United States: U.S. Tax Reform Bill Passes Both Houses; Awaits President's Signature

 On December 20, 2017, both the House and the Senate passed H.R. 1 (the "Bill"),1 which President Trump is expected to sign by January 3, 2018.2 The Bill dramatically alters the U.S. approach to domestic and international taxation. It represents the results of a conference agreement between the House and Senate reconciling the version passed by the House on November 16, 2017, and the version passed by the Senate on December 2. For most provisions, the final legislation follows the approach of either the House or Senate version of the Bill, but in some places the Bill adds something new.

The following is a brief summary of the key provisions in the Bill in the individual, business, and international spaces.

Individual Tax3

  • The number of tax brackets remains the same at seven, but the rates applicable to each bracket are: 10%, 12%, 22%, 24%, 32%, 35%, and 37% (as opposed to 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% under current law).
  • The standard deduction is increased to $24,000 (married filing jointly), $18,000 (head-of-household), and $12,000 (single). These amounts represent an increase over current law, which provides for a standard deduction of $12,700 (married filing jointly), $9,350 (head-of-household) and $6,350 (single).
  • Gives non-corporate taxpayers a deduction from gross income equal to 20% of domestic "qualified business income" ("QBI") from a partnership, S corporation, sole proprietorship, estate, or trust. The deduction therefore reduces the maximum tax rate on such income to 29.6%.4 The deduction is also available for ordinary dividends from a real estate investment trust ("REIT") and qualified income earned through a publicly traded partnership (e.g., a master limited partnership or "MLP").5 For income earned from a partnership, S corporation, sole proprietorship, estate, or trust the deduction equals 20% of the QBI amounts for each qualified trade or business carried on by the taxpayer. The 20% of QBI deduction is limited to the greater of (i) 50% of the taxpayer's share of W-2 wages paid with respect to the qualified trade or business or (ii) the sum of 25% of the W-2 wages and 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property.6 QBI does not include income from "specified services" trades or businesses including health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or which involves the performance of services that consist of investing and investment management, or trading or dealing in securities, partnership interests, or commodities. Architecture and engineering, however, are not treated as specified services and, therefore, are eligible for the deduction. The deduction for the taxable year is the lesser of (i) the sum of the deductible amounts for each qualified trade or business carried on by the taxpayer and 20% of the taxpayer's qualified REIT dividends and qualified publicly traded partnership income or (ii) 20% of the taxpayer's ordinary income less net capital gain.7 The wage or wage and capital limit and the specified services exclusion do not apply to taxpayers with annual taxable incomes under certain threshold amounts ($315,000 for joint filers and $157,500 for single filers) subject to scale back as taxable income increases (to $415,000 for joint filers and $207,500 for single filers). The deduction is available to itemizers and non-itemizers.
  • Disallows excess business losses of a taxpayer other than a corporation. For this purpose, "excess business loss" generally means the excess (if any) of the aggregate deductions attributable to trades or businesses of the taxpayer (determined without regard to the limitation in this provision) over the sum of aggregate gross income or gain attributable to such trades or businesses plus a threshold amount ($250,000 or twice the amount in the case of a joint return). Such losses are carried forward and treated as part of the taxpayer's net operating loss ("NOL") carryforward in subsequent taxable years as determined under the NOL rules provided in the Bill.
  • Repeals the so-called "Pease limitation," which generally limits itemized deductions for high-income taxpayers.
  • Reduces the amount of home mortgage indebtedness on which interests payments are deductible. Under current law, taxpayers may deduct interest on up to $1,000,000 in acquisition indebtedness. The acquisition indebtedness for which interest deductions are allowed will be reduced to $750,000 for taxable years beginning after December 31, 2017, and beginning before January 1, 2026 ($375,000 in the case of married taxpayers filing separately). In the case of acquisition indebtedness incurred before December 15, 2017, this limitation is $1,000,000 ($500,000 in the case of married taxpayers filing separately). Additionally, the deduction for interest on home equity indebtedness is suspended.
  • Doubles the child tax credit from $1,000 to $2,000 per qualifying child and provides for a $500 nonrefundable credit for qualifying dependents other than qualifying children.
  • Limits the itemized deduction for state and local taxes to up to $10,000 for the aggregate of (i) state and local property taxes and (ii) state and local income taxes (or sales taxes in lieu of income taxes). The Bill prohibits individuals from prepaying state and local income taxes for taxable years after December 31, 2017, and receiving a deduction for such prepayments in 2017.
  • Limits gambling deductions to the extent of gambling winnings. Under current law, gambling losses are limited to gambling winnings, but other expenses connected to gambling (when conducted as a trade or business) are not so limited.
  • Increases the limitation on charitable contributions to 60% of adjusted gross income (up from 50% under current law).
  • Repeals deductions for any expenses that would currently be subject to the "miscellaneous itemized deduction" 2% floor, including deductions for expenses paid or incurred for the production or collection of income and unreimbursed expenses attributable to the trade or business of being an employee.
  • Preserves the itemized deduction for unreimbursed medical expenses, but only to the extent such expenses exceed 7.5% of adjusted taxable income for taxable years beginning after December 31, 2016, and ending before January 1, 2019.
  • For taxable years beginning after December 31, 2018, repeals deductions for alimony and separate maintenance payments to the payor and excludes such amounts from income for the payee.
  • Repeals deduction for moving expenses.
  • Increases the exemption from estate and gift taxes from $5 million to $10 million.
  • Preserves the individual alternative minimum tax ("AMT") but increases both the exemption amount and the exemption amount phase-out thresholds.
  • Eliminates the "individual mandate" under the Affordable Care Act for health coverage status of months beginning after December 31, 2018.

Footnotes



 1 The Bill is entitled "An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018." It was originally known as the "Tax Cuts and Jobs Act," but that title was dropped on a point of order in the Senate.

2 The text of the Bill, the Conference Report for the Bill, our Client Alerts on the Bill's prior versions, and other tax reform resources are available on our tax reform website, at http://www.mofotaxreform.com.

3 Generally, most individual provisions in the Bill are effective for taxable years beginning after December 31, 2017. The Bill generally provides that provisions applicable to individuals expire on December 31, 2025. After that date, all affected provisions revert back to their form under current law.

4 Taking into account the new 37% maximum individual rate.

5 Dividends paid by a regulated investment company (e.g., a mutual fund or closed end fund) are not eligible for the 20% deduction. Also, there is no provision in the Bill for a regulated investment company to pass through the deduction to its shareholders.

6 Qualified property means tangible property of a character subject to depreciation that is held by, and available for use in, the qualified trade or business at the close of the taxable year and that is used in the production of QBI. The unadjusted basis is essentially original cost, but an asset is not counted beyond the earlier of (i) ten years after acquisition or (ii) the end of its useful life for depreciation purposes.

7 There is also a deduction for certain cooperative dividends. Thus, certain agricultural and horticultural cooperatives are entitled to a 20% deduction after accounting for dividends to members and subject to the wage and wage and capital limits described above.

To read the full article please click here.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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