Monday, December 18, 2017
The Congress appears to finally be on the brink of a major overhaul of the Tax Code this week. The stated goal is to get a bill to the President’s desk before Christmas. Prior blog posts have highlighted both the House-passed version (http://lawprofessors.typepad.com/agriculturallaw/2017/11/comparison-of-the-house-and-senate-tax-bills-implications-for-agriculture.html) and the Senate-passed version (http://lawprofessors.typepad.com/agriculturallaw/2017/12/senate-clears-tax-bill-on-to-conference-committee.html). The Conference Committee produced a bill based largely on provisions drawn from both bills and produced a result for the two bodies to consider.
Today’s post takes a look at the major provisions on the Conference Committee bill that will be voted on this week. On January 10, 2018, Prof. Lori McMillan and I will conduct a two-hour seminar/webinar on the new law (assuming that the bill passes this week, as expected). If there is no new law by Jan. 10, we will update practitioners on the status of the law for 2017 and going forward. Registration for those attending in person and online is available here: https://www.agmanager.info/present-tax-landscape-implications-individuals-businesses-investors-and-others.
Now, a look at the major provisions in the Conference Committee bill.
Note: This is my attempt to understand the statutory language as it modifies current law. The text of the language is nearly 500 pages, with many interrelated provisions. Any mistakes in interpreting that language are my own.
Income tax rates. The conference agreement temporarily replaces the existing rate structure with a new rate structure for 2018-2025. Seven rate brackets are provided from 10 percent to 37 percent. The benefit of the 12 percent bracket is not phased-out for taxpayers with adjusted gross income in excess of $1,000,000 ($1,200,000 in the case of married taxpayers filing jointly). Also, the conference bill generally retains present-law maximum rates on net capital gains and qualified dividends.
Standard deduction. Starting for tax year 2018, through tax years beginning before 2026, the basic standard deduction is increased for all individuals. It will be $24,000 for MFJ, $18,000 for HOH and $12,000 for all other individuals. The amount of the standard deduction is indexed for inflation using the C-CPI-U for taxable years beginning after December 31, 2018. The additional standard deduction for the elderly and the blind remains unchanged.
Inflation adjustments. For tax years beginning after 2018, the basic standard deduction and the marginal tax brackets are indexed for inflation utilizing the chained CPI-U.
Personal exemptions. Effective for tax years beginning after 2017, the deduction for personal exemptions is suspended through 2025. The suspension does not apply to taxable years beginning after December 31, 2025.
Repeal of overall limitation on itemized deductions. The bill repeals the overall limitation on itemized deductions. The provision is effective for taxable years beginning after December 31, 2017 and before 2026.
Commodity gifts. Under current rules, a parent can gift grain to a child and eliminate the self-employment tax on the gifted grain and, under the “kiddie-tax” rules, the tax rate of the child is generally the parent’s rate. However, under the bill, in most situations, the tax rate of the child will be the tax rates applicable to estates and trusts. Thus, once the child has $12,500 of unearned income, the tax rate applicable to the child will be 37 percent on all excess amounts. This provision is applicable for tax years 2018 through 2025.
Family and individual tax credits. Effective for tax years beginning after 2017 through 2025 child tax credit is temporarily increased to $2,000 per qualifying child (one that hasn’t attained age 17 during the tax year), with up to $1,400 (indexed to the next lowest multiple of $100) of the credit refundable. In addition, the bill provides for a $500 nonrefundable credit for qualifying dependents other than qualifying children. In order to receive the child tax credit (i.e., both the refundable and non-refundable portion), a taxpayer must include a Social Security number (that is issued before the due date for the filing of the return for the tax year at issue) for each qualifying child for whom the credit is claimed on the tax return. If a taxpayer can’t claim the child tax credit for an otherwise qualifying child because the child didn’t have a Social Security number, the $500 nonrefundable credit can still be claimed. The credit is phased out for MFJ taxpayers with AGI exceeding $400,000 (not indexed for inflation).
Home mortgage interest. For taxable years beginning after December 31, 2017, and before January 1, 2026, a taxpayer may deduct interest paid on up to $750,000 (MFJ) of acquisition indebtedness, unless the debt is incurred before December 15, 2017, in which case the limit is $1,000,000. For taxable years beginning after December 31, 2025, a taxpayer may treat up to $1,000,000 (MFJ) of indebtedness as acquisition indebtedness, regardless of when the indebtedness was incurred. The additional deduction for interest attributable to home equity debt is suspended for tax years beginning after 2017 and before 2026.
