Last Friday, December 15, the Conference Report reconciling the House and Senate versions of tax reform was released. Both the House and Senate have passed the legislation. We expect President Trump to sign the bill, though it is unclear whether the signing ceremony will take place in December or in January.
Once there is a signed bill, we will send several detailed alerts analyzing specific provisions and how they will directly impact you and your business. In the meantime, the following highlights the domestic tax provisions. An overview of the international provisions will follow.
Most of the individual provisions are temporary until the end of 2025, in contrast to the corporate provisions, most of which are permanent.
- There will be eight individual brackets, with a top rate of 37% beginning at a taxable income threshold of $600,000 for married filing joint ($500,000 for single) taxpayers. The individual alternative minimum tax (AMT) is NOT repealed. However, the exemption amounts are increased to $109,400 for married filing joint ($70,300 for single) taxpayers and the exemptions phase out at $1,000,000 ($500,000 for singles).
|NOTE: It appears unlikely that many taxpayers will find themselves subject to the AMT, since the deduction for state and local taxes is limited. Additionally, most other itemized deductions are suspended for the next eight years (see below) and since the exemption is significantly increased.|
- The standard deduction is doubled to $24,000 for married filing joint ($12,000 for single) taxpayers. However, personal exemptions and the overall limitation on itemized deductions are suspended for the next eight years.
- The mortgage interest deduction is limited to interest on $750,000 of acquisition indebtedness. The deduction would not be limited to interest on a taxpayer’s principal residence. For tax years beginning after December 31, 2025, the limitation reverts back to $1,000,000 regardless of when the debt was incurred. Existing mortgages remain subject to the current law’s $1 million cap. The conference agreement suspends the mortgage interest deduction with respect to interest on home equity indebtedness for tax years beginning after December 31, 2017 and before January 1, 2026. No provision was included to modify the exclusion of gain from the sale of a principal residence, even though such a provision was included in both the House and Senate bills.
- Through tax years ending December 31, 2025, the state and local tax deduction is limited to $10,000 in property, income or sales tax (any combination at election of taxpayer).
|NOTE: Prepayments of income tax due for taxable years beginning after December 31, 2017 will NOT be deductible on your 2017 tax return but will be treated as paid in 2018. It appears that prepaid real estate taxes MAY be deductible, particularly if the taxing body assesses tax on a fiscal year basis.|
- The deductibility of most miscellaneous itemized deductions subject to the current 2% floor on deductions, including the deduction for business expenses of employees, is suspended for eight years.
|NOTE: Unlike prepayments of income taxes, there does not appear to be a similar disallowance of prepaid miscellaneous itemized deductions.|
- Retains the itemized deduction for medical expenses and lowers the floor to 7.5% of Adjusted Gross Income (AGI) (from 10%) in 2018 and 2019.
- Limits excess business losses in excess of $500,000 for taxpayers other than corporations. Such losses are carried forward and treated as a net operating loss carryforward.
- The deduction for alimony (and the corresponding inclusion of alimony in the income of the receiving spouse) is permanently repealed for any divorce or separation instrument executed after December 31, 2018.
- Increases the estate and gift tax basic exclusion amount (doubled from $5.5 million to $11 million) through December 31, 2025. The estate tax itself is not repealed. Similarly, the bill increases the federal Generation Skipping Tax exemption amount to $10 million (with inflation adjustments), effective for generation-skipping transfers made after 2017 and before 2026.
|NOTE: The Conference bill does not include the Senate bill’s provision requiring the first-in-first-out method of determining cost basis of securities.|
With some exceptions, most of the business tax provisions are permanent.
- The tax rate for taxable corporations is reduced to 21%, effective January 1, 2018, and the Corporate Alternative Minimum Tax is repealed. Prior year Minimum Tax Credits are refundable in an amount equal to 50% (100% for tax years beginning in 2021) of the excess of the credit for the tax year over the amount of the credit allowable for the year against regular tax liability.
