November 3, 2017 Highlights of House 'Tax Cuts and Jobs Act' On November 2, 2017, House Ways and Means Committee Chairman Kevin Brady (R-TX) released a comprehensive tax reform bill called the "Tax Cuts and Jobs Act." The bill will be the subject of Committee consideration next week, kicking off formal tax committee action on the first such overhaul of the US tax system in over 30 years. Senate Finance Committee Chairman Orrin Hatch (R-UT) announced that he plans to release a Senate Republican version of a tax reform bill after the Ways and Means Committee completes its work in as soon as a week. It is possible the Senate Finance Committee could consider Hatch's plan at the same time the Ways and Means Committee product is on the House floor in an effort to make as much progress as possible on the legislation before Thanksgiving. Brady's plan would immediately and permanently reduce the statutory corporate tax rate to 20% while eliminating many current business tax benefits, and move to a territorial system of taxing foreign earnings with anti-base erosion provisions targeting both US-based and foreign-based multinational companies. Significantly, the bill includes a new excise tax on otherwise deductible payments from US companies to related foreign companies that acts similar to the border adjustment in the House Republican Blueprint, but only for outbound payments. The adoption of a territorial tax system includes a one-time transitional tax on accumulated foreign earnings, determined as of November 2, 2017, or December 31, 2017 (whichever is higher), at 12% for cash and cash equivalents and 5% for illiquid assets, and payable over up to eight years. In addition to individual tax rates set at 12%, 25%, and 35% under the September 27 "Unified Framework" on tax reform, the current 39.6% rate would be retained for couples with income over $1 million. Many current individual tax benefits would be eliminated or limited, and the personal exemption would be repealed. The standard deduction would be roughly doubled to $12,200 for individuals and $24,400 for married couples. A Ways and Means release said "a typical middle-income family of four, earning $59,000 (the median household income), will receive a $1,182 tax cut." The bill does not include major changes to 401(k) plan contributions that had been under discussion, but would impose limitations on the mortgage interest deduction, repeal the deductibility of state and local income and sales taxes, and cap the property tax deduction at $10,000. The Joint Committee on Taxation issued a conventional "static" revenue estimate showing the bill as adding $1.487 trillion to the deficit over 10 years; a "dynamic" estimate reflecting the macroeconomic effects of the bill is not expected until later, possibly after Ways and Means completes its consideration of the bill. The FY 2018 budget resolution provides reconciliation instructions for a tax bill that can add to the deficit by no more than $1.5 trillion over 10 years, and the House bill demonstrates the types of trade-offs necessary to lower rates and meet other goals of tax reform within that revenue constraint. Many provisions in the bill overlap with those included in former House Ways and Means Committee Chairman Dave Camp's (R-MI) 2014 tax reform bill. The House bill, which reflects months of negotiations between congressional Republican leaders and the Administration, is scheduled to be marked up by the Ways and Means Committee beginning on Monday, November 6, at 12:00 p.m. Chairman Brady has said there may be changes to the bill before the start of the markup, and that a Chairman's Mark may be released as soon as November 3. The goal is for both the House and Senate to pass their respective tax reform bills by Thanksgiving and to resolve their differences and agree to a single bill before the end of the year. Highlights of the House bill are grouped into the following main topics below: — Corporate Corporate Consistent with the Unified Framework, the House bill provides for: 20% corporate tax rate — The 20% rate would be set without a phase-in or phase-out. While the House bill provides no effective date, the section-by-section summary provides that the rate would be effective for tax years beginning after 2017. 100% expensing — Taxpayers would be able to expense 100% of the cost of qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023 (with an additional year for certain qualified property with a longer production period). Qualified property would not include any property used by a regulated public utility company or any property used in a real property trade or business. Repeal of corporate AMT — The corporate alternative minimum tax would be repealed under the House bill. Taxpayers could claim a refund of 50% of the remaining credits (to the extent the credits exceed regular tax for the year) in tax years beginning in 2019, 2020 and 2021. Taxpayers would be able to claim a refund of all remaining credits in the tax year beginning in 2022. The provision would generally be effective for tax years beginning after 2017. R&D tax credit and LIHTC — The research and development (R&D) tax credit and Low-Income Housing Tax Credit (LIHTC) would be preserved without modification from current law. Section 199 — The domestic production deduction relating to deductions for qualifying receipts derived from certain activities performed in the United States would be repealed for tax years after 2017. Interest limitation — Multiple limitations would be provided through revisions to current Section 163(j) and a new Section 163(n), with a small business exception keyed to businesses satisfying a gross receipts test of $25 million. — Section 163(j) would be "revised" and expanded to limit the deduction for net interest expense of all businesses. The limitation would apply to net interest expense that exceeds 30% of adjusted taxable income (ATI). The bill would repeal or modify many other deductions and exclusions, including: Section 179 expensing — This benefit would be expanded by increasing the dollar limitation