November 13, 2017 Highlights of Senate Finance Committee Chairman's Mark of the 'Tax Cuts and Jobs Act' Senate Finance Committee Chairman Orrin Hatch (R-UT) released late on November 9, 2017, his Chairman's Mark of the "Tax Cuts and Jobs Act," which adheres to the same basic tax overhaul framework as the tax bill approved by the House Ways and Means Committee but includes significant differences in the design of provisions and their timing. Notably, the statutory corporate tax rate would be reduced to 20% but not until 2019. While the Senate proposes moving to a territorial tax system for foreign earnings, the plan includes different approaches to preventing base erosion. In addition, the Chairman's Mark adds numerous changes to business and partnership provisions of current law that are not included in the Ways and Means plan. The Finance Committee will mark up its plan beginning on Monday, November 13 at 3 p.m. and Chairman Hatch said he hopes to report the legislation by the end of that week. A list of filed amendments and a Chairman's Modification may be issued before then. Changes are possible during the Committee process. For individuals, the Chairman's Mark includes seven tax rates, compared to four under the House bill, and would drop the top individual tax rate slightly to 38.5%. The current estate and gift tax exemption would be doubled but the tax would remain on the books; some Senate Republicans previously warned they would not support estate tax repeal. The state and local tax deduction would be fully repealed, but the $1 million cap on the mortgage interest deduction would be left unchanged and the medical expense deduction retained. On the business side, the Chairman's Mark varies from the Ways and Means Committee bill on pass-through taxation and interest deductibility. Chairman Hatch's plan would provide a general 17.4% deduction for pass-through income, with a more limited deduction for taxpayers with income related to services. Deductibility of net interest expense would, like the House bill, be subject to a 30% limitation, but at a different measure of adjusted taxable income that excludes depreciation and raises significantly more revenue than the House approach. Chairman Hatch's Mark was released several hours after the House Ways and Means Committee approved its own version of the Tax Cuts and Jobs Act, following a four-day markup and multiple revisions made in an effort to solidify support for the bill. House Republican leaders would like to bring the bill to the House floor late next week. While the bill will likely be considered under a "closed rule" that will not permit floor amendments, it is possible that further changes to the bill could be made before final House passage as part of the adoption of that rule, meaning that adoption of the rule for House consideration of the bill would automatically incorporate changes developed by the leadership over the next few days. Finance Committee member and second-ranking Republican Senator John Cornyn (R-TX) has said the full Senate would likely consider the final product of the Finance Committee deliberations after Thanksgiving. Speaker Paul Ryan (R-WI) said a House-Senate conference would follow Senate approval, and both he and Ways and Means Committee Chairman Kevin Brady (R-TX) played down differences between the two chambers as simply reflective of the normal legislative process. Still, the differences between the House and Senate plans would need to be ironed out in a compromised version so a final bill can be approved by both chambers and sent to the President for his signature. The FY 2018 budget included reconciliation instructions for a tax bill that can add to the deficit by no more than $1.5 trillion over the first 10 years, to which the plans adopted by Ways and Means and proposed by the Finance Committee adhere. However, the Byrd Rule under the reconciliation process precludes any title of the tax bill from adding to the deficit beyond the 10-year budget window, and how the Senate proposal fares in relation to that requirement will be of great interest as the process moves forward. It is likely that changes will have to be made to the Chairman's Mark before the bill is brought to the Senate floor in order to accommodate this rule. Highlights of the Senate plan are grouped into the following main topics: — Corporate Corporate The Senate plan provides for: 20% corporate tax rate — The rate would be effective for tax years beginning after December 31, 2018. For taxpayers subject to the normalization method of accounting, excess deferred tax reserves would be allowed normalization on allowances taken for assets placed in service before the date of enactment. Dividends received deduction (DRD) — The amount of deduction allowable against dividends received from a domestic corporation would be reduced to correlate with the reduction in the corporate rate. Specifically, the deduction for dividends received from other than certain small businesses or those treated as "qualifying dividends" would be reduced from 70% to 50%. Dividends from 20%-owned corporations would be reduced from 80% to 65% for the DRD. Repeal of corporate AMT — The corporate alternative minimum tax (AMT) would be repealed under the Chairman's Mark. Taxpayers could claim a refund of 50% of any remaining AMT credits (to the extent the credits exceed regular tax for the year) in tax years beginning before 2022. The provision would apply to tax years beginning after 2017. Research tax credit and LIHTC — The research and development tax credit and Low-Income Housing Tax Credit (LIHTC) would be preserved without modification from current law. Expensing — For "qualified property" placed in service in tax years beginning after 2017, Section 179 expensing would increase to $1 million with a phase-out beginning at $2.5 million; additionally, the term "qualified property" would be expanded to include certain depreciable personal property used to furnish lodging, and improvements to nonresidential real property (such as roofs, heating and property protection systems). — Bonus depreciation would be increased from 50% to 100% for "qualified property" placed in service after September 27, 2017 (the