Individual Provisions: Tax Reform Moves Forward – Comparison of House and Senate Bills
This is further content in our comparison of the provisions contained in the House and Senate versions of tax reform legislation. As we’ve noted, while there are many similarities, there are also meaningful differences -- for example, in the individual context, tax rates, the deductibility of state and local property taxes, the taxation of business income of individuals, the treatment of carried interests and the future of the estate tax. How these differences are resolved, and if they can be resolved, will likely determine the fate of tax reform legislation. Meanwhile, the House and Senate leadership have placed this legislative initiative on a very fast track, with the hope that tax legislation can be passed by Congress and sent to the President for signature perhaps by Christmas. EisnerAmper will continue to report on developments as they occur. What follows are highlights and a comparison of the individual provisions of these two approaches to tax reform. The business and international provisions are covered in separate Alerts.
Senate: There would be seven brackets – 10%, 12%, 22.5%, 25%, 32.5%, 35% and 38.5%. For married individuals filing jointly, the 38.5% bracket threshold would be $1,000,000. For unmarried individuals it would be $500,000. Bracket thresholds would be adjusted for inflation using the “chained consumer price index for all-urban consumers” in lieu of the “consumer price index for all-urban consumers.” (The result would be that the inflation adjustments will be slower.) Present law maximum rates on net capital gain and qualified dividends would generally remain.
The “kiddie tax” would be changed by effectively applying ordinary and capital gains rates applicable to trusts and estates to the net unearned income of a child. Thus, taxable income attributable to earned income would be taxed according to an unmarried taxpayer’s brackets and rates. Taxable income attributable to net unearned income would be taxed according to the brackets applicable to trust and estates, with respect to both ordinary income and income taxed at preferential rates. The child’s tax would no longer be affected by the tax situation of the child’s parents or the unearned income of any sibling.
House: The current seven tax brackets would be consolidated into four brackets of 12%, 25%, 35% and 39.6%, also adjusted for inflation using the chained consumer price index for all-urban consumers. Present law maximum rates on net capital gain and qualified dividends would generally remain. The kiddie tax would be modified.
Individual Alternative Minimum Tax
Standard Deduction and Personal Exemptions
Senate: Personal exemptions would be eliminated and consolidated into a larger standard deduction -- $24,000 for married taxpayers filing jointly and $12,000 for single filers. The additional standard deduction for the elderly and the blind would be retained.
House: Personal exemptions would be eliminated, with a standard deduction of $24,400 for married taxpayers filing jointly and $12,200 for single filers.
Business Income of Individuals
Senate: An individual taxpayer generally may deduct 17.4% of domestic qualified business income from a partnership, S corporation, or sole proprietorship. In the case of a taxpayer who has qualified business income from a partnership or S corporation, the amount of the deduction would be limited to 50% of the W-2 wages. Only those wages that are properly allocable to qualified business income would be taken into account. If the amount of qualified business income for a taxable year is a loss, the amount of the loss would be treated as a loss from qualified businesses in the next taxable year. Qualified business income would not include any amount paid by an S corporation that is treated as reasonable compensation, nor would it include certain investment related income, gain, deductions or loss.
The deduction would not apply to specified service businesses, except for a taxpayer whose taxable income does not exceed $150,000 (married filing jointly; $75,000 for other taxpayers), subject to phase-out. A specified service trade or business is any trade or business activity involving the performance of services in certain specified fields, including for example, health, law, accounting, athletics, financial services and brokerage.
House: A portion of net income distributed by a pass-through entity (i.e., sole proprietorship, partnership limited liability company (LLC) taxed as a partnership or S corporation) to an owner or shareholder may be treated as “business income” subject to a maximum rate of 25% instead of ordinary individual income tax rates. The remaining portion of net business income would be treated as compensation and continue to be subject to ordinary income tax rates. Rules are provided to determine the proportion of business income and to prevent the recharacterization of actual wages paid as business income. Net income derived from a passive business activity would be treated as business income and fully eligible for the 25% maximum rate. Under certain default rules, owners or shareholders receiving net income derived from an active business activity (including wages received) would treat 70% of business income as ordinary income and 30% as business income eligible for the 25% rate; alternatively, such owner or shareholders may elect to apply a specified formula based on the business’s capital investments to determine an allocation greater than 30%. As noted in the case of the Senate proposal, certain personal services businesses would generally not be eligible for the reduced 25% rate on business income with respect to such personal services business, though they would be allowed to use the alternative formula based on the business’s capital investments, subject to certain limitations.
In addition, the bill would provide a special reduced 9% tax rate for the first $75,000 ($37,500 for an unmarried individual) in net business taxable income of an active owner or shareholder earning less than $150,000 ($75,000 for an unmarried individual) in taxable income through a pass-through business, subject to a phase-out. Businesses of all types would be eligible for this 9% tax rate. The 9% rate would be phased in – the rate would be 11% for tax years beginning in 2018 and 2019, and the rate would be 10% for tax years beginning in 2020 and 2021.