Deduction for State and local taxes. For tax years beginning after 2017, for individuals, State, local, and foreign property taxes and State and local sales taxes are allowed as a deduction only when paid or accrued in carrying on a trade or business, or an activity that produces income. Thus, only those deductions for State, local, and foreign property taxes, and sales taxes, that are presently deductible in computing income on an individual’s Schedule C, Schedule E, or Schedule F are allowed. However, an itemized deduction of up to $10,000 may be taken for the aggregate of state and local real property taxes not paid or accrued in carrying on a trade or business or an income-producing activity, plus either state and local income tax or sales tax. It is also not possible to claim an itemized deduction in 2017 for a pre-payment of income tax for a future tax year in order to avoid the dollar limitation applicable for tax years after 2017.
Personal casualty and theft losses. Beginning in 2018, and lasting through 2025, a taxpayer may claim a personal casualty loss (subject to certain limitations) only if the loss was attributable to a disaster declared by the President.
Deduction of charitable donations. For tax years beginning after 2017, the bill increases the percentage limit for contributions of cash to public charities from the current 50 percent of the taxpayer’s contribution base to 60 percent. Effective for tax years beginning after 2016, the bill eliminates the possibility that a charity can substantiate a contribution of a donor via the charity’s return.
Repeal of certain miscellaneous itemized deductions subject to the two-percent floor. Effective for tax years beginning after 2017 and before 2026, the bill suspends all miscellaneous itemized deductions that are subject to the two-percent floor under present law.
Medical expenses. For taxable years beginning after December 31, 2016 and ending before January 1, 2019, the threshold for deducting medical expenses returns to 7.5 percent for all taxpayers. It had been increased by Obamacare to 10 percent, thus making it more difficult for taxpayers to deduct medical expenses. For 2017 and 2018, the threshold applies for purposes of the AMT in addition to the regular tax.
Alimony. The bill specifies that alimony and separate maintenance payments are not deductible by the payor spouse, and are not income to the recipient. Income used for alimony payments is taxed at the rates applicable to the payor spouse rather than the recipient spouse. The treatment of child support is not changed. The provision is effective for any divorce or separation instrument executed after December 31, 2018, or for any divorce or separation instrument executed on or before December 31, 2018, and modified after that date, if the modification expressly provides that the amendments of the bill apply to such modification.
Moving Expenses. The bill, effective for tax years beginning after 2017 and before 2026, generally suspends the deduction for moving expenses and repeals the exclusion for qualified moving expense reimbursement except for members of the military on active duty.
Alternative Minimum Tax (AMT). Under the bill, the individual AMT exemption amount and phase-out threshold are both increased for tax years beginning after 2017 and before 2026. The exemption goes to $109,400 (MFJ) and the phase-out begins at $1,000,000 (MFJ).
Treatment of business income of individuals. For tax years beginning after 2017 and before 2026, an individual business owner (other than the owner of a personal service business with income of $315,000 (MFJ) and above for the tax year) as well as an owner of an interest in a pass-through entity is entitled to a deduction of 20 percent of the individual’s share of qualified business income (QBI). QBI is the net amount of income, gain, deduction and loss attributable to the business less net long-term capital gains. However, the deduction comes with a limitation. The limitation (computed on a business-by-business basis) is the greater of (a) 50 percent of the W-2 wages paid with respect to the qualified trade or business, or (b) the sum of 25 of percent of the W-2 wages with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property. But, the wage limitation does not apply if the business owner's income is less than $315,000 (MFJ). As noted, the ability of a personal service business to claim the deduction is phased-out once taxable income reaches $315,000 (MFJ). The phase-out range is $100,000 (MFJ).
The 20-percent deduction is not allowed in computing adjusted gross income. It’s allowed as a deduction reducing taxable income. Thus, for example, the provision does not affect limitations based on adjusted gross income. However, the deduction is available to both nonitemizers and itemizers. The QBI deduction is allowed when computing AMT. Thus, it does reduce AMTI.
Corporate tax. A flat 21 percent tax corporate rate applies, effective for tax years beginning after 2017.
Corporate AMT. The AMT is repealed for tax years beginning after 2017. For corporations, the AMT credits offsets regular tax liability and is refundable for tax years beginning after 2017 and before 2022 in an amount equal to 50 percent (except it is 100 percent for tax years beginning in 2021) of the excess minimum tax credit for the tax year over the amount of the credit allowable for the year against regular tax liability. Thus, the full amount of the minimum tax credit will be allowed in taxable years beginning before 2022.
