CONTACT US

Business Provisions Update: Tax Reform Moves Forward – Comparison of House and Senate Bills

Like the prior Thursday, November 16 was indeed a very active day on Capitol Hill.  The House of Representatives approved its version of tax reform by a vote of 217 to 205.  And late that evening, the Senate Finance Committee (on a party-line vote) approved its tax reform legislation and sent it to the full Senate for consideration, scheduled for the week after Thanksgiving.  What follows are highlights and a comparison of the business provisions of these two approaches to tax reform, now taking into account the markup by the Senate Finance Committee of its original plan. The individual and international provisions are being covered in separate alerts.

The tax reform process has been and continues to be a “moving target.”  If the Senate Finance Committee bill is approved by the full Senate, the two versions will then go to a House-Senate conference, where the final version will be written.  We have previously noted the impact of the “budget reconciliation” process on the makeup of this legislation, and perhaps there is no better example of this than the many seemingly weird sunset provisions scattered through the Senate Finance Committee version so as to manage the impact on the deficit over the next ten years and thereafter. 

Some of the following is presented untouched from our previous Alert. However, you will find that much has changed in a week of give and take. At the current pace, it is certainly possible that a tax reform bill could be ready for the President’s signature before Christmas.  But, before that time, there is still much to accomplish, many hard decisions to make to garner the necessary votes, particularly in the Senate.  EisnerAmper will report on further developments as circumstances warrant.

Corporate Tax Rate

Senate:  For taxable years beginning after 2018, the corporate tax rate would be a flat 20%.  The rate reduction is intended to be permanent.  The special tax rate for personal service corporations would be eliminated. The 80% dividends received deduction would be reduced to 65% and the 70% dividends received deduction to 50%.

House:  For taxable years beginning after 2017, the corporate tax rate would be a flat 20%, 25% for personal service corporations.  The 80% dividends received deduction would be reduced to 65% and the 70% dividends received deduction to 50%.

Alternative Minimum Tax (AMT)

Senate:  Similar to House.

House:  The corporate AMT would be eliminated.  Taxpayers that have AMT credit carryforwards would be able to use them against their regular tax liability and would also be able to claim a refundable credit equal to 50% of the remaining AMT credit carryforward in years beginning in 2019, 2020 and 2021 and the remainder in 2022.

Dividends Paid Deduction and Reporting

Senate:  Corporate taxpayers that pay dividends to shareholders would be required to report the total amount of dividends paid during the taxable year and the first two and a half months of the succeeding year, effective for taxable years beginning after December 31, 2018.  Failure to file that information return would be subject to a $1,000 a day penalty, not to exceed $250,000.  Dividends will continue to be nondeductible in computing taxable income.

House:  No provision.

Increased Bonus Depreciation

Senate:  Businesses would generally be allowed to immediately write off (expense) the cost of new investments in depreciable assets made after September 27, 2017 and before January 1, 2023.

House:  Similar to Senate, except that qualified property would include used property acquired by the taxpayer, provided it was not used by the taxpayer before the taxpayer acquired it.  Qualified property would exclude property used in a real property trade or business.

Section 179 Expensing

Senate:  “Section 179” small business expensing limitations would be increased to $1,000,000, and the phase-out threshold would be increased to $2,500,000, effective for property placed in service in tax years beginning after December 31, 2017.  These amounts would be indexed for inflation.  The definition of qualifying property would be expanded.

House:  Section 179 small business expensing limitations would be increased to $5 million and the phase-out amount would be increased to $20 million (indexed for inflation), effective for tax years beginning after 2017 and before 2023.  The definition of qualifying property would be expanded, effective for certain property acquired and placed in service after November 2, 2017.

Depreciation Limitation for Luxury Automobiles and Personal Use Property

Senate:  For passenger automobiles placed in service after December 31, 2017 and for which bonus depreciation is not claimed, the luxury automobile depreciation limitation would be increased to a maximum of $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.  The limitations would be indexed for inflation for automobiles placed in service after 2018.

House:  The bill would raise the $8,000 first year depreciation for passenger automobiles eligible for business depreciation to $16,000, effective for vehicles placed in service after September 27, 2017 and before January 1, 2023.