date the Unified Framework was released). The increased allowance would remain until 2022. Qualified property would be defined to exclude — as with the Section 163(j) interest limitation described next — certain public utility property. A transition rule would allow for an election to apply 50% expensing for one year. Interest limitations — Multiple interest limitations are proposed: — Section 163(j) would be repealed and replaced with a provision that would disallow net business interest expense deductions that exceed 30% of adjusted taxable income (ATI). For partnerships, the limitation would apply at the partnership level. The targeted interest — business interest income and expense — is defined similar to the definitions in the House bill, in which interest paid or accrued on indebtedness and interest received would need to be properly allocable to a trade or business. Certain activities that would be excluded from being a trade or business — as in the House bill — are performing services as an employee, a real property trade or business and certain activities of regulated utilities. Activity related to floor plan financing contained in the House bill is not identified in the Senate bill. An exception from interest limitations would be provided for small businesses that meet a $15 million gross receipts test. ATI would be defined differently from current Section 163(j). The current rule does not reduce taxable income for certain items (like depreciation, amortization and depletion) but those items would be taken into account under the new provision — resulting in a lower amount by which to measure the 30% threshold. The new provision also computes ATI without regard to any non-trade or business income, gain, deduction or loss, the 17.4% deduction for pass-through income and any net operating loss (NOL) deduction. — A worldwide limitation on interest deductibility would be targeted at US interest deductions that are seen as eroding the US tax base. The limitation would be based on a comparison of the debt that could be incurred if the US group had a debt-equity ratio in proportion to the worldwide group's debt-equity ratio. The resulting amount of debt that "should" be in the United States (based on the proportionate ratios) is grossed-up by 110% to determine the amount of the US debt exceeding the "proper" amount — this excess would be the "excess domestic indebtedness." The excess domestic indebtedness would be divided by all actual domestic debt and multiplied by the net interest expense. Thus, the more the actual US leverage exceeds the leverage that "should" be in the US group, the more the numerator increases and the allowable percentage of interest deductions decreases. — As with the House bill, when both the Section 163(j) and worldwide interest limitations apply, the one that results in the lower limitation on interest deductions — and therefore the greatest amount of interest to be carried forward — will take precedence. Any disallowed interest would be carried forward indefinitely (as opposed to five years proposed in the House bill). The bill would repeal or modify many other deductions and exclusions, including: Net operating losses — For losses arising in tax years beginning after 2017, the NOL deduction would be limited to 90% of taxable income. The carryback provisions would be repealed, except for losses incurred in a farming trade or business, which would be allowed a two-year carryback. An indefinite carryforward would be allowed, but the provision does not address whether NOL carryforwards would be increased by an interest factor as proposed in the House bill. Like-kind exchanges — Like-kind exchanges would be limited to those involving real property only. Transactions involving like-kind exchanges currently underway would be allowed to complete the like-kind exchange. Otherwise, the limitation would be effective for exchanges completed after 2017. Real property cost recovery — The recovery period for real property would be shortened. Specifically, nonresidential real and residential rental property would be shortened to 25 years with a 10-year recovery period for qualified improvements and a 20-year ADS recovery period. The provision would apply to property placed in service after 2017. Section 199 — The domestic production deduction for qualifying receipts derived from certain activities performed in the United States would be repealed for tax years after 2018 (a one-year delay from the House bill's proposal to repeal the deduction starting in tax years after 2017). Entertainment expenses — The current rules on deductibility of entertainment expenses would be tightened for fringe benefits provided to employees. The Senate plan would repeal or modify the following business credits: Orphan drug credit — The 50% credit would be retained but generally would need to exceed 50% of the average expenses over three years. The creditable expenses would no longer include those for testing drugs that have been previously approved for use. Rehabilitation for old and/or historic buildings — The credit for pre-1936 buildings would be repealed and the credit for certified historic structures would be reduced from 20% to 10% for amounts paid or incurred after 2017, with transition rules to be applied in the case of property owned or leased by the taxpayer on or after 2018. Deduction for unused business credits — The loss or limitation on the use of business credits under current law would no longer create a deduction for the amount of the credit lost or otherwise limited. The provision would apply to tax years beginning after 2017. Business credits addressed in the House bill but not in the Senate bill: — Employer-provided child care — Work Opportunity Tax Credit — New Markets Tax Credit (terminated through disallowance of any additional allocation of the credits with existing credits being available for up to seven years) — The tax credit for expenses to provide access for disabled individuals — The employer tax credit for its share of FICA relating to 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 Senate 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. 