, we will take a look at the revisions to the House Bill, the new Senate Bill, and of course, some key differences between them.
Amendments from the House Ways and Means Committee
Adoption Tax Credit
While the Adoption Tax Credit was reinstated, it was not without some drama. While the Democrats proposed an amendment that would have restored the credit, Republicans voted it down. However, after pushback from religious conservatives, the Republicans ended up reinstating the credit. As a refresher, the initial proposal would have eliminated the Adoption Tax Credit that allows a credit of up to $13,750 per child for qualified adoption related expenses.
Flex Spending Accounts for Childcare
Another interesting reinstatement came after much outcry from constituents regarding the elimination of Flex Spending Accounts for Childcare. An amendment passed earlier in the week restored the accounts, which allows families to save up to $5,000 pre-tax for child care expenses. However, this restoration is limited to the next five years only.
Child Tax Credit
While the Child Tax Credit remains at its increased level of $1,600, up from $1,000, a valid Social Security number will now be required to receive it. Currently, a Child Tax Credit can be claimed with a Social Security Number (issued by the Social Security Administration) or with an Individual Taxpayer Identification Number (“ITIN” – issued by the IRS) for certain nonresident and resident aliens. In other words, an ITIN can be obtained regardless of immigration status, whereas a Social Security Number can only be issued to citizens, green-card holders, and other limited groups, such as refugees and people granted political asylum. The motivation behind this was to eliminate tax credits for illegal immigrants.
Medical Expense Deductions
Presently, individuals are allowed to deduct medical expenses (including long-term care insurance premiums) that exceed 10% of their adjusted gross income. (This floor was actually raised from 7.5% under the Affordable Care Act). The initial tax legislation eliminated this deduction, and even after much debate this week, that elimination remains in the final version from the Committee.
Corporate Tax Changes
Excise Tax on Transactions with Related Foreign Entities
The initial legislation had a 20% excise tax (tax charged on a specific item) on payments from U.S. companies to related companies in foreign countries for goods produced there (ie: Ford making payments to its Mexican affiliate for cars produced in Mexico). The intent of this tax was to prevent multi-national companies from reducing their tax burden by transacting with foreign affiliates. After much outcry, however, this tax was greatly reduced. The initial legislation was expected to raise $155 billion in revenue over the next 10 years, but the change will greatly reduce anticipated revenue by $148 billion over that same period. This change is also significant because the budget passed allows the tax legislation to increase debt by $1.5 trillion over the next decade. In order for the Bill to pass with a simple majority vote in the Senate, the House Bill cannot exceed that $1.5 trillion limit, so $148 billion less revenue is significant. (The process of reconciliation, which allows certain budgetary legislation with a simple majority vote, would not allow an increase in the debt of more than $1.5 trillion over the next decade).
Companies that have assets overseas must now repatriate them. Previously, certain profits earned abroad could be earned without paying U.S. taxes. The initial legislation required a minimum tax, regardless of where the profit was earned, and offered an initial tax break to bring the funds earned back into the U.S. Now that “repatriation rate” was increased in recent amendments. The one-time tax on these repatriated assets would increase slightly from 12% to 14% in liquid assets and from 5% to 7% on illiquid assets.
Many corporations in the US, including many small businesses, are taxed as “pass through” entities, meaning that the profits of the company “pass through” to the individual owner’s tax return and are taxed at individual rates. An estimated 70% of the income that passes through entities will still be taxed at the individual owner’s rate. However, the initial legislation capped the tax rate on the remaining 30% of flow through business income at 25%. The recent amendment would further reduce the rates that the owner would pay tax on their “pass through” business income. Specifically:
- 9% rate on the first $75,000 on business income, down from the current 12% rate, so long as the individual does not make more than $150,000 total.
- The new rate would be slowly introduced, dropping every two years until it reaches 9% in 2022.
- After $225,000 of income, there would be a surcharge on the additional income in order to recoup funds given at the lower rate.
Carried interest is the share of profits that managers of private equity and hedge fund investments receive as compensation. It is viewed as incentive compensation for the managers. However, there is a “carried interest” loophole that is utilized heavily by these managers to gain a tax advantage. By holding assets for more than a year, the profits paid to these managers would be taxed at the lower capital gains tax rate of 20% rather than the ordinary individual income tax rate (as high as 39.6%). This controversial loophole has been criticized for years, by everyone from Warren Buffet to Donald Trump. However, the initial proposed legislation did nothing to close the loophole. Now a recent amendment tweaks the provision, by requiring certain assets to be held for a longer period of time (now three years) before qualifying for the lower tax rate. Given the time that many of these types of investments are held, some are criticizing it as a superficial fix that ultimately will not close the loophole for the majority of those that utilize it.
