House Republican taxwriters presented their long-awaited tax reform plan November 2, giving the first detailed look at the GOP’s priorities after months of outlines and statements of principles.
The Tax Cuts and Jobs Act of 2017 (H.R. 1) would lower the corporate income tax rate to 20 percent. It also would cap the tax rate on business income earned by owners and shareholders of some passthrough entities at 25 percent and adopt a territorial system of international taxation, among many other changes.
House Ways and Means Committee Chair Kevin Brady, R-Texas, said his committee expects to mark up the legislation November 6. The legislation would meet the fiscal 2018 budget requirement by losing approximately $1.48 trillion in revenue over the next decade, according to an estimate released by the Joint Committee on Taxation, $200 billion less than the budget allows. Nothing in the bill would make changes to the tax provisions of the Affordable Care Act, Brady said.
On the individual side, the GOP tax plan would establish five income tax brackets to replace the current seven: 0 percent, 12 percent, 25 percent, 35 percent, and 39.6 percent. The zero bracket would apply to individuals making up to $12,000 and married couples making up to $24,000; the 12 percent bracket would be for individuals making up to $45,000 and couples making up to $90,000; the 25 percent bracket would cover individuals making up to $200,000 and couples making up to $260,000; while the 35 percent bracket would apply to individuals making up to $500,000 and couples making up to $1,000,000. The top 39.6 percent bracket stays the same, applying to individuals making over $500,000 and couples making over $1,000,000.
“We expect families, starting January 1, to be able to adjust their withholding so they see tax relief immediately,” Brady said.
The bill would allow those living in high-tax states to deduct up to $10,000 in state and local property taxes, while homeowners would be able to deduct interest on new mortgages of up to $500,000. The interest deductibility on existing mortgages would be unaffected. “We know the average property tax deduction across America is $5,000, so $10,000 reaches deep into those high-tax states,” Brady said.
Education benefits would be streamlined into a few college savings vehicles, and a new family tax credit would expand the child tax credit to $1,600 and allow a new $300 credit for parents and college-age dependents. Even though all personal exemptions would be eliminated, the new family credits combined with the $24,000 standard deduction would provide tax relief, Brady said.
Republicans plan to keep the earned income tax credit and the deduction for charitable contributions, but the cap on the deduction would be raised to 60 percent of an individual’s income. The alternative minimum tax would be permanently repealed, and the estate tax would be phased out over six years. The generation skipping transfer tax also would be eliminated.
During the phaseout, the amount of the exemption from the estate tax would be doubled, with fully stepped-up basis. Brady estimated that estate tax repeal would create 140,000 new American jobs.
Republicans left unchanged section 401(k) and individual retirement plans, except for harmonizing the age at which distributions would be allowed at 59 years old.
On the business side, businesses of all sizes would be able to immediately write off their investments for five years, except real estate businesses and regulated utilities would only be allowed to deduct interest expenses and not participate in the expensing. The legislation would allow businesses with gross receipts of up to $25 million to maintain the current interest deductibility.
The expensing provisions would be retroactive to September 27, 2017 — the date of the release of the unified GOP tax reform framework.
The research credit and the low-income housing tax credit would continue under the GOP plan, while it would prohibit tax-exempt entities from accumulating excess cash from operations unrelated to their purpose.
For businesses with profits held overseas, the bill would allow a deemed repatriation tax rate of 5 percent for brick-and-mortar businesses and 12 percent for cash and cash equivalents.
The bill also would institute a “high return trigger” of 10 percent to ensure that businesses operating worldwide are not hiding their profits in tax havens. Brady said Republicans want feedback on their international tax provisions, which he said mesh traditional ideas with new approaches.
The lower passthrough business rate of 25 percent would be available through two options that Republicans believe will distinguish between wage and ownership income. One option would allow small businesses to classify 70 percent of income as wage income and 30 percent as business income. A second option would be the application of a formula to determine capital percentage of more than 30 percent based on rate of return multiplied by the capital investments of the business. Electing the second option would be binding for five years and is expected to be used by owner-operators that make capital investments, including personal service firms such as physicians, engineers, or architects.
“What we’re trying to do is drive tax relief to the local job creators that this is designed to help the most,” Brady said.