Accounting Simplification for Small Businesses

Senate:  For certain businesses with not more than $15 million in average annual gross receipts (indexed for inflation), the following accounting simplifications would apply:

  • Cash Method of Accounting.  C corporations and partnerships with C corporation partners would be able to use the cash method of accounting.  Currently, the gross receipts limitation is $5 million.  The new threshold would be indexed for inflation.
  • Accounting for Inventories.  A business would be able to use the cash method of accounting even though it had inventory.  The business would have to treat the inventory as non-incidental materials and supplies or conform to the taxpayer’s financial accounting treatment of inventories.
  • Capitalization and Inclusion of Certain Expenses in Inventory Costs.  Businesses would be fully exempt from the UNICAP rules for real and personal property, acquired or manufactured.
  • Long-Term Contract Accounting.  Businesses that meet the threshold would be able to use a non-percentage of completion method including the completed contract method.

House:  Similar to the Senate, except that the threshold would be not more than $25 million.

Accounting Methods/Special Rules for Taxable Year of Inclusion

Senate:  The provision would revise the rules associated with the recognition of income.  For taxable years beginning after December 31, 2017, it would require a taxpayer to recognize income no later than the taxable year in which such income is taken into account as income on an applicable financial statement, subject to an exception for certain long-term contract income.  It would codify the current deferral method of accounting for advance payments for goods and services under an IRS revenue procedure; i.e., taxpayers would be allowed to defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt if such income also is deferred for financial statement purposes.

House:  No provision.

Interest Expense Deduction

Senate:  For taxable years beginning after December 31, 2017, the deduction for business interest would be limited to the sum of business interest income plus 30% of the “adjusted taxable income” of the taxpayer for the taxable year.  The adjusted taxable income is the taxable income of the taxpayer computed without regard to: (i) any item of income, gain, deduction or loss which is not properly allocable to a trade or business; (ii) any business interest or business interest income; (iii) the 17.4% deduction for certain pass-through income (under the Senate proposal); and (iv) the amount of any net operating loss deduction.  The amount of disallowed interest would be carried forward indefinitely.  Exempt from these would be businesses with average gross receipts of $15 million or less, regulated public utility companies and real property trade or businesses.  The trade or business of performing services as an employee would not be treated as a trade or business; as a result the wages of an employee would not be counted in adjusted taxable income for purposes of determining the limitation.  The rules would apply at the entity level for pass-through entities and special rules would apply to the pass-through entities’ unused interest limitation for the year.

House:  Similar to the Senate, except that the small business exemption would be average gross receipts of $25 million or less.  Also, the determination of adjusted taxable income for purposes of calculating the interest deduction limitation would be made without regard to any deduction allowable for depreciation, amortization or depletion.

Net Operating Loss Deduction

Senate:  The proposal would limit the net operating loss (“NOL”) deduction to 90% of taxable income (determined without regard to the NOL deduction), effective for losses arising in taxable years beginning after December 31, 2017.  The NOL deduction would be limited to 80% of taxable income (determined without regard to the NOL deduction) in taxable years beginning after December 31, 2022.  This proposal would be repealed effective for taxable years beginning after December 31, 2025 if certain Federal October 1, 2017-Sepember 30, 2026 revenue targets are met.

Carryovers to other years would be adjusted to take account of this limitation, and could be carried forward indefinitely.  The two-year carryback and certain special carryback provisions would be repealed.  These would apply to losses arising in taxable years beginning after December 31, 2017.

House:  The NOL deduction would be limited to 90% of taxable income (determined without regard to the NOL deduction).  Carrybacks of NOLs would no longer be allowed except for one-year carrybacks for small businesses and farms with casualty or disaster losses.  The provision would apply to losses arising in tax years beginning after 2017.  For tax years beginning in 2017, the current NOL carryback rules would apply but NOLs created from the increased expensing discussed above would not be available for carryback.  NOLs arising in taxable years beginning after 2017 that are carried forward would be increased by an interest factor.  NOL carryforwards can be carried forward indefinitely, rather than the 20 years allowed under current law.

Like-Kind Exchanges of Real Property

Senate:  The like-kind exchange rules would only be available for real property not held primarily for sale.  The rule would be effective for transfers after 2017 but a transition rule would apply to any exchange if either the property being exchanged or received is exchanged or received on or before December 31, 2017.

House:  Same as Senate.

Recovery Period for Real Property

Senate:  The recovery period for nonresidential real and residential rental property would be reduced to 25 years.  The provision would also eliminate the separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property and would provide a general ten-year recovery period for qualified improvement property, and a 20-year “alternative depreciation system” (“ADS”) recovery period for such property.  The ADS recovery period for residential rental property would be reduced from 40 to 30 years, effective for property placed in service after December 31, 2017.