Child Tax Credit
Senate: The child tax credit would be increased to $1650 per child under the age of 18. There would also be a $500 nonrefundable credit for qualifying dependents other than qualifying children. The threshold at which the credit would begin to phase out would be increased to $1,000,000 for married taxpayers filing jointly and $500,000 in the case of other taxpayers (not indexed for inflation). The refundable portion of the child credit would be limited to $1,000.
House: The child tax credit would be increased to $1600 per child under 17; alternatively, a credit of $300 would be allowed with respect to a taxpayer (each spouse in the case of a joint return) who is neither a child nor a non-child dependent. The refundable portion of the child credit would be limited to $1,000. The family flexibility credit and the non-child dependent credit would be effective for taxable years beginning before January 1, 2023.
Deduction for Taxes Not Paid or Accrued in a Trade or Business
Senate: In the case of an individual, state, local, and foreign property taxes and local sales taxes would be deductible ONLY when paid or accrued in carrying on a trade or business or in connection with production of income (i.e., deductible in computing income on Form 1040 Schedules C, E or F). For example, an individual could deduct such taxes only if they were imposed on business assets, such as residential rental property. State and local income tax would not be deductible.
House: The section is similar to the Senate proposal except that up to $10,000 of foreign, state and local real property tax would continue to be deductible.
Home Mortgage Interest
Senate: The deduction for home equity interest would be repealed.
House: The deduction for mortgage interest on existing mortgages would continue, but for debt incurred after November 2, 2017, interest paid on only $500,000 of principal residence mortgage debt would be deductible.
Senate: The income-based percentage limit for certain charitable contributions by an individual taxpayer of cash to public charities and certain other organizations would be increased from 50% to 60%.
House: Same as Senate.
Senate: The bill would maintain the current deduction for medical expenses.
House: The itemized deduction for medical expenses would be repealed.
Senate: No provision.
House: The deduction for alimony payments would be repealed. Similarly, provisions providing for inclusion of alimony payments in gross income would also be repealed.
Senate: Subject to a limited exception, the bill would repeal this deduction.
House: Same as Senate.
Personal Casualty and Theft Losses
Senate: The bill would generally repeal this deduction except for losses incurred as a result of certain federally declared disasters.
House: Similar to Senate.
Tax Preparation Expenses
Senate: Tax preparation expenses would be nondeductible.
House: Same as Senate.
Miscellaneous Itemized Deductions Subject to 2% Floor
Senate: All miscellaneous itemized deductions subject to the 2% floor under current law would be repealed.
House: No provision.
Limitation on Itemized Deductions
Expenses Attributable to Trade or Business of Being an Employee
Senate: No provision.
House: The bill would deny a deduction for expenses attributable to the trade or business of being an employee. Working condition fringe benefits currently excluded from income would continue to be excluded.
Modification of Exclusion of Gain from Sale of a Principal Residence
Senate: Under existing law an individual taxpayer may exclude up to $250,000 ($500,000 if married filing jointly) of gain realized on the sale or exchange of a principal residence if the taxpayer has owned and used the residence as a principal residence for at least two of the five years ending on the date of the sale of exchange, subject to certain qualifications. Under this provision, the two-of-five year rule would be modified to a five-of-eight year rule, subject to certain qualifications. A taxpayer may benefit from the exclusion only once every five years.
House: The provision is similar to the Senate version with the added restriction that the exclusion phases out one dollar for each dollar by which the taxpayer’s average adjusted gross income exceeds $250,000 ($500,000 for joint filers) for the taxable year and the two preceding taxable years.
Qualified Moving Expense Reimbursement and Deduction for Moving Expenses
Senate: The exclusion from gross income and wages for qualified moving expense reimbursement and the deduction for moving expenses (except for certain Armed Forces-related moving expenses and reimbursements) would be repealed.
House: Substantially the same as Senate.
Adoption Assistance Programs
Senate: Not addressed.
House: The exclusion for adoption assistance programs would be repealed.
Senate: Not addressed.
House: The many existing provisions on education incentives would be consolidated and simplified. Certain deductions and exclusions would be repealed. Currently, allowable deductions for certain interest on education loans and for qualified tuition and related expenses would be repealed.
Estate and Gift Tax Exemption
Senate: The estate and gift tax exemption would be doubled, accomplished by increasing the basic exclusion amount from $5 million to $10 million. The $10 million exclusion amount is indexed for inflation after 2011 ($10.98 million for 2017). The proposal would be effective for decedents dying, generation skipping transfers and gifts made after December 31, 2017. The proposal does not indicate a future repeal of these taxes.
House: Similar to the Senate, the House bill would increase the basic exclusion amount to $10,000,000 (with inflation adjustments), effective for decedents dying and gifts made after 2017. Beginning after 2024, the estate and generation-skipping transfer tax would be repealed while maintaining a beneficiary’s step-up basis in estate property. Beginning in 2025, the gift tax would be lowered to a top rate of 35%.
During the week of November 13, the Senate Finance Committee is marking up the Senate version of tax reform legislation. This mark-up is likely to result in changes to the individual provisions described above. EisnerAmper will keep you apprised of further developments.