100% exemption for foreign-source dividends — The Senate bill, similar to the House bill, exempts 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. There are a few major differences between the two provisions: — Holding period — The Senate bill requires a more than one-year holding period in the stock of the foreign corporation, whereas the House bill requires only a six-month holding period. — Hybrid dividends — The Senate bill does not allow an exemption for any dividend received by a US shareholder from a CFC if the dividend is deductible by the foreign corporation when computing its taxes. — The effective date for the Senate bill would be the tax year of foreign corporations beginning after December 31, 2017. The House bill would apply to distributions made after December 31, 2017 — regardless of fiscal years. Special rules for the sale of foreign corporations — The Senate bill would apply the dividend exemption to gain from the sale of foreign stock to the extent of the foreign corporation's E&P. Additionally the Senate bill would clarify that the dividend exemption would apply to gain from the sale of lower-tier CFCs to the extent of the CFC's E&P. The House bill did not address either provision. Similar to the House bill, 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. Transition tax on tax-deferred foreign earnings — A one-time transition tax would apply to a US 10% shareholder's pro rata share of the foreign corporation's post-1986 tax-deferred earnings, at the rate of either 10% (for accumulated earnings held in cash, cash equivalents or certain other short-term assets) or 5% (for accumulated earnings invested in illiquid assets (e.g., property, plant and equipment)). The House bill applies rates of 14% and 7%, respectively. A foreign corporation's post-1986 tax-deferred earnings would be the earnings as of November 9, 2017, limited to the earnings accumulated after the shareholder's acquisition of the foreign corporation from a foreign shareholder. Similar to the House bill, the Senate bill would allow an affected US shareholder with a 10%-or-greater stake in a foreign corporation with a post-1986 accumulated deficit to offset the deficit against tax-deferred earnings of other foreign corporations. The US shareholder could elect to pay the transitional tax over eight years or less. The Senate bill also has a new anti-inversion provision. The anti-inversion provision requires the US corporation to pay the full 35% rate on the deferred foreign earnings (less the taxes it already paid), if the US corporation inverted within 10 years after enactment. No foreign tax credits would be available to offset the tax in this instance. Anti-base erosion rules — — "Carrot" — Unlike the House bill, the Senate bill has an incentive for US companies to sell goods and services abroad. Income from the sale of goods and services abroad would be effectively taxed at only 12.5%. Under the House bill, those same sales would be taxed at 20%. — "Stick" — The Senate bill would tax a US shareholder's aggregate net CFC income at a rate that, presumably, would be similar to the rate on the incentives for US companies (i.e., less than or equal to 12.5%). Net CFC income is gross income in excess of extraordinary returns from tangible assets excluding effectively connected income (ECI), subpart F income, high-taxed income, dividends from related parties, and foreign oil and gas extraction income. The carve-outs are similar, but not identical, to the House bill. Most notably the carve-outs do not include AFE-qualifying income or commodities income. The extraordinary return base equals 10% of the CFCs' aggregate adjusted basis in depreciable tangible property. Only 80% of the foreign taxes paid on the income would be allowed as a foreign tax credit. Similar to the House bill, all CFCs would be aggregated rather than the CFC-by-CFC approach that was in the Camp bill. — Intangible property repatriation — Under the Senate bill, US companies could repatriate their intangible property tax-free. There was no such provision in the House bill. Subpart F modification — compared to the House bill, the Senate bill makes the following modifications: — Repeal of foreign base company oil-related income as subpart F income — Repeal of the inclusion based on withdrawal of previously excluded subpart F income from a qualified investment in foreign base company shipping operations — Addition of an inflation adjustment to the de minimis exception for foreign base company income Modification of stock attribution rules for CFC status — Similar to the House bill, the Senate bill would change the stock attribution rules. Under this provision, US corporations would be deemed to own the foreign stock that is owned by the US corporation's foreign parent for purposes of determining CFC status. Repeal of 30-day CFC rules — Under both the Senate and House bills, foreign corporations would be considered CFCs as soon as the ownership requirements were met and subject to the subpart F and base erosion rules. 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, similar to the House bill, the Senate bill would make the provision permanent for tax years of foreign corporations beginning after 2019. Repeal of tax on investment in United States property — The Senate bill would modify current law that taxes as dividends investments made by certain foreign corporations in US property. The bill would provide an exception for domestic corporations that are US shareholders in the CFC directly or through a domestic partnership. The House bill would repeal the whole section. Anti-base erosion provisions — Several provisions address the Senate's effort to prevent erosion of the US tax base. — Interest limitations — As described previously, an interest expense limitation based on a worldwide ratio would be imposed on a US corporation's interest deductions. — Change in intangibles definition — The Senate bill would change the definition of intangible property to include workforce in place, goodwill and going concern value, and "any similar item" whose value is not attributable to tangible property or the services of an individual. The bill would also confirm the authority to require certain valuation methods. — Hybrid rule — The Senate