House:  No provision.

S Corporation Conversions to C Corporations

Senate:  No provision.

House:  In the case of an S corporation which revokes its S corporation election during the two-year period beginning on the enactment date (of this tax reform legislation) and has the same owners on both the enactment date and the revocation date, distributions from the terminated S corporation would be treated as paid from its accumulated adjustments account and from its earnings and profits.  Adjustments attributable to the conversion from S corporation status to a C corporation (IRC Section 481(a)) would be taken into account ratably over six years.

Income Exclusion for Contributions to Capital

Senate:  No provision.

House The exemption from income for contributions to the capital of a corporation would be repealed.  Effective as of the date of enactment, contributions to the capital of a corporation would be included in gross income unless exchanged for stock.  Contributions in excess of the fair market value of the stock issued would be included in gross income.  Similar rules would apply to other business entities.

Cost Basis of Specified Securities

Senate:  The cost of any “specified security” sold, exchanged, or otherwise disposed of on or after January 1, 2018 would be required to be determined on a first-in, first-out basis except to the extent the average basis method is otherwise allowed (e.g., stock of a regulated investment company (mutual fund)).  A specified security includes, for example, corporate stock (including stock of a mutual fund); any note, bond, debenture or other evidence of indebtedness; commodities; certain derivatives and any other financial instrument for which the Treasury Secretary determines that adjusted basis reporting is appropriate.  RICs would be exempt from the first-in, first-out rule. 

House:  No provision.

Gain Rollover to Special Small Business Investment Companies (“SSBIC”)

Senate:  No provision.

House:  For sales after 2017, the rollover of capital gains on publicly traded securities into an SSBIC would no longer be allowed.

Repeal of Certain Business Expenses

Senate:  The following business deductions would be repealed:

  • The IRC Sec. 199 domestic production activity deduction (“DPAD”) [for taxable years beginning after December 31, 2018].
  • The deduction for entertainment expenses other than business meals.

    The employer’s deduction for expenses associated with meals provided for the convenience of the employer on the employer’s business premises, or provided on or near the employer’s business premises through an employer-operated facility that meets certain requirements would be repealed for taxable years beginning after December 31, 2025 (this provision would be repealed effective for taxable years beginning after December 31, 2025 if October 1, 2017- September 30, 2026 federal government revenue targets are met).
  • The deduction for FDIC premiums would only be allowed for institutions with consolidated assets not exceeding $10 billion.

House:  Similar to the Senate, except that the repeal of the DPAD would apply for taxable years beginning after December 31, 2017. Also, the House would repeal the deduction for local lobbying expenses; there is no provision in the Senate version.

Local Lobbying Expenses

Senate:  Deductions for lobbying expenses with respect to legislation before local government bodies would be disallowed, effective for amounts paid or incurred on or after the date of enactment.

House:  Same as Senate, except it would be effective for amounts paid or incurred after 2017.

Self-Created Intangibles

Senate:  No provision.

House:  The gain or loss from the disposition of a self-created patent, invention, model or design (whether or not patented), or secret formula or process would be ordinary in character, effective for dispositions of property after 2017.  This would be consistent with the treatment of copyrights under current law. The election to treat musical compositions and copyrights in musical works as a capital asset would be repealed. 

Uniform Treatment of Expenses in Contingency Fee Cases

Senate:  Attorneys would be denied an otherwise allowable deduction for litigation costs paid under a contingency fee arrangement until the contingency ends, applicable to expenses and costs paid or incurred in taxable years beginning after the date of enactment.

House:  No deduction would be allowed for any expense paid or incurred in the course of the practice of law resulting from a case for which the taxpayer is compensated primarily on a contingency basis until such time as the contingency is resolved.

Sale or Exchange of Patents

Senate:  No provision.

House:   The special rule treating the transfer of a patent prior to its commercial exploitation as long-term capital gain would be repealed, effective for dispositions after 2017.

Basis Limitation on Partnership Losses

Senate:  For partnership taxable years beginning after December 31, 2017, the proposal would modify the basis limitation on partner losses to provide that a partner’s distributive share of items that are not deductible in computing the partnership’s taxable income, and not properly chargeable to capital account, are allowed only to the extent of the partner’s adjusted basis in its partnership interest at the end of the partnership taxable year in which the expenditure occurs.  Thus, the basis limitation on partner losses would apply to a partner’s distributive share of charitable contributions and foreign taxes. In the case of charitable contributions of property whose fair market value exceeds its adjusted basis, the basis limitation on partner losses does not apply to the extent of the partner’s distributive share of such excess.

