November 6, 2017 House Ways and Means Committee's tax reform bill proposes four tax rates for individuals, higher standard deduction, repeal of most itemized deductions The House Ways and Means Committee's tax reform proposal (the Tax Cuts and Jobs Act (the "bill")) released November 2, 2017, would change the individual income tax rates and make other significant changes to the individual income tax system. Taxes and rates Reduction and simplification of individual income tax rates Current law: Seven individual federal income tax brackets apply for tax year 2017: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The applicable tax bracket for an individual taxpayer depends upon the person's filing status and income level, as follows:
In addition, current law taxes net long-term capital gain and qualified dividend income (QDI) at either 0%, 10% or 15%, depending on the ordinary income tax bracket of the taxpayer:
Proposal: The bill would reduce the number of tax brackets to four: 12%, 25%, 35%, and 39.6%. The applicable tax bracket for an individual taxpayer depends upon the person's filing status and income level, as follows:
The bill also proposes to adjust the inflation adjustment mechanism for the brackets. The benefit of the 12% rate would be phased out for high-income taxpayers. For married couples filing jointly, this phase out begins at adjusted gross income (AGI) in excess of $1.2 million. For single and head-of-household taxpayers, the phase out begins at AGI in excess of $1 million. The bill would apply three tax rates (0%, 15% and a 20%) to capital gains income of individuals (indexed for inflation), based on the amount of gain and the filing status of the taxpayer, as follows:
Effective date: These provisions would be effective for tax years beginning after 2017. According to JCT, the provision would reduce revenues by $1,051.2 billion over 2018-2027. Implications: The seven brackets were reduced to four brackets, and the spacing between the brackets are much wider. The lower rates would essentially mean a tax cut for all taxpayers (except those who were already not paying income tax). The phase-out of the 12% bracket is an attempt to preserve progressivity. Interestingly, the phase out the 12% bracket is based on AGI, not taxable income, so the 12% phase out would, in many cases, begin while the taxpayer is in the 35% bracket. Although a discussion of the consumer price index (CPI) is not warranted in this alert, the chained CPI takes into consideration substitutions consumers make in response to rising prices of certain goods and services. The result is that the brackets will generally rise slower than they otherwise would under the CPI. (Under the bill, the indexing of income tax brackets and other income thresholds for inflation would be changed from the CPI for urban consumers (CPI-U) to the chained CPI after 2022. See Tax Alert 2017-1831.) Another thing that must be kept in mind is the Net Investment Income Tax (NIIT). The bill did not proposed to repeal the tax. However, the changes to items of income and deduction would impact NIIT. In fact, it is likely that NIIT liabilities will increase as deductions are disallowed. As NIIT liabilities increase, the feasibility of repeal becomes more difficult because of the amount of tax revenue that would be eliminated will increase. Repeal of alternative minimum tax Current law: Current law requires taxpayers to compute their income tax obligation in two ways — to determine both the regular income tax amount and the alternative minimum tax (AMT) — and to remit the higher of those two amounts as their income tax liability for the year. For individual taxpayers, estates, and trusts the two AMT brackets are 26% (applied to the first $182,500 of AMT income) and 28% (applied to AMT income over $182,500). Provision: The provision would repeal the AMT. Taxpayers with AMT credit carryforwards generally would be permitted to claim a refund of 50% of the remaining credits in the 2019, 2020, and 2021 tax years, and could claim any remaining credits in the 2022 tax year. Effective Date: The provision would be effective for tax years beginning after 2017. According to the Joint Committee on Taxation (JCT), repeal of the individual AMT would reduce revenues by $695.5 billion over the 2018-2027 time period, and repeal of the corporate AMT would reduce revenues by $40.3 billion over the 2018-2027 time period. Implications: The requirement that taxpayers compute their income for purposes of both the regular income tax and the AMT is one of the most far-reaching complexities of the current Code. According to JCT, the AMT affected about 4.5 million American families in 2017. The AMT is particularly burdensome for small businesses, which often do not know whether they will be affected until they file their taxes and therefore must maintain a reserve that cannot be used to hire, expand, and give raises to workers. In its 2001 tax simplification report, JCT concluded that the AMT "no longer serves the purposes for which it was intended," and recommended its repeal. For taxpayers who expect to fall under the AMT for the 2017 tax year, it may be prudent to accelerate ordinary income because