would deny a deduction for any amount paid to a hybrid company or under a hybrid transaction if the recipient country treats the payment differently than the US. — Special rules for domestic international sales corporations — The Senate bill would repeal special rules for DISCs and IC-DISCs. — Inversion rules for qualified dividends — Individual shareholders could not claim reduced rates of tax on qualified dividends received from inverted companies. Foreign tax credit changes — Similar to the House bill, 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 could not be carried forward or back. Separate branch FTC baskets — The Senate bill would form a separate foreign tax credit basket for branches. This would minimize a corporation's ability to cross-credit. Worldwide interest allocation — The bill would accelerate the effective date of the worldwide interest allocation rules to tax years beginning after December 31, 2017. Inbound base erosion rule — The Senate bill would create a new base erosion minimum tax. The tax would apply to corporations (other than RICs, REITs or S-corporations) subject to US net income tax with average annual gross receipts of at least $500 million and that have made related-party deductible payments totaling 4% or more of the corporation's total deductions for the year. A corporation subject to the tax would generally determine the amount of tax owed under the provision (if any) by adding back to its adjusted taxable income for the year all deductible payments made to a foreign affiliate for the year (the modified taxable income). The excess of 10% of the corporation's modified taxable income over its regular tax liability for the year (net of an adjusted amount of tax credits allowed) is the base erosion minimum tax amount that is owed. Cruise ship tax — The Senate bill would treat a portion of revenue generated by cruise ship in the US as effectively connected to US trade or business based on the time it is considered in US territorial waters. Sales of partnership interests by foreign partners — As described later, the Senate bill would treat the gain or loss from the sale of a partnership interest by a foreign partner as ECI that is taxable in the United States if the gain or loss from the sale of the partnership assets by the partnership itself were treated as effectively connected income that is taxable in the United States. In addition, the Senate bill would require the purchaser of a partnership interest from a partner to withhold 10% of the sale price (similar to the operation of the FIRPTA rules applicable to sales of US real estate by foreign owners). Taxation of pass-throughs Pass-through Income: Special 17.4% deduction — Unlike the special rate of 25% for certain pass-through income in the House bill, the Senate bill provides individuals with a 17.4 % deduction on certain pass-through income. Special limitations would apply to "specified service businesses" based on the income of their owners. — General rule — An individual taxpayer could deduct 17.4 % of domestic "qualified business income" (QBI) from a partnership, S corporation or sole proprietorship (qualified businesses). At the top rate of 38.5% that the Senate bill proposes, if a taxpayer's sole income source is domestic QBI, then the effective tax rate on the domestic QBI would be 31.8%. — Qualified business income — QBI for a tax year means the net amount of domestic qualified items of income, gain, deduction and loss with respect to a taxpayer's qualified businesses, which includes any trade or business other than specified services trades or businesses (defined later). In determining a taxpayer's qualified items of income, gain, deduction and loss, items are taken into account only to the extent included or allowed in the determination of taxable income for the year. REIT non-capital gain dividends and certain cooperative dividends are considered qualified items of income for this purpose. QBI does not include reasonable compensation of an S corporation shareholder, amounts allocated or distributed to a partner who is acting other than in his/her capacity as a partner for services, and guaranteed payments in the nature of remuneration for services. It also does not include certain investment-related items and contains limitations based on "W-2 wages." If the computation of QBI results in a loss for a tax year, the amount of the loss is carried forward and treated as a loss from a qualified business in the next tax year. — Limit — 50% of wages — The amount of the deduction would be limited to 50% of the W-2 wages of the taxpayer. Only those wages that are properly allocable to qualified business income would be taken into account. — Special limitation for specified service businesses — The deduction would not apply to "specified service businesses," except for taxpayers whose taxable income does not exceed $150,000 (if married filing jointly) or $75,000 (for other individuals). The benefit of the deduction would also be phased out for these taxpayers over a $50,000 range for taxable income exceeding the aforementioned thresholds. A "specified service business" means any trade or business activity involving the performance of services in the fields of 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. Though no Code section is referenced, this appears consistent with the definition under Section 1202 that is used in the House bill for the same term. The proposal is effective for tax years beginning after December 31, 2017. Loss limitation rules applicable to individuals — Excess business losses of a taxpayer other than a C corporation would not be allowed for the tax year, but would be carried forward. An excess business loss would be the excess of aggregate deductions of the taxpayer attributable to trades or businesses, over the sum of aggregate gross income or gain of the taxpayer, plus a threshold amount $500,000 for married individuals filing jointly and $250,000 for other individuals. For a partnership or S corporation, the proposal would apply at the partner or shareholder level. Each partner's or S corporation shareholder's share of items of income, gain, deduction or loss of the partnership or S corporation