House:  No provision.

Tax Gain on the Sale of a Partnership Interest on a Look-Through Basis

Senate:  In response to the Tax Court decision in Grecian Magnesite Mining, gain or loss from the sale or exchange of a partnership interest would be effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange.  Any gain or loss from this hypothetical asset sale would be allocated to interests in the partnership in the same manner as non-separately stated income and loss.  The transferee of a partnership interest would be required to withhold 10% of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation.  This provision would be effective for sales and exchanges after December 31, 2017.

House:  No provision.

“Technical Termination” of Partnerships

Senate:  No provision.

House:  The technical termination rule would be repealed, effective for taxable years beginning after 2017.  Accordingly, a partnership would be treated as continuing even if more than 50% of the total capital and profit interests of the partnership are sold or exchanged, and new elections would not be required or permitted.

Carried Interest

Senate:  Consistent with the House version, there would be a three-year holding period requirement for qualification as long-term capital gain with respect to certain partnership interests received in connection with the performance of services. 

House:  Applicable to tax years beginning after December 31, 2017, and subject to certain qualifications and exceptions, transfers of “applicable partnership interests” held for three years or less would be treated as short-term capital gain.  An applicable partnership interest is an interest in a partnership which, directly or indirectly, is transferred to (or is held by) the taxpayer in connection with the performance of substantial services by the taxpayer or any other related person in any “applicable trade or business.”  An applicable trade or business is any activity conducted on a regular, continuous, and substantial basis which, regardless of whether the activity is conducted in one or more entities, consists in whole or in part of raising or returning capital and either (i) investing in or disposing specified assets (or identifying such assets for investing or disposition) or (ii) developing specified assets.  Certain equity interests and interests held by corporations would be exempt.  To the extent provided in Income Tax Regulations, this provision would not apply to income or gain attributable to any asset not held for portfolio investment on behalf of third-party investors.   

Amortization of Research and Experimental Expenditures

Senate:  Specified research or experimental expenditures, including software development expenditures, would be capitalized and amortized over a five-year period (15 years if attributable to research conducted outside of the United States.  This does not include expenditures for land or for depreciable or depletable property used in connection with the research or experimentation but does include the depreciation and depletion allowances of such property. 

In the case of retired, abandoned, or disposed property, any remaining basis would continue to be amortized over the remaining amortizable period.  This provision would be repealed effective for taxable years beginning after December 31, 2025, if October 1, 2017-September 30, 2026 federal government revenue targets are met.

This provision would apply on a cut-off basis to expenditures paid or incurred in taxable years beginning after December 31, 2025.  A reporting requirement is added for research and experimentation expenditures in taxable years beginning after December 31, 2024.  Failure to file would result in a penalty of $1,000 per day, not to exceed $250,000.

House:  Certain research or experimental expenditures, including software development expenditures, would be capitalized and amortized ratably over a five-year period (15-year period for expenses attributable to foreign research).  Expenditures for the acquisition or improvement of land would not be covered by this provision.  This would apply to amounts paid or incurred in taxable years beginning after December 31, 2022.

Research and Development Credit

Senate:  There is no explicit provision, but the intention is to preserve this credit.

House:  Same as Senate.

Low Income Housing Credit

Senate:  The proposal would incorporate a number of provisions from the Affordable Housing Credit Improvement Act of 2017.

House:  There is not explicit provision, but the intention is to preserve the credit.

Orphan Drug Credit

Senate:  There would be a 27.5% credit for clinical testing expenses for certain drugs for rare diseases or conditions (“orphan drug credit”).  Certain reporting requirements would be required.  The proposal would be effective for amounts paid or incurred in taxable years beginning after December 31, 2017.

House:  The orphan drug credit would be repealed for amounts paid or incurred in taxable years beginning after December 31, 2017.

Employer-Provided Child Care Credit, Work Opportunity Credit, New Markets Tax Credit, Credit for Expenditures for Disabled Individuals

Senate:  No provision.

House:  Repealed.

Rehabilitation Credit

Senate:  The proposal would repeal the 10% credit for pre-1936 buildings.  Also, there would be a 20% credit for qualified rehabilitation expenditures with respect to a certified historic structure, claimed ratably over a five-year period beginning in the taxable year in which a qualified rehabilitated structure is placed in service.  The proposal would apply to amounts paid or incurred after December 31, 2017, subject to a transition rule.