In a somewhat surprising move, the initial proposal targeted university endowments (universities are typically tax exempt organizations). The initial proposal would charge a 1.4% tax on investment income for endowments that had at least $100,000 of endowment per student. This amendment raises the endowment level to $250,000 per student, giving some breathing room to smaller endowments.
Senate Tax Reform
Individual Tax Brackets
The Senate bill would retain the same number of individual tax brackets – seven – but would lower the associated rates. Presently, the rates are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The new rates would be 10%, 12%, 22.5%, 25%, 32.5%, 35% and 38.5%.
Standard Deduction and Personal Exemptions
Just like the House Bill, the standard deduction will (almost) double, from $6,350 per person to $12,000. (For married filing joint couples, it would increase from $12,700 to $24,000). The personal exemption of $4,050 per each member of the household would also be eliminated in the Senate Bill.
An estimated 30% of taxpayers choose to itemize their deductions. In light of the standard deduction doubling, that amount will very likely change, which means that less people would be impacted by any changes to the itemized deductions proposed in the new Act. While the House Bill eliminated or reduced many of the itemized deductions, the Senate Bill left many more in place, but still modified or eliminated some. The following are certain itemized deductions that would change, or are different than the House Bill.
- Alimony/Maintenance: The Senate Bill would not change the current law regarding the deductibility of maintenance payments (presently tax deductible to the payor and includible in the taxes of the recipient).
- Mortgage Interest: The Senate would preserve the Mortgage Interest Deduction at its current level, which allows one to deduct mortgage interest on debt up to $1 Million. The House Bill reduced the maximum amount of debt that mortgage interest can be deducted from $1,000,000 to $500,000.
- Charitable Donations: The Senate Bill would still allow for charitable donation deductions.
- Property Taxes: Local real estate taxes will no longer be an itemized deduction in the Senate bill, even though the House bill capped the previously unlimited deduction at $10,000.
- State and Local Taxes: Just like the House Bill, the Senate Bill eliminates the deduction for state and local taxes. Again, this component has faced strong opposition from House members from states with high state and local taxes. The Senate does not have as many Republican Senators from those states as compared to the House.
- Student Loan Interest: Although the House Bill eliminated the deduction for interest on student loans, the Senate will still allow eligible taxpayers to deduct up to $2,500 a year in interest on student loans.
- Medical Expenses: The House Bill eliminated the deduction for Medical Expenses. In the Senate Bill, eligible taxpayers can still deduct medical expenses that exceed 10% of a taxpayer’s adjusted gross income.
A tax credit reduces the actual amount of taxes owed, which is different than deductions and exemptions which reduce the amount of taxable income. To that end, here is how the Act will impact those credits.
Child Tax Credit
The child tax credit (which applies to dependent children 16 and under) will increase by $650, from $1,000 to $1,650, which is $50 more than the House Bill. However, it does not appear to include the Non-Child Dependent Credit of $300 that the House Bill included.
Family Flexibility Credit
The Senate would not provide this $300 credit that each spouse could claim for a total of $600 for a married filing joint return that the House Bill proposes.
Earned Income Tax Credit
Similar to the House Bill, the Senate Bill does not extend the Earned Income Tax Credit, which is aimed at lower income households, and is a credit equal to a percentage of earnings, up to a certain amount, before phasing out.
The Senate Bill would preserve the Adoption Credit, which allows individuals that incur certain expenses to adopt a qualifying child to be eligible for a tax credit up to $13,570 per child. (As mentioned above, the House is now in agreement with this).
The Alternative Minimum Tax, or AMT, is perhaps one of the most confusing aspects of the tax code. The AMT requires individuals who earn over $130,000 to calculate their taxes two times, once under the regular rules and a second time under a second set of rules, to determine taxable income without certain deductions allowed under the “regular” rules. Similar to the House Bill, the Senate Bill would also eliminate the AMT altogether.
The Estate Tax – the tax levied upon one’s estate, before it passes to their heirs – is imposed on estates that, for 2017, exceed $5.49 million per individual. This exemption would double under the Senate Bill, but not be eliminated after six years, like the House Bill proposes. The only adjustments would be for inflation.
The corporate tax rate would drop from 35% to 20%, just as it did in the House version of the bill, but the Senate would implement this change in 2019, as opposed to the house, which would implement it immediately.
With the key distinctions between the House and Senate Bills, as well as the previously stated Republican goal of passing legislation by Thanksgiving, expect additional modifications to come about in the coming days and weeks. Of course we will continue to monitor those updates and post about the developments, so be sure to check back.