Conference Report for the Tax Cuts and Jobs Act of 2017
Background: The Senate passed the Tax Cuts and Jobs Act of 2017 on December 2 by a vote of 51-49. The conference committee released the conference agreement on December 15.
Floor Situation: The Senate is expected to consider the conference report the week of December 18.
Executive Summary: The conference report would lower individual, small business, and corporate tax rates. It nearly doubles the standard deduction, effectively eliminates Obamacare’s individual mandate, increases the child tax credit, eases the burden of the estate tax, and includes other provisions lowering taxes for individual people and families. For small businesses, the conference report includes a deduction to lower the marginal tax rate applied to pass-through business income. For corporations, the conference report lowers the tax rate to 21 percent, moves to a territorial tax system for international operations, and simplifies the corporate tax code.
CONSIDERATIONS ON THE CONFERENCE REPORT
The tax code was last reformed in 1986. Since then, the tax code has grown in length and complexity; complying with the tax code takes families and businesses 6 billion hours a year, at a cost of $263 billion. The U.S. has the highest corporate tax rate in the developed world, and the international tax system imposes a second layer of tax on a corporation that brings profits back to the U.S. from overseas.
Tax Reform for Individuals
Simplification of Tax Rates
The conference report lowers marginal tax rates and keeps the number of tax brackets at seven. The new tax brackets are 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent.
All tax parameters that are currently indexed to the consumer price index will instead be indexed to chained CPI-U. Chained CPI-U more accurately reflects actual consumer costs because it reflects how consumers can switch to less expensive substitute goods when prices rise. This change is permanent.
Increase in the standard deduction
The conference report would nearly double the standard deduction to $24,000 for joint filers, $18,000 for heads of households, and $12,000 for single filers. These amounts will be indexed for inflation using chained CPI-U. Under current law, people may itemize their deductions or take the standard deduction. The standard deduction for tax year 2017 is $12,700 for joint filers, $9,350 for heads of households, and $6,350 for single filers. JCT estimates that this increase in the standard deduction will result in approximately 95 percent of taxpayers taking the standard deduction, up from the nearly 70 percent who take the standard deduction currently.
Repeal of personal exemptions
The conference report repeals the deduction for personal exemptions. Under current law, taxpayers are allowed to reduce their adjusted gross income for themselves and dependents by a personal exemption of $4,050 in 2017.
Effective repeal of Obamacare’s individual mandate
Beginning in 2014, Obamacare required everyone either to purchase a government-approved health care plan or to pay a tax, known as the individual mandate penalty. In 2017, the amount of the tax is 2.5 percent of income or $695, whichever is greater. The conference report reduces the penalty amount to zero dollars beginning in tax year 2019, effectively repealing Obamacare’s individual mandate tax. The Joint Committee on Taxation estimates that reducing the mandate tax to zero dollars will save $314 billion between 2018 and 2027.
Changes to the medical expense deduction
The conference report preserves the existing deduction for medical expenses. However, the current 10 percent of AGI threshold before a deduction is allowed is reduced to 7.5 percent for 2017 and 2018. Beginning in tax year 2019, the threshold returns to 10 percent.
Increase in Child Tax Credit
The child tax credit is increased to $2,000 from the current $1,000 beginning in 2018. The income level at which the credit begins to be phased out will be $400,000 for joint filers, an increase from the current $110,000. Up to $1,400 of the credit may be refundable, indexed to inflation. In order to receive the refundable portion of the credit, a taxpayer must provide a Social Security number for each qualifying child.
Simplification and reform of deductions and exclusions
The conference report would repeal or modify several tax deductions and exclusions, including the following:
Home mortgage interest deduction. The conference report maintains the mortgage interest deduction for new mortgages up to $750,000 taken in acquiring a home but repeals the deduction for interest with respect to home equity loans.
Tax preparation expenses. The conference report would repeal the deduction for tax preparation expenses.
$10,000 cap on deduction for taxes not paid or accrued in a trade or business. The conference report limits the deduction for state and local taxes to $10,000. The taxes eligible for this deduction are income taxes, sales taxes, or property taxes. There is no limit if the state or local tax was paid or accrued in carrying on a trade or business or with respect to property held for the production of income.
