Comparison of the House and Senate Tax Bills – Implications for Agriculture

Overview

Last week, the House passed its version of legislation to overhaul the tax Code.  H.R. 1 passed on a 227-205 (two abstentions).  Also, last week, the Senate Finance Committee approved its version of tax legislation by a 14-12 vote.  The bills are similar on some points, but dramatically different on others.  While I tend not to focus to heavily on tax bills before the legislation takes the form of a bill that is headed to the President’s desk, there have been some items in these two bills that have required a detailed examination and commentary to staffers of Committee members with further explanation of their likely impact on the agricultural sector.  My blog post of November 6 on the self-employment tax impact of the House bill was an example of that.  Fortunately, those provisions were stripped out in a Chairman’s amendment.

Today, I compare some of the provisions contained in the bills and also point out a few areas of likely impact on ag producers and agribusiness activities. My friend, Tony Nitti (a CPA in Colorado) who is a contributor to Forbes, has done a great job in breaking down some of the provisions in both the House and Senate bills in one of his recent columns.  Today’s post begins with Tony’s framework and expands into additional areas that have direct application to agricultural producers and businesses.  I am also not covering every provision contained in either the House or Senate bills.  The bills are each several hundred pages long. 

For those interested in hearing my commentary on these provisions, I will be covering it on RFD-TV and my other radio interviews in the coming days.  Those interviews and commentary will be captured and made available on www.washburnlaw.edu/waltr.  I will also be discussing the two bills at upcoming practitioner seminars, including one this week in Kansas City.  I will also cover the bills in Topeka, Salina and Wichita, Kansas the following week, and in Des Moines, Iowa on December 6 as well as in Pittsburg, KS on Dec. 14 (also simulcast over the web).  My full CPE schedule can also be found on www.washburnlaw.edu/waltr.

The following is what I “think” the language in the House and Senate bills on the provisions discussed means at the present time.  Some of the bill language is confusing and convoluted and practically impossible to discern.  Thus, the reader is duly cautioned.

Ordinary Income Tax Brackets and Rates

The House bill contains four brackets (from 12% to 39.6% (with a tack-on for those with over $1 million of AGI). 

The Senate bill has seven brackets (from 10% to 38.5%).  While the rates are indexed for inflation, they sunset after 2025.  In addition, based on the where the brackets begin and end, many people with modest-to-high incomes, particularly under the Senate Bill, will see a significant rate increase, at least as compared to the House Bill. 

Capital Gain/Dividend Rates

The House bill preserves the present rates of 0 percent, 15 percent and 20 percent.  The Senate bill is the same as the House bill on capital gain/dividend rates.  Also, neither the House nor the Senate bill repeals (or otherwise modifies) I.R.C. §1411 – the 3.8 percent additional tax on passive sources of income that was added by the health care law.  Thus, the maximum capital gain (or ordinary dividend) rate (based on the ordinary income tax rate applicable to the taxpayer) would be 23.8 percent.  For estates and trusts, the capital gain rates are also 0 percent, 15 percent and 20 percent, with the 20 percent rate beginning amounts above $12,700.  The 3.8 percent additional tax would also apply to passive gains.

Standard Deduction

Both the House bill and the Senate Bill essentially double the existing level of the standard deduction, setting it at $24,000 for a married couple filing jointly, for example.

Personal Exemption

The “price” for the doubling of the standard deduction, at least in part, is the elimination of the personal exemption for a taxpayer.  The House bill, while it eliminates the personal exemption and the use of a flexible spending account for child care, enhances the existing child tax credit ($1,600 per qualified child; and increases the phase-out range), and adds a $300 credit for non-child dependents (through 2022), and a “Family Flexibility” credit of $300 for each spouse.   The refundable portion of the child tax credit is set at $1,000, with the phase-out beginning (MFJ) at $230,000. 

The Senate bill also eliminates the personal exemption, and increases the child tax credit to $2,000 (through 2025 for children under age 18, when it is then eliminated) with the phaseout range set much higher than the House phase-out range – it begins at $1,000,000 (MFJ). 

Itemized Deductions

The House bill eliminates all major deductions except for up to $10,000 of property taxes; mortgage interest (up to $500,000 on new loan and none for second home or on home equity loans); losses associated with federally declared disaster areas; and charitable deductions.  As for charitable contributions, the contribution limit is increased to 60 percent.  Also, the charitable mileage statutory cap of $.14 is eliminated and adjusted for inflation.  In addition, the House bill requires that all charitable contributions (of any dollar amount) be substantiated.

The Senate bill also eliminates all major deductions except for medical expenses (they remain deductible to the extent they exceed 10 percent of AGI); mortgage interest (limited to $1,100,000 with no deduction on home equity loans); charitable contributions (same provisions as the House bill with additional specification that an electing small business trust must follow the charitable contribution deduction rules for individuals); alimony deduction; the deduction for student loan interest; and the educator deduction.  Unlike the House bill, the Senate bill entirely eliminates all deductibility for property taxes.  That last point on property tax deductibility will be a sticking point in getting a final bill to the President’s desk.