Ways and Means member Kenny Marchant, R-Texas, offered insight into how the passthrough income rate would be administered, describing the 70-30 split as a “no-brainer” approach and an “industry safe harbor.” Marchant told Tax Analysts he expects many businesses would choose the second option to potentially receive a better split between personal and passthrough income.
“A lot of businesses are going to go the other route and do the computation of assets. If you’re a passive investor and you’re not active in the day-to-day business, you're going to pay the passthrough rate,” he said November 2. “But if you’re an active manager — and in most small businesses the predominant employee is the owner-operator or the family members — they’re the ones that are going to have to do this computation, and clearly whatever their salary is is going to be paid at the personal rate.”
Marchant noted that passthrough businesses that choose the capital option “are going to need accountants and lawyers.” He added that businesses heavily invested in capital would be most likely to benefit from the option, and suggested that “a cottage industry” would surface as a result of the passthrough policy, aimed at “coaching companies how to organize themselves to minimize their liability.”
As an example, Marchant said that “if you ran through the capital computation, the split was more like 85 percent passthrough income, 15 percent at wage.” But he said that “we could never afford” including all passthrough businesses under the 25 percent rate.
Marchant explained that professional service businesses could take advantage of the capital option to determine what income is subject to the passthrough income rate, but doing so would be increasingly difficult under the proposed new rules, he said. “[If] a bunch of lawyers rent an office building and their biggest investment is a copy machine or computers, it’s going to be harder,” Marchant said. “They can probably do it, but there’s a whole class of people that are upset they probably won’t be able to” take advantage of the lower passthrough business income tax rate.
Ways and Means member Patrick Meehan, R-Pa., told reporters that the language included with the reduced tax rate for passthrough business income should prevent certain individuals from avoiding higher individual tax rates on their income.
“The objective here is to allow small businesses to appreciate that there is commitment to their business, and a part of it is the salary associated with their labor — to create a fair identification of that,” Meehan explained. For professional services, “we don’t want to be able to take somebody like a lawyer that may be in the 39 percent tax bracket, and then use an LLC to create the suggestion that somehow they’re a small business person,” he said.
State and Local Tax Deduction Issue Persists
Several House Republicans concerned about the elimination of the deduction for state and local income taxes continue to oppose the tax bill. Rep. Peter T. King, R-N.Y., told Tax Analysts that he dislikes the compromise to allow a deduction of up to $10,000 for state and local property taxes.
“It’s not enough; I was not a part of the compromise,” King said. “I didn’t agree to it, and property taxes are far more than $10,000 in probably every part of my district. I don’t know of anyone who only has $10,000 in property taxes. And the state income taxes are a major issue. So, it’s not enough.”
The property value deduction cap, combined with a cap on the mortgage interest deduction on new mortgages of up to $500,000 “is certainly not going to help” households in his district, King said.
King offered a proposal to retain the full deductibility of state and local property taxes but cap the state and local income portion of the deduction for households earning above a certain threshold. “One of our proposals to leadership was that property tax [deduction be] maintained for everybody, and the state income tax [deduction] would be for a number of years, and then cap it for those making over $400,000,” King said.
Rep. Lee M. Zeldin, R-N.Y., said he harbors enough concerns about the loss of the state and local tax deduction that he would vote against the bill in its current form. “Adding back in the property tax deduction up to $10,000 is progress, but not enough progress,” he said in a statement.
House Ways and Means member Brian Higgins, D-N.Y., said he hopes that more Republicans representing high-tax states such as New York and California will vote with Democrats against the bill. “I hope there are enough responsible Republicans to categorically reject this plan,” Higgins said. “My hope is that they will stand up as Peter King has done and clearly just say this is a nonstarter, this is unacceptable.”
Meehan said he was less worried about the cap on the ability to deduct state and local property taxes, arguing that the combination of provisions like the expanded child tax credit, the almost-doubled standard deduction, and the reduction in individual tax rates would leave families better off than preservation of the full state and local tax deduction would.
“I think that it’s going to give a good number of people the kind of support, in combination with other important things like the child tax credit — the fact that the simple rates are reduced so taxpayers in certain income streams will get relief upfront, that’s not insignificant,” Meehan said.
He added that many districts would still benefit from the capped state and local property tax deduction, and the overall compromise is “a pretty reasonable resolution.”
