November 14, 2017 Senate tax reform plan would affect individual taxpayers somewhat differently than Ways & Means bill would The Senate Finance Committee on November 9, 2017, released a detailed description of its forthcoming tax reform bill (the Senate Plan). The Senate Plan describes many changes to the current tax systems and is similar in many respects the recently proposed and marked-up bill by the House Ways & Means Committee (the W&M Bill). In this Alert, we compare provisions in the Senate Plan with the current law and highlight the implications of these differences. Reduction and simplification of individual income tax rates and modification of inflation adjustment 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:
Provision The provision would establish a new individual income tax rate structure under seven tax brackets as follows:
The proposal would simplify the "kiddie tax" essentially by applying the ordinary and capital gains rates used for trusts and estates to the net unearned income of children. Effective date The proposal would be effective for tax years beginning after December 31, 2017. Implications The provision in the Senate Plan would retain seven brackets, but lower the rate for the brackets. The provision appears to mitigate the so-called marriage penalty — particularly at the higher level of income. The provision does not have a recapture of the 12% bracket that is part of the W&M Bill. As in the W&M Bill, the brackets would be indexed for inflation using the Chained Consumer Price Index (CPI) instead of the current CPI. Chained CPI takes into consideration substitutions consumers make in response to rising prices of certain goods and services. The result is that the brackets would generally rise slower than they otherwise would under the CPI. Assuming a single individual with taxable income of the following amounts (comprised of 10% qualified dividend income and 90% wages), the federal income tax liability would be as follows:
This example does not include the additional Medicare tax and the Net Investment Income Tax (NIIT), both enacted as part of the Affordable Care Act and both retained under the W&M Bill and the Senate Plan. With changes to itemized deductions and the increase of the standard deduction, taxpayers should expect the NIIT tax liabilities to increase under both plans going forward. It then logically follows that the repeal of the NIIT will become more difficult as the NIIT liabilities increase because the revenue cost of repeal will be even more challenging to overcome. Increase in standard deduction Current law Under current law, adjusted gross income (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 provision would increase the standard deduction to: — $24,000 for married couples filing jointly and surviving spouses — $18,000 for single filers with at least one qualifying child — $12,000 for all other taxpayers Effective date The provision would be effective for tax years beginning after December 31, 2017. Repeal of the 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; heads-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 provision would repeal the personal exemption deduction and phase-out. Effective date The repeal would be effective for tax years beginning after December 31, 2017. Allow 17.4% deduction for certain pass-through income Current law The tax liability of individual taxpayers is determined by applying the tax rate tables to the taxpayer's regular taxable income, according to the taxpayer's filing status. Partnerships, S corporations, and sole proprietorships are generally treated as pass-through entities so income is taxed to the partners or owners on an individual basis, rather than at the entity level. The individual taxpayer may deduct his share of the entity's losses to the extent of the individual's adjusted basis in the pass-through entity; generally, unused losses may be carried over to the next year. Provision The provision would allow an individual taxpayer generally to deduct 17.4% of domestic qualified business income from a partnership, S corporation or sole proprietorship. For taxpayers whose taxable income exceeds $150,000 (for married couples filing jointly; $75,000 for other individuals), the deduction would be phased out for income from certain service businesses. For a taxpayer with qualified business income from a partnership or S corporation, the deduction would be limited to 50% of W-2 wages. This limitation appears to have its conceptual roots in the Section 199 deduction for domestic production activities (which may be repealed). "Qualified business income" is the net amount of domestic qualified items of income, gain, deduction and loss from the taxpayer's qualified business. Dividends from a real estate investment trust (REIT), except any portion constituting a capital gain dividend, are considered qualified items of income. A taxpayer's "qualified business" means any trade or business other than: (1) one that has as its principal asset the reputation or skill of an employee, or (2) one involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services. Qualified business income does not include: — Any amount an S corporation pays that is treated as reasonable compensation of the taxpayer — Any amount