such accelerated items may be subject to an effective rate close to 28%, whereas the rates proposed for 2018 might be higher. The income that is best to accelerate are items that are not taxable for state income tax purposes (e.g., cashing in US savings bonds with accrued interest or converting IRAs to Roth IRA when the state does not tax the rollover). If the income subject to the acceleration is also subject to state income tax, then one must consider when the associated state income tax payment should be made in light of the potential for the deduction to be disallowed in 2018. Deductions — personal exemption and standard deductions Enhancement of the standard deduction Current law: Under current law, AGI is reduced by either the standard deduction or itemized deductions, if the taxpayer chooses to itemize. For the 2017 tax year, the standard deduction was: — $6,350 for single individuals and married individuals filing separately — $9,350 for heads of households — $12,700 for married couples filing jointly Provision: The bill proposes to increase the standard deduction to: — $12,000 for single filers and married individuals filing separately — $18,000 for single filers with at least one qualifying child — $24,000 for married couples filing jointly and surviving spouses Effective date: The provision would be effective for tax years beginning after 2017.According to JCT, the provision would reduce revenues by $921.4 billion over the 2018-2027 time period. Implications: According to JCT, "the increase in the standard deduction would achieve substantial simplification by reducing the number of taxpayers who choose to itemize their deductions from roughly one-third under current law to fewer than 10% under the legislation." Repeal of deduction for personal exemptions Current law: Current law allows a taxpayer to claim a personal exemption for the taxpayer, his or her spouse, and any dependents. The amount that may be deducted for each personal exemption in the 2017 tax year is $4,050. The personal exemption begins to phase out for taxpayers at certain income levels: single taxpayers beginning at $261,500; head-of-household beginning at $287,650; married couples filing jointly beginning at $313,800; and married taxpayers filing separately beginning at $150,000. Provision: The bill would repeal the personal exemption deduction and phase-out. Effective date: The repeal would be effective for tax years beginning after 2017. According to JCT, the provision would increase revenues by $1,562.1 billion over the 2018-2027 time period. Implications: The JCT summary notes that "the personal exemption for the taxpayer and taxpayer's spouse would be consolidated into a larger standard deduction. The personal exemption for children and dependents would be consolidated into an expanded child tax credit and a new family tax credit." Interestingly, the bill also repeals the personal exemption for estates and trusts. However, estates and trusts are not entitled to a standard deductions, so the repeal of the exemption is simply a small tax increase on those entities. Deductions — changes to itemized deductions Repeal of deduction for certain taxes not paid or accrued in a trade or business. Current law: Current law provides taxpayers who itemize deductions to claim a deduction for state and local government income and property taxes paid during the tax year. Rather than deducting state and local income taxes, an itemizing taxpayer may choose to claim an itemized deduction for state and local sales taxes paid. Provision: The provision would (1) repeal the itemized deduction for foreign, state and local income and sales taxes generally for individuals; (2) limit itemized deductions for real property taxes paid on personal use property up to $10,000; and (3) continue to allow a deduction for state and local property taxes (real or personal) paid or accrued in carrying out a trade or business or producing income. Effective date: The provision would be effective for tax years beginning after December 31, 2017. Implications: JCT asserts, "in conjunction with an increased standard deduction and lower overall tax rates, the provision" arguably "simplifies the tax laws for taxpayers who currently claim itemized deductions for state and local taxes. " According to JCT, "the provision would eliminate a tax benefit that effectively subsidizes higher state and local taxes and increased spending at the state and local level." However, the bill only seeks to eliminate the individual deduction for state and local income taxes — the provision does not affect the corporate deductions for state and local income taxes. Arguably, a similar policy assertion could be made that corporate tax payments to state and local governments "effectively subsidize" higher state and local taxes and increased spending at the state and local level. Repeal of the state and local income tax deduction also repeals state and local income tax deductions associated with business income. It would seem that it would be equitable for state and local income tax associated with business income be deductible by individuals. This is not a new concept of tracing state and local income taxes to