The Tax Cut and Jobs Act will bring the first considerable overhaul of the U.S. tax system in thirty years.
Tax Reform Review
Now that the U.S. Senate has passed its version of the tax reform bill in Washington, let’s take a look at the notable changes in both chambers’ bills.
Remember, next comes the conference committee, so we still have a long way to go before we have a final bill for the House and Senate to vote on.
- Under the House Bill, Alternative Minimum Tax would be repealed and Income tax would be reduced by prior year alternative minimum tax payments. The Senate Bill would retain the Alternative Minimum Tax, increasing the threshold.
Partnerships, LLCs taxed as Partnerships, and S Corporations are treated differently in the House and Senate Bills:
- Corporate tax would be reduced to a flat 20% rate. The House Bill would create a special 25% flat rate for service corporations. The Senate Bill would tax service corporations at 20%.
- The House Bill would create a favorable 25% tax rate for 30% of the entity’s qualified business income. The remaining 70% would be taxed at individual tax rates.
- The Senate Bill would allow partners to take a deduction on their personal returns equal to 23% of the entity’s qualified business income. The income that remains would then be taxed at individual rates. The 23% deduction also applies to rental real estate income, but does not apply to service companies unless taxable income is below $250,000 for single filers or $500,000 for married filers. The 23% deduction would also be limited to 50% of the entity’s W-2 wages.
- The cash method of accounting would be allowed for entities with less than $25 million in sales under the House Bill or less than $15 million in sales under the Senate Bill.
- Businesses would be allowed to immediately write off the full cost of new equipment.
For businesses that have sales greater than $25 million under the House Bill or $15 million under the Senate Bill, the deduction for interest expense would be limited to an amount equal to 30% of taxable income.
- The special deduction for U.S. manufacturers (DPAD) would be eliminated.
Business losses from prior years would only be able to offset a maximum of 90% of taxable income. Any unused portion would have an unlimited carryforward period. NOL carrybacks are eliminated.
- Tax free exchanges of equipment and vehicles would be repealed. Real estate would still be eligible for tax free exchanges.
- Meals would continue to be 50% deductible. Entertainment would be nondeductible compared with the current law which allows a 50% deduction.
- The R&D Credit would be preserved.
- International DISC entities would no longer be recognized.
- Interest income on bonds for sports stadiums would not be tax-exempt.
- Non-qualified deferred compensation taxation would not be changed from existing law.
- Under the Senate Bill, but not the House Bill, the Obamacare individual mandate payment would be reduced to zero.
- Individual Tax brackets would be as follows:
- The House Bill has five brackets: 0%, 12%, 25%, 35%, and 39.6% with the highest bracket starting at $500,000 for single taxpayers and $1,000,000 for married taxpayers.
- The Senate Bill has seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 38.5% with the highest bracket starting at $500,000 for single taxpayers and $1,000,000 for married taxpayers.
- Capital gains tax brackets would continue to be 0%, 15%, and 20%.
- The standard deduction would be increased from $6,350 to $12,000 (or $12,400 under the Senate Bill) for individuals and $12,700 to $24,000 (or $24,400 under the Senate Bill) for married couples.
- The Child Tax Credit would be increased from $1,000 to $1,600 under the House Bill or $2,000 under the Senate Bill.
- The Child and Dependent Care Tax Credit would be preserved.
- The Earned Income Tax Credit would be preserved.
- The House Bill preserves the home mortgage interest deduction for existing mortgages and maintains the home mortgage interest deduction for newly purchased homes up to $500,000 – half of the current $1,000,000. The Senate Bill retains the existing $1,000,000 threshold but excludes interest on home equity loans.
- The House and Senate Bills limit the deduction of state and local property taxes to $10,000.
- The House Bill eliminates the student-loan interest deduction, medical expense deduction, moving deduction, and alimony-payment deduction. The Senate Bill does the same except it retains the medical expense deduction and the alimony-payment deduction. The Senate Bill also lowers the income threshold for the deductibility of medical expenses from 10% to 7.5%.
- Retains popular retirement savings options such as 401(k) plans and IRAs.
- 529 Plans which have been traditionally used for college savings would now be available for K-12 education including private schooling and homeschooling.
- Retains the low-income housing tax credit.
- The estate tax threshold would increase to $10 million in 2018.
The Tax Cut and Jobs Act will bring the first considerable overhaul of the U.S. tax system in thirty years. How will the two reconcile the differences? Use the MarketWatch Tax Calculator to see how you will be affected.