a partnership allocates or distributes to a partner who is acting other than in his capacity as a partner for services — Any amount that is a guaranteed payment for services actually rendered to or on behalf of a partnership to the extent that the payment is in the nature of remuneration for those services — Certain investment-related income, gain, deductions, or loss Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications It is difficult to determine what effect this provision would have on taxpayers because the Senate Plan does not go into great detail on the definition of "domestic qualified business income." The term "qualified business" seems to be similar to the House's cross reference to businesses ineligible for Section 1202 treatment, but missing from the definition are investment advisory businesses specifically identified in the W&M Bill. The provision seems to require some sort of "domestic" nexus with the income, but it provides no detail on the measurement of gross and net domestic income. The Senate has vague language that excludes investment income from the definition of qualified business income, and a rule similar to the House about carryover of losses. Unlike the W&M Bill, which provided a separate tax rate, the Senate version would create a phantom deduction in order to achieve some after-tax target result. We have seen this before with Section 199 (which is proposed to be repealed). It will be interesting to see how the carryover loss aspect of this provision will interact with the fourth loss limitation provision discussed next. Finally, given the generalities of the description, it is unclear whether this deduction would apply to taxpayers other than individuals. Limitation on losses for taxpayers other than corporations Current law Passive loss rules limit the deductions and credits that individuals, estates, trusts and closely held corporations may claim attributable to passive trade or business activities, allowing passive losses to be deducted only against passive gains. A passive activity is a trade or business activity in which the taxpayer holds an interest but does not materially participate (i.e., the taxpayer's involvement in the activity is not regular, continuous or substantial). Deductions and credits from passive losses that may not be claimed in one year generally may be carried forward to the next tax year; suspended losses from a passive activity may deducted in full when the taxpayer disposes of his entire interest in the activity to an unrelated party. Excess farm losses are limited for taxpayers other than C corporations. If a taxpayer other than a C corporation receives an applicable subsidy for the tax year, the excess farm loss may not be claimed for that year and must be carried forward and treated as a deduction attributable to farming the next year. An excess farm loss for a tax year is the amount by which aggregate deductions attributable to farming exceeds the sum of aggregate gross income or gain attributable to farming, plus a threshold amount. The threshold amount is the larger of (1) $300,000 (for married couples filing jointly; $150,000 for single taxpayers); or (2) for the five-year period preceding the tax year, the excess of the taxpayer's aggregate gross income or gain attributable to farming over the aggregate deductions attributable to farming. Provision The provision would disallow excess business losses, including the excess farm loss, for taxpayers other than C corporations. These losses may be carried forward and treated as part of the taxpayer's net operating loss (NOL) carryforward. An excess business loss is: the excess of the taxpayer's aggregate deductions attributable to the taxpayer's trades or businesses over the sum of the taxpayer's aggregate gross income or gain, plus a threshold amount ($500,000 for married taxpayers filing jointly; $250,000 for other individuals). For partnerships or S corporations, the provision would apply at the partner or shareholder level. Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications This is a surprising new item in the Senate Plan that would have far reaching implications. Under a separate provision, the Senate Plan proposes allowing NOL carryovers (but no carrybacks) for a tax year up to the lesser of the carryover amount or 90% of taxable income, determined without regard to the NOL deduction. It appears the intent is to prevent taxpayers from using business losses (that have survived the three current loss limitations — basis, at-risk and passive) to offset any nonbusiness income. Instead, the business loss would create an NOL — even if none were to naturally occur under section 172 — and then be carried forward. But not only would business losses be disallowed, they would only be entitled to a 90% recovery in the future year. It is unclear whether individuals would be denied the creation of NOLs under the current Section 172 or whether this is meant to be the sole mechanism. Recall, in order for an individual to create an NOL, the business deductions must exceed business income and net nonbusiness income. Reform of the child tax credit Current law Generally, a taxpayer may claim a $1,000 tax credit for each qualifying child who is younger than 17. A qualifying child must be a US