On the issue of capping the mortgage interest deduction on new home purchases at $500,000, Meehan predicted that the value of the neighborhoods would outweigh the tax consequences. “My experience is that people are moving into neighborhoods like that for the school system, the size of the homes, and the beauty of the neighborhoods,” he said.
Temporary Corporate Rate Cut Rejected
House Republican taxwriters finalized plans the evening of November 1 to make the corporate rate cut permanent, Marchant said. Delaying the repeal of the estate tax for six years was “a major component” of making the corporate cut permanent, he said. Ending the new $300 supplemental credits that are proposed expansions of the child tax credit after five years helped as well, Marchant said.
Republican lawmakers are confident that a future Congress will extend those provisions anyway, and merely offering them for five years aids taxpayers, Marchant said when asked about potential blowback from ending them. “They haven’t been on the books before,” he said.
Ending immediate business expensing after five years along with the delayed estate tax repeal and the five-year sunset of the $300 credits also contributed to House GOP taxwriters being able to make the corporate rate cut permanent, said Rep. Tom Reed, R-N.Y., a member of the House Ways and Means Committee.
“They were all part of that Rubik’s cube that at the end of the day . . . made the best combination that we could come up with to get the benefit of permanency of the rate,” Reed said.
House Speaker Paul D. Ryan, R-Wis., said he has more confidence in tax reform’s passage because the House, Senate, and White House worked together on the unified tax reform framework.
“What we did in the healthcare bill is that the House passed its bill, the president supported it, and the Senate kind of went in a different direction,” Ryan said on CNN. “What we really labored to do this time around on tax reform is get the three of us working all year long on this project.”
Democrats “will fight this bill tooth and nail,” Senate Minority Leader Charles E. Schumer, D-N.Y., said during a November 2 press conference. Republicans are “ashamed of this bill” and afraid of public scrutiny, he said. “In short, the bill is a like a fish: If it stays out in the sunlight too long, it stinks.”
Democrats will play the same role they did during Republican attempts to repeal and replace the Affordable Care Act, Schumer added. “Let the public know about the bill,“ he said. “They won’t like it, and as a result [Republicans] won’t get enough votes to pass it.”
House Minority Leader Nancy Pelosi, D-Calif., told reporters that Democrats want “real bipartisan tax reform,” and that the Republicans’ bill targets certain states such as California by removing “over $100 billion of possible tax deductions . . . for a state.”
House Ways and Means member Judy Chu, D-Calif., said eliminating the state and local tax deduction would result in “double-taxing middle-class families.”
In the Senate there is bipartisan interest in developing a tax bill among Finance Committee Democrats and Republicans, but leadership has prevented those talks from occurring, Senate Finance Committee member Benjamin L. Cardin, D-Md., told Tax Analysts.
“I’ve had lots of conversations with Republicans who I think would acknowledge that this is not the way tax reform should be done,” Cardin said. “I’ve talked to many Republicans on the committee . . . and I’ve checked in with them on a regular basis about working together. I think we could work together and do some good things, but they’re not permitted to do that. It’s not that they don’t want to — they’re not permitted to.”
Cardin also said the expected schedule for the Senate to move a bill about a week behind the House leaves “no chance for any analytical process through this.”
“I am not aware of any Democrat that’s been in the room as they’re talking about their bill, and if it’s released next Thursday and they want to mark it up the following week, that doesn’t give us any time to negotiate or understand,” Cardin said. “We’ve been shut out.”
Cardin added that he is unimpressed by the House Republican tax bill. “It is . . . more disturbing than the original outline because it looks like it will drive a bigger hole in the deficit,” he said.
When he spoke, Cardin had yet to review the bill in detail, but said he was concerned about several provisions he had glanced over, and feared there would be more concerns as he read through legislative text. “I can start a list," he said, naming the limitation on state and local tax deductions, removing deductions for medical expenses, and eliminating the housing and historic tax credits. "The attack on middle-income families by how they get rid of the dependent and personal exemptions for larger families — I mean, there’s a whole host of issues that are going to have very negative consequences,” Cardin said.
Cardin complained that the bill provides several permanent tax changes for corporations, but leaves many changes on the individual side temporary.
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