from $500,000 to $5 million and increasing the phase-out amount from $2 million to $20 million. Entertainment expenses — The current rules on deductibility of entertainment expenses would be tightened significantly. Like-kind exchanges — This provision would be modified by limiting like-kind exchanges to those involving real property only. Like-kind exchanges currently underway would be under a transition rule to allow for the like-kind exchange to be completed. Otherwise, the limitation would be effective for transfers after 2017. Net operating losses — The deduction of an NOL carryforward would be limited to 90% of a C corporation's taxable income for the year. The carryback provisions would be generally repealed, except for a special one-year carryback for small businesses and farms for certain casualty and disaster losses. A two-year carryback would be allowed for life insurance companies. NOLs arising in tax years beginning after 2017 could be carried forward indefinitely with an interest factor to preserve its value. Life insurance companies would be limited to a 20-year carryforward. Self-created property and sale and exchange of patents — Self-created property (i.e., patents, inventions, model or design) would no longer be treated as a capital asset and the disposition would be treated as ordinary in character. Further, a separate provision would repeal the current rule that treats the sale or exchange of certain patents as long-term capital gain. The House bill would repeal or terminate the following: — Orphan Drugs tax credit The employer tax credit for its share of FICA on tip income related to the provision of food and beverages would be modified to reflect tips reported above the current minimum wage and would expand the reporting information requirement for allocations among tipped employees. International The bill's major proposals for the international system include: (1) implementing a territorial tax system; (2) imposing a transition tax on accumulated foreign earnings; and (3) imposing anti-base erosion rules. See below for more detail on the significant changes to the international system: 100% exemption for foreign-source dividends — The House bill would exempt 100% of the foreign-source portion of dividends received by a US corporation from a foreign corporation in which the US corporation owns at least a 10% stake. Repeal of investment in United States Property — The House bill would repeal rules that taxed as dividends investments made by certain foreign corporations in US property. Since the bill would exempt distributions in their entirety, this current law anti-abuse provision would no longer be needed. Limitation on losses with respect to 10% owned foreign corporations — Only for determining loss on the sale of stock of a 10% owned foreign corporation, a US parent would reduce its basis in the stock of the foreign corporation equal to the amount of any exempt dividend it received from that foreign corporation. Mandatory toll charge on tax-deferred foreign earnings — A one-time transitional tax would be imposed on a US 10%-shareholder's pro rata share of the foreign corporation's post-1986 tax-deferred earnings, at the rate of either 12% (in the case of accumulated earnings held in cash, cash equivalents or certain other short-term assets) or 5% (in the case of accumulated earnings invested in illiquid assets (e.g., property, plant and equipment)). A foreign corporation's post-1986 tax-deferred earnings would be the greater of those earnings as of November 2, 2017 or December 31, 2017. An affected US shareholder with a 10%-or-greater stake in a foreign corporation with a post-1986 accumulated deficit would be able to offset the deficit against tax-deferred earnings of other foreign corporations. The US shareholder could elect to pay the transitional tax over a period of up to eight years. Repeal of foreign base company oil-related income as subpart F — Foreign base company oil income would no longer be subject to immediate taxation in the United States. Repeal of 30-day controlled foreign corporation rules — Under the House bill, foreign corporations would be considered controlled foreign corporations as soon as the ownership requirements are met and subject to the subpart F and anti-base erosion rules. Under current law, a foreign corporation must meet the ownership requirements for 30 days before it is considered a controlled foreign corporation. Anti-base-erosion provisions — The House bill would impose current US tax on 50% of a US shareholder's aggregate net CFC income (excluding income from commodities, subpart F income, active finance income qualifying under Section 954(h) and 954(i), insurance income and certain related-party payments) in excess of extraordinary returns from tangible assets. The extraordinary return base would equal 7%, plus the Federal short-term rate of the CFCs' aggregate adjusted basis in depreciable tangible property, minus interest expense. Only 80% of the foreign taxes paid on the income would be allowed as a foreign tax credit. This approach is somewhat similar to the anti-base erosion mechanism in the Camp bill but there are significant differences. The Camp bill taxed each CFC's income separately whereby the House bill would allow for aggregation. The Camp bill also taxed the excess income at a 15% rate with 100% of the company's foreign tax credits, whereby the House bill would only tax the income effectively at 10% but would only allow 80% of foreign tax credits. Overall, it appears to be more taxpayer-favorable than the Camp bill. Excise tax on payments to foreign affiliates — Under the House bill, all deductible payments except interest paid to a related foreign company would be subject to a 20% excise tax unless the related foreign company elected to treat those payment as effectively connected income (ECI) and thus taxable in the US. If the ECI election were made to treat the payments as taxable in the US, the income would be taxed on a net basis. The deduction allowed to offset the income would be determined by reference to