Tax Reform – What Are The Changes If It’s Enacted Into Law?

On Saturday, December 2, 2017, the Senate garnered 51 votes to pass its proposed Tax Reform Bill. It now goes to the Joint Committee on Taxation, a joint creature of the Senate and the House, for reconciliation to try to work out the differences in the two proposed versions of the Tax Bills.
 
The Senate Bill contains both tax and non-tax legislation. The following explains the basics of the tax and non-tax provisions of the Senate’s Bill. The House is also working on its own version of the Bill. The specifics of the House legislation are not settled at this time and could impact the way these provisions are worded in the final version of the legislation.
 
TAX PROVISIONS
 
Business Taxation
 
The most significant proposed tax change is the tax rate for large corporations, which would fall from 35 percent to 20 percent starting in 2019. This would presumably place the US on an equal footing with other western nations in terms of their business income tax structure.
 
The second most significant change is that the Bill would transform the tax system on business income from a worldwide approach to a territorial system. Currently, U.S. companies are taxed on all income earned throughout the world. The territorial system would change this, focusing taxation of businesses primarily on their earnings in the U.S., a change corporations have advocated for many years. Historically, the U.S. was the only nation to utilize the worldwide taxation approach to companies and individuals.
 
The Bill would also allow companies to bring back any money they have stored overseas at a tax rate of 14.5 percent.
 
Additionally, in an attempt to spur new investment by American businesses, companies would also be able to write off most of their cost for new buildings and other investments for the next five years. The usual method for companies to recover the cost of buildings and other investments is through a deduction for depreciation over many years.  This makes this particular change significant, especially for large corporations seeking to expand their operations.
 
The Bill also would lower the tax on non-professional service companies that are structured as pass-through entities. This includes S corporations, limited liability companies, and partnerships. The Bill allows owners of such entities to deduct 23 percent of their pass-through earnings. There is an exception for owners of professional service businesses. Owners of professional corporations would only be allowed to take the 23 percent deduction if their income is less than $500,000. If left unprotected, the Bill would create a very strong incentive for owners of pass-through entities to not pay themselves a salary because the salary would be taxable at one of the new tax bracket rates.  By not taking a salary, the business owner would utilize the overall lower effective rate on all income generated by the entity resulting from the 23% deduction of all pass through earnings. In addition, the incentive that exists today, which is to avoid the 15.3% Social Security Tax on Self-Employment income, would continue under the new law. The Bill does have some measures built into it to prevent this from happening.
 
Individual Income Taxation
 
The top tax rate for higher income taxpayers would fall under this plan from 39.6 percent to 38.5 percent. The other tax brackets would also be slightly lower than under current law. However, some of the deductions which save taxpayers taxes – particularly in the Midwest – would be limited, which would result in net higher taxes for some starting in 2018, rather than lower taxes.
 
At the moment, Americans are able to deduct $4,050 as a “personal exemption” for themselves, their spouse and each dependent. The Senate Bill eliminates the personal exemption entirely. Instead, the Bill expands the standard deduction so the first $24,000 of income for a married couple ($12,000 for an individual) would not be taxed. The Bill also would bump up the child tax credit from the current $1,000 to $2,000. The overall effect here is that most people are better off, but not everyone.
 
Taxpayers would still be able deduct their contributions to charity under the Bill. In addition, the deduction for mortgage interest would still be available. The deduction for state and local property taxes would be capped at $10,000.
 
The threshold for deducting medical expenses would be reduced from medical expenses exceeding 10 percent of adjusted gross income down to 7.5 percent.
 
Under the current law, if a taxpayer owns and has lived in their home for two out the past five years and they sell the home, they can exclude up to $500,000 of capital gain. Under the proposed Bill, a taxpayer would have to own and live in the home for five out of the last eight years. This change will discourage “house flippers” and home builders who typically build or rehab, live in the home for two years, and then sell it off at capital gains tax rates, repeating this process every two years. With respect to Michigan construction law in particular, this change may serve to further discourage the abuse of builders failing to obtain a residential builder’s license by “flipping” the house as an unlicensed Michigan builder.  Currently, the tax code is more favorable to unlicensed builders who may utilize the exemption to build houses under the veil of their own personal use and then sell them to unsuspecting buyers after living in the home for a short period.
 
The House Bill, unlike the Senate Bill, would eliminate the tax deduction for ex-spouses that pay alimony for divorces occurring on and after January 1, 2018.
The deductions for moving expenses, casualty losses, biking to work and tax preparation have all been eliminated in the proposed Bill.
 
Estate Taxation
 
Under present law, up to $5,490,000 can be excluded from the Estate Tax per individual. This number would be doubled under the Bill, but not eliminated as rumored.  
 
NON-TAX CHANGES
 
The Bill would eliminate the individual mandate under the Affordable Care Act. The Congressional Budget Office estimates this will result in 13,000,000 Americans losing health insurance.
 
The Bill would also allow for oil drilling in the Alaskan Arctic Wildlife Refuge.
 
ACTION STEP
 
We urge business and individual clients alike to review their own situation in light of the Senate Tax Bill, and to begin to consider what changes in their future plans may be necessary to take advantage of the positives in the Bill and avoid the negatives. For example, if you are thinking about constructing a building or making long-term capital expenditures, doing so in the next five years makes sense. Additionally, if you live in a home that has greatly increased in value, and you are thinking of selling, beware of the five of eight year “live-in” requirement for exclusion of capital gain that would be imposed by the Bill.
 
Please contact us if you have questions about the likely impact of the tax legislation on your business or personal situation.