would be taken into account in applying the limitation. Sales of partnership interests by foreign partners — In Grecian Magnesite (Grecian Magnesite Mining, Industrial & Shipping Co., SA vs. Comm'r, 149 T.C. No. 3 (Jul. 13, 2017)), the Tax Court declined to follow Revenue Ruling 91-32 (1991-1 C.B. 107.), holding that the gain recognized by a foreign person on its redemption from a partnership engaged in a US trade or business did not result in effectively connected income (ECI). The Senate bill would effectively reverse this decision, reestablishing, by statute, a provision similar to the Revenue Ruling 91-32 holding to treat gain or loss from the sale of a partnership interest by a foreign partner as ECI that is taxable in the US if the gain or loss from the sale of the underlying assets held by the partnership would be treated as ECI. In addition, the Senate bill would require the purchaser of a partnership interest from a partner to withhold 10% of the amount realized on the sale or exchange of the partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or a foreign corporation (similar to the operation of the FIRPTA rules applicable to sales of US real estate by foreign owners). Mandatory basis adjustments for sales of partnership interests with built-in losses — The Senate bill would require a partnership to adjust the basis in its assets upon the sale of a partnership interest if the partnership has a built-in loss of more than $250,000 in its assets (as under current law), or if the partner selling a partnership interest would be allocated a loss of more than $250,000 upon a hypothetical taxable disposition by the partnership of all of the partnership's assets for cash equal to the assets' fair market value, immediately after the transfer of the partnership interest. This provision would expand the application of mandatory downward basis adjustments on transfers of partnership interests by taking into account gain and loss allocations to the transferee. Partner loss limitation to include charitable contributions and foreign taxes — Under existing law, Treasury regulations do not take into account a partner's share of partnership charitable contributions and foreign taxes paid or accrued in applying the basis limitation on partner losses. The Senate bill would modify the basis limitation on partner losses to include as losses the partner's share of partnership charitable contributions and foreign taxes. This would conform the basis limitation that applies to partnerships to the treatment of these items by shareholders in an S corporation. Financial services Tax-exempt bonds — The Senate bill leaves in place both the tax exemption for general obligation bonds and, unlike the House bill, the exclusion from gross income for interest on qualified private activity bonds. However, the bill would repeal the exclusion for interest on any bond issued to advance refund a tax-exempt bond, effective for bonds issued after December 31, 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. Requirement to use the FIFO method to compute basis in securities for determining gain or loss — The Senate bill would require the cost of any security sold, exchanged or disposed of to be determined on a first-in first-out basis, except when the average basis method is allowed to compute the cost basis of a security. The requirement to use FIFO would apply to securities disposed of on or after January 1, 2018. Insurance Life insurance tax proposals Similar to the House bill, the Senate bill contains proposals modifying rules for life insurance companies. Notably, unlike the House bill, the bill does not include a "placeholder provision" aimed at raising $24 billion over 10 years from changes to subchapter L; rather, the bill would raise close to that amount — $23 billion — from one change to deferred policy acquisition costs. Deferred policy acquisition (DAC) costs — For purposes of capitalizing and amortizing specified insurance policy acquisition expenses, this proposal would update the proxy DAC rules of Section 848 in the following ways: — This proposal would require insurance companies to deduct their expenses associated with earning a stream of premium income over 50 years, instead of 10 years. — This proposal would increase the specific percentage of net premiums by which insurance companies calculate such expenses: 3.17% for annuity contracts (increased from 1.75%); 3.72% for group life insurance contracts (increased from 2.05%); and 13.97% for all other specified insurance contracts (increased from 7.70%). Adjustment for change in computing reserves — This proposal would reduce 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 to a four-year period. This proposal is effective for tax years after 2017. Under the House proposal, the 10-year period was repealed, subjecting life insurance reserve changes to the accounting method change rules under Section 481. Repeal of small life insurance company deduction — As in the House bill, this proposal 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 proposal would be effective for tax years after 2017. NOL deductions — Like the House bill, this proposal would repeal the special carryforward period of 15 years and carryback period of three years for NOLs of life insurance companies. Thus, NOLs of life insurance companies would be subject to the same rules as all other corporations under Section 172. This proposal would apply to NOLs arising in tax years after 2017. Rule for distributions from policyholders' surplus accounts — Identical to the House bill, this proposal 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. Life insurance contracts — Unlike the House bill, the Senate bill includes certain rules related specifically to life insurance contracts: — First, this proposal would impose a reporting requirement on both the acquirer of an interest in an existing life insurance contract and the payor of death benefits. This proposal would be effective for tax years after 2017. — Second, this proposal would reverse the position of the IRS in Revenue Ruling 2009-13 so that no adjustment would be made for the "cost of insurance" (i.e., mortality, expense, or other reasonable charges incurred