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The House and Senate tax reform bills would affect small businesses, corporate tax rates, depreciation and the AMT for taxable years after 2018.

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

The Senate passed its version of the Tax Cuts and Jobs Act early in the morning on December 2, 2017.  In a prior version of this Alert, we detailed the provisions of both the House and the Senate Finance Committee bills.  We have updated the Senate provisions to include the changes made by the full Senate.

The differences in the House and Senate bills will be reconciled by a conference committee.  Once that is accomplished, both chambers of Congress will vote on the final bill, and if passed it will then be sent to the President for his signature.   Passing the bill in the Senate was a high hurdle, and that significantly increases the likelihood that the law will be enacted by year-end.  What follows are highlights and a comparison of the business provisions of these two approaches to tax reform.  The individual and international provisions are covered in separate Alerts.

EisnerAmper will provide an update as the soon as the conference committee agrees to a final bill. 

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:  In the bill adopted by the Senate, the corporate AMT has been preserved.  Since the current AMT rate and the proposed corporate tax rate of 20% would be the same, many taxpaying corporations would fall into the AMT.  And, while the Senate bill does not repeal the Research and Experimentation Credit, this would effectively make this and other credits worthless since they cannot offset the AMT.  

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.

Increased Bonus Depreciation

Senate:  Businesses would generally be allowed to write off (expense) a percentage of the cost of new investments in depreciable assets.  The write-off percentages would be as follows:

9/28/17 to 12/31/22  100%
2023 80%
2024  60%
2025 40%
2026 20%

House:  The House bill provides for the immediate expensing of qualified property placed in service after September 27, 2017 and before January 1, 2023.  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 limitation 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. 
  • 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, floor plan financing interest, and 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 23% 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, electing real property trade or businesses, and electing farming 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. 

Carryovers to other years would be adjusted to take account of this limitation, and could be carried forward indefinitely.  The two-year carryback, except for certain farming businesses and property and casualty insurance businesses, 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:  Same as the House.

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, 2017 for all entity types other than C corporations and for taxable years beginning after December 31, 2018 for C corporations.
  • 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.

  • 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 for all entities.

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.

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 November 27, 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 apply on a cut-off basis to expenditures paid or incurred in taxable years beginning after December 31, 2025. 

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.  However, see the discussion of the AMT above.

 House:  Same as Senate.

Low Income Housing Credit

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

 House:  Same as Senate.

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: No provision.

House:  Effective for taxable years beginning after December31, 2017, the provision would repeal the deduction for any unused business credits that remain after they are carried back one year and forward 20 years.

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.

Denial of Deduction for Settlements Subject to Nondisclosure Agreements Paid In Connection with Sexual Harassment or Sexual Abuse

Senate:  No deduction would be allowed for any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or for attorney’s fees related to such settlement or payment.  This provision would apply to amounts paid or incurred after the date of enactment.

House:  No provision.

Deductibility of Fines and Penalties for Federal Income Tax Purposes

Senate:  No deduction would be allowed for any amount paid or incurred to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by that government or entity into the potential violation of any law.

An exception would apply to amounts constituting restitution (including remediation of property) identified in a court order or settlement agreement as restitution or remediation or as an amount paid to come into compliance with any law.  Restitution for failure to pay any tax imposed under the Internal Revenue Code would be deductible to the extent it would have been allowed if the amount had been timely paid.  Another exception would be for any amount paid or incurred as taxes due. 

Subject to certain limited qualification, this provision would not apply to any amount paid or incurred by reason of an order in a suit in which no government or governmental entity is a party. 

This provision would be effective for amounts paid or incurred on or after the date of enactment, subject to transition rules. 

House:  No provision.

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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.

Anthony DiGiacinto is a Tax Director and member of the Cleantech Group with expertise in corporate and partnership tax planning, ASC 740 (FAS 109), FIN 48, consolidated returns, as well as mergers and acquisitions.