Tax Reform Hits a Critical Juncture

Over the last week, the pace of work in Congress on tax reform has picked up substantially. The House passed the “Tax Cuts and Jobs Act” last Thursday, and the Senate Finance Committee reported out their version of the bill that evening. After this week’s Thanksgiving recess, the full Senate will begin to consider their bill starting next week. Most, but not all, provisions would be effective in 2018.

There are some notable similarities in both bills but also some key differences. On the individual side, the House bill has four permanent tax brackets and a top individual rate of 39.6% while the Senate bill has seven tax brackets, a top rate of 38.5% and these rates expire after 2025 due to budgetary constraints. Both bills eliminate personal exemptions and nearly double standard deductions. Both bills also eliminate the individual alternative minimum tax (AMT). The child tax credit increases to $1,600 per child in the House bill and to $2,000 in the Senate bill. Neither bill eliminates the net investment income (NII) tax or the additional Medicare tax under the Affordable Care Act (ACA), and both retain current tax treatment for qualified dividends, capital gains, and retirement plan contributions.

Other key individual provisions have some significant variations. These include a limited deduction for property taxes in the House bill that is not in the Senate bill, a more restrictive home mortgage interest deduction in the House bill than the Senate bill, a continued deduction for medical expenses and education incentives in the Senate bill that are repealed in the House version, and more. The property tax provision is particularly important to the House to help protect Republican members from high tax states like New York, New Jersey, and California.

The House would double the estate tax exemption and repeal the tax after 2024. The Senate would double the estate tax exemption but not repeal it.

On the business side, both the House and Senate call for a permanent cut in the corporate tax rate to 20%, but the House would start this in 2018, while the Senate waits until 2019. The corporate AMT would be repealed. On pass-through business income, the provisions vary widely as to method and application and exclusions, but importantly, the provisions did make it into both bills, so a compromise is likely. Both bills expand immediate expensing of qualified business assets (bonus depreciation) to 100% for assets placed in service after September 27, 2017 and before January 1, 2023.

Also, both bills eliminate a number of business credits, the domestic production activities deduction (9% of taxable income if qualified), the deduction for most business meals, non-real property like-kind exchanges, limit many taxpayers ability to deduct net interest expense, and provide further limitations on the utilization of net operating loss carryforwards and certain business losses. There are a number of small business and industry-specific provisions in both bills, and each bill takes a different approach to reforming our international tax system. A late Senate change also eliminates the ACA’s individual mandate to have health insurance coverage.

So, given all that, where does this leave us? What is the likelihood of passage, and the timing?

The Senate bill is the key. With the slim 52-48 Republican majority in the Senate, finding something that will pass there is the whole ballgame. And, there are already several Republican senators who have expressed serious reservations, including the individual mandate repeal. Also, as to timing, the next two to three weeks will tell the tale. The Senate will need to add some sort of provision along the lines of the House property tax deduction and may have to nix the ACA individual mandate repeal. These cost tax revenue, though, and will force other uncertain changes to stay within Senate budget rules.

At that point of passage, the House Republican majority has to decide if they will just accept the Senate bill (whatever its final form), figuring they can’t do any better, or go to a conference committee to hash out further compromise. A conference could take a while and push final passage into 2018, if at all.

Meanwhile, the Senate Democrats can use various tactics to slow the Senate bill in anticipation of a possible government shutdown on December 8th and the Alabama Senate election on December 12th, where they may pick up a seat and reduce the Republican majority to 51-49.

Many variables and unknowns remain, but we will stay on top of the latest updates and keep you informed. Stay tuned!

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