under the contract) in determining the basis of a life insurance or annuity contract. This proposal would be effective for transactions entered after August 25, 2009. — Finally, this proposal provides that the exceptions to the transfer for value rules under Section 101(a) do not apply to a reportable policy sale, which means that some or all of the death benefits could be includible in taxable income. This proposal would be effective for tax years after 2017. Property/casualty insurance tax proposals Proration for property/casualty insurance companies — Similar to the House bill, under this proposal, the amount by which a property/casualty insurer must reduce its loss reserve deduction would be increased. Specifically, the 15% reduction would be replaced with a reduction equal to 5.25% divided by the top corporate tax rate. Due to the one year phase-in of the 20% top corporate tax rate, the reduction percentage would remain at 15% for 2018 (5.25% divided by a top corporate tax rate of 35%), and increase to 26.25% beginning in 2019. Notably, the provision is linked to the corporate tax rate, so that if the corporate tax rate were to be increased in the future, the reduction would decrease accordingly. Special estimated tax payments — Matching the House bill, this proposal 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. Modification of 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, and certain reserves for life and health insurance risks and life and health insurance claims with respect to contracts providing coverage for mortality or morbidity risks, constitute greater than 25% of a foreign corporation's total assets (or 10% if 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. Unlike the House bill, unearned premium reserves are not included in the calculation of total assets. Pensions and retirement Conformity of contribution limits for employer-sponsored retirement plans — The bill would apply the same limit for contributions for an employee under a government 457(b) plan that applies under present law to elective deferrals to Section 401(k) or 403(b) plans. It would repeal special rules allowing additional elective and catch-up contributions under 403(b) and 457(b) plans, as well as the current rule allowing employer contributions to Section 403(b) plans for five years after termination of employment. The proposal would also revise the limit on aggregate contributions to a qualified defined contribution plan, so that a single overall limit applies to contributions for any employee by the same employer. Elimination of catch-up contributions for high-wage employees — Under current law, employees aged 50 or older may make additional contributions (generally $6,000 for 2017) to a 401(k), 403(b), or 457(b) plan. Under the proposal, employees who receive wages of $500,000 or more could not make catch-up contributions for the following year. Executive compensation Limitations on nonqualified deferred compensation — The Senate bill would eliminate Section 409A and add Section 409B, which essentially imposes taxation on 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 such compensation is actually paid. In addition, "vesting" under Section 409B is 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) will 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 Senate provision would clarify that Incentive Stock Options and Employee Stock Purchase Plans are not considered nonqualified deferred compensation and would not be covered by the provision. 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 must 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 Senate 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 expand the applicability of the deduction limitation to foreign companies that are publicly traded on an American Depositary Receipt. Importantly, the definition of publicly-traded companies subject to the deduction limit may include certain additional corporations that are not publicly traded, such as large private C or S corporations. The provision would be effective for tax years beginning after December 31, 2017. Worker classification Determination of worker classification and information reporting requirements — The proposal creates a new elective safe harbor under which, if certain requirements are met, for all Code purposes, a service provider is not treated as an employee, the service recipient is not treated as an employer, a payor is not treated as an employer, and compensation paid for services is not treated as paid or received with respect to employment. Under the proposal, a payor is any person that pays the service provider for performing the service, or any marketplace platform that operates a digital website or mobile application that facilitates the provision of goods or services by providers to recipients. The provision would impose requirements service providers must meet to qualify under the safe harbor, and create a detailed written contract requirement. The proposal would also impose an income tax withholding requirement of 5% on up to $20,000 of compensation with respect to compensation paid that meets the requirements of the safe harbor. Importantly, the provision would not disrupt or change the ability of any service provider or recipient to operate under existing law, specifically including the safe harbor under Section 530 of the Revenue Act of 1978. Nor would it lift the regulatory moratorium that has been in effect since 1978. The proposal would be effective for services performed after December 31, 2017. Reporting requirements — The proposal would increase the reporting threshold for two categories of reportable payments from $600 to $1,000. It would also create new reporting requirements relating to payments made in settlement of third-party network transactions. The proposal would define a marketplace platform as a person that is a central organization and operates a website or mobile application through which users transact for the provision of goods or services and through which the organization settles such transactions and guarantees payments to providers. The reporting requirements would apply to payments made after December 31, 2018. Energy Energy tax — The