citizen, national or resident. The aggregate amount of the credit that a taxpayer may claim is phased out for taxpayers with AGI above $75,000 for single taxpayers and heads of households, or above $110,000 for married couples filing jointly and $55,000 for married individuals filing separately. The credit may be claimed under the regular tax system and the AMT. Provision The provision would increase the child tax credit to $1,650 per qualifying child, and raise the age limit for a qualified child by one year, permitting the credit to be claimed for each qualifying child who is younger than 18. The credit is further modified to provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children. The income level at which the credit begins to phase out would be increased to $1 million for married taxpayers filing jointly and $500,000 for all other taxpayers. Effective Date The provision would be effective for tax years beginning after December 31, 2017. Implications The threshold at which the proposed credit begins to phase out has been dramatically, and somewhat surprisingly, increased to $1 million for married taxpayers filing a joint return and $500,000 in the case of all other taxpayers. These amounts are not indexed for inflation. Repeal of deduction for taxes not paid or accrued in a trade or business Current law Current law allows 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 allow an individual taxpayer to claim a deduction for state, local or foreign property or sales taxes only when the taxes were paid or accrued in carrying on a trade or business or an activity described in Section 212 (expenses incurred for the production of income). The provision would eliminate the ability of an individual taxpayer to deduct his state or local income taxes, war profits or excess profits tax. Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications This provision follows the spirit of the W&M Bill, but would disallow all property tax deductions for individuals. As is the case for the W&M Bill: (1) individuals could still deduct property taxes and sales taxes if they are associated with a trade or business or for-profit activity, and (2) state and local income taxes would not be allowed, even if they are associated with a trade or business or for-profit activity. Even though the itemized deductions for state and local income taxes are proposed to be eliminated, foreign income taxes appear to still be deductible. It appears that these amendments would not affect the non-income-tax liability of individuals (and, for example, partnerships and S corporations) conducting trade or business or for-profit activity. It has been understood for several generations that the use of income as a measurement does not, however, necessarily make a tax an "income tax." In determining whether a tax is an "income tax" — for purposes of this proposed elimination — taxpayers should not simply look to whether income, either gross or net, is used as the measure of taxation; instead, taxpayers must look to the purpose and application of the tax at issue. In any event, it appears that state taxes that are non-itemized deductions, but yet are imposed on businesses and individuals (such as the New York City Unincorporated Business Tax and the Metropolitan Commuter Transportation Mobility Tax) would probably remain deductible because they never were taxes described in Section 164(a)(3). Additionally, the Senate explanation states that state and local property tax associated with a business or for-profit activity would continue to be deductible on Schedules C, E or F. However, property taxes that are associated with a non-rental real property held for investment would still be considered an investment activity, and thus could still likely remain an itemized deduction. Of course, this type of determination must only be done by individuals (and those that compute their tax in the same manner as an individual), because state and local income taxes remain fully deductible by corporations (and those that compute their tax in the same manner as a corporation). Modification of deduction for home mortgage interest 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. Under the alternative minimum tax (AMT), however, a taxpayer may not claim a home equity mortgage interest deduction. Provision The provision would eliminate the deduction for interest on home equity loans. Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications The Senate provision would repeal the deduction for interest on home equity indebtedness, while retaining the $1-million overall limit and the ability to deduct interest on a mortgage on a second house. The provision in the W&M Bill would also repeal the deduction for home equity indebtedness but would decrease the overall limit to $500,000 on a taxpayer's principal residence. Whether repeal of the deduction for interest on a $100,000 home equity amount affects particular taxpayers will depend on how they used the proceeds. If the $100,000 can be traced to investment or business activities, the loss of a mortgage interest deduction would be replaced with investment interest or business interest expense. Additionally, the exclusion of the home equity line may increase the taxes of senior citizens who use reverse