Monday, December 4, 2017
My post of November 20, 2017, compared the House and Senate proposed tax bills. At that time the House had passed its bill, but the Senate was still working its way through a different piece of tax legislation. Now, with numerous last-minute amendments, the Senate has approved (51-49) a tax bill that sets the stage for the Conference Committee to work out the differences and produce a final bill for the President’s signature. In reality, the final Senate version is not much different from the version I wrote about on November 20, but there were some last-minute amendments (primarily offered as revenue-related provisions) that were included in the bill that make the final version a bit different.
Or is there a process that will short-circuit working out the differences between the two bills?
Today’s post examines the final version of the Senate bill as approved on December 2, 2017. The reader can refer to my November 20 post for a look at the House bill. That post is accessible here: http://lawprofessors.typepad.com/agriculturallaw/2017/11/comparison-of-the-house-and-senate-tax-bills-implications-for-agriculture.html
For readers interested in learning more and getting continuing education in the process, on Dec. 14 I will be covering the tax rules that are in place at that time at a live seminar from Pittsburg State University. That seminar will also be live simulcast over the web. You can register for that seminar/webinar here: https://www.agmanager.info/events/kansas-income-tax-institute On January 10, 2018, I will be conducting a seminar/webinar on the new tax law (if we have one) which will include insight into planning issues related to the changes in the Code. Prof. Lori McMillan of Washburn Law will be on the program with me. That seminar/webinar will be live from the law school in Topeka, Kansas. The event is sponsored by Washburn University School of Law and the Kansas State University Department of Ag Econ and the Kansas Society of CPAs. Be watching this blog and my website – www.washburnlaw.edu/waltr for further information about registration.
Now, the key provisions in the Senate tax bill – The Tax Cuts and Jobs Act.
Major Individual Income Tax Provisions
Rate brackets. The Senate bill retains the existing structure of seven brackets, but changes the bracket margins and rates. For 2017, the percentage rates are 10, 15 (up to $77,400 mfj), 25, 28, 33, 35 and 39.6 percent. Under the Senate bill, for tax years 2018 through 2025, the rates would be 10, 12, 22, 24, 32, 35 and 38.5 percent. The compressed bracket rates remain for estates and trusts, with the top rate of 38.5 percent applying at income above $12,500. The brackets would be adjusted for inflation for tax years beginning after 2018.
Standard deduction/personal exemption. The Senate bill also nearly doubles the standard deduction by taking it to $24,000 for a married couple filing jointly. Along with this, the bill eliminates the personal exemption (presently $4,050) that a taxpayer can claim for themselves, spouse and dependents, but retains the additional standard deduction for the aged or blind. Thus, a taxpayer would itemize deductions only if itemized deductions exceed the standard deduction.
Note: The reduction in marginal rates (depending on a taxpayer’s income level) increases the after-tax cost of charitable donations which, for some taxpayers, will reduce the incentive to make charitable donations. When this is combined with elimination of many itemized deductions and the near doubling of the standard exemption, the impact on charitable giving is magnified. Presently, it is estimated that over 80 percent of total charitable giving is from taxpayers that itemize deductions, with this group giving approximately $240 billion annually. A negative impact on charitable would also likely result from the elimination or a reduction in the impact of the federal estate tax on high wealth taxpayers. For some taxpayers, making extra charitable donations by the end of 2017 may be a good tax planning move.
Itemized deductions. For tax years beginning after 2017 and before 2026, the Senate bill eliminates the allowance of miscellaneous itemized deductions that, in the aggregate, exceed two percent of the taxpayer’s AGI. In addition, the overall limitation on itemized deductions does not apply to tax years beginning after 2017 and before 2025.
Other deductions. The bill eliminates most deductions, including the deduction for state and local taxes. However, the bill was amended at the last minute to allow an itemized deduction of up to $10,000 in property taxes. Other deduction provisions include:
- Mortgage interest deduction is allowed up to $1 million, but interest on home equity loans would not be deductible for tax years beginning after December 31, 2017 and before January 1, 2026.
- The existing $250 deduction for certain expenses of schoolteachers is increased to $500 for tax years beginning after 2017 and before 2026.