- Partners in partnerships, members of LLCs, S corporation shareholders and sole proprietors will be entitled to a deduction of 20% of the qualified income of those businesses. Thus, pass-through income will be taxed at a marginal tax rate of not more than 29.6%. The deduction is limited to either 50% of allocable W-2 wages of the business or the sum of 25% of W-2 wages plus 2.5% of the adjusted basis at acquisition of qualified tangible property. Specified service businesses are excluded, except for income thresholds below $315,000 for Married Filing Joint/ $157,500 single taxpayers.
|NOTE: The second limitation based on the adjusted basis at acquisition of tangible property provides a significant benefit to real estate investors since those businesses typically do not have significant W-2 wages.|
- The Conference agreement allows full cost recovery/expensing of qualified depreciable assets acquired after September 27, 2017 and before January 1, 2023, with a phase-out from 2024 to 2027. The original-use requirement under present law is removed and qualified property is expanded as under the Senate bill to include films, television and live theatrical productions.
|NOTE: The Senate bill had proposed shorter depreciable lives but the Conference agreement retains the 39-year and 27.5-year recovery periods for nonresidential real and residential rental property but allows a 15-year recovery period for qualified improvement property. The agreement eliminates the separate definitions of “qualified leasehold improvement property,” “qualified restaurant property” and “qualified retail improvement property.”|
- Interest expense will be deductible up to 30% of adjusted taxable income, generally following the Senate bill. However, from 2018 to 2021, adjusted taxable income is computed before the deductions for depreciation, amortization or depletion.
|NOTE: Real estate businesses can elect out of the limitation on interest expense deductibility, but they must elect to use the ADS depreciation system. The ADS system is modified. The ADS system is modified. The ADS life for qualified improvement property will be 20 years and residential rental property will us a 30-year ADS life. The ADS life for non-residential property will remain 40 years.|
- Net operating loss (NOL) carryforward deductions will be limited to 80% of taxable income for losses arising in taxable years beginning after December 31, 2017. NOL carrybacks for losses arising in years beginning after December 31, 2017 are repealed. This provision is more restrictive than either the House or Senate bills.
- Section 1031 like-kind exchanges are limited to real property not held for sale in the ordinary course of business.
|NOTE: There is an exception for any exchange if either the property being exchanged or the property received is exchanged or received on or before December 31, 2017.|
Other Significant Business Tax Provisions
There were a number of business tax provisions where there were significant differences between the House and Senate bills, or where one or the other of the houses did not address the topic.
- While the House repealed the technical-termination rules for partnerships, the Senate did not. The House provision is included in the Conference Report.
- The House attempted to deal with carried interests by requiring a three-year holding period for long-term capital gain treatment with respect to carried interests and the Senate echoed the House language. The Conference report includes some clarifying language.
- The Senate bill contained a provision, adopted in Conference, to significantly increase the depreciation limitations for luxury passenger automobiles placed in service after December 31, 2017. The new limits will be $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. The bill provides that the amounts will be indexed for inflation for automobiles placed in service after 2018. Also, computers or peripheral equipment will no longer be considered listed property effective for property placed in service after December 31, 2017.
- The Section 199 Domestic Production Activity Deduction is repealed.
- The Research and Development credit is retained but research expenses which, in the past, were otherwise deductible, must be capitalized and amortized ratably over a five-year period for amounts incurred beginning in 2022.
- The House bill set the limit for using the cash basis of accounting and the completed contract method at average annual revenue of $25 million for the prior three years. The Senate bill was less generous. The Conference agreement follows the House bill.
|NOTE: Since the bill does not address the issue, guidance will have to be provided by the IRS informing taxpayers now eligible for the cash basis and completed contract methods how to make the accounting method change. It is possible this could give rise to a significant one-time deduction if the regulations or other guidance follow the current provisions for similar accounting method changes.|
- The Orphan Drug Credit is retained but the rate is reduced to 25%. Many other credits, which were repealed in the House bill but not mentioned in the Senate bill, are spared from repeal.
- The House bill contained a provision, which the Senate did not address, but which that was adopted in Conference. This would require corporations – but not partnerships or LLCs – to include in income any contribution in aid of construction or any other contribution as a customer or potential customer, and any contribution by a governmental entity or civic group. These were formerly considered non-taxable contributions to capital. The provision is effective for contributions made after the date of enactment.
- Private activity bonds were not repealed but the exemption for income from advance refunding bonds was.
|NOTE: Bonds issued to pay for professional sports stadiums and arenas were spared repeal.|
- The Historic Rehabilitation Tax Credit was retained in part with a transition rule applicable to qualified rehabilitation expenditures for either a historic structure or a pre-1936 building. This is specifically in respect to any building owned or leased by the taxpayer at all times on or after January 1, 2018, through the 24-month period selected by the taxpayer.
- The Low Income Housing Tax Credit appears to be spared, since it was not addressed at all in the Conference agreement.
We will have more detailed analyses in the coming weeks, including the real estate, depreciation, expensing, tax-exempt entities, and international provisions. In the meantime, please feel free to contact your Friedman LLP professional for answers to specific questions.