Last week, the Senate passed its own version of the Tax Cuts and Jobs Act (TCJA), its tax reform bill with the same name as the House’s version. The Senate significantly modified the bill approved by the Senate Finance Committee prior to Thanksgiving. This alert will focus on the key changes.
In part, these changes were the result of the need to raise revenue in order to meet Senate budget rules as well as responding to pushback by several “deficit hawks,” who are concerned with the bill adding $1.5 trillion to the deficit over the next 10 years. Even with amendments, the Joint Committee on Taxation estimates the TCJA will cost $1.45 trillion over a decade based on “static scoring,” which does not account for the bill’s estimated economic impact. Taking that into consideration, the “dynamic scoring” estimates the bill will cost $1 trillion over the next 10 years.
Tax rate for pass-through business entities. The original Senate bill included a 17.4 percent deduction for pass-through businesses. Amendments on the Senate floor increased that deduction to 23 percent. The House version does not contain a similar deduction; instead, it applies a complex formula to determine the percentage of pass-through business income subject to lower rates. While the Senate version may be easier to administer, there is no indication the House will agree to this approach.
Be aware the Senate version is not an outright 23 percent deduction. Rather, the deduction is the lesser of 23 percent of 1) qualified income of the pass-through business, or 2) 50 percent of the W-2 wages with respect to the qualified trade or business. This is similar to the wage limitation used in the Internal Revenue Code section 199 domestic production activities deduction (which would be repealed in both versions of the TCJA).
Retention of the alternative minimum tax (AMT). Among the most significant changes is the retention of both the individual and corporate AMT — each of which would have been repealed under the original bill.
Repatriation of foreign earnings. Last-minute changes were made to the repatriation rates to help pay for the rate reduction for pass-through businesses. The Senate bill’s rates on the deemed repatriation of offshore accumulated earnings is now closely in line with the House bill’s: 14.5 percent for earnings held as cash and 7.5 percent for other earnings. The House bill calls for rates of 14 and 7 percent, respectively.
Business interest. Both the House and Senate generally restrict the ability to deduct business interest to 30 percent of income. The Senate added a provision that mirrors the House to provide an exception to the limitation for “floor plan” interest, generally paid by automobile dealers and similar businesses. Under the Senate amendment, these businesses would be allowed a full deduction of interest expense related to “floor plan financing indebtedness.” However, the 100 percent expensing of assets would not be allowed to any business with floor plan financing debt that takes the full interest expense deduction.
State and local tax (SALT) deduction. The Senate added an amendment to allow individuals an itemized deduction of up to $10,000 for state and local property taxes, mirroring the provision included in the House bill. The retention of the property tax deduction is doubtful to benefit a substantial portion of homeowners since the loss of the state income tax deduction will make it unlikely they will be able to itemize deductions.
Medical expense deductions. Another amendment would allow individuals to deduct medical expenses in 2017 and 2018 if the expenses exceed 7.5 percent of adjusted gross income (AGI). Under current law, those expenses are deductible once they exceed 10 percent of AGI.
Private activity bonds. The Senate proposes retaining the private activity bond tax exemption, used by universities, hospitals and lower-income housing, as well as advanced refunds, which comprises about 20 percent of issuance. However, the House version would eliminate this tax exemption. If enacted, this could lead to higher borrowing costs for municipal issuers and increase the strain on local budgets. While no changes were made to this provision during Senate debate, expect intense lobbying on this issue from both local governments and tax-exempt organizations during the reconciliation process.
The bill now heads to conference committee between the House and the Senate to work out the differences. Anticipated to be a contentious process, critical disagreements are expected over the phaseout of individual rate reductions, the taxation of pass-through businesses and the ultimate corporate rate. Other stumbling blocks may include the repeal of the individual mandate, attempted fixes for the healthcare marketplace included in the Senate version, along with retention of AMT and the estate tax.
Some observers have speculated that most provisions from the Senate version are likely to prevail due to the closer voting margin in the Senate. However, House Ways and Means Committee Chairman Kevin Brady recently insisted that the Senate version will not receive deference just to comply with Senate budget rules.
For a more complete comparison of the House and Senate versions, see our previous alert.
We continue to monitor the legislative process and will publish insights and analysis as negotiations move through Congress.
For related insights and in-depth analysis, see our tax reform resource center.
For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.