the profit margins reported on the group's consolidated financial statements for the relevant product line. No foreign tax credits would be allowed to reduce the US tax on that income. If no election were made to treat the payments as taxable income, the excise tax paid would not be deductible. The provision would apply to covered amounts paid by domestic corporations after December 31, 2018. Foreign tax credit changes — Indirect foreign tax credits would only be available for Subpart F income. No credits would be allowed for any dividends associated with exempt dividends. Foreign tax credits would be used on a current-year basis and would not be allowed to be carried forward or back. The export sales source rules would be repealed. Denial of treaty benefits on certain deductible FDAP income payments — The House bill would deny the benefit of treaty-reduced withholding tax on a payment made to an affiliate unless a treaty would reduce withholding tax on the payment if it were made to the common parent company. Look-through rule for related CFCs made permanent — Current law excludes certain passive income received by one foreign subsidiary from a related foreign subsidiary from current inclusion as Subpart F income. The current provision is effective for tax years of foreign subsidiaries beginning before 2020 but, the House bill would make it permanent for tax years of foreign corporations beginning after 2019. Taxation of pass-throughs Pass-through rate The bill includes the addition of a new income tax rate of 25% for individuals who own pass-through businesses. In general, to the extent that an individual had taxable income that would otherwise be subject to a rate higher than 25%, any qualified business income (QBI) would be taxed at 25%. QBI would, generally, be 100% of "net business income" derived from a "passive business activity" and 30% of any "net business income" derived from any "active business activity." Identifying business activities — QBI would be determined by first identifying each particular business activity. The bill defines a "business activity" as any activity (within the meaning of Section 469) that involves the conduct of a trade or business. Under Section 469 and its regulations, trade or business activities may be treated as a single activity if the activities constitute an appropriate economic unit for the measurement of gain or loss. Whether an appropriate economic unit exists depends upon all the relevant facts and circumstances using any reasonable method but generally taking into account similarities and differences in types of trades or businesses, the extent of common control, the extent of common ownership, geographical location, and interdependencies between or among the activities. Determining income or loss — After each business activity was identified, the taxpayer's income, gain, deduction, and loss allocable to the activity would be netted, accounting only for items includible or allowable in determining taxable income. The bill would exclude certain items from being allocated to the business activity: capital gains and losses, dividends and dividend equivalents, interest income (unless properly allocable to a trade or business), certain foreign currency and commodity hedging gains and losses, annuities not connected with the trade or business, and any deduction or loss on these items. Separating passive and active activities — Because the eligibility for the QBI rate will vary, each business activity would also have to be identified as active or passive for the taxpayer. The bill defines a "passive business activity" by cross-reference to Section 469(c), which treats as passive any trade or business activity in which the taxpayer does not materially participate. The bill disregards Section 469(c)(3), which excludes from the passive category any working interest in any oil or gas property that the taxpayer holds through an entity that does not limit the taxpayer's liability. Similarly, the bill disregards Section 469(c)(6), which includes expenses for the production of income, such as investment expenses in the concept of "a trade or business." The bill defines an "active business activity" as any business activity that is not passive. Identifying specified service activities — Subject to an exception (discussed later) for capital-intensive activities, active business income from specified service activities would generally be ineligible for the QBI rate. The bill identifies those activities that would be treated as specified service activities by cross-reference to Section 1202(e)(3)(A), which include health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business whose principal asset is the reputation or skill of one or more of its employees or owners. In addition to the Section 1202 list, the bill would also treat investing, trading, or dealing in securities, partnership interests, or commodities as a specified service activity. Determining the capital percentage — For each active business activity, the capital percentage of the activity must be determined. For the specified service activities described earlier, the capital percentage would be zero unless the activity qualified for an exception for capital-intensive specified service activities. In any tax year, a taxpayer could elect this exception for a specified service activity only if the taxpayer's "applicable percentage" (discussed later) is at least 10%. If the exception were elected, the taxpayer's capital percentage for that activity would be the applicable percentage. For all other business activities, the capital percentage is 30% unless the taxpayer elects to use the applicable percentage. Once a taxpayer made the election for a non-specified service activity, it would apply for the current tax year and the four succeeding tax years and could not be revoked. For any business activity (whether or not a specified service activity), the net business income or loss would be calculated by including the following items: wages, Section 707(a) and (c) payments, and director's fees properly