- In addition, the bill allows all taxpayers an itemized deduction for medical (and dental) expenses exceeding 7.5 percent of a taxpayer’s AGI for tax years beginning after 2016 and ending before 2019. The bill also applies the 7.5 percent threshold for tax years 2013 through 2016 for a taxpayer (or spouse) that has attained age 65 by the end of the tax year.
- As for charitable contributions, the total amount that can be deducted in a tax year beginning after 2017 and before 2026 is limited to 60 percent (up from 50 percent) of the taxpayer’s contribution base. A five-year carryover applies to amounts not deductible due to the percentage limitation.
- The existing deduction for qualified moving expenses is suspended for tax years 2018 through 2025, except such expenses incurred by active duty members of the military that move pursuant to a military order and the move is incident to a permanent change of station. R.C. §217 is similarly conformed.
Exclusion of gain on sale of personal residence. The Senate bill increases the time that a taxpayer must own and use a home as their principal residence to be able to exclude a portion (or all) of the gain on sale. Under the modified provision, for a taxpayer to exclude up to $500,000 of gain (MFJ) on sale or exchange of the residence, the taxpayer must own the residence and use it as the taxpayer’s principal residence for five-out-of-eight years. The provision applies for sales or exchanges occurring after 2017 and before 2026. However, the five-out-of-eight-year rule does not apply to any sale or exchange for which there was a written binding contract in effect before 2018.
Credits. The Senate bill doubles the child tax credit, setting it at $2,000 per child under age 18 (rather than the current under age 17 limit) through 2024. The $2,000 amount of the credit reverts to $1,000 after 2025. In addition, the enhanced amount of the credit is not refundable. Thus, for lower income families that don’t have a filing requirement (which is more likely to be the case with the doubling of the standard deduction), the enhanced child tax credit will be of no effect. Also, the credit doesn’t begin to phase-out until AGI reaches $500,000 (MFJ).
Taxpayers with dependents that don’t qualify for the child tax credit but do meet certain requirements are eligible for an additional $500 (nonrefundable) credit for each such dependent.
Casualty and theft losses. For tax years beginning after 2017 and before 2026, personal casualty and theft losses are only deductible to the extent they are attributable to a Presidentially-declared disaster. However, this rule does not apply to any net operating loss carried over to a tax year beginning after 2017 and before 2026 from a tax year beginning before 2018.
Alternative Minimum Tax (AMT). The Senate bill retains the AMT. For tax years beginning after 2017 and before 2026, the exemption (MFJ) is increased to $109,400 (from $78,750) and to $70,300 from $50,600 (single).
Estate tax. The Senate bill doubles the base amount of the applicable exclusion to $10 million, with the exclusion remaining adjusted for inflation for decedents dying and gifts made in 2018 through 2025. Thus, the applicable exclusion will be $11.2 million per person in 2018. Stepped-up basis is retained, as is the gift tax and the existing rules for portability of the unused exclusion at the death of the first spouse.
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 Senate 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 38.5 percent on all excess amounts. This provision is applicable for tax years 2018 through 2025.
Like-kind exchanges. The Senate bill eliminates like-kind exchanges for personal property exchanges, but retains the existing rules for real property exchanges. An interest in a partnership that has elected to be excluded from subchapter K is treated as an interest in each of the partnership’s assets and not as an interest in the partnership.
Fringe benefits. The Senate bill leaves unchanged the taxation to the individual taxpayer with respect to fringe benefits.
Obamacare. The Senate bill repeals the “Roberts Tax” by eliminating the mandate that a taxpayer acquire government-approved health insurance.
Corporate rate. The Senate bill repeals the existing rate structure for C corporations and replaces it with a flat 20 percent rate for tax years beginning after 2018. Thus, the 15 percent bracket on the first $50,000 of corporate income is eliminated. This amounts to a tax increase (as compared to current law through 2018) for corporations with $75,000 of taxable income and less. For example, under current law the tax owed on $75,000 of corporate taxable income is $13,750 while the tax liability under the new law would be $15,000.
AMT. The corporate AMT is retained at a 20 percent rate with an exemption of $40,000.