Education Provisions

The House bill enhances the American Opportunity Tax Credit, but repeals the Lifetime Learning Credit and the Hope Scholarship Credit.  Also, new Coverdell ESA contributions would be barred, but tax-free rollovers to an I.R.C. §529 plan would be allowed.  Similarly, elementary and high school expenses of up to $10,000 annually would qualify for I.R.C. §529 plans.  The House bill repeals the deductibility of interest expense on education loans; the exclusion for interest on U.S. savings bonds that are used to pay higher education expenses; the deduction for qualified tuition and related expenses; the exclusion for qualified tuition reduction programs, and the exclusion for employer-provided educational assistance.  The House bill also includes a 1.4 percent excise tax on the endowment income of colleges, and treats tuition reductions for graduate students (and others) as taxable income.

The Senate bill, while not including many of the higher education provisions of the House bill, does impose a tax on the investment income of private colleges with endowments of at least $250,000 per student.  It also increases the schoolteacher deduction to $500. 

Pass-Through Business Income

The House bill establishes a top rate of 25 percent on S corporation income.  That rate applies to all of a passive owner’s income, and it applies to 30 percent of a materially participating owner’s income that is attributable to the capital of the business.  The balance of the owner’s income is taxed at the taxpayer’s applicable individual rate.  The House bill establishes a presumption that none of the income of an owner of a service business is subject to the 25 percent rate.  As noted above, the self-employment tax changes that were in the original House version have been removed.

Under the Senate bill, sole proprietors, S corporation owners and partnership members get a deduction of 17.4 percent of “qualified business income” (limited to 50 percent of FICA wages paid by the business owner).  The deduction is not available to “specified service businesses.”  The calculation of the deduction is brought over from the domestic production activity deduction (DPAD) provision of I.R.C. §199, which is removed by both the House and Senate versions.  Unfortunately, it is impossible to tell whether the computation for the deduction is at the individual level or the entity level. 

Carried Interest

The House bill taxes “carried interest” (the portion of an investment fund’s profits (typically 20 percent) that is paid to investment managers), but limits the application of the capital gain rate to the gain on the sales of assets held three years or more (as opposed to one-year under current law). 

The Senate bill mirrors the House bill.

Alternative Minimum Tax (AMT)

Both the House bill and the Senate bill eliminate the AMT. 

Worker Classification

The House bill contains no significant change in the manner of how a worker is classified either as an independent contractor or an employee.

The Senate bill establishes a safe harbor under which a worker is treated as an independent contractor and not an employee upon the satisfaction of three objective tests – the relationship between the parties; the location of the services or means by which they are provided; and the existence of a written contract stating the independent contractor relationship and acknowledging responsibility for taxes and a reporting/withholding obligation.  The bill establishes a $1,000 threshold for Form 1099-K reporting, and raises the 1099-MISC threshold from $600 to $1,000.  The Senate bill also limits the ability of the IRS to reclassify service providers as employees (and service recipients/payors as employers) in cases where the parties try in good faith to comply with the safe harbor, but fail.  In other words, the IRS can only recharacterize the relationship as an employment relationship on a prospective basis.  The Senate bill also amends Tax Court jurisdiction to allow a worker to bring a case challenging worker classification. 

Transfer Taxes

The House bill sets the applicable exclusion from estate, gift and generation-skipping transfer tax (GSTT) at $11.2 million for 2018.  The House bill eliminates the estate tax and the GSTT after 2023.  The House bill retains stepped-up basis for property included in a decedent’s estate, and also retains the gift tax.

The Senate bill does not repeal the estate or GSTT, but doubles the applicable exclusion (11.2 million for 2018).

“Obamacare”

The House does not repeal the penalty tax applied to an individual that is mandated to purchase health insurance (the so-called “Roberts” tax).

The Senate bill eliminates the individual mandate penalty tax. 

Corporate Tax

The House bill establishes a 20 percent top corporate rate beginning in 2018.  For personal service corporations, the rate is 25 percent.  The bill also modifies current accounting rules in numerous aspects.  For example, a C corporation must use accrual accounting if gross receipts exceed $25 million, and businesses with inventory must use accrual accounting if gross receipts exceed $25 million.   The bill also requires a business to change from the completed contract method to the percentage of completion method for accounting for long-term contracts if gross receipts exceed $25 million.  In addition, the House bill specifies that the uniform capitalization rules apply to inventory if the taxpayer’s gross receipts exceed $25 million.  The bill also eliminates the carryback for net operating losses (NOLs) (except for small businesses and farms – they get a one-year carryback), but they can be carried forward indefinitely but are limited to 90 percent of pre-NOL taxable income.  In addition, deductible net interest expense is limited to 30 percent of business “adjusted taxable income” (with a 5-year carryover).  However, interest deductibility is retained for a business with average gross receipts up to $25 million, with an “opt-out” election for farmers.  If the opt-out provision is elected, alternative depreciation will apply to all of the taxpayer’s farm property and a 10-year recovery period will apply.  That could be an especially important election for larger cattle feedlots and other livestock facilities that are highly leveraged.  Entertainment expenses are not deductible, and the I.R.C. §199 DPAD is eliminated.