attributable to the business activity. Those specific items, however, might reduce the capital percentage. Specifically, the capital percentage would be limited to the portion of the net business income not comprised of those items. For example, if wages constituted 80% of the net business income from the activity, the capital percentage would limited to 20%. Determining the applicable percentage — For purposes of determining whether a larger percentage of active business income would be eligible for the lower tax rate, taxpayers would need to calculate the "applicable percentage." That figure would equal the taxpayer's "specified return on capital" from the activity for the tax year, divided by the taxpayer's net business income from the activity for that tax year. The taxpayer's specified return on capital would be the taxpayer's share of the active business activity's "asset balance," multiplied by a deemed rate of return (the Federal short-term rate, plus 7%) and reduced by deductible interest attributable to the activity. The asset balance would be the taxpayer's adjusted basis of the property used in connection with the active business activity as of the end of the tax year. For this purpose, Sections 168(k) (concerning bonus depreciation) and 179 (concerning accelerated depreciation) would be disregarded. Determining the amount eligible for the QBI rate — For those activities with a net income, 100% of passive net business income would be combined with the capital percentage of active net business income. From that total, loss activities would be subtracted. All passive net business loss would be combined with 30% of active net business loss and, if a prior year had negative QBI, that negative QBI would be included with the loss activities. If the remaining amount were a positive number, that dollar amount would be eligible for the QBI rate. If the remaining amount were a negative number, it would be tracked to the following year to be taken into account in determining QBI in the later year. Other pass-through items Repeal of partnership technical terminations caused by the sale or exchange of a 50% or more interest in the capital and profits of a partnership — Under Section 708(b)(1)(B) of current law, a sale or exchange of 50% or more of interests in partnership capital and profits within 12 months causes a "technical termination" of the partnership. The bill would repeal Section 708(b)(1)(B) for partnership tax years beginning after December 31, 2017. Repeal of exclusion from self-employment tax for limited partners — Section 1402(a), which defines "net earnings from self-employment," would be modified to conform to the new pass-through rate regime and the determination of QBI. Section 1402(a)(1) and (13) would be repealed, so that individuals could have net earnings from self-employment as a result of rental income and any partner could have net earnings from self-employment regardless of the individual's status as a limited partner. Deductibility of interest expense — Interest deductibility would be limited to the taxpayer's business interest income plus 30% of its "adjusted taxable income" for the tax year. Adjusted taxable income for this purpose would be computed without regard to business interest income or expense, net operating loss deductions, or deductions for depreciation, amortization, or depletion. Adjusted taxable income would also exclude items attributable to certain trades or businesses specified by the statute. For partnerships, the computation would apply at the partnership level, and would be taken into account in determining its non-separately stated taxable income or loss. For partners, the adjusted taxable income used in the 30% test would be determined without regard to their distributive share of non-separately stated income or loss, but would be increased by the partner's share of any "excess amount" of the partnership. The excess amount of a partnership would be the amount by which 30% of the partnership's adjusted taxable income exceeds the partnership's net business interest expense. Financial services The House bill does not change the taxation of financial products. Among other things, the House bill does not change the taxation of derivatives or other financial instruments, nor does it change the calculation of gain or loss on the sale of securities. Tax-exempt bonds — The House bill would repeal the exclusion from gross income for interest on qualified private activity bonds and for interest on any bond issued to advance refund a tax-exempt bond, effective for bonds issued after December 31, 2017. In addition, the bill would repeal, prospectively, all the existing authority for issuing tax credit bonds. In addition, the federal tax exemption for interest on bonds issued to finance the construction of, or capital expenditures for, a professional sports stadium would be repealed, effective for bonds issued after November 2, 2017. Deductibility of FDIC premiums — No deduction would be allowed for a certain percentage of premiums paid by banks to the Federal Deposit Insurance Corporation for tax years after 2017. The deduction would be disallowed for taxpayers with consolidated assets of $50 billion or more, and limited for smaller financial institutions. Insurance Life insurance tax proposals Computation of life insurance tax reserves — The House bill would amend the method for computing life insurance tax reserves under Section 807 so that life insurance companies would take into account only 76.5% of the increase or decrease in "reserves for future unaccrued claims" in computing taxable income. Generally, "reserves for future unaccrued claims" would include life insurance reserves as reported on the taxpayer's annual statement for the tax year, unpaid losses included in total reserves under Section 816(c)(2), and the amount of reserves solely for claims with respect to insurance risks. Further, asset adequacy reserves, contingency reserves, unearned premium reserves, and any other amount not constituting reserves for future unaccrued claims deficiency reserves