Repeal of overall limitation on itemized deductions. The conference report repeals the limit on itemized deductions. Under current law, the total amount of itemized deductions is limited for taxpayers earning more than: $313,800 for joint filers; $287,650 for heads of household; $261,500 for single filers; or $156,900 for married people filing separately.
Treatment of pass-through business income
Pass-through businesses are S corporations, sole proprietorships, or partnerships. Limited liability companies are organized under state law, but are treated as partnerships for federal tax purposes. These businesses pass their profits directly to their owners without being taxed at the business level. The business owner pays tax on business profit on his or her personal tax returns.
To reduce the tax burden on pass-through business owners, the conference report allows an individual taxpayer to deduct 20 percent of qualified business income. This avoids having separate rates for individual wage income versus pass-through business income, while still providing a lower effective rate to pass-through businesses.
Estate and gift taxes
The conference report would double the exemption amount for the federal estate, gift, and generation-skipping transfer taxes from $5 million to $10 million. The $10 million amount is indexed for inflation occurring after 2011. For 2017, the exemption amount is $5.49 million per person.
529 education savings accounts
The conference report would allow up to $10,000 in annual distributions from a 529 plan for elementary or secondary education. The conference report would also allow a child in utero to be designated as a beneficiary of a 529 education savings account. The conference report defines a child in utero as being a child carried in the womb, regardless of the stage of development.
While the conference report modifies or repeals many deductions and credits, notable provisions that are preserved by this conference report include: charitable contributions; child and dependent care credit; adoption tax credit; earned income tax credit; 401(k) and individual retirement accounts; the blind and elderly’s enhanced standard deduction; and provisions for graduate students.
Under the conference report, most provisions in this title take effect for tax year 2018 and will expire after December 31, 2025. Increased exemption amounts for the individual alternative minimum tax also expires at the same time.
Business Tax Reform
The conference report simplifies the corporate tax code, and makes these changes permanent. Although many provisions of current law are altered, the conference report preserves two notable provisions of current law: the research and development credit; and the low-income housing credit for business investment in low-income housing.
Corporate tax rate reduction
The conference report lowers the corporate income tax rate to 21 percent, effective in tax year 2018. Currently, the top corporate income tax rate is 35 percent, the highest in the Organization for Economic Cooperation and Development.
Cost recovery – expensing and bonus depreciation
A business generally must capitalize the cost of property used in the business, with the recovery of the cost achieved through depreciating the property or by expensing it. The methods can also be used together, expensing part of the cost and depreciating the balance. The conference report includes modifications to current law on both:
Section 179 expensing. This allows businesses to deduct the full cost of a piece of equipment used in a business, rather than depreciating it over many years. The conference report increases the section 179 expensing maximum deduction from $500,000 to $1,000,000. A phase-out begins when the total cost of property placed in service during the year exceeds $2,500,000.
Bonus depreciation. If a business depreciates its property, an additional first year depreciation deduction – or “bonus depreciation” – is allowed under current law through 2019 (or 2020 in certain cases). Under current law, in 2017 the percentage of the property’s cost that can be depreciated in the first year is 50 percent. The percentage decreases in future years until it expires at the end of 2019. The conference report would increase bonus depreciation to 100 percent for property placed in service after September 27, 2017, through 2022 (or 2023 in certain cases).
Net interest limitation
Under current law, interest expenses of a business are generally deductible, subject to certain limits. The conference report would limit this interest to 30 percent of the business’ adjusted taxable income. Businesses with average annual receipts of less than $25 million over the previous three tax years are not subject to this limitation. Businesses subject to the limit could carry forward any interest amounts above this threshold, with no limit to the number of years that the excess interest could be carried forward before it is claimed as a deduction against future income. Certain exceptions are provided for small businesses, real estate businesses, and farming businesses.
Modification of net operating loss deduction
The conference report limits the amount of a net operating loss from a prior year that a business can deduct to 80 percent of the current year’s taxable income.
Like-kind exchanges of real property
Under current law, like-kind exchanges of most types of business property are generally not treated as a taxable event, and any gain is deferred. The conference report limits like-kind exchanges to real property that is not held primarily for sale.
Amortization of research and experimental expenditures
Beginning in 2022 unless certain revenue targets are met, the conference report would require certain research and experimental expenditures to be capitalized and amortized over a five-year period, rather than being deducted in a single year.
