United States:
House Committee On Ways And Means Releases Tax Reform Proposal
09 November 2017
Shearman & Sterling LLP
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The House Committee on Ways and Means released today its
proposed legislative language (the "House Proposal")
implementing, in large part, the framework for tax reform issued by
the so-called "Big Six" on September 27, 2017. This
client alert summarizes the key income, estate and gift tax
provisions of this proposal.
The House Proposal generally would be effective for taxable
years beginning on or after January 1, 2018. Portions of the House
Proposal may be revised by Chairman Brady over the coming days or
weeks. A Committee hearing on tax reform is scheduled for November
6. The House Proposal faces a number of significant legislative
hurdles prior to being signed into law. We expect to provide a more
detailed analysis of the proposal in a follow-up client alert
in the coming days.
Summary of House
Proposal |
Individuals |
- Reduces number of tax brackets from 7 to 4
- Top tax bracket remains at 39.6%, which applies to adjusted
taxable income of more than $1 million (compared to the current
level of more than $470,700) for married taxpayers filing
jointly
- Roughly doubles the standard deduction from $12,700 per year to
$24,400 per year for married taxpayers filing jointly
- Eliminates personal exemptions
- Eliminates most itemized deductions (including for state and
local income taxes and medical expenses) other than deductions for
mortgage interest (for new loans with a principal amount of
$500,000 compared to the current grandfathered level of
$1,000,000), property tax deductions (although capped at $10,000
per year), and charitable donations
- Repeals the individual alternative minimum tax (AMT)
- Doubles the estate tax exemption starting in 2018 and
eliminates the estate and generation-skipping transfer tax starting
in 2024
- No modification to the current rules that provide a step- up in
tax basis to fair market value for assets owned at death
- Reduces the highest marginal gift tax rate to 35% beginning in
2024 and retains the annual exclusion of $14,000 (indexed for
inflation)
- No modification to 401(k), traditional IRA, or Roth IRA
contribution limits
- No elimination of the 3.8% net investment income tax
- No modification of the reduced tax rate on long-term capital
gains and certain types of investment income
|
Corporations |
- Corporate tax rate is reduced from 35% to a flat 20% (with no
phase-in)
- Repeals the corporate AMT
- NOL usage limited to 90% of taxable income; new NOL
carryforwards increased by interest factor to preserve value;
carrybacks of NOLs eliminated
- Repeals the $1 million deduction limitation for commissions and
performance based compensation
|
Other Business Provisions |
- Limits interest deductions to 30% of earnings before interest,
taxes, depreciation and amortization for businesses with gross
revenues exceeding $25 million (applies to both corporations and
pass-through entities); real estate firms exempt from this limit;
repeals current section 163(j) limitations
- 100% expensing for certain acquired property until January 1,
2023, but excludes real property
- Eliminates the current-law domestic production deduction, but
preserves the research and development credit and the low-income
housing credit
|
Business Income of Individuals (i.e., Special Rate for
Pass- Through Income) |
- Caps at 25% the tax rate applicable to qualified business
income of individuals derived from businesses conducted as sole
proprietorships, partnerships, limited liability companies (taxed
as partnerships) and S corporations
- Passive business activity: Individuals for whom a particular
business is a passive business activity generally are eligible for
the maximum 25% rate with respect to all income from that
business
- Active business activity: Individuals who do not qualify as
"passive" with respect to a business are entitled to
choose either:
-
- Default Option: Categorize 70% of business income as ordinary
income and 30% of business income as qualified business income
eligible for the capped 25% rate
- Alternative Option: Elect to establish ratio of compensation
income to qualified business income based on a deemed rate of
return (AFR plus 7%) on the amount of capital invested; election
binding for 5 years
- Active or passive business activity determination based on
current passive activity loss rules (section 469)
- Certain types of businesses generally are not eligible for the
reduced 25% rate under the "Default Option," including
medical offices, law firms, and accounting firms
("Professional Service Firms"); "Alternative
Option" described above is available to Professional Service
Firms (subject to limitations)
- Self-employment tax: Repeals limited partner exception
- Repeals "technical termination" of partnerships
- No carried interest reform
|
International |
- Partial shift from a worldwide tax system to a
"territorial" tax system
-
- Establishes a new "Participation Exemption System"
that exempts from US tax dividends paid by foreign corporations out
of foreign-source earnings to their 10-percent US
shareholders.
- Repeals the section 956 "deemed dividend" tax on US
shareholders of foreign subsidiaries that invest earnings in US
property
- As a transition measure, the House Proposal imposes a one-time
tax on existing foreign profits held offshore: A 12% tax rate on
accumulated foreign earnings held in cash and cash equivalents and
a 5% tax rate on accumulated foreign earnings held in other
assets
-
- The one-time tax will be payable over 8 years,in equal annual
installments
- Retains subpart F income rules, with certain limited
modifications
- Implements a new minimum tax on 50% of "foreign high
returns," which represent the aggregate income of foreign
subsidiaries that exceeds a return of 7% plus short-term AFR on the
subsidiaries' aggregate basis in depreciable tangible property,
adjusted downward for interest expense
-
- "Foreign high returns" exclude income effectively
connected with a US trade or business, subpart F income, and
insurance and financing income that satisfies the active financing
exemption under subpart F and certain other income
- Limits the foreign tax credit associated with foreign high
returns to 80% of foreign taxes paid
- Foreign taxes paid on "foreign high returns" cannot
be used to offset tax on other foreign-source income, and cannot be
carried forward or carried back
- Limits interest deductions for US corporations that are members
of international groups with gross receipts of more than $100
million to the extent the US corporation's share of global net
interest expense exceeds 110% of its share of the group's
global earnings
- Generally imposes a 20% excise tax on payments (other than
interest) from a US corporation to a related foreign corporation,
subject to certain exceptions
|
Miscellaneous Provisions |
- Restricts section 1031 exchanges to like-kind exchanges of real
property
- Imposes a 1.4% tax on net investment income of university
endowments that have assets of more than $100,000 per full-time
student
|
Additional Commentary
There has been much discussion by GOP leadership in Congress and
the White House on their goal to enact tax reform legislation by
the end of 2017. However, the House Proposal faces a number of
significant obstacles prior to enactment into law.
House Ways and Means Committee Chairman Brady announced this
week that the Committee remains on schedule to take action and
approve a bill during the week beginning November 6. If the House
Ways and Means Committee can agree on legislative text, the
Committee would vote on the bill that would be released to the full
House of Representatives. Chairman Brady has stated that he would
like to have the Committee bill completed and approved by the full
House of Representatives prior to the Thanksgiving holiday
recess.
Senator Patrick Toomey has stated that the Senate Finance
Committee expects to release its tax reform legislation the week of
November 6. In the Senate, a bill can pass with simple majority
through the reconciliation process. Reconciliation allows the bill
to pass with only 50 votes (with Vice President Pence casting a
tie-breaking vote), rather than 60 votes, but is only permitted for
bills that do not add to the deficit beyond a ten-year window after
passage. The budget resolution approved by Congress in October
allows a tax bill that adds as much as $1.5 trillion during the
ten-year window to the federal deficit to pass without 60 votes in
the Senate.
Given potential differences in approach between the Trump
Administration and Congress, the expectation of significant
opposition to certain elements of the House Proposal, and the
complexity of such proposal, the passage of a comprehensive tax
reform bill into law by the end of 2017 will likely face
significant hurdles.
Special thanks to Devon Yamauchi for her contributions to
this client publication.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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