would not be included in computing taxable income. This provision would be effective for tax years after 2017. Deferred policy acquisition (DAC) costs — For purposes of capitalizing and amortizing specified insurance policy acquisition expenses, the House bill would update the proxy DAC rules of Section 848 to reflect current expense ratios for insurance products. Currently, insurance companies must deduct their expenses associated with earning a stream of premium income over 10 years and calculate the expenses that are spread based on a specific percentage of net premiums received on annuity contracts (1.75%), group life insurance contracts (2.05%) and other specified insurance contracts (7.70%). This proposal would reduce the categories of insurance contracts subject to the DAC rules from three to two — namely, group contracts and all other specified contracts — and increase the capitalization rate to 4% for group contracts and 11% for other specified contracts. This provision would be effective for tax years after 2017. Life insurance proration of dividends received deduction (DRD) — The House bill would change the life insurance company proration rules under Section 812 to limit the company share (i.e., the life insurance company's deductible portion) of DRD to 40% of net investment income. This provision would be effective for tax years after 2017. Adjustment for change in computing reserves — Under the House bill, the 10-year period provided under Section 807(f) for including income or taking deductions for changes in life insurance reserves attributable to a change in the method of computing the reserve would be repealed. Accordingly, life insurance reserve changes would be subjected to the accounting method change rules under Section 481. This provision would be effective for tax years after 2017. Repeal of deduction for small life insurance company — The House bill would repeal the "small life insurance company deduction" under Section 806, which provides a life insurer with assets worth less than $500 million and taxable income (determined without the small life insurance company deduction) of less than $15 million a deduction equal to 60% of the first $3 million of taxable income, reduced by 15% of taxable income exceeding $3 million. This provision would be effective for tax years after 2017. Net operating loss (NOL) deductions — Under the House bill, the carryback period available to life insurers would be reduced from three years to two years, and the available carryforward period increased from 15 years to 20 years. This provision would be effective for losses arising in tax years after 2017. Rule for distributions from policyholders' surplus accounts — The House bill would repeal Section 815, subjecting life insurers in existence before 1984 to tax on "Phase III" income, which is measured by reference to certain deemed distributions from amounts accumulated in "policyholders' surplus accounts," amounts that ceased accumulating after changes in the tax rules applicable to life insurers in 1984. Any remaining "Phase III" balance as of December 31, 2017, would be included in taxable income ratably over eight years. Property/casualty insurance tax proposals Loss reserve discounting — The House bill would change the discount rate rules applicable to unpaid loss reserve deductions to require property/casualty companies to use the corporate bond yield curve as determined by the U.S. Department of Treasury to determine the discount. In addition, the special rule under current law that extends loss payment pattern periods for long-tail lines of business would apply similarly to all lines of business for consistency. Finally, the election to use company-specific, rather than industry-wide, historical loss payment patterns would be repealed. Generally, this provision would be effective for tax years after 2017, with a transition rule that would spread adjustments relating to pre-effective date losses and expenses over such tax year and the succeeding seven years. Proration for property/casualty insurance companies — The amount by which a property/casualty insurer must reduce its loss reserve deduction would be increased from 15% to an amount equal to 26.25% of the sum of its tax-exempt income, its DRD and any increase in cash value of life insurance or annuity contracts owned by the insurer. This provision would be effective for tax years after 2017. Special estimated tax payments — The House bill would repeal the elective deduction available to insurance companies under Section 847, equal to the difference between a company's reserves computed on a discounted basis and reserves computed on an undiscounted basis. Currently, companies that make this election must make a special estimated tax payment equal to the tax benefit attributable to the deduction. This provision would be effective for tax years after 2017. International proposals Restriction on insurance business exception to passive foreign investment company (PFIC) rules — The PFIC exception for insurance companies under Section 1297(b)(2)(B) would be amended to apply only if loss and loss adjustment expenses, unearned premiums and certain reserves constitute greater than 25% of a foreign corporation's total assets (or 10% if the corporation is predominantly engaged in an insurance business; and the reason for falling below 25% is temporary) and if the foreign corporation would be taxed as an insurance company were it a US corporation. This provision would be effective for tax years after 2017. Pensions and retirement The anticipation of major changes to retirement savings tax incentives was eased with release of the House bill. Reports of possible reductions in levels of pretax contributions to 401(k) plans were not borne out in the bill, which included no major changes to defined contribution plans. The bill includes a handful of relatively noncontroversial provisions, including several that have been sought by plan sponsors. From a revenue perspective, the only significant retirement provision would change the minimum age for