business income — it has been done since 1970, when the IRS ruled in Revenue Ruling 70-40 that expenditures for state individual income taxes on net income from business profits, interest on state and federal income taxes that are related to income derived from a trade or business carried on by the taxpayer, and litigating expenses in connection with such taxes, are "attributable to a taxpayer's trade or business" for purposes of the NOL calculation. Interestingly, the explanation that accompanied the bill text stated that the provision was a repeal of itemized deductions for state and local taxes. However, there is a viable reading of the bill's text that it does much more, and not only for individuals. There are situations in which state and local income taxes are not itemized deductions when they are associated with businesses. For example, Revenue Ruling 81-288 states that the reference in Reg. Section 1.62-1T(d) to "state taxes on net income" pertains to state income taxes of general application, such as those imposed on salaries, investment income, and other forms of income in addition to business income. Revenue Ruling 81-288 indicates that an income tax on the net profits of business that is not an income tax of general application is deductible by a sole proprietor in determining AGI. Of course, this issue is not limited to an individual's Schedule C, E, or F — it also affects many other business that "shall be computed in the same manner as in the case of an individual," which includes partnerships (Section 703(a)) and S corporations (Section 1363(b)). There is also a possibility that the flush language of Section 164(a) may allow trade or business income taxes that are of the type described in Revenue Ruling 81-288 to continue to be deducted. In any event, calcification on the matter would be much appreciated. In the context of property taxes, the bill did recognize that property taxes associated with businesses and for-profit activities remain fully deductible. Only real estate taxes on personal use real property located in the United States are limited to $10,000. Personal property tax on personal use property (such as state automobile taxes) are disallowed entirely. Intuitively, one might think that Schedule A itemized deductions would be limited to $10,000, but that would not be the case. Real property held for investment, but not rented, would still enjoy full deduction on Schedule A. Additionally, the bill provides that foreign real property taxes would be nondeductible, which would primarily affect citizens working abroad, which in turn, would likely end up being borne by their employer due to comprehensive equalization agreements. Outside of noting the inequitable outcome between passthrough businesses and corporations regarding the state tax deduction, the bill reduces the corporate tax rate to 20% (which is imposed on taxable income after the deduction for state taxes); the passthrough rate on business income is proposed to be 25% without the deduction for state taxes. This inequity may contribute to some passthrough businesses evaluating whether the corporate form may be worth considering. For taxpayers that do not expect to be subject to the AMT in 2017, a planning opportunity would be accelerate the payment of state and local income tax and property taxes. However, taxpayers need to keep in mind that Revenue Ruling 82-208 held that a cash basis taxpayer may not deduct an estimated state income tax payment if on the date of payment the taxpayer could not reasonably determine, in good faith, that there is an additional state income tax liability. It further indicated that where a taxpayer, pursuant to state law, makes an estimated payment of state income taxes that it reasonably determined in good faith at the time of payment, the payments are deductible. Repeal of deduction for personal casualty losses Current law: Current law allows a taxpayer who itemizes deductions to claim a deduction for personal casualty losses, including property losses from fire, storm, other casualty or theft, for amounts that exceed 10% of AGI. Provision: The provision generally would repeal the personal casualty loss deduction, although deductions for casualty losses associated with special disaster relief legislation would not be affected. Effective date: The repeal would be effective for tax years beginning after 2017. Implications: In a year in which Hurricanes Irma, Maria and Harvey amounted to the largest casualty losses in US history,it is perplexing why Congress would propose to eliminate deductions for personal casualty losses. Additionally, for some in this country, the effects of high profile Ponzi schemes are still affecting their lives. Although in many instances, personal casualty losses are covered by insurance, the loss of this deduction will still hurt those who are caught in various schemes, such as Ponzi schemes or internet fraud. If these deductions are eliminated from the Code, it is highly likely Congress may wind up reconsidering in the wake of the next natural disaster or financial fraud scandal. Housing changes: mortgage interest and exclusion of gain from sale of a principal residence Current law: Current law allows a taxpayer who chooses to itemize deductions to claim a deduction for interest paid on the mortgage for the taxpayer's principal residence and one other residence (second home). Mortgage deductions may be claimed on interest payments on up to $1 million in acquisition indebtedness and up to $100,000 in home equity indebtedness. However, under the alternative minimum tax (AMT), a taxpayer may not claim a home equity mortgage interest deduction. Additionally, current law allows a taxpayer to exclude from gross income a limited amount of gain on the sale of a principal residence. For joint filers, up to $500,000 in gain may be excluded; for single filers, the limit is $250,000. The taxpayer must have owned and used the property as his principal residence for at least two of the last five years, and may claim the exclusion once every two years. Provisions: The mortgage interest provision proposes to eliminate the mortgage interest deduction for home equity loans and mortgages on second homes. For mortgages on principal residences acquired after November 2, 2017, interest would be deductible on up to $500,000 in acquisition indebtedness. For a refinancing of a principal mortgage that was incurred before November 2, 2017, the refinanced debt will be treated as incurred on the same date as the original mortgage for purposes of the mortgage interest deduction. If a taxpayer entered into a binding contract to purchase a principal residence before November 2, 2017, the related debt will be treated as incurred before November 2, 2017. The exclusion of gain provision would maintain the exclusion but require a taxpayer to own and use the home as his principal residence for five out of the last eight years. The exclusion could be used once every five years, and would be phased out by one dollar for every dollar by which the taxpayer's AGI exceeds $250,000 for single filers and $500,000 for joint filers. Effective date: The mortgage interest provision would apply to mortgages acquired after November 2, 2017. The home sale exclusion changes apply to closings occurring after December 31, 2017 (regardless of whether the contract was in force prior to the release of the bill). Implications: These provisions will likely be hotly contested. The grandfathering of existing mortgages is helpful, but the elimination of interest deductions for mortgages on second homes and home-equity intendedness is not. These later two types of mortgages would lose deductibility immediately. On the sale exclusion side, "the provision would continue to protect homeowners who either do not have the documentation to establish basis in their home or who have experienced gains as a result of inflation over a long period of ownership. Meanwhile, speculators and so-called "flippers" in the housing market would not be rewarded for their activity with tax-exempt income," according to JCT. The provision's "five-out-of-eight year" rule existed prior to 1978, when Congress decided to reduce the necessary holding period. This provision would merely restore the holding period requirement to what it was prior to 1978. Regardless of the policy, the modification to the home sale exclusion came as a bit of a surprise. Increase of the holding and use period from five years and two years to eight years and eight years will have a moderate impact, but the really surprising aspect is the phase-out of the deduction altogether. When these provisions are combined, it suggests a policy shift by the current Congress against taxpayer mobility. In the case of corporate employee relocations, the mortgage interest deduction changes and the changes to the home sale exclusion will likely land directly on employers because individuals will likely not be as willing to move without being "made whole" on such items. It is also widely reported that $500,000 mortgages are commonplace on the East and West Coasts of the United States, as well as in large cities in the middle of the country. In many cases, residences costing more than $500,000 are "middle class" in places like Washington, DC. Interestingly, when the $1.1 million mortgage limit was created 30 years ago, it was not indexed for inflation. So today's $1.1 million limit has already been effectively reduced by more than 50% because inflation has taken $1.1 million in 1987 to $2.35 million in 2017. By this standard, cutting the mortgage amount down to $500,000 essentially equates to mortgages of approximately $250,000 in a 1987 market. Repeal of deduction for tax preparation expenses Current law: Current law allows a taxpayer who itemizes deductions to claim an itemized deduction for tax preparation expenses. Provision: The provision would repeal the deduction for tax preparation expenses. Effective date: The provision would be effective for tax years beginning after 2017. Implications: This provisions is broader than just income tax return preparation — it includes estate planning and tax controversy. Section 212(3) allows deductions for expenses paid or incurred by an individual in connection with the determination, collection, or refund of any tax, whether the taxing authority is federal, state, or municipal, and whether the