Tax Reform Headed to President for Final Approval
On December 13, 2017, House and Senate Republicans reached a compromise on tax reform legislation, the “Tax Cuts and Jobs Act” (H.R. 1). Subsequently, the conference report was agreed to by House and Senate representatives and was released on December 15, 2017. The conference report reflects reconciliation of various provisions between the House bill and the Senate amendment. The House and Senate both passed H.R. 1 yesterday (Tuesday, December 19th). However, due to procedural errors, the House was required to re-vote and approve the bill again today. The President is expected to sign the bill before the end of the year.
Key provisions of the report affecting individual taxpayers include lower tax rates, higher standard deductions, and limitations on certain itemized deductions such as state and local taxes. For corporations, the tax rate is reduced to a flat 21 percent and the alternative minimum tax is repealed. Certain partners and shareholders will be eligible to deduct 20 percent of their “qualified business income” income from pass-through entities. Foreign taxation shifts to a territorial system, and the deemed repatriation tax rate is 15.5 percent for earnings held in cash or cash equivalents, and 8 percent on all other earnings. The report also includes increases in certain property expensing and depreciation limits, and changes to accounting methods. Highlights include:
- The highest individual tax rate will be reduced from 39.6% to 37%.
- Individuals will be allowed to deduct a combined total up to $10,000 of property taxes and/or state income taxes.
- The individual alternative minimum tax (AMT) will remain, but the exemption amounts are being increased and the phase out threshold amounts are being increased to $500,000 for individuals and $1,000,000 for couples.
- The corporate tax rate will be reduced to 21% starting in 2018, with the AMT for corporations being repealed.
- Individuals receiving qualified pass-through business income from entities such as partnerships and S corporations generally will be able to deduct 20% of this income from their taxable income. This deduction will be subject to various limitations and applicable to only certain income sources.
- The estate tax will remain in place; however the lifetime exemption is increased to roughly $10 million per individual (and will be indexed for inflation).
- Mortgage interest will be deductible based on indebtedness up to $750,000.
- Medical deductions are retained and the Obamacare mandate tax will be repealed.
More detail regarding proposed taxation of Individuals, Corporations and Businesses (Partnerships and Pass-Through Entities) is provided below, along with information related to Cost Recovery Provisions (Depreciation) under the proposed legislation.
To discuss the impact that the Tax Cuts and Jobs Act (H.R. 1) will have on you and your business, please contact your WNDE tax professional.
The conference report includes a reduction of individual rates, which are generally effective January 1, 2018, and expire December 31, 2025. For individuals:
- The top individual rate will be 37 percent for joint filers with more than $600,000 of taxable income and single filers with more than $500,000 of taxable income.
- The standard deduction will be increased to $24,000 for joint filers and $12,000 for single filers. The personal exemption is repealed through 2025.
- The Child Tax Credit is increased to $2,000 per qualifying child, with up to $1,400 being fully refundable. An additional $500 credit may be available for other dependents. The Credit begins to phase out for joint filers with adjusted gross income exceeding $400,000 and single filers with adjusted gross income exceeding $200,000.
- The adjusted gross income limitation for cash contributions to certain charitable organizations is increased to 60 percent.
- The itemized deduction for medical expenses is made more available for taxpayers under age 65 by reducing the adjusted gross income floor for 2017 and 2018 to 7.5 percent for all taxpayers.
- The itemized deduction for state and local taxes has been limited to $10,000 for the aggregate sum of real property taxes, personal property taxes, and either (i) state or local income taxes or (ii) state and local sales tax.
- The itemized deduction for mortgage interest has been reduced to only permit the deduction of interest on acquisition indebtedness not exceeding $750,000. The additional interest deduction for home equity indebtedness is repealed through 2025. Debt incurred on or before December 15, 2017, is grandfathered in to the current limitations Further, taxpayers who entered into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and who purchase such residence before April 1, 2018, are also eligible for the current higher limitations.
- All miscellaneous itemized deductions subject to the two percent adjusted gross income floor have been repealed through 2025. This includes the miscellaneous itemized deductions for investment fees and expenses, tax preparation fees, and unreimbursed employee business expenses, among others.
- The overall limitation on itemized deductions enacted in 1990, often called the “Pease limitation” (named after former Congressman Donald Pease) has been repealed through 2025.
- The lifetime exemption for estate and gift taxes is increased to $10,000,000 as of 2011 (and adjusted forward from there for inflation).
- The shared responsibility payment for individuals failing to maintain minimum essential health insurance coverage has been reduced to $0 beginning after December 31, 2018.