in-service distributions from government defined benefit plans from 62 to 59 1/2. The change, which would bring Section 457 government defined contribution plans, and all defined benefit plans into line with private sector defined contribution plans, would raise $13.1 billion over 10 years. The House bill includes two provisions affecting hardship withdrawals from defined contribution plans. The first would overturn Treasury regulations that bar participants in defined contribution plans who have taken a hardship distribution from making new contributions to the plan for six months after taking a hardship distribution. The second would remove a limitation on a participant's ability to access funds in her or his account for hardship withdrawals. Currently only employee-contributed amounts, and not earnings or employer contributions, are available for hardship withdrawals. The new provision would make all account funds, including earnings and employer contributions, available for hardship withdrawals. It is estimated that the first provision would have a negligible revenue effect, and the second would increase revenue by $700 million over 10 years. The House bill also includes a provision that would provide protection to frozen defined benefit plans against possible violations of nondiscrimination testing rules. The provision has long enjoyed bipartisan support in both houses of Congress. JCT estimates that it would have negligible impact on revenue. Executive compensation Limitations on nonqualified deferred compensation — The House bill would eliminate Section 409A and add Section 409B, which would essentially tax deferred compensation when the promised compensation is no longer subject to a substantial risk of forfeiture. Thus, employees and other service providers would generally be subject to taxation at the time the compensation vests, regardless of whether that compensation is actually paid. In addition, "vesting" under Section 409B would be limited to the requirement to perform future services; a covenant not to compete or a condition relating to a purpose of the compensation (other than the performance of future services) would not constitute a substantial risk of forfeiture. This provision would apply to stock options and stock appreciation rights (other than qualified stock options) that are issued at fair market value and otherwise have not been previously viewed as deferred compensation. The provision would be effective for all amounts attributable to services performed after December 31, 2017. All amounts attributable to services performed before December 31, 2017, that are not included in income before 2026 would have to be included in income by the later of the last tax year beginning before 2026, or the tax year in which the compensation is no longer subject to a substantial risk of forfeiture. Limitations to Section 162(m) — The House bill would expand the $1 million deduction limit that applies to compensation paid to top executives of publicly-traded companies. The bill would eliminate the performance-based compensation and commissions exceptions to Section 162(m) and expand the definition of covered employee to specifically include the CFO. In addition, it would limit the ongoing deductibility of deferred compensation paid to individuals who previously held a covered employee position, even after they no longer hold that position. Thus, once an individual is named as a covered employee, the $1 million deduction limitation would apply to compensation paid to that individual at any point in the future, including after the cessation of services. The provision would be effective for tax years beginning after December 31, 2017. Energy Energy-specific provisions — The House bill's approach to energy sector-specific tax incentives for conventional energy is hit and miss: the enhanced oil recovery tax credit (Section 43) and the credit for producing oil and gas from marginal wells (45I) would both be repealed. A number of provisions previously targeted in the 2014 GOP bill, however, including the Section 179C election to expense certain refineries; the passive activity exception for working interests in oil and gas wells; and the special rules for gain or loss on timber, coal and domestic iron ore, would be unchanged. Perhaps most importantly for the conventional energy sector, several of its highest priorities — maintaining the deductibility of intangible drilling costs, eligibility to take percentage depletion, and the designation of certain natural resource-related activities as generating qualifying income under the publicly traded partnership rules (PTP) — were not touched. International items impacting energy companies — The international tax section of the bill includes several energy specific provisions, including the proposed repeal of the foreign base company oil related income (FBCORI) rules. This proposal would be effective for tax years of foreign corporations beginning after 2017, and for tax years of US shareholders in which or with which such tax years of foreign subsidiaries end. Additionally, in calculating multinationals' one time repatriation tax bill, recapture of foreign oil and gas losses (FOGL) would be treated similarly to overall foreign losses (OFL), thus ensuring that the rules do not inadvertently discriminate against the oil & gas sector. Production tax credit — The House bill proposes major changes to the Section 45 production tax credit (PTC) for electricity produced from renewable resources. The inflation adjustment, under which the base credit amount of 1.5 cents per kilowatt hour has risen with inflation to 2.4 cents, would be repealed, effective for electricity and refined coal produced at a facility whose construction begins after November 2, 2017. The statutory language appears to provide that the reduction in the credit rate would apply only to newly constructed facilities, but the section-by-section analysis accompanying the House bill indicates that a "taxpayers' credit amount would revert to 1.5 cents per kilowatt hour for the remaining portion of