The Senate bill is similar.  The top corporate rate is set at 20 percent, but the bill delays the implementation of that rate until the start of 2019.  Like the House bill, the Senate bill contains similar accounting rule changes from current law.  Under the Senate bill, a C corporation must use accrual accounting if gross receipts exceed $15 million.  Likewise, businesses with inventory must use accrual accounting if gross receipts exceed $15 million.  Businesses will also be forced to change from the completed contract method to the percentage of completion method when accounting for long-term contracts if gross receipts exceed $15 million.  Also, the uniform capitalization rules will apply to inventory if the taxpayer’s gross receipts exceed $15 million.  Also, under the Senate bill, there is no carryback for net operating losses.  However, a net operating loss can be carried forward indefinitely, subject to a limit of 90 percent of taxable income; deductible net interest expense is limited to 30 percent of adjusted taxable income capped at $15 million of revenue with an indefinite carryover.  Also, entertainment expenses are not deductible, and the DPAD is eliminated.

Cost Recovery

The House bill specifies that the I.R.C. §179 limit is enhanced to $5 million (phaseout beginning at $20 million), and immediate expensing of assets is allowed for assets with a life of less than 20 years that are acquired and placed in service after September 27, 2017 through 2022.  A tax-deferred exchange (I.R.C. §1031) would be allowed only for real property.

The Senate bill pegs the I.R.C. §179 limit at $1 million, and there is immediate expensing of new assets with a life of less than 20 years through 2022.   Under the Senate bill, farm equipment would be depreciated over five years, and the 150 percent declining balance depreciation method for farm property would be eliminated (except for 15-year and 20-year property).   

IRS Forms

The Senate bill creates a new IRS Form – Form 1040SR.  The 1040SR is to be a simplified return for those taxpayers over age 65.

Energy

The House bill reduces the existing $.023-per-kilowatt-hour tax credit for wind energy production to $.015/kWh and changes the definition of “under construction.”  That definition applies in the context of defining when the credit availability begins.  The House bill also eliminates the $7,500 electric vehicle tax credit and makes the investment tax credit for solar projects a targeted credit.  The House bill also extends the credit for residential energy efficient property through 2021, with a reduced rate of 26 percent for 2020 and 22 percent for 2021. 

The Senate bill largely leaves existing energy credits in place, including the existing credit for marginal wells.

International Tax

The House bill provides for a 100 percent dividends-received deduction to U.S. corporations when amounts are repatriated from foreign subsidiaries.  There is also a one-time “deemed repatriation” tax imposed that applies a 14 percent tax on cash parked overseas and seven percent on any illiquid assets

The Senate bill is the same as the House bill, except that the deemed repatriation tax is 10 percent on cash and 5 percent on illiquid assets.

Miscellaneous

The House bill also modifies the FICA tip credit.  In addition, the Employer-Provided Child Care Credit is eliminated, as is the Rehabilitation Credit, the Work Opportunity Tax Credit, the New Markets Tax Credit, the deduction for certain unused business credits, and deductions for expenses incurred to provide access to disabled persons.  In addition, the House bill repeals I.R.C. §118 (capital contributions to a corporation); the deduction for transportation fringe benefits; the deduction for on-premises gyms; and limits the deduction for qualifying businesses meals to 50 percent. The House bill makes deferred compensation taxable when there is no longer a substantial risk of forfeiture.  The bill also imposes an excise tax on excess tax-exempt organization executive compensation – its 20 percent on compensation that exceeds $1 million (in certain situations).

The Senate bill specifies that the alternative depreciation system for residential rental property is shortened to 30 years.  It also eliminates the deduction for meals provided for the convenience of the employer.  The Senate bill allows for rollovers between I.R.C. §529 plans and ABLE plans, bars an increase in user fees for installment agreements, delays the deduction by lawyers for litigation costs associated with expenses paid on contingent fee cases until the contingency is resolved, and eliminates the deduction for attorney fees and settlement payments in sex harassment or abuse cases if there is a nondisclosure agreement.  The Senate bill also proposes to significantly impact the tax strategy of grain gifting by a farmer to a child by changing the child’s tax rates on unearned income to be equal to the tax rates for estates and trusts.  Thus, once the child reaches $12,700 (2018) of unearned income, the child will face a maximum tax rate of 38.5 percent on all income above the $12,700 threshold. 

Conclusion

It remains to be seen whether any of the provisions described above will ever become law.  Certainly, the “sausage-making” process will be interesting to watch.  The cynic in me says nothing of significance will ultimately get accomplished this year.  There are just too many in the Senate that don't want the President to be perceived to have achieved a legislative victory on anything.  Perhaps I am wrong.  Time will tell.