On Saturday, Dec. 2, the Senate version of the Tax Cuts and Jobs Act was passed by a 51 to 49 vote. The vote, taking place at 2 am, was another major step down the road of tax reform. The Senate plan, which moved from the Senate Finance Committee to the Senate Floor on the same day that the House of Representatives voted in favor of their version of the bill, proposes to make significant changes to the tax code. However, because the two versions of the bill differ they will need to be reconciled through a “conference” committee before being signed by the President.
Individual Income Tax Changes
Looking first to individual income tax, there are several key differences between the Senate and House plans. Where the House plan proposes to reduce the number of taxable brackets from seven to four, the Senate plan maintains seven brackets but reduces the taxable percentage for each. Furthermore, where the House has proposed permanent individual income tax reductions, the Senate plan’s amendments would eventually expire.
Another major difference between the House and Senate plans is the treatment of pass-through income. While the House proposed a special tax rate for a portion of pass-through income, the Senate plan proposes a deduction for pass-through income defined as qualified business income (QBI). Currently, pass-through income is taxed at the tax rate of the individual receiving the income. Under the Senate plan the pass-through income rates wouldn’t change, but a deduction of 23 percent of QBI would be allowed. This deduction would generally be limited to 50 percent of the taxpayer’s pro rata share of W-2 wages of the partnership or S corporation, or 50 percent of the W-2 wages of a sole proprietorship. These limits only apply to taxpayers with income greater than $250,000 for individuals or $500,000 for married couples filing jointly. Other limitations apply to taxpayers earning QBI from certain enumerated services, partnerships, and S corporations.
The AMT, repealed in the House plan but not the Senate, the estate tax, phased out in the House plan but not the Senate, and the individual mandate for healthcare, repealed in the Senate plan but not the House, are among the many other differences between the two bills that will have an impact on individuals.
Corporate Tax Changes
There are also a number of differences between the House and Senate plans on the corporate tax side as well. For example, both the House and Senate plans propose to replace the current income tax brackets of 15 percent, 25 percent, 34 percent, and 35 percent with a flat tax rate of 20 percent. However, unlike the House plan which goes into effect in 2018, the Senate tax rate would not become effective until Jan. 1, 2019.
Another significant proposed reform would limit how taxpayers may utilize net operating losses (NOL). Under the current law, taxpayers may carryback an NOL for two years and carryforward up to 20 years. Under the proposed Senate reforms taxpayers would be permitted to carryforward NOLS indefinitely, but the carryback provision would be removed. Also, beginning Jan. 1, 2023 the Senate plan would limit the utilization of an NOL to 80 percent of the taxpayer’s taxable income for the year.
NOL carrybacks would also be repealed under the House plan, with an exception allowing small business and farms to carryback the NOL for one year. The House plan would also allow for indefinite carryforwards of NOLs, but would limit the taxpayer to utilizing up to 90 percent of their net taxable income.
Both the House and Senate plans propose to move the US to a territorial tax system for international taxes. Currently, the US taxes all of a resident’s global income through a worldwide system of taxation. Under a territorial system, income would only be taxed where it is earned. However, as with any major reform, the devil is in the details. Both the House and Senate plans have similar provisions, but some of the specific provisions differ.
For example, certain US companies “locking out” income by not repatriating it, will be deemed to have repatriated the income under both plans. However, the House and Senate have each proposed a different taxable rate for that income. Another example of a detail with major impacts is the tax on US subsidiaries owned by foreign corporations. Under the Senate plan, and unlike the House plan, foreign companies would be required to make certain add backs when calculating their taxable income. The proposed anti-abuse rules surrounding base erosion are also significantly different between the two plans.
There is still a long way to go before tax reform is finalized, even though both Chambers of Congress have passed a version of the bill. Regardless of the final form of this legislation the impacts will be significant. Should you have any questions regarding complex tax issues please contact Steven Miller, alliantgroup, LP’s National Director of Tax, at Steven.Miller@alliantgroup.com.