Cooperatives. An agricultural or horticultural cooperative engaged in the MPGE (manufacturing, production, growth or extraction) of an agricultural or horticultural product, the marketing of such a product that a patron has conducted MPGE on, or the provision of supplies or services to farmers is entitled to a deduction (computed separately from the patron with no pass-through to the patron) equal to the lesser of (a) 20 percent of the cooperative’s taxable income (gross income less qualified cooperative dividends) for the taxable year or (b) the greater of 50 percent of the W-2 wages paid by the cooperative with respect to its trade or business, or the sum of 25 percent of the W-2 wages of the cooperative with respect to its trade or business plus 2.5 percent of the unadjusted basis immediately after acquisition of qualified property of the cooperative. The deduction can't exceed the cooperative's taxable income for the year.
In addition, for tax years beginning after 2017, trusts and estates are eligible for the 20-percent deduction. Rules similar to the rules under current I.R.C. §199 apply for apportioning between fiduciaries and beneficiaries any W-2 wages and unadjusted basis of qualified property under the limitation based on W-2 wages and capital.
Loss limitation for non-corporate taxpayers. For taxable years beginning after December 31, 2017 and before January 1, 2026, excess business losses of a taxpayer other than a corporation are not allowed for the taxable year. The excess losses are carried forward and treated as part of the taxpayer’s net operating loss (“NOL”) carryforward in subsequent taxable years. NOL carryovers generally are allowed for a taxable year up to the lesser of the carryover amount or 80 percent of taxable income determined without regard to the deduction for NOLs. A two-year carryback rule applies for NOLs arising from a farming business. The carryback is to each of the two taxable years preceding the taxable year of the loss.
An excess business loss for the taxable year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer (determined without regard to the limitation of the provision), over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount.
The threshold amount for a taxable year is $500,000 (net) on a joint return. The threshold amount is indexed for inflation. In the case of a partnership or S corporation, the provision applies at the partner or shareholder level. Each partner’s distributive share and each S corporation shareholder’s pro rata share of items of income, gain, deduction, or loss of the partnership or S corporation are taken into account in applying the limitation under the provision for the taxable year of the partner or S corporation shareholder.
Business interest. For tax years beginning after 2017, deductible business interest (interest paid or accrued on debt allocable to the trade or business, including investment interest) is limited to business income plus 30 percent of the taxpayer’s adjusted taxable income (taxable income computed without business interest expense, business interest income, NOLs, the 20 percent QBI deduction, and other adjustments as provided in forthcoming regulations) for the tax year that is not less than zero. The deductible amount is determined at the tax-filer level except for pass-through entities where it is made at the entity level. Any disallowed amount is treated as paid or accrued in the succeeding tax year. However, businesses entitled to use cash accounting (as noted below) are not subject to the limitation, but large cash accounting businesses such as personal service businesses are limited in the deductibility of business interest. Special rules apply to excess business interest of partnerships.
An electing farm business (as defined by I.R.C. §263A(e)(4) and including an agricultural or horticultural cooperative) that is barred from using cash accounting can make an irrevocable election to not be subject to the limitation on the deductibility of interest. In return, such farm businesses (not farm landlords) must use alternative depreciation on farm property with a recovery period of 10 years or more. However, the election out will likely result in the inability to qualify otherwise eligible assets for bonus depreciation (in accordance with I.R.C. §263A). In addition, a farm business that elects out of the limitation on deducting interest must use ADS to depreciate any property with a recovery period of 10 years or more. This provision is also effective for tax years beginning after 2017.
Cash accounting. Cash accounting is available for taxpayers with annual average gross receipts that do not exceed $25 million for the three prior taxable year periods (the “$25 million gross receipts test”). The $25 million amount is indexed for inflation for taxable years beginning after 2018. The provision expands the ability of farming C corporations (and farming partnerships with a C corporation partner) that may use the cash method to include any farming C corporation (or farming partnership with a C corporation partner) that meets the $25 million gross receipts test. The provision retains the exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations. Thus, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other passthrough entities are allowed to use the cash method without regard to whether they meet the $25 million gross receipts test, so long as the use of the cash method clearly reflects income. In addition, the provision also exempts certain taxpayers from the requirement to keep inventories, and from the uniform capitalization rules. In the case of a sole proprietorship, the $25 million gross receipts test is applied as if the sole proprietorship is a corporation or partnership. In the case of a sole proprietorship, the $25 million gross receipts test is applied as if the sole proprietorship is a corporation or partnership.