tax is income, estate, gift, property, or any other tax. Thus, expenses paid or incurred by a taxpayer for tax counsel or expenses paid or incurred in connection with the preparation of his tax returns or in connection with any proceedings involved in determining the extent of his tax liability or in contesting his tax liability are deductible under current law. It is odd that personal property taxes and real property taxes on property held for investment are fully deductible, but tax compliance costs associated with them are not. In other words, even if the property tax is deductible, the cost to challenge an erroneous determination would not be. Similar to state and local taxes, corporations are entitled to the deductions for tax preparation services for their business returns, yet individuals are not. As more and more taxpayers turn to paid preparers for assistance with compliance with the tax code, this provision, if enacted, would have a broad impact. Charitable contributions Current law: Current law allows a taxpayer who itemizes deductions to claim deductions for charitable contributions made by the last day of the tax year. The deduction is limited to a certain percentage of the taxpayer's AGI, which varies depending on the type of property contributed and the type of tax-exempt organization to which the donation is made. Generally, deductions for contributions to public charities, private operating foundations, and some non-operating foundations are limited to 50% of the donor's AGI. Contributions to private foundations may be deducted up to the lesser of (1) 30% of AGI or (2) the amount by which the 50%-of-AGI limitation for the tax year exceeds the amount of charitable contributions subject to the 30% limitation. Deductions of up to 30% of AGI may be claimed for capital gain property contributed to public charities, private operating foundations, and certain non-operating private foundations. For donations of capital gain property to non-operating private foundations, deductions may be claimed for the lesser of (1) 20% of AGI or (2) the amount by which the 30%-of-AGI limitation exceeds the amount of property subject to the 30%-limitation for contributions of capital gain property. Excess contributions may be carried over for up to five years (15 years for qualified conservation contributions). To claim a charitable deduction for a contribution of $250 or more, the taxpayer generally must provide the IRS with a contemporaneous written acknowledgement by the donee organization. This requirement does not apply if the donee organization files a return with the required information. Provision: The provision would change a number of rules applicable to the charitable contribution deduction, including: — Imposing a 60%-limitation for cash contributions to public charities and certain private foundations — Repealing a rule that allows a charitable deduction of 80% of the amount paid for the right to purchase tickets for athletic events — Adjusting the deduction for mileage driven for charitable purposes to a "rate [that] takes into account the variable cost of operating an auto mobile" — Repealing the exception that relieves a taxpayer from obtaining and providing a contemporaneous written acknowledgement for contributions over $250 if the donee organization files a return with the required information Effective date: The provision would be effective for tax years beginning after 2017. Implications: Two of these provisions came as a welcome surprise to taxpayers: (a) indexing the charitable mileage rate for inflation (which was well overdue) and (b) increasing cash donations to 60% of AGI. The elimination of the deduction for college athletic event seating rights probably won't affect those colleges that charge their season ticket holders for such rights as there is no indication season ticket holders will refuse to pay for these rights. In general, to deduct a gift to a charity, the giving of the gift must be with charitable intent — it is debatable whether this intent exists regarding the purchases of tickets to gaming events. There was no change to the charitable contribution deduction under Section 642(c) for estates and trusts. Repeal of medical expense deduction Current law: Current law allows a taxpayer who itemizes deductions to claim an itemized deduction for out-of-pocket medical expenses for the taxpayer, a spouse and dependents to the extent the expenses exceed 10% of the taxpayer's AGI. Provision: The provision would repeal the itemized deduction for medical expenses. Effective date: The repeal would be effective for tax years beginning after 2017. Implications: The repeal of the medical expense deductions came as a bit of a surprise. The individuals who are largely impacted by this provision are those who are chronically ill, such as those with special needs and those in assisted living and acute care nursing homes. Query whether disallowing the deduction for this group of taxpayers is desirable policy. Denial of deduction for expenses attributable to the trade or business of being an employee Current law: Current law allows a taxpayer to claim a deduction for certain trade or business expenses, even if the