Tax Cuts and Jobs Act: What’s In and What’s Out?

Tax Cuts and Jobs Act: What’s In and What’s Out?

The first domino that may eventually lead to a thorough overhaul of the tax law was toppled by the House of Representatives with the release of the Tax Cuts and Jobs Act.

Individual Changes

There would be four brackets of 12%, 25%, 35%, and 39.6%. High-income taxpayers would also be required to “claw back” the benefit of the 12% bracket at a 39.6% rate. This amounts to an increase in tax of $12,420 for single taxpayers and $24,840 for married filing jointly, which will be phased in slowly as income exceeds the $1,000,000 for a single taxpayer and $1,200,000 for a married taxpayer.

Here is a comparison of old versus new rates, first, for single taxpayers:

Next, for married taxpayers filing jointly:

The plan retains the “marriage penalty,” with the start of the 35% bracket, which begins at $200,000 for single taxpayers but at only $260,000 (rather than $400,000, or an amount twice the single bracket) for married couples.

Capital Gain/Dividend Rates

The GOP plan preserves the 0%, 15% and 20% rates on long-term capital gains and qualified dividends, and aligns those rates with the new brackets. First, for single taxpayers:

Income Level	Old Rate	New Rate
$0 – $9,525	0%	0%
$9,526-$38,700	0%	0%
$38,701-$45,000	15%	15%
$45,001-$93,700	15%	15%
$93,701-$195,450	15%	15%
$195,451-$200,000	15%	15%
$200,001-$424,950	15%	15%
$424,951-$426,700	15%	20%
$426,701-$500,000	20%	20%
> $500,000	20%	20%

And then married filing jointly:

Income Level	Old Rate	New Rate
$0 – $19,050	0%	0%
$19,051-$77,400	0%	0%
$77,401-$90,000	15%	15%
$90,001-$156,150	15%	15%
$156,151-$237,950	15%	15%
$237,951-$260,000	15%	15%
$260,001-$424,950	15%	15%
$424,951-$480,050	15%	15%
$480,051-$1,000,000	20%	20%
> $1,000,000	20%	20%

The 3.8% “net investment income tax” that was added to the law as part of Obamacare remains in place. Thus, the top rate on long-term capital gains and dividends is more accurately represented as 23.8%.

Standard Deduction

The standard deduction increases from $6,350/$12,700 (single/MFJ) to $12,000/$24,000.

Personal Exemptions

Personal exemptions would be eliminated under the House bill. The Child Tax Credit will be increased from $1,000 to $1,600, though the refundable amount will not rise. In addition, a new $300 credit will be allowable for non-child dependents, and for the next five years, a “family flexibility” credit of $300 will be allowed for each spouse. In addition, the income limits at which a taxpayer starts to lose the Child Tax Credit will be increased from $75,000 to $115,000 for single taxpayers and $110,000 to $230,000 for married taxpayers.

Itemized Deductions

The following itemized deductions would be eliminated under the House bill:

• Medical expenses
• Personal casualty losses (other than those incurred in a federally declared disaster area)
• State and local income taxes
• Unreimbursed employee expenses
• Tax preparation fees

In addition, on any new mortgages, only the interest on the first $500,000 of acquisition debt would be deductible. No interest deduction would be permitted on home equity debt or a second home. The deduction for real estate taxes is retainedbut limited to a maximum of $10,000.

Page 1 Deductions

The bill eliminates deductions for the following:

• Alimony (and alimony income becomes tax-free)
• Student loan interest
• Moving expenses

Pass-Through Business Income Tax Rates

The House bill creates a unified maximum “business tax rate” on the flow-through income of owners of S corporations, partnerships and sole proprietorships. The proposal comes with many caveats, however.