the 10-year period," which implies that the change would also apply to electricity produced at existing facilities. The bill would also alter the current rules for qualification of when construction begins on a qualified facility. There are two methods by which a taxpayer can establish that construction has begun — a physical work test and a 5% safe harbor. Both methods require the taxpayer to satisfy a continuous construction requirement. Under guidance issued by the Internal Revenue Service in 2016 (Notice 2016-31), if a taxpayer places a facility in service during a calendar year that is no more than four calendar years after the calendar year during which construction of the facility began, the facility will be deemed to have satisfied the continuous construction requirements. The House bill would overturn this guidance and provide instead that the construction of any facility, modification, improvement, addition, or other property may not be treated as beginning before any date unless there is a continuous program of construction that begins before such date and ends on the date that such property is placed in service. This clarification would apply to tax years beginning before, on, or after November 2, 2017. Investment Tax Credit — The House bill would leave largely intact the investment tax credit (ITC) provisions for both residential and commercial solar property that were enacted in 2015, preserving the 30% ITC for solar energy property whose construction begins before 2020, phasing down to 26% for solar property whose construction begins before 2021, and to 22% for projects that begin construction before 2022. For the residential solar credit under Section 25D, the credit would expire at the end of 2021. For the commercial ITC under Section 48, a permanent 10% ITC would be available for solar property whose construction begins after 2021. The bill would terminate the 10% ITC for property whose construction terminates after 2027. The House bill would also extend the Section 48 investment tax credit to technologies that were left out of the 2015 PATH Act, namely fiber-optic solar property, geothermal energy, fuel cells, microturbines, combined heat and power systems, and small wind systems. The expiration dates and phase-out schedules for these technologies would be harmonized with the solar ITC. Accordingly, fiber-optic solar energy, qualified fuel cell and qualified small wind energy property would receive a 30% ITC for property whose construction begins before 2020; 26% for property whose construction begins before 2021; and 22% for property whose construction begins before 2022. No ITC would be available for property whose construction begins after 2021. Additionally, the 10% ITC for qualified microturbine, combined heat and power system, and thermal energy property would be made available for property whose construction begins before 2022. The Section 25D residential energy efficiency credit likewise would be extended and phased out for other technologies that were omitted from the 2015 PATH Act, including qualified geothermal heat pump property, qualified small wind property and qualified fuel cell power plants. Finally, the House bill would clarify that the construction of any solar facility, modification, improvement, addition, or other property may not be treated as beginning before any date unless there is a continuous program of construction that begins before such date and ends on the date that such property is placed in service. This clarification would apply to tax years beginning before, on or after November 2, 2017. The House bill would not extend a number of other temporary tax incentives for renewable energy. On December 31, 2016, provisions aimed at stimulating both renewable baseload electricity facility development, and advanced biofuel production expired. Technologies affected by the electricity credit expiration include hydropower; biomass and waste-to-energy. Biofuel companies passed over for an extension of their expired incentives include biodiesel; renewable diesel; alternative fuels and second generation biofuels. Exempt organizations The House bill contains a number of provisions directly affecting tax-exempt organizations. Charitable organizations also raised early concerns that some of the individual tax provisions in the bill could dramatically reduce charitable giving, pointing to provisions that would double the standard deduction (limiting the number of taxpayers eligible to itemize their charitable contributions), and the effect of the estate tax changes. Other key provisions affecting tax-exempt organizations include: AGI limitations for cash contributions — Currently the charitable deduction is limited to a percentage of AGI. The current 50% limitation on cash contributions would be increased to 60%, and the five-year carryover period would be retained. Charitable mileage — The charitable mileage deduction currently set at 14 cents would be changed to account for the variable cost of operating an automobile to allow adjustments for inflation. College athletic seating — The individual deduction for fees for the right to purchase college athletic seating would be repealed. Unrelated business income tax (UBIT) — Many of the UBIT-related provisions included in the Camp bill were not included in the new House bill, but the House bill does clarify that all tax-exempt entities under 501(a), including state and local entities and pension plans, would be subject to the UBIT rules and that income from research by an exempt entity would only be exempt from UBIT if the results of the research were made freely available to the public. Fringe benefits provided by tax-exempt entities — Tax-exempt entities would be taxed on the value of providing employees with transportation fringe benefits, on-site gyms and other athletic facilities by treating the funds used to pay for such benefits as UBIT. This would create parity between tax-exempt and taxable entities under the House proposal. Excise tax on tax-exempt executive compensation — Tax exempt organizations would