Employer credit for paid family and medical leave
The conference report creates a new business tax credit for employers who provide paid family and medical leave to their employees. The credit is 12.5 percent to 25 percent of the wages paid to an employee when on family and medical leave, depending on the percentage of the typical wage paid to the employee.
Repeal of deduction for income attributable to domestic production activities
Current law provides a section 199 deduction for qualified domestic production activities. This has the effect of reducing the corporate tax rate on domestic production activities from 35 percent to less than 32 percent. The conference report repeals this deduction, since the new corporate rate will be 21 percent, and pass-through businesses will benefit from the new deduction for pass-through income.
Limitation on deduction by employers of expenses for fringe benefits
Current law allows a deduction for costs incurred in providing fringe benefit activities that are entertainment, amusement, recreation, or club membership dues, as long as the business establishes that these expenses are related to conducting a trade or business. The conference report would repeal this deduction. Businesses are also permitted to deduct certain transportation benefits and costs of meals provided to employees. The conference report limits these deductions.
Limitation on deduction for FDIC premiums
The conference report limits the ability for financial institutions to deduct the premiums paid to the Federal Deposit Insurance Corporation for deposit insurance. For institutions with less than $10 billion in assets, 100 percent of premiums are deductible. For institutions with more than $50 billion in assets, none of the premiums are deductible. For institutions between these two values, the limitation is phased in.
Craft beverage modernization and tax reform
The conference report includes various provisions lowering the excise taxes on beer, wine, and distilled spirits.
Qualified opportunity zones
The conference report creates a process to designate certain low-income areas as “qualified opportunity zones.” The tax incentives provided to encourage investment in these zones are (1) deferral of tax on capital gains that are reinvested in a qualified opportunity fund, and (2) no tax on the capital gains from investments in these funds, if the investment in the fund is held for at least 10 years.
International Tax Reform
Currently, the United States has a worldwide tax system. Under this system, a corporation headquartered in the U.S. must pay the corporate income tax on all of its income, regardless of whether it is earned in the U.S. or overseas. However, the tax is only due when the foreign earnings are brought back to the U.S. This is known as “deferral,” because the income tax owed can be deferred until a later date when the income is repatriated. When a business chooses to repatriate earnings and pay the U.S. corporate income tax, the law also allows what was paid to a foreign government as a credit against the U.S. tax that the corporation would otherwise have to pay, subject to certain limitations.
In the 1980s, 24 countries in the OECD had a worldwide tax system. The tax rates of most countries were comparable to the U.S. After the Tax Reform Act of 1986 brought the U.S. corporate rate down to 34 percent, the U.S. had a lower rate than most other developed nations. After the U.S. lowered its rate, other countries began to lower their rates and move to a territorial system. Today only seven OECD nations have worldwide tax systems, while 28 have territorial systems. Ireland kept its worldwide system, but lowered rates to 12.5 percent. In contrast, the U.S. has both the highest corporate rate of any OECD country and also a worldwide system.
Territorial tax system
The conference report would move the U.S. to a territorial tax system. It does this by allowing U.S. corporations to deduct 100 percent of the payments they receive from their foreign subsidiaries, provided the U.S. corporation owns at least 10 percent of the foreign corporation. This has the effect of exempting the foreign income from the second layer of U.S. tax that is imposed under the current worldwide system.
The conference report includes deemed repatriation, an approach necessary to make the transition to a territorial tax system. Under the conference report, the accumulated foreign earnings of U.S. corporations are treated as if they were repatriated, and a tax rate of 15.5 percent will be applied to cash or easily liquidated assets. An 8 percent rate will apply to fixed assets, e.g., a factory overseas financed with past overseas profits.
Base erosion rules
The conference report also includes a number of provisions to prevent companies from moving their operations offshore simply to take advantage of the new territorial tax system and to guard against base erosion.
Alternative Minimum Tax
The conference report would increase the exemption amount for the individual AMT; the phase-out thresholds are $1 million for joint filers and $500,000 for all other taxpayers. The individual AMT exemption amounts would expire after December 31, 2025. The conference report would repeal the corporate alternative minimum tax.
Oil and Gas Program
The conference report includes the text of the Senate’s provisions on the 1002 Area in Alaska and a temporary increase in offshore revenue sharing for the Gulf Coast in 2020 and 2021.
The Joint Committee on Taxation estimates that the conference report would reduce revenues by $1.456 trillion from 2018-2027 in static terms, based on a current law baseline.