Senate Chairman's Mark is largely silent on energy tax, including neither a slate of items proposed in the House bill, nor a package of widely supported Senate energy tax proposals. Given the support in the Senate for technologies like nuclear energy and biodiesel fuels, it is possible that senators may yet be planning to process an energy tax package, either later in the Senate tax reform process, or perhaps in another end-of-the-year tax legislative vehicle. Oil & gas energy tax incentives — While the House bill would repeal the enhanced oil recovery tax credit (Section 43) and the credit for producing oil and gas from marginal wells (45I), the Senate bill would not repeal any conventional energy tax credits. Also, the bill follows the House bill and leaves untouched the deductibility of intangible drilling costs (IDCs), taxpayers' 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). International tax items affecting energy companies — The international tax section of the Senate bill would repeal the foreign base company oil related income (FBCORI) rules. This proposal, which was also included in the House bill, is effective for tax years of foreign corporations beginning after December 31, 2017, and for tax years of US shareholders in which or with which such tax years of foreign subsidiaries end. New restrictions on renewable energy production and investment incentives — The Senate bill did not adopt any of the House proposals to eliminate the renewable electricity PTC inflation adjustment factor, revisit the rules defining beginning of construction of renewable energy facilities, or terminate the permanent 10% investment tax credit available for geothermal and solar technologies. Renewable electricity and biofuel producers — Unlike the House bill, the Senate bill would not extend the incentives for certain renewable electricity technologies (fiber-optic solar property, fuel cells, microturbines, combined heat and power systems, thermal energy property and small wind systems). Likewise, the bill does not address credits for Section 25D residential energy efficiency property (qualified geothermal heat pump property, qualified small wind property and qualified fuel cell power plants). Like the House approach, the Senate bill would not extend a number of other temporary tax incentives for renewable electricity, including expired credits for production of hydropower; biomass and waste to energy. Similarly, the bill is silent on the fate of expired fuel tax incentives for biodiesel; renewable diesel; second generation biofuels, alternative fuels, and alternative fuels mixtures. The nuclear production tax incentives modification, featured in the House bill, also was not included in the Senate proposal. Exempt organizations The Senate bill includes some of the same provisions as the House bill, and also adds new provisions and omits others. Charitable organizations remain concerned that changes to the individual tax provisions in the bill could dramatically reduce charitable giving, pointing to provisions that would double the standard deduction (thus limiting the number of taxpayers eligible to itemize their charitable contributions) and the effect of the estate tax changes. These concerns linger in spite of changes that would increase the 50% adjusted gross income (AGI) cap on the charitable deduction to 60%, potentially positively affecting giving for a limited number of taxpayers. An estimate by JCT found that the changes in the House bill could reduce the number of charitable itemizers from 40.7 million to 9.4 million. Unlike the House bill, the Senate bill does not eliminate private activity bonds, make changes to donor-advised fund reporting requirements, modify the excise tax on private foundations, or address the charitable mileage rate, art museums or "philanthropic enterprises." Key provisions in the Senate bill affecting tax-exempt organizations include: Unrelated business income (UBI) computed separately for each trade and business — UBI must first be computed separately for each trade or business and NOL operating loss deductions would be allowed only for a trade or business from which the loss arose. Excise tax on executive compensation in exempt organizations — A 20% excise tax would apply to compensation over $1 million for the five highest compensated employees of an exempt organization. The calculation includes cash and benefits (not retirement or health), and excess parachute payments, even if remuneration is less than $1 million. Name and logo royalties treated as UBI — Royalty income earned from licensing of any name or logo of the organization would be subject to the tax on UBI. College athletic seating — The individual charitable deduction associated with the right to purchase college athletic seating would be repealed. Professional sports leagues — The bill would eliminate the tax exemption for all professional sports leagues. Excess benefit transactions/ Intermediate sanctions — To prevent a "disqualified person" from receiving "excess benefit" from a charity, the excess benefit would be subject to a 10% tax under the Senate bill. Rules are enhanced to require organizations to perform minimum standards of due diligence to avoid penalty, eliminate special rules for managers who rely on professional advice, add investment advisors and employees of donor-advised funds and athletic coaches to the list of disqualified persons and apply the excess benefit rules to 501(c)(5) and (c)(6) organizations, including labor organizations and business leagues. Accounting methods The accounting method reforms in the Senate bill are beneficial to taxpayers but are confined to small businesses, with one significant exception that is generally applicable and generally not beneficial to taxpayers. Notably absent from the Senate bill (as well as the House bill) are 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 Senate bill generally would require a taxpayer to recognize income no later than the tax year in which the income is taken into account on the taxpayer's financial statements. In addition, the Senate bill would apply this rule in lieu of the original issue discount (OID) rules, so that items such as late-payment