taxpayer does not itemize. Certain expenses related to the trade or business of being an employee may only be deducted if the taxpayer itemizes, although some employment-related expenses may be deducted above-the-line (including certain: reimbursed expenses included in the taxpayer's income; expenses of performing artists; expenses of state and local government officials; expenses of elementary and secondary school teachers; expenses of US military reserve members). Provision: No itemized deductions would be permitted for expenses attributable to the trade or business of performing services as an employee. Above-the-line deductions would be limited to two expenses attributable to the trade of business of being an employee: reimbursed expenses and certain expenses of US military reserve members. Effective date: The provision would be effective for tax years beginning after 2017. Implications: The explanation accompanying the bill notes that, in conjunction with an increased standard deduction and lower overall tax rates, the provision would simplify the tax laws for taxpayers who currently claim deductions for employee business expenses. Keeping records of these expenses is often very burdensome for taxpayers, and this current-law deduction also poses administrative and enforcement challenges for the IRS. It appears that this provision eliminates deductions for expenses incurred by (a) performing artists, (b) teachers, and (c) officials as employees of a state or a political subdivision thereof in a position compensated in whole or in part on a fee basis. It appears that the accountable plan rules (generally known as employer reimbursement rules) in Section 62(a)(2)(A) remain. The following common unreimbursed expenses, listed in IRS Publication 529, Miscellaneous Deductions, are examples of expenses that will become nondeductible under this proposed rule: — Business bad debt of an employee — Business liability insurance premiums — Damages paid to a former employer for breach of an employment contract — Depreciation on a computer your employer requires you to use in your work — Dues to a chamber of commerce if membership helps you do your job — Dues to professional societies — Educator expenses — Home office or part of your home used regularly and exclusively in your work — Job search expenses in your present occupation — Laboratory breakage fees — Legal fees related to your job — Licenses and regulatory fees — Malpractice insurance premiums — Medical examinations required by an employer — Occupational taxes — Passport for a business trip — Repayment of an income aid payment received under an employer's plan — Research expenses of a college professor — Rural mail carriers' vehicle expenses — Subscriptions to professional journals and trade magazines related to your work — Tools and supplies used in your work — Travel, transportation, meals, entertainment, gifts, and local lodging related to your work — Union dues and expenses — Work clothes and uniforms if required and not suitable for everyday use — Work-related education This provision may ultimate cause employers to pick up more of these costs as reimbursements. It would not be hard to imagine that this provision would likely be a new negotiating point for employers and employees operating under collective bargaining agreements. Repeal of overall limitation on itemized deductions Current law: Current law limits the total amount of itemized deductions (except deductions for medical expenses, investment interest, and losses due to casualty, theft, and wagering) for certain high-income taxpayers (Pease limitation). The Pease limitation applied in addition to any other applicable limitations (e.g., deductions) but could not reduce itemized deductions by more than 80%. For 2017, the thresholds at which the Pease limitation applied were: (1) $261,500 for single taxpayers, (2) $313,800 for married couples filing jointly and surviving spouses, (3) $287,650 for heads of households, and (4) $156,900 for married taxpayers filing a separately. Provision: The bill would repeal the overall limitation on itemized deductions. Effective date: The provision would be effective for tax years beginning after 2017. Implications: This provision is taxpayer-favorable because many higher income taxpayers found their mortgage interest and charitable deductions being subject to the 3% haircut of Section 68. The taxpayers who will benefit most from this are the ones for whom the disallowed itemized deductions (state income tax, property taxes, etc.) are less than the amount of reduction caused by Section 68. Although many itemized deductions are proposed to be eliminated, many still exist. For example, expenses paid to produce or collect taxable income and manage or protect property held for earning income (Section 212(1)-(2)) such as: — Fees for services of investment counsel, custodial fees, clerical help, office rent, and similar expenses paid or incurred by a taxpayer in connection with investments — Reasonable amounts paid or incurred for the services of a guardian or committee for a ward or minor, and other expenses of guardians and committees that are ordinary and necessary, in connection with