Business-provided meals. Beginning in 2018, the current 100 percent deduction for amounts incurred and paid for the provision of food and beverage associated with operating a business drops to 50 percent. The provision applies to amounts incurred and paid after December 31, 2017 and until December 31, 2025, that are associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and are for the convenience of the employer. After 2025, the amount goes to zero. Thus, the provision allowing a deduction for meals provided to employees for the convenience of the employer is repealed for amounts paid or incurred after 2025.
Partnership losses. When determining a partner’s distributive share of any partnership loss, the partner takes into account the distributive share of the partnership’s charitable contributions and taxes, except that if the fair market value of a charitable contribution exceeds the contributed property’s adjusted basis, the partner is not to take into account the partner’s distributive share of the charitable contribution as to the excess. The result of this provision is that basis is not decreased by the excess fair market value over basis. The provision applies to partnership taxable years beginning after 2017.
Expensing. The bill allows for full expensing of assets presently eligible for “bonus” depreciation under I.R.C. §168(k) for property place in service after September 27, 2017 through December 31, 2022 (see below). After 2022, the provision is phased-out by 20 percentage points every year thereafter with a complete phaseout for property placed in service beginning in 2027. The same rules apply to plants bearing fruits and nuts.
Expense method depreciation. The maximum amount a taxpayer may expense under I.R.C. §179 to $1,000,000, and increases the phase-out threshold amount to $2,500,000 for tax years beginning after 2017. The $1,000,000 and $2,500,000 amounts are indexed for inflation for tax years after 2018. In addition, some additional types of property are specified to qualify for I.R.C. §179, including qualified real property.
Bonus depreciation. First-year “bonus” depreciation is extended through 2026 at 100 percent for property acquired and placed in service after September 27, 2017, and before 2023. The 100-percent allowance is phased down by 20 percent per calendar year for property placed in service, and specified plants planted or grafted, in taxable years beginning after 2022. It is not required that the original use of the qualified property commence with the taxpayer. Thus, bonus applies to new and used property. A transition rule provides that, for a taxpayer’s first taxable year ending after September 27, 2017, the taxpayer may elect to apply a 50 percent allowance instead of the 100 percent allowance.
Luxury autos. For passenger automobiles placed in service after December 31, 2017, for tax years ending after 2017, and for which bonus depreciation is not claimed, the maximum amount of allowable depreciation is $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 in the recovery period. The limitations are indexed for inflation for passenger automobiles placed in service after 2018. The provision removes computer or peripheral equipment from the definition of listed property. Such property is therefore not subject to the heightened substantiation requirements that apply to listed property.
Farm property. The bill shortens the depreciable recovery period from seven to five years for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business, the original use of which commences with the taxpayer and is placed in service after December 31, 2017. The provision also repeals the required use of the 150-percent declining balance method for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property). The 150 percent declining balance method will continue to apply to any 15-year or 20-year property used in the farming business to which the straight-line method does not apply, or to property for which the taxpayer elects the use of the 150-percent declining balance method. For these purposes, the term “farming business” means a farming business as defined in I.R.C. § 263A(e)(4).
Depreciation of real property. Unlike the prior versions, the conference committee bill maintains the present law general MACRS recovery periods of 39 and 27.5 years for nonresidential real and residential rental property, respectively. As for qualified improvement property (QIP), it was apparently the intent of the drafters (according to the conference report) to maintain eligibility for I.R.C. §179 and bonus depreciation. However, that is not the result that the statutory language produces. Under the revised statutory language, for assets placed in service after 2017, (QIP) (qualified leasehold improvement property; qualified restaurant improvement property; qualified real property) no longer exist and there is no provision in the Code identifying QIP as 15-yr property. It's not in the 15-yr property list of I.R.C. §168(e)(3)(E). Also, QIP is removed from the definition of qualifying property for bonus depreciation purposes. As a result, it doesn't have any defined cost recovery period which therefore leaves it as 39-yr property and ineligible for bonus depreciation. However, it remains eligible for I.R.C. §179 expensing. Absent a technical correction, the only argument or claiming post September 27, 2017, QIP as being eligible for bonus is legislative intent based on the language of the conference report.
