Tax Reform
November 12 Update
During a presentation Friday on the current tax reform legislation, I mentioned that the political talk about taxes you hear on radio and television is mostly nonsense. Though the audience seemed to nod in agreement, I immediately regretted saying it – wondering if it needed to be said. I needn’t have worried. Sunday morning I watched Republican Ways and Means Committee Chairman Kevin Brady and Maryland Democrat Senator Chris Van Hollen answering with their talking points no matter what they were asked. We have clearly reached the point in our political discourse in this country where responding to a question with a clear acknowledgement of the obvious is simply not done, if it can be construed as an admission. Brady was asked if it was possible that some taxpayers would pay more in taxes under the Republican House bill. The clear answer is yes unless you can state that not a single one of the 300 million Americans will be caught in its snare. But Brady didn’t go there because then the headline tonight would be “Brady Acknowledges Tax Hikes on Some”. Then our President would start to tweet about you. I’ll stay out of that world thank you and happily blog away. This is a status report.

The Ways and Means Committee has completed its markup on the bill and scheduled a house vote for next week. Brady says it will pass. Meanwhile the Senate Finance Committee has released its tax bill and will begin its markup sessions shortly. The objective is to have both houses pass their respective bills before Thanksgiving, go to conference committee to reconcile differences and have a bill on President Trump’s desk before year end.

Therefore it is not too early to begin to look at some of the more significant differences between the two bills. They will need to be worked out before a final bill can be voted on and sent to the President for signature.

The bills are similar in most respects. There are no large issues addressed in one and not in the other, though there are some significant differences in how those issues are handled. Both bills are scored preliminarily by the Joint Committee on Taxation at roughly a $1.5 trillion revenue deficit, which is within the budget reconciliation provision of the budget approved by both houses. Most commentators seem to be of the mind that the Senate version smooths out some of the distribution issues contained in the House bill, which has been criticized in some quarters for favoring the wealthy at the expense of the middle class.

Here in bullet points are some of the differences:

  • There are many provisions in the house version that are not addressed at all in the Senate bill. It is hard to say if the conference version will address them or omit them. There are fewer provisions in the Senate bill not included in the house.

  • Both versions contain a number of provisions that favorably affect small businesses – changes to cash accounting rules and inventory accounting are a couple that are worth mentioning. In such provisions, the House generally defines small as under $25 million in annual revenues while the Senate defines small as under $15 million in annual revenues.

  • Both versions provide for corporate tax rates to drop from 35% (current) to 20%. The house bill does this immediately (beginning in 2018); the Senate version delays the rate change until 2019.

  • Both versions provide for net operating losses to be carried forward indefinitely, but also limit the amount that can be applied to 90% of taxable income before deduction of the NOL. The house version repeals NOL carrybacks, which under current law is for 2 years. The senate version does not repeal carrybacks.

  • The special treatment of flow through income has been a hot topic. The house version applies a special 25% rate to qualified flow through income; the Senate accomplishes the same thing with a deduction that results in a slightly higher effective rate than 25%. Both bills exclude professional service entities from the lower rates. The house bill applies the lower rate to passive investors, while the senate version applies equal treatment to all owners whether passive or active. Under the Senate version, it appears that passive owners of flow through entities will not obtain any benefit of the lower rates.

  • Both versions increase the lifetime exemption for estate tax purposes from $5M to $10M per individual adjusted for inflation since 2011. The house version repeals the estate and generation skipping tax after 5 years, while specifically retaining the rules allowing step up of tax basis on death. The Senate version does not repeal the estate tax or generation skipping tax and says nothing about step up, presumably retaining it also.

  • Another hotly contested provision concerns the treatment of deductions for state and local taxes. The house version repeals the deduction for income tax and sales taxes, while retaining a $10,000 deduction for property taxes. The Senate version repeals all state and local tax deductions, including property taxes.

  • Under current law mortgage interest is deductible to the extent it is incurred on mortgages up to $1 million; the house bill reduces the mortgage limit to $500,000 on future home purchases; the Senate version retains the $1 million limit.

  • Medical expenses would no longer be deductible under the house bill, but remain deductible in the Senate version.

  • Both versions make extensive changes to the treatment of foreign source income, changing to a territorial system, repatriating past deferred income held in overseas entities, and providing for base erosion protections. The house version as originally released was significantly changed during Ways & Means markup sessions last week and like everything else will have to be reconciled with the Senate version. I’ll handle the specifics of these provisions in a separate post later this week.
In summary, the House Ways and Means and the Senate Finance Committee are largely addressing the same issues in their respective proposals. The differences are over specifics and not over concepts. Republicans who are comfortable with the overall direction of the framework will surely vote for the version which will come up for vote in his respective house of congress and will also be able to support the conference committee version to follow. Republicans who are troubled will have to be convinced. Democrats are unlikely to support any of this. There are some technical issues concerning compliance with the budget reconciliation provisions that will need to be worked out. On the fence Republicans will have to be assuaged without the resulting changes driving the Freedom Caucus members off the reservation. The pieces of this seem to be falling in place for the Republicans but it’s way too early to declare this a done deal.

Steve Metzenthin, CPA, CFP ® , CVA

Steve Metzenthin’s practice areas include personal financial planning, estate planning, business succession planning, income tax planning, and business valuations. Steve frequently works with clients on financial issues related to the elderly and retired, including retirement, Social Security and Medicare. He also advises corporate clients on matters related to business strategy and implementation and corporate governance.