mortgages to supplement their annual income without having to leave their homes. Modification of exclusion of gain from sale of a principal residence Current law 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. Provision The provision would require that a taxpayer own and use the property as his principal residents for at least five of the eight years that preceded the sale. If the taxpayer fails to meet this requirement due to a change in employment or health or due to unforeseen circumstances, the taxpayer may, to the extent provided under regulations, exclude an amount equal to the fraction of the excludable amount ($250,000 or $500,000) that is equal to the fraction of the five years that the ownership and use requirements are met (e.g., an individual taxpayer who lived in a home for three years before having to move for work would be able to exclude $250,000 x 3/5 = $150,000). A taxpayer would only be able to use the exclusion once every five years. Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications This provision is substantively similar to the provision in the W&M Bill except that the provision in the W&M Bill would phase out the exclusion for higher-income taxpayers. Although the Senate report does not provide reasoning for the provision, it can be assumed to be similar to the House's reasoning that "speculators and so-called 'flippers' in the housing market would not be rewarded for their activity with tax-exempt income." Modification of deduction for personal casualty and theft losses Current law Current law allows a taxpayer who itemizes deductions generally to claim a deduction for any loss sustained during the tax year that is not compensated by insurance or otherwise. For individuals, deductible losses must be incurred in a profit-seeking activity or consist of property losses due to fire, storm, or other casualty or from theft, for amounts that exceed 10% of AGI. Provision The provision would limit deductions for personal casualty losses to those incurred in a disaster declared by the President under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications The provision would limit the deduction for personal casualty and theft losses and is similar to the W&M Bill. Under the provision, a taxpayer may claim a personal casualty loss if the loss was incurred in a disaster declared by the President under Section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act (the Act constitutes the statutory authority for most Federal disaster response activities especially as they pertain to FEMA and FEMA programs). The provision does not appear to address personal theft losses incurred in declared disaster. Consequently, for example, a car that was stolen — rather than ruined — during a Presidential-declared disaster, doesn't seem to be addressed by this provision. 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 "in connection with the determination, collection, or refund of any tax." Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications Both the W&M Bill and the Senate Plan propose to repeal Section 212(3), which permits an itemized deduction for amounts paid for the determination, collection or refund of any tax. Repeal of this deduction would also affect estates and trusts. Individuals, estates and trusts may continue deducting amounts paid for the determination, collection or refund of any taxes associated with a trade or business reported on Schedule C, Schedule E or Schedule F because they are deductible by reason of Section 162, not Section 212(3). See Revenue Ruling 92-29. Repeal of miscellaneous itemized deductions subject to the 2% floor Current law Under current law, individual taxpayers who itemize may claim deductions for certain miscellaneous expenses. Some of these expense must exceed 2% of the taxpayer's AGI to be deductible, including: — Expenses for the production or collection of income — Unreimbursed expenses attributable to the trade or business of being an employee — Repayments of income received under a claim of right (only subject to the 2% floor if less than $3,000) — Repayments of Social Security benefits — Shares of deductible investment expenses from pass-through entities Provision The provision would repeal all miscellaneous itemized deductions subject to the 2% floor. Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications Unlike the provision in the W&M Bill, the Senate provision would eliminate all itemized deductions subject to the 2% floor. The most common of these items are investment advisory expenses, unreimbursed employee business expenses (which were separately repealed in the W&M Bill) and tax preparation fees (which were repealed in both the W&M Bill and Senate Plan). The explanation of the provision was simply "the [provision] repeals all miscellaneous itemized deductions that are subject to the [2%] floor under present law." The JCT provided a nonexclusive list of examples of deductions that would be repealed under this provision such as: — Appraisal fees for a casualty loss or charitable contribution (even though the casualty loss and contribution are themselves deductible) — Casualty and theft losses from property used in performing services as an employee — Clerical help and office rent in caring for investments — Depreciation