Pass-through entities. The Senate bill establishes a deduction to be applied against the lesser of a pass-through entity owner’s qualified business income (limited to 50 percent of W-2 wages subject to FICA) or 23 percent of the owner’s taxable income less net capital gain for the tax year. Qualified business income does not include any amount of reasonable compensation the owner receives from the pass-through entity, and also does not include the amount of any guaranteed payment. Those amounts are not entitled to the deduction and are taxed at ordinary income rates. To prevent a pass-through owner from recharacterizing wage income as the owner’s share of business profit, the deduction is limited to one-half of the Form W-2 wages paid by the pass-through entity or the entity’s share of the pass-through income passed through to the owner. However, this limitation only applies if the owner’s taxable income exceeds $500,000 (mfj). The taxable income limit is adjusted for inflation for tax years beginning after 2018.
Note: An owner of a pass-through service business is eligible for the deduction if taxable income is under $500,000 (mfj). However, the deduction is not available on the first $500,000 if the provision has been fully phased-out. Also, when determining alternative minimum taxable income, “qualified business income” is determined without regard to any adjustments under I.R.C. §§56-59.
Cooperatives. An agricultural or horticultural cooperative that is subject to part I of Subchapter T and is engaged in manufacturing, growing, producing or extracting any agricultural or horticultural product, or is engaged in the marketing of agricultural or horticultural products that its patrons have manufactured, produced, grown or extracted, or provides supplies to farmers or other similar cooperatives, can claim a deduction equal to the lesser of 23 percent of the cooperative’s taxable income for the tax year or 50 percent of the cooperative’s W-2 wages related to the cooperative’s trade or business. This provision, however is only available for tax years beginning after 2018 and before 2026.
Cost recovery. The Senate 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. 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. The bill also increases the maximum base amount deductible under I.R.C. §179 to $1,000,000 and the beginning of the phase-out to $2,500,000 of qualified property placed in service. Both amounts remain subject to inflation adjustments. In addition, qualified property for purposes of I.R.C. §179 includes I.R.C. §1245 property or, by election, certain qualified real property.
“Luxury” automobiles. Under §280F, passenger automobiles, trucks and vans are subject to special annual depreciation limits, known as luxury auto limits. Under the Senate bill, the first-year depreciation for certain automobiles is increased to $10,000, with subsequent years set at $16,000, $9,600, and then $5,760. Computer equipment is removed from the definition of “listed” property.
Farm property. The five-year MACRS rule that was in effect for machinery and equipment used in a farming business and placed in service in 2009 is restored for such property placed in service after 2017. In addition, the use of the 150 percent declining balance method for farm property is repealed for such property placed in service after 2017 in tax years ending after 2017. Thus, farm property, except for farm buildings and land improvements, will be eligible for the 200 percent declining balance method.
Real estate. The bill changes the applicable depreciable recovery period for residential rental property from 27.5 years to 25 years, and changes the applicable depreciable recovery period for nonresidential real property from 39 years to 25 years. Eliminated from the category of “15-year property” are qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property.
Loss limitation. For tax years beginning after 2017 and before 2026, the excess farm loss rule of I.R.C. §461(j) will not apply. In essence, that rule limits the deductibility of farm losses exceeding the greater of $300,000 for a farmer that receives a Commodity Credit Corporation loan. However, the Senate bill includes an overall $500,000 limit on the deductibility of losses from all businesses of the taxpayer.
Cash accounting. For tax years beginning after 2017, a corporation or partnership with average gross receipts for the three taxable years ending with the taxable year preceding the taxable year not exceeding $15 million can use the cash method of accounting (the present limit is $1 million). For family corporations, the limit is $25 million. The $15 million limit applies to farming corporations, except that family farm corporations have a $25 million limit. Both the $15 million and $25 million amounts are adjusted for inflation for tax years beginning after 2018. There remains no limit for S corporations.
Inventories. Small businesses using cash accounting that are not required to use inventories when accounting for income can treat the inventories as a non-incidental material or supply (or whatever categorization the taxpayer uses for their books and records) for tax years beginning after 2017. The “small business” for this purpose is one allowed to use the cash method of accounting under the provision noted above.
Business interest. For tax years beginning after 2017, deductible business interest is limited to business income plus 30 percent of the taxpayer’s adjusted taxable income for the tax year that is not less than zero. Any disallowed amount is treated as paid or accrued in the succeeding tax year. However, businesses entitled to use cash accounting 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)) is not subject to the limitation on the deductibility of interest deduction. In return, such farm businesses that elect out of the interest deductibility limitation 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).