Education saving plans. For distributions made after 2017, the bill allows I.R.C. §529 plans to distribute up to $10,000 in expenses for tuition incurred during the taxable year in connection with the enrollment or attendance of the designated beneficiary at a public, private or religious elementary or secondary school on a per-student basis.
Student loan debt. The bill modifies the exclusion of student loan discharges from gross income, by including within the exclusion certain discharges on account of death or disability. The provision is effective for discharges after 2017 and before 2026.
Rollovers between Qualified Tuition Programs and Qualified ABLE programs. Amounts from an I.R.C. §529 plan account can be rolled over to an ABLE account without penalty, provided that the ABLE account is owned by the designated beneficiary of that I.R.C. §529 account, or a member of the designated beneficiary's family. The rolled-over amounts count towards the overall limitation on amounts that can be contributed to an ABLE account within a taxable year, with any excess includible in the gross income of the distribute. The provision is effective for distributions after date of enactment through 2025
ABLE accounts. Effective for tax years beginning after the date of enactment, the contribution limit to an ABLE account is increased with respect to contributions made by the designated ABLE account beneficiary. The provision does not apply to tax years beginning after 2025.
Qualified retirement plan distributions. For tax years beginning in 2016 and 2017, a special provision is included that waives the 10 percent early withdrawal penalty for distributions from a qualified retirement plan in the event of a qualified disaster in 2016, up to $100,000.
Recharacterization of IRA contributions. For tax years beginning after 2017, the current rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA does not apply to a conversion contribution to a Roth IRA. Thus, recharacterization cannot be used to unwind a Roth conversion. However, recharacterization is still permitted with respect to other contributions.
Estate and gift tax. Effective for estates of decedent’s dying and gifts made after 2017 and before 2026, the bill doubles the existing amount of the estate and gift tax (coupled) exemption for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026. Thus, for 2018, it will be $11.2 million per person.
Obamacare. For months beginning after 2018, the bill eliminates the “Roberts tax” that is imposed on a taxpayer that fails to acquire government-mandate health insurance (known as “minimum essential coverage”).
Like-kind exchanges. For exchanges completed after 2017, the bill modifies the provision providing for nonrecognition of gain in the case of like-kind exchanges by limiting its application to real property that is not held primarily for sale.
Domestic Production Activities Deduction (DPAD). The bill repeals the deduction for income attributable to domestic production activities, effective for non-corporate taxpayers, ag and horticultural cooperatives, and corporations for tax years beginning after 2017.
The following provisions in the current Tax Code remain unchanged:
- Credit for the elderly and permanently disabled
- Credit for plug-in electric drive motor vehicles
- The American Opportunity Tax Credit
- The Lifetime Learning Credit
- Deduction for student loan interest
- Deduction for qualified tuition and related expenses
- Exclusion for qualified tuition reductions
- Exclusion for interest on United States savings bonds used for higher education expenses
- Exclusion for educational assistance programs
- Deduction and exclusions for contributions to medical savings accounts
- Deduction for certain expenses of school teachers
- Employer-provided housing
- Gain on sale of principal residence
- Exclusion for dependent care assistance programs
- Exclusion for adoption assistance programs
- Minimum age for allowable in-service distributions from an IRA
- Rules governing hardship distributions from an IRA
- Employer-provided child care credit
- Credit for portion of employer social security taxes paid with respect to employee tips
- Credit for electricity produced from certain renewable resources
- Energy investment tax credit
- Extension and phaseout of residential energy efficient property credit
- Credit for producing oil and gas from marginal wells
- Cost basis of specified securities determined without regard to identification
The conference committee bill is a fairly good blend of the House and Senate bills. Whether the bill will benefit a particular taxpayer is highly dependent on the taxpayer’s facts. But, clearly, many taxpayers and businesses will benefit. Personally, if the bill passes the House and Senate and becomes law, I will be making 2018 charitable contributions before the end of 2017, pre-paying the last quarter of 2017 estimated taxes that would normally be paid in January of 2018 and pre-paying the last half of the 2017 real property taxes that aren’t due until sometime in 2018. That technique will likely then be employed on an every-other-year basis.
What’s your strategy? Attend (either in-person or online) on January 10 and learn what the planning options are. Here's the registration link for the event that is co-sponsored by the Kansas Society of CPAs and the Iowa State Bar Association: http://washburnlaw.edu/employers/cle/taxlandscape.html. See you then.