fees, cash-advance fees, and interchange fees would be included in taxable income when received if these items are treated as income when received on the taxpayer's financial statements. This provision would overturn the Capital One case involving interchange and other credit card fees. Conversely, the Senate bill also would codify Revenue Procedure 2004-34, which permits taxpayers to defer the inclusion of income from certain advance payments to the following year if the income also is deferred on the taxpayer's financial statements. The small business accounting method proposals in the Senate 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 increase to $15 million and be indexed to inflation, and the increased threshold would extend to farms. — The cash method of accounting for these businesses would apply even if the business has inventories, and these businesses would be completely exempt from the uniform capitalization (UNICAP) rules. — These businesses could use the percentage-of-completion accounting method for contracts that are expected to be completed within two years. Individual taxes For individuals, the Senate bill would eliminate several itemized deductions, but tax incentives for home mortgage interest and charitable contributions would be retained (in slightly modified form). The controversial state and local tax deduction would be repealed entirely. 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 Senate bill would reform (but not consolidate) individual income tax rates so that: — The 10% rate would apply to the first $9,525 in taxable income for single filers and the first $19,050 for joint filers. — The 15% rate would be eliminated and a new 12% rate would apply to taxable income exceeding $9,525 for single filers and $19,050 for joint filers. — A new 22.5% rate would apply to taxable income exceeding $38,700 for single filers and $77,400 for joint filers. — The 25% rate would apply to taxable income exceeding $60,000 for single filers and $120,000 for joint filers. — The 28% and 33% rates would be eliminated and a new 32.5% rate would apply to taxable income exceeding $170,000 for single filers and $290,000 for joint filers. — The 35% rate would apply to taxable income exceeding $200,000 for single filers and $390,000 for joint filers. — The 39.6% rate would be eliminated and a new 38.5% rate would apply to taxable income exceeding $500,000 for single filers and $1 million for joint filers. Capital gains and dividends — Under the Senate bill, net capital gains and qualified dividends would continue to be taxed at the current 0%, 15% and 20% rates, and also would continue to be subject to the 3.8% net investment income tax. Other changes — The standard deduction would be set at $24,000 for joint returns, and $12,000 for single filers; unlike the House bill, the Senate bill would not repeal the additional standard deduction for the elderly and the blind. — Personal exemptions would be repealed. — The "Pease" limitation on itemized deductions would be repealed. — The indexing of income tax brackets and other income thresholds for inflation would be changed from the Consumer Price Index for urban consumers (CPI-U) to the chained CPI (resulting in slower adjustments to the brackets and thresholds). — The AMT would be repealed. — The estate, gift and generation-skipping taxes would be retained with a doubled $10 million basic exclusion that is indexed for inflation. — The child tax credit would increase from $1,000 to $1,600 (and the age limit for a qualifying child increased by one year to age 18), a new $500 credit would be available for non-child dependents and the earned income threshold for the refundable child tax credit would be reduced from $3,000 to $2,500. Phase-outs — Unlike the House bill, the Senate bill would not phase out any of the individual income tax rates for upper-income taxpayers. Furthermore, the phase-out for the child tax credit would increase significantly from $75,000 to $500,000 for single filers and from $110,000 to $1 million for joint filers. Modification and repeal of current tax expenditures — The Senate bill would modify or eliminate several individual income tax deductions, exclusions and credits, including the following: — The deduction for home mortgage interest would be retained, except for interest on home equity lines of credit (including interest paid after 2017 on existing lines of credit). — The deduction for individual state and local taxes would be repealed (including taxes on pass-through business income), with no exceptions. — The 50% AGI limitation for charitable contributions would increase to 60%. — All itemized deductions subject to the 2% floor would be repealed (e.g., home office deductions, license and regulatory fees, dues to professional societies, and subscriptions to professional journals and trade magazines) — The deductions for tax preparation and moving expenses would be repealed. — The exclusions for bicycle commuting and moving expense reimbursements would be repealed. — The ownership period for the exclusion of gain from the sale of a principal residence generally would be extended from two out of the five previous years to five out of the eight previous years, and the exclusion would only be available once every five years. Education — Unlike the House bill, the Senate bill would preserve numerous provisions of the tax code affecting higher education. Notably, the bill makes no changes to the current higher education tax credits or education savings accounts, and retains the student loan interest deduction, the qualified tuition and related expenses deduction, exclusions from income for qualified tuition reductions, employer-provided education assistance and interest income from US savings bonds used for qualified tuition and related expenses. Identical to the House bill, the Senate bill would impose a 1.4% excise tax on the net investment income of private colleges and universities with assets (other than those used directly in carrying out the institution's educational purposes) valued at the close of the preceding tax year of at least $250,000 per full-time student. ———————————————
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