the production or collection of income inuring to the ward or minor, or in connection with the management, conservation, or maintenance of property, held for the production of income, belonging to the ward or minor — Amounts taken into account by an individual with respect to certain notional principal contracts — Investment expenses of a regulated investment company In addition to Section 212 expenses, the following itemized deductions remain deductible: — Investment interest expense — Gambling losses (with modification in the bill, but not discussed in this Alert) — Casualty and theft losses of income-producing property — Federal estate tax on income in respect of a decedent (Section 691(c)) — Deduction for amortizable bond premiums — An ordinary loss attributable to a contingent payment debt instrument or an inflation-indexed debt instrument (for example, a Treasury Inflation-Protected Security) — Deduction for repayment of amounts under a claim of right under $3,000 (subject to 2% AGI limitation) or over $3,000 (not subject to 2% AGI limitation) — Certain unrecovered investment in a pensions In the case of trusts and estates, other than expenses that are common to individuals described above (e.g., state and local taxes and tax preparation fees being eliminated while investment interest expense being retained), the unique deductions allowed to trusts and estates remain largely intact. For example, these unique deductible items include: trustee fees, attorney fees, court accounting fees, and the income distribution deduction. Deductions — removal of other deductions Repeal of deduction for alimony payments Current law: Current law generally provides that alimony payments must be included in the income of the payee and may be claimed as an above-the-line deduction by the payor. Provision: Under the provision, alimony payments would not be included in the payee's income and would not be deductible by the payor. Effective date: The provision would be effective for divorce decrees and separation agreements executed after 2017, as well as for any modification made after 2017 to a divorce decree or separation agreement if the expressly states that this change is intended. According to JCT, the provision would increase revenues by $8.3 billion over the 2018-2027 time period. Implications: The explanation accompanying the bill states that the provision would eliminate what is effectively a "divorce subsidy" under current law, in that a divorced couple can often achieve a better tax result for payments between them than a married couple can. "The provision recognizes that the provision of spousal support as a consequence of a divorce or separation should have the same tax treatment as the provision of spousal support within the context of a married couple, as well as the provision of child support." This is probably one of the most surprising provisions in the bill. Similar to the medical expense deduction discussed above, the rationale for the deduction is a wherewithal to pay. The revenue estimate is probably an acknowledgement that the payor spouse is usually in a higher tax bracket than the recipient spouse. Going forward, the gross amount will be tax effected — instead of a spouse getting $10,000 per month, the spouse will get $6,000 tax free. It is not hard to imagine that an additional factor in negotiating alimony will be which spouse should bear the consequences of this tax change. Repeal of deduction for moving expenses Current law: Current law generally allows a taxpayer to claim a deduction for certain moving expenses incurred in connection with beginning a new job in a new location. Provision: The provision would repeal the deduction for moving expenses. Effective date: The repeal would be effective for tax years beginning after 2017. According to JCT, the provision would increase revenues by $10.6 billion over the 2018-2027 time period. Implications: Interestingly, this seems to fit, along with mortgage interest and property taxes, with the bill's general policy of seeming to discourage taxpayer mobility. For those who move for business, these costs will likely be now more borne by the employer — either through higher signing bonuses to compensate for the non-deductibility or more tax gross-ups to induce employees to move. Termination of deduction and exclusions for contributions to medical savings accounts Current law: Current law allows a taxpayer to claim an above-the-line deduction for contributions to an Archer Medical Savings Account (MSA) and exclude from income contributions an employer makes to an MSA. Archer MSAs could not be established after 2005; their balances may be rolled over tax-free into another Archer MSA or into a Health Savings Account (HSA). Provision: The provision would eliminate any deduction for taxpayer contributions to an Archer MSA and would not allow employer contributions to an Archer MSA to be excluded from income. But, existing Archer MSA balances could still be rolled over tax-free into an HSA. Effective date: The provision would be effective for tax years beginning after 2017. According to JCT, the provision would have negligible revenue effect over the 2018-2027 time period. Implications: According to JCT, "there is no manner in which Archer MSAs are more favorable than HSAs; thus, no taxpayer would see his ability to save for future health costs restricted. As a result, the provision merely simplifies the Code by consolidating two similar tax-favored accounts into a single account with more taxpayer-friendly rules (i.e., HSAs)." Repeal of exclusion for dependent care assistance programs Current law: Current law allows the value of employer-provided dependent care assistance programs to be excluded from an employee's income up to a yearly $5,000 limit ($2,500 for married taxpayers filing separately) to pay the work-related expenses of caring for a child under 13 years old or a spouse or other dependent who is physically or mentally unable to care for himself or herself. Provision: The provision would repeal the exclusion for dependent care assistance expenses. Effective date: The provision would be effective for tax years beginning after 2017. According to JCT, the provision would increase revenues by $3.0 billion over the 2018-2027 time period. Implications: It is peculiar that the bill eliminated the payroll savings mechanism for dependent care, but did not remove the dependent care credit. Because the amounts contributed to a dependent care account are not eligible for the credit, eliminating the accounts simply allows more expenses to be eligible for the credit. This eliminates the tax-arbitrage for high-earning taxpayers who benefit more from the above-the-line deduction than the dependent care credit. Transfer taxes Increase in credit against estate, gift, and generation-skipping transfer tax; repeal of estate and generation-skipping transfer taxes Current law: Current law generally applies a top tax rate of 40% to property inherited through an estate. If a donor makes a gift of property during life, a top gift tax rate of 40% applies to any gift that exceeds the annual per-donee gift tax exclusion ($15,000 for 2018). If the donor gives property directly to grandchildren, for example, a generation-skipping tax applies, also at the 40% rate. The first $5 million in transferred property (the basic exclusion) is exempt from any combination of estate, gift, and generation-skipping taxes. Transfers between spouses are generally exempt from these taxes, and a surviving spouse may carryover (add) to his own basic exclusion any portion of his spouse's basic exclusion that has not been exhausted. A beneficiary who receives property from an estate receives a stepped-up basis in the property, but a donee who receives a gift from a living donor takes a carryover basis in the property. Provision: With regard to the estate tax, the provision (1) doubles the basic exclusion amount to $10 million, indexed for inflation; (2) repeals, beginning after 2023, the estate and generation skipping taxes; (3) retains the stepped-up basis for estate property. With regard to gift tax, the provision (1) lowers the gift tax to a top rate of 35%; (2) retains the $10 million basic exclusion; and (3) retains the $14,000 annual exclusion. Both exclusion amounts will be indexed for inflation. Effective date: The provision would be effective for tax years beginning after 2017 and repeals the estate tax after 2023. According to JCT, these reduce revenues by $172.2 billion over the 2018-2027 time period. Implications: The explanation accompanying the bill states that the estate and generation-skipping taxes impose additional levels of tax on income and assets that have generally already been subject tax. "By repealing the estate and generation-skipping taxes, family businesses that would pass from one generation to the next would no longer be subject to double or even triple taxation. By repealing the estate and generation-skipping taxes, a small business would no longer be penalized for growing to the point of being taxed upon the death of its owner, thus incentivizing the owner to continue to invest in more capital and hire more employees." In keeping with a promise that Republicans have made for almost 20 years, the bill would repeal the estate and generation-skipping transfer tax for persons dying after 2023. In the meantime, it doubles the current estate, gift and generation-skipping transfer tax exclusion until such repeal. The gift tax will survive. Thus, until 2024, taxpayers will continue to plan their estates in much the same manner as they do under the current regime — planning with exclusion amount. As with the last attempt to repeal the estate tax in the Economic Growth Tax Relief Reconciliation Act of 2001, tax reform is scheduled to move forward under the Senate's reconciliation process which means that the repeal of the estate and generation-skipping transfer tax is set to sunset in 2027. Many tax practitioners were wondering whether the step-up in basis at death would survive if the estate tax was repealed. Surprisingly, the bill leaves Section 1014 (the provision providing for a step-up in basis at death) intact. The retention of this provision and the repeal of the estate tax will be a strong incentive for taxpayers to hold assets until they die. ———————————————
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