on home computers used for investments — Excess deductions (including administrative expenses) allowed a beneficiary on termination of an estate or trust — Fees to collect interest and dividends — Hobby expenses, but generally not more than hobby income — Indirect miscellaneous deductions from pass-through entities (such as those from partnerships, S corporations, REMICs, Liquidating Trusts, Environmental Remediation Trusts, Fixed Investment Trusts, and Common Trust Funds) — Loss on deposits in an insolvent or bankrupt financial institution — Loss on traditional IRAs or Roth IRAs, when all amounts have been distributed — Repayments of income — Safe deposit box rental fees, except for storing jewelry and other personal effects — Service charges on dividend reinvestment plans — Trustee's fees for an IRA, if separately billed and paid Because no legislative text was provided, it is difficult to determine how dramatic the impact will be for individuals. The difficulty is that the Senate is proposing to eliminate a provision that defines its scope by exclusion. In other words, it proposes to eliminate every deduction for individuals in the entire Code that is not specifically identified in Section 62 as an above-the-line expense and not specifically identified in Section 67(b). Given that the definition is one of exclusion, it is hard to know the provision's exact scope. Regardless of the unknown expanse of the deduction-cutting for individuals, expenses that are not commonly or customarily incurred by individuals remain deductible for estates and trusts. These expenses include: probate court fees and costs; fiduciary bond premiums; legal publication costs of notices to creditors or heirs; the cost of certified copies of the decedent's death certificate; and costs related to fiduciary accounts. Additionally, certain incremental costs of investment advice beyond the amount that normally would be charged to an individual investor remain deductible. Increase percentage limit for charitable contributions of cash to public charities 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 increase the income-based percentage limit (Section 170(b)(1)(A)) from 50% to 60% on the total charitable contribution deduction an individual taxpayer may claim for certain charitable contributions of cash to public charities. This change would allow an individual taxpayer to claim a charitable contribution deduction for cash donations to charity totaling up to 60% of the taxpayer's AGI for the year. Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications The provision in the Senate Plan does not include three of the four Section 170 provisions included in the provision in the W&M Bill, namely: — 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 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 applies in addition to any other applicable limitations (e.g., deductions) but may 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 provision would repeal the overall limitation on itemized deductions. Effective date The provision would be effective for tax years beginning after December 31, 2017. Implications Both the W&M Bill and the Senate Plan would repeal Section 68, which is more commonly known as the Pease limitation. Because many of the common itemized deductions that were subject to the Pease limitation are proposed to be eliminated, it is logical to eliminate this provision be as well. Repeal of deduction for moving expenses and exclusion for qualified moving expense reimbursement 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. An employee may generally exclude from gross income any reimbursements of qualified moving expenses. Provision The provision would repeal the deduction for moving expenses and the exclusion for moving expense reimbursements. Effective date The repeal would be effective for tax years beginning after December 31, 2017. Implications The provision in the Senate Plan is somewhat similar to the provision in the W&M Bill, but the markup of the W&M Bill eased this repeal to exclude members of the military. Modification to the limitation on wagering losses Current law Current law generally allows a taxpayer who itemizes to claim: (1) a deduction for gambling losses to the extent of the taxpayer's gambling winnings; and (2) certain other deductions connected to gambling. Provision The provision would clarify that the limitation on losses a taxpayer may claim from wagering applies not only to the costs that wagerers actually incur but also to other expenses that wagerers incur in connection with their gambling activities (e.g., hotel and travel expenses). Effective date The provision would be effective for tax years beginning after 2017. Implications The provision would statutorily override the Tax Court case of Mayo v. Comm'r, 136 T.C. 81 (2011), which held that Section 165(d) limitation does not apply to individual's otherwise deductible expenses in traveling to or from a casino. This provision really only applies to professional gamblers because the proposed elimination of the 2% itemized deductions would eliminate the deduction of non-gambling expenses for those whose gambling activities are hobbies. Increase in estate and gift tax exemption 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 