be subject to a 20% excise tax on compensation over $1 million paid to its five highest paid employees. The excise tax would apply to all remuneration and is intended to create a parallel to the deduction limitation that applies to publically traded C corporations. Excise tax on private foundations — The current excise tax on net investment income would be unified at a single rate of 1.4% and the 1% and 2% rates would be repealed, simplifying the tax. Excise tax on private colleges and universities — Certain private colleges and universities would be subject to a 1.4% excise tax on net investment income if the entity enrolled at least 500 students and the entity's applicable assets exceeded $100,000 per full-time student. Private foundations operating art museums — Such art museums would be required to be open to the public for at least 1000 hours per year to maintain status as a private operating foundation. Philanthropic enterprises — Private foundations that own a for-profit business would be exempt from the excess business holdings tax if certain limiting conditions were met and the business contributed its net operating income after taxes to the private foundation. Donor-advised funds — Donor-advised funds would be required to disclose annually information intended to improve transparency related to the use of such funds by requiring the fund to disclose their policies on inactive donor-advised funds and the average amount of the grants made from such funds. Political speech by religious tax-exempt entities — The changes to the "Johnson Amendment" were a frequent campaign promise of President Trump. The provision would allow churches to make statements related to political campaigns without jeopardizing their tax-exempt status, provided the speech is de minimus and completed in the ordinary course of the organization's business. Accounting methods The accounting method reforms in the House bill would be beneficial to taxpayers but confined to small businesses. The House bill does not include generally applicable proposals that were included in the Camp bill, such as repeal of the last-in/first-out (LIFO) and lower-of-cost-or-market (LCM) accounting methods (along with recapture of LIFO reserves and LCM positive adjustments), and limitations on the cash method of accounting. The small business accounting method proposals in the House bill include the following: — The $5 million annual gross receipts threshold for the use of the cash method of accounting for corporations (and partnerships with a corporate partner) would be increased to $25 million and indexed to inflation. Individual taxes For individuals, the House bill would eliminate most itemized deductions, but tax incentives for home mortgage interest and charitable contributions would be retained (in modified form). The controversial state and local tax deduction would be repealed, except for up to $10,000 in real estate taxes. The bill also would repeal many of the other exemptions, deductions and credits for individuals in the pursuit of rate reduction, simplicity and fairness. Rates — The House bill would modify and consolidate individual income tax rates so that: — The 10% and 15% rates would be eliminated and a new 12% rate would apply to the first $45,000 in taxable income for single filers and the first $90,000 for joint filers. Capital gains and dividends — Under the House bill, net capital gains and qualified dividends would continue to be taxed at their current 0%, 15%, and 20% rates, and also would continue to be subject to the 3.8% net investment income tax. Dividends from REITs and cooperatives would be treated as qualified dividends and taxed at these rates. Other changes — The standard deduction would be set at $24,400 for joint returns, and $12,200 for single filers. Phase-outs — Certain tax items would be phased out for upper-income taxpayers. Specifically, the benefit of the new 12% individual income tax rate would be phased out for single filers with adjusted gross income (AGI) over $1 million and joint filers with AGI over $1.2 million. The phase-out for the enhanced child credit (in combination with the new family tax credit) would increase for single filers from $75,000 to $115,000 and for joint filers from $110,000 to $230,000. Modification and repeal of current tax expenditures — The House bill would modify or eliminate several individual income tax deductions, exclusions and credits, including the following: — The principal cap on deductible home mortgage interest for new mortgages (after November 2, 2017) would be reduced immediately from $1 million to $500,000. The deduction would no longer be available for second homes or home equity lines of credit. Education — The House bill contains a number of provisions affecting higher education, including: American Opportunity Tax Credit (AOTC) — The House bill would consolidate three existing higher education tax credits (i.e., the AOTC, the Hope Scholarship Credit (HSC), and the Lifetime Learning Credit (LLC)) into one modified AOTC. Like the current AOTC, the new AOTC would provide a 100% credit for the first $2,000 of expenses, and a 25% credit for the next $2,000 of expenses, for the first four years of education. The new AOTC also would provide a 50% credit for the first $2,000 of expenses, with up to $500 of the credit being refundable. Education savings — In general, the House bill would consolidate education savings accounts by disallowing new contributions to Coverdell educations savings accounts after 2017, and expanding Section 529 plans to allow unborn children to be designated as beneficiaries and to cover expenses for apprenticeship programs and up to $10,000 of elementary and high school expenses. Repeal of other education provisions — — Above-the-line deduction for interest payments on qualified education loans for qualified higher education expenses of a taxpayer, the taxpayer's spouse, or dependents. ———————————————
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Section by Section
Text of Bill
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