Net operating losses (NOLs). For tax years beginning after 2017, the Senate bill limits net operating losses to the lesser of the aggregate of the NOL carryovers to the tax year plus the NOL carryback to the tax year, or 90 percent of taxable income computed without regard to the NOL allowed for the tax year. The 90 percent amount drops to 80 percent for tax years beginning after 2022. For tax years ending after 2017, NOL carrybacks are disallowed, but an NOL can be carried forward indefinitely. A two-year carryback is allowed for farming NOLs with an election available forgo the two-year carryback.
Fringe benefits. The Senate bill reduces or eliminates the deduction for entertainment expenses presently allowed under I.R.C. §274(a)(1)(A). The 50 percent expense deduction for entertainment expenses is limited to 50 percent of food and beverage expenses. The deduction for corporate-provided meals is limited to 50 percent of such qualified meals. The existing deduction for qualified transportation fringe benefits is eliminated. Expenses associated with the operation of an employer-provided eating facility are disallowed as are associated expenses for food and beverages. All of these provisions are effective for amounts paid or incurred after 2017, except for the provision governing employer-provided meals. That provision is eliminated for amounts paid or incurred after 2025.
Domestic Production Activities Deduction (DPAD). The Senate bill repeals the DPAD for any taxpayer other than a C corporation for tax years beginning after 2017. Thus, the DPAD is eliminated for agricultural and horticultural cooperatives for tax years beginning after 2017. For C corporations, the DPAD is eliminated effective for tax years beginning after 2018.
Family and medical leave. The Senate bill creates a credit for an eligible employer a paid family medical leave credit in an amount equal to 12.5 percent of normal hourly wages paid to a qualifying employee during any period in which the qualifying employee is on family and medical leave (not to exceed 12 weeks). The credit is increased by .25 percentage points for each percentage point by which the rate of payment exceeds 50 percent. Any leave paid by a State or local government or required by State or local law is not taken into account in determining the amount of paid family and medical leave that the employer provides. In other words, if a state or locality mandates a level of family or medical leave, there is no credit.
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.
- The Senate bill expands the qualifying beneficiaries of an electing small business trust, effective January 1, 2018.
- Effective for distributions after the date of enactment, the Senate bill amends I.R.C. §1371 concerning cash distributions after the post-termination transition period when an S corporation converts to a C corporation.
- For tax years beginning after 2017, the Senate bill imposes a tax on excess tax-exempt organization executive compensation.
- For tax years beginning after 2017, Roth IRA contributions would not be able to be recharacterized as traditional IRA contributions.
- For organizations with multiple unrelated trades or businesses, unrelated business taxable income is computed separately for each trade or business activity. Except for a carryover provision, the new rule applies to tax years beginning after 2017.
- The deduction for amounts paid in exchange for college event seating rights is repealed effective for contributions made in tax years beginning after 2017.
- The provision that waives the substantiation requirement for charitable gifts of $250 or more if the donee organization files a return that contains the necessary written acknowledgement substantiation concerning the gift, is eliminated for contributions made in tax years beginning after 2016.
- The current system for the taxation of capital gains remains unchanged.
- Farm income averaging remains unchanged.
- The prohibition on the production of oil and gas from a portion of the Artic National Wildlife Refuge is removed, presumably upon enactment.
Both the House and Senate will now vote to advance their respective bills to the conference committee that will be assembled. While the bills are different, there are many similarities. One possibility is that the House conferees will simply adopt the Senate bill. If that is done, the Senate bill will then be presented to the President for signature.
My view is that the individual provisions will be beneficial to many taxpayers. But, taxpayers residing in states with an income tax that would normally itemize deductions under current law will not likely see a rate reduction, unless their taxable income is between $480,000 and $1 million, and they can no longer be able to deduct state income tax or sales tax. But, as always, the specific taxpayer’s situation will determine how beneficial, if at all, the new tax system will be. On the corporate side, the new changes do pose additional complexity.
It is still possible that the wheels come off of the House and Senate proposals and a bill is not able to be presented to the President this year. However, it no longer looks like that will be the case.