carry over (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 The provision would double the estate tax and gift tax exemption. The basic exclusion under Section 2010(c)(3) would increase from $5 million to $10 million, indexed for inflation occurring after 2011. Effective date The provision would be effective for estates of decedents who die after December 31, 2017, as well as for gifts and generation-skipping gifts made after that date. Implications The provision in the Senate Plan is similar to the provision in the W&M Bill, which would double the amount of the current exemptions for gift, estate and generation-skipping transfer taxes (the exemptions are all tied to the amount set forth in Section 2010(c)(3). However, the W&M Bill would repeal the estate and generation-skipping transfer tax regimes (while retaining the gift tax regime) for decedents dying beginning in 2024. According to press reports, total repeal of the estate and generation-skipping transfer tax regimes is not included in the Senate Plan to encourage certain key senators to vote for the Plan who do not believe repeal is necessary (e.g., Susan Collins). Repeal of the individual 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 for any tax year between 2018 and 2021, and could claim 100% any remaining credits beginning in 2021. Effective date The provision is effective for tax years beginning after December 31, 2017. Implications Both the House and the Senate agree that repeal of the AMT is a necessary component of tax reform. Gratefully, both chambers also allow for a slow release of unused AMT credit carryforwards. The repeal of the AMT is certainly a positive step toward making tax comply simpler. Of course, it will be replaced with the preferential rate (or phantom deduction) on pass-through business income and a fourth loss limitation provision (three loss limitations already exist). Even though both the Senate and House propose to eliminate the AMT, but they are actually blending the AMT system with the "new" regular system. It seems somewhat coincidental that, with the repeal of itemized deduction for taxes, home equity indebtedness and 2% itemized deductions, and capping NOLs at 90% of income, "taxable income" under the provisions begins to look similar to "alternative minimum taxable income." Interestingly, the AMT is not really repealed. It is more akin to the Rip Van Winkle of tax systems. Because Congress is using budget reconciliation, the separate AMT regime can only be repealed for 10 years. So, to some extent, the AMT is not really being repealed; it is merely put to sleep for a while. As the AMT could return in 10 years, taxpayers will likely continue to keep two sets of books to determine, for example, AMT tax basis; if all of the current AMT provisions spring back into effect in 10 years, taxpayers will need to know if there is a gain/loss difference in assets that are sold after its "awakening." Modification of rules for expensing depreciable business assets Current law Businesses may elect to immediately expense up to $510,000 of the cost of any Section 179 property placed in service each tax year. If a business places in service more than $2,030,000 of Section 179 property in a tax year, the immediate expensing amount is reduced by the amount by which the Section 179 property's cost exceeds $2,030,000. Section 179 property includes tangible personal property or certain computer software that is purchased for use in the active conduct of a trade or business, as well as certain "qualified real property," which is defined as qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property that is depreciable and that is purchased for use in the active conduct of a trade or business. Provision The provision would increase the expensing limitation under Section 179 from $510,000 to $1 million, with the phase-out increasing from $2,030,000 to $2.5 million for tax years beginning after 2017. The provision would reduce the $1 million amount (but not below zero) by the amount by which the cost of the qualifying property placed in service during the tax year exceeds $2.5 million. Both expensing limitation amounts would be indexed for inflation for tax years beginning after 2018. The provision also would index the $25,000 sport utility vehicle limitation for inflation for tax years beginning after 2018. Additionally, the provision would modify the definition of Section 179 property to include certain tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging. It would modify the definition of qualified real property to include the following improvements to nonresidential real property placed in service after the date the property was first placed in service: — Roofs — Heating, ventilation and air-conditioning property — Fire protection and alarm systems — Security systems Effective date The provision would apply to property placed in service in tax years beginning after December 31, 2017. Implications This provision would allow for some additional expensing for small business with less capital spent in a given year. The integration with 100% expensing discussed next, however, may minimize the use of this provision. Temporary 100% expensing for certain business assets Current law Current law allows taxpayers to