House:  The rehabilitation credit would be repealed, effective for amounts paid or incurred after December 31, 2017, subject to a transition rule.

Employer Credit for Paid Family and Medical Leave

Senate:  The proposal would allow eligible employers to claim a general business credit equal to 12.5% of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave, if the rate of payment under the program is 50% of the wages normally paid to an employee.  The credit would be increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%.  This would generally be effective for wages paid in taxable years beginning after December 31, 2017; it would not apply to wages paid in taxable years beginning after December 31, 2019. 

House:  No provision.

Deduction for Unused Business Credits

Senate:  Repealed, for taxable years beginning after December 31, 2017.

House:  Same as Senate.

Nonqualified Deferred Compensation

Senate:  Any compensation deferred under a nonqualified deferred compensation plan would be includible in the gross income of the service provider when there is no substantial risk of forfeiture of the service provider’s rights to such compensation.  A substantial risk of forfeiture exists only if the rights are conditioned on the future performance of substantial services by any individual.   A condition related to a purpose of the compensation other than the future performance of substantial services (such as a condition based on achieving a specified performance goal or a condition intended in whole or in part to defer taxation) would not create a substantial risk of forfeiture, regardless of whether the possibility of forfeiture is substantial).  A covenant not to compete does not create a substantial risk of forfeiture.

The provision would apply without regard to the method of accounting of the service provider.  It would apply to all stock options and stock appreciation rights (“SARs”).  It is intended that no exceptions are to be provided in regulations or other administrative guidance; however, statutory options would not be considered nonqualified deferred compensation and certain limited statutory exceptions would apply.  It would generally apply to amounts attributable to services performed after December 31, 2017.

House:  Current law would be retained.

Modification of Limitation on Excessive Employee Compensation

Senate:  Applicable to taxable years beginning after December 31, 2017, the exception to the $1 million deduction limitation for commissions and performance-based compensation in the case of publicly held corporations would be repealed.  The definition of covered employee would be amended to include the principal executive officer, the principal financial officer and the three other highest paid employees.  Once an employee qualifies as a covered employee, his/her compensation would be subject to the $1 million limitation as long as the executive (or beneficiary) receives compensation from the company.

House:  Similar to Senate provision.

Excise Tax on Excess Tax-Exempt Organization Executive Compensation

Senate:  The provision would impose a 20% excise tax on compensation in excess of $1 million paid to a tax-exempt organization’s five highest paid executives.  It would apply to all remuneration paid to such executives, including cash and the cash value of all remuneration (including benefits) paid in a medium other than cash, and excluding payments to a tax-qualified retirement and amounts otherwise excludable from the executive’s gross income.  The excise tax would also apply to “excess parachute payments” by the organization to such individuals.   An excess parachute payment generally would include a payment contingent on the executive’s separation from employment with an aggregate present value of three times the executive’s base compensation or more.  The provision would be effective for taxable years beginning after December 31, 2017, subject to a transition rule that the proposed changes would not apply to any remuneration under a written binding contract in effect on November 2, 2017 not modified thereafter in any material respect.

House:  Similar to Senate provision. 

Qualified Equity Grants

Senate:  Similar to House.

House:  Employees of nonpublic companies who are granted stock options or restricted stock units (“RSUs”) would be able to defer the recognition of income for up to five years through a newly created election.  Elections would apply only to employer stock (“qualified stock”) received in connection with the exercise of an option or in settlement of an RSU provided by the corporation in connection with the performance of services as an employee.  The corporation must have a written plan under which not less than 80% of all employees who provide services to such corporation in the United States are granted stock options or RSUs with the same rights and privileges.  Not entitled to make this election would be any individual who was a 1% owner at any time during the ten preceding calendar years, is or has been at any prior time the CEO or CFO, or has been one of the four highest compensated officers for any of the ten preceding taxable years.  An arrangement under which an employee may receive qualified stock will not be treated as a nonqualified deferred compensation plan solely because of an employee’s election, or ability to make an election, to defer recognition of income under this provision.  This would generally apply to stock attributable to options exercised, or RSUs settled, after December 31, 2017, subject to transition rules.

Richard Shapiro, Tax Director and member of EisnerAmper’s Financial Services and Corporate Tax Groups, has more than 40 years’ experience in federal income taxation, including the taxation of financial instruments and transactions, both domestic and international, corporate taxation and mergers and acquisitions.

* Required