- The individual alternative minimum tax (AMT) has been retained. However, the exemption amounts have been increased to $109,400 for joint filers and $70,300 for single filers. The current exemptions are $83,800 and $53,900 for joint and single filers, respectively. (The House bill would have repealed the individual AMT.)
- The earlier Senate proposal to require the basis of specified securities be determined on a first-in, first-out basis is not included in the conference report. The Senate had sought to prevent taxpayers from specifically identifying the lot sold in the sale of specified securities.
- The corporate tax rate has been reduced by forty percent—from thirty-five to twenty-one percent. The corporate AMT has been repealed.
- Net operating losses (NOLs) are limited to 80 percent of taxable income and may only be carried forward, indefinitely. NOLs are likely to increase based on expanded expensing of capital investments in certain property – including property that had previously been used by, and provided benefit to, another taxpayer. The property must be placed in service between September 27, 2017, and January 1, 2023, to be deductible. The 100-percent allowance is phased down by 20 percent per year beginning in 2023.
- Under the conference report, shareholders of S corporations may obtain a deduction equal to the lesser of 20 percent of “qualified business income,” which requires a complex computation, with respect to such trade or business, or 50 percent of the W-2 wages with respect to such business. Further, a nonresident alien individual may now be in indirect shareholder of an S corporation as a potential current beneficiary of an electing small business trust.
TAXATION OF PARTNERSHIPS AND PASS THROUGH ENTITIES
- For tax years beginning after December 31, 2017, partners and shareholders of S corporations and LLCs may deduct up to 20 percent of their “qualified business income” from the partnership or S Corporation. For taxpayers in a service business (e.g., law, health, consulting or accounting), no deduction is permitted unless their taxable income is less than $157,500 ($315,000 if married filing a joint return).
- Under the conference agreement, application of Section 1031 is limited to transactions involving the exchange of real property that is not held primarily for sale. The like-kind exchange rules will no longer apply to any other property, including personal property that is associated with real property. This provision will be effective for exchanges completed after December 31, 2017. However, if the taxpayer has started a forward or reverse deferred exchange prior to December 31, 2017, section 1031 may still be applied to the transaction even though completed after December 31, 2017.
- The technical termination rules under section 708(b)(1)(B) are repealed for tax years beginning after 2017. No changes are made to the actual termination rules under section 708(b)(1)(A).
- Under general rules, gain recognized by a partnership upon disposition of a capital asset held for at least one year is characterized as long-term capital gain. Further, the sale of a partnership interest held for at least one year will generate long-term capital gain, except to the extent section 751(a) applies. Under the conference agreement, long-term capital gain will only be available with respect to “applicable partnership interests” to the extent the capital asset giving rise to the gain has been held for at least three years.
COST RECOVERY PROVISIONS
- Property defined under section 168(k) and placed in service after 2007 and before 2020 is currently allowed a 50 percent deduction for the taxable year in which the property is placed in service The conference report would allow full expensing for the property placed in service after September 27, 2017, for a five-year period. There would be a phase down of the full expensing by 20 percent per year for property placed in service after January 1, 2023 (January 1, 2024 for longer production period property). Bonus property previously had only been allowed for new property. The conference report expands bonus property to include used property.
- Annual depreciation limitations for luxury automobiles under section 280F is currently $3,160 in the first year, $5,100 in the second year, $3,050 in the third year, and $1,876 in the fourth and later years. The conference report was significantly increased under the conference report to $10,000 in the first year, $16,000 in the second year, $9,600 in the third year, and $5,760 in the fourth and later years.
- Computer or peripheral equipment is removed from the definition of listed property and no longer subject to the heightened substantiation requirements currently required.
- Under the conference report, the MACRS recovery periods maintains the present law general recovery MACRS recovery periods of 39 years for nonresidential real property and 27.5 years for residential rental property. The Senate amendment had lowered the life to a 25-year recovery period for all real property.
- Definition of qualified improvement property eliminates the separate definitions for “qualified leasehold improvement”, “qualified restaurant property”, and “qualified retail improvement property”. The 15-year recovery period remains unchanged.
- The conference report increases the expensing limitation from $500,000 to $1 million. Further, the phase out under the conference report would begin when the amount of the property exceeds $2.5 million, up from the $2 million dollar amount.
- The section 179 definition of qualified real property under the conference report is expanded to include improvements to nonresidential real property including roofs, heating, ventilation, air conditioning, fire protection, alarm systems, and security systems.