claim additional depreciation (i.e., bonus depreciation) under Section 168(k) in the year in which qualified property (as described later) is placed in service through 2019 (with an additional year for qualified property with a longer production period, as well as certain aircraft). The bonus depreciation generally equals 50% of the cost of the property placed in service in 2017 and phases down to 40% in 2018 and 30% in 2019. Qualified property is defined as tangible property with a recovery period of 20 years or less under the modified accelerated cost recovery system (MACRS), certain off-the-shelf computer software, water utility property or qualified improvement property. Certain trees, vines, and fruit-bearing plants also are eligible for additional depreciation when planted or grafted. To be eligible for bonus depreciation, the original use of the property must begin with the taxpayer. Under current law, taxpayers have the option of making an annual election to not claim bonus depreciation for qualified property under Section 168(k)(7). Alternatively, taxpayers may elect under Section 168(k)(4) to accelerate AMT credits (as refundable credits) in lieu of claiming bonus depreciation for qualified property. Such election comes with the added requirement to depreciate that qualified property using a straight-line recovery method. Provision The provision would: — Extend through 2022 (through 2023 for longer-production-period property and certain aircraft) the additional first-year depreciation deduction — Increase the 50% allowance to 100% for property placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for longer production period property and certain aircraft), as well as for specified plants planted or grafted after September 27, 2017, and before January 1, 2023. (i.e., repeal the phase-down of the additional first-year depreciation deduction for property placed in service after December 31, 2017, and for specified plants planted or grafted after such date) — Increase the depreciation deduction for passenger automobiles placed in service after December 31, 2017, by $8,000 — Exclude certain public utility property from the definition of qualified property — Repeal the election to accelerate AMT credits in lieu of bonus depreciation Effective Date The provision generally would apply to property placed in service after September 27, 2017. Implications Because we have no legislative text, it is difficult to envision how immediate expensing will work for individuals given that they now are proposed to have a fourth loss limitation and a phantom deduction based on a percentage of business income. It is easy to imagine the complexity of aligning these provisions together, especially when adding the three current loss limitations into the mix. The complexity will likely have some mitigating effect on the value of this provision — especially when taxpayers looking to purchase equipment have no idea if they are actually going to get a deduction until they weave their way through four limitations and a phantom deduction. Modifications to depreciation limitations on luxury automobiles and personal use property Current law Section 280F(a) limits the amount of depreciation taxpayers may claim for certain passenger automobiles. For passenger automobiles placed in service in 2017, and for which the additional first-year depreciation deduction under Section 168(k) is not claimed, the maximum amount of allowable depreciation is $3,160 for the year in which the vehicle is placed in service, $5,100 for the second year, $3,050 for the third year, and $1,875 for the fourth and later years in the recovery period. The limitation is indexed for inflation and applies to the aggregate deduction provided for depreciation and Section 179 expensing. For passenger automobiles that qualify for the additional first-year depreciation allowance in 2017, the first-year limitation increases by $8,000. Special rules apply to listed property, which includes: (1) any passenger automobile; (2) any other property used as a means of transportation; (3) any property used for entertainment, recreation or amusement purposes; (4) any computer or peripheral equipment; and (5) any other property of a type specified in Treasury regulations. Provision The provision would increase the depreciation limitations that apply to listed property. As such, for passenger automobiles placed in service after December 31, 2017, and for which the additional first-year depreciation deduction under Section 168(k) is not claimed, the maximum amount of allowable depreciation would be $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period. The provision would index the limitations for inflation for passenger automobiles placed in service after 2018. In addition, the provision would remove computer or peripheral equipment from the definition of listed property. Effective date The provision would be effective for property placed in service after December 31, 2017. Implications The provision would allow for a faster write off of certain assets used in deductible activities and may more closely represent the economic depreciation of these assets, resulting in a lower gain or loss on disposition. ———————————————
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