• So-called “passive” investors in business are entitled to the 25% rate on the full income from the business.
• Any owner who “materially participates” in the business defaults to having 70% of the income taxed at regular rates, with only 30% of the income subject to the 25% business rate. These owners, however, may use a formula to establish, based on the “facts and circumstances” of their particular business, that more than 30% of the income from the business was attributable to capital and should be taxed at 25%.
• Owners of service businesses – like accountants and lawyers – begin with the presumption that none of the income is subject to the 25% rate, but again, the owners in these businesses can elect to apply a formula to justify a higher percentage.

Individual Alternative Minimum Tax

The alternative minimum tax is eliminated.

Estate Tax

The proposed legislation immediately increases the exemption amount from $5.6 million to over $10 million (over $22 million if married). After 2023, the estate tax would be eliminated entirely, while preserving a stepped-up fair market value basis to the heirs.

Business Tax Changes

Corporate Tax Rates

The corporate income tax rate would be reduced from 35% to 20%.

Expensing of Asset Acquisitions

For the next five years, the House bill would permit full expensing of all assets with a useful life of 20 years or less. In addition, the Section 179 deduction limit would be increased from $500,000 to $5,000,000.

Method of Accounting

The House bill would greatly expand the availability of the cash method. A C corporation (or partnership with a C corporation partner) would be permitted to use the cash method provided the average gross receipts for the preceding three years does not exceed $25 million. In addition, all businesses with average gross receipts of less than $25 million will be permitted to use the cash method even if the business is required to maintain inventories.

Limitation on Interest Expense

For any business with average gross receipts in excess of $25 million, the deduction for interest expense would be limited to 30% of the company’s EBITDA. Any excess interest expense could be carried forward for five years.

Net Operating Losses

For losses generated beginning in 2018, any NOL carryforward would only be permitted to offset 90% of a taxpayer’s taxable income. In addition, NOL carrybacks would be eliminated.

Modification of Business Credits

All business credits – save for the R&D Credit and Credit for Low-Income Housing – would be eliminated.

International Tax Changes

Shift Away from Deferral System

All dividends from a more than 10% owned foreign subsidiary would be exempt from the income of a U.S. parent. No foreign tax credit or deduction for foreign taxes would be permitted.

Deemed Repatriation of Prior Foreign Earnings

To facilitate the shift away from the deferral system, there would be a one-time deemed repatriation of the Earnings and Profits (E&P) of a foreign subsidiary (as of the end of 2017) to a U.S. parent. The portion of the E&P comprising cash or cash equivalents would be taxed at 12%, while the portion of the E&P representing illiquid assets would be taxed at 5%. The U.S. parent may elect to pay the tax in eight annual installments of 12.5% each.

• Deemed repatriation of accumulated untaxed earnings as of November 2, 2017 or December 31, 2017. Liquid accumulated earnings will be taxed at 12% in the U.S. and illiquid accumulated earnings will be taxed at 5% in the U.S. There will be no foreign tax credit available on this deemed repatriation, nor will this income reduce an Overall Foreign Loss.

International Provisions

• Effective taxable years starting 1/1/18 participation exemption on foreign source dividends to 10% or more U.S. shareholders. These dividends are deducted from the U.S. Shareholders tax base.

• Repeal of Section 902 Indirect Foreign Tax credit. The Section 960 credit is still available on Subpart F income.

• New category of Subpart F type income for U.S. Shareholders of CFCs. This category provides for current U.S. taxation on 50% of “foreign high return amounts.”

• Limitation on deductibility of interest paid to foreign related party.

• 20% excise tax on most foreign related party payments in excess of $100,000,000.

• Income from sale of inventory which was formerly sourced 50% to location of production and 50% to a location of sale will be entirely sourced to the country of production.

• De Minimis rule for Subpart F adjusted for inflation.

• Constructive ownership rules will allow for the attribution of ownership from a foreign person to a U.S. person in specific instances.

Conclusion

Mark-up of the House bill is scheduled to begin on Monday, November 6. In addition, the Senate may publish its vision of tax reform as early as next week.

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