Individual Provisions Further Update: Tax Reform Moves Forward – Comparison of House and Senate Bills

This is further content in our comparison of the provisions contained in House and Senate tax reform legislation.  As we have noted, while there are many similarities, there are also meaningful differences -- for example, in the individual context, tax rates, the deductibility of state and local property taxes, the taxation of business income of individuals, the treatment of carried interests and the future of the estate tax.  And, the Senate effectively eliminated the Affordable Care Act’s individual mandate, thereby bringing the contentious health care debate into the tax reform dialogue.  How these differences are resolved will shape the legislation in its final form.
 
Some of the following is presented untouched from our previous Alerts. The House and Senate leadership have moved this legislative initiative on an exceedingly fast track, with the expectation that tax legislation can be passed by Congress and sent to the President for signature by Christmas.  The next step in the process is the consideration of the different versions by a conference committee.  If the differences can be resolved quickly and the necessary votes obtained, this aggressive timetable will be met.

EisnerAmper will continue to report on developments as they occur.  What follows are highlights and a comparison of the individual provisions of these two approaches to tax reform.  The business and international provisions are covered in separate Alerts.

Rates

Senate:  For tax years beginning after December 31, 2017, there would be seven brackets – 10%, 12%, 22%, 24%, 32%, 35% and 38.5%.  For married individuals filing jointly, the 38.5% bracket threshold would be $1,000,000. For unmarried individuals it would be $500,000.  Bracket thresholds would be adjusted for inflation using the “chained consumer price index for all-urban consumers” (“C-CPI-U”) in lieu of the “consumer price index for all-urban consumers.” (The result would be that inflation adjustments will be slower.) Present law maximum rates on net capital gain and qualified dividends would generally remain.   The “kiddie tax” would be changed by effectively applying ordinary and capital gains rates applicable to trusts and estates to the net unearned income of a child.  Thus, taxable income attributable to earned income would be taxed according to an unmarried taxpayer’s brackets and rates.  Taxable income attributable to net unearned income would be taxed according to the brackets applicable to trust and estates, with respect to both ordinary income and income taxed at preferential rates.  The child’s tax would no longer be affected by the tax situation of the child’s parents or the unearned income of any sibling.

The new rate structure would apply to taxable years beginning after December 31, 2017.  It would expire after December 31, 2025 and would revert to its form as it existed prior to January 1, 2018, except for the use of the C-CPI-U for inflation indexing.

House:   For tax years beginning after December 31, 2017, the current seven tax brackets would be consolidated into four brackets of 12%, 25%, 35% and 39.6%, also adjusted for inflation using the C-CPI-U.  Present law maximum rates on net capital gain and qualified dividends would generally remain.  The kiddie tax would be modified.

Individual Alternative Minimum Tax (“AMT”)

Senate:   For taxable years beginning after December 31, 2017 and before January 1, 2026, the individual AMT would be retained, with increased exemption amounts and phase-out thresholds.  The repeal would expire after December 31, 2025.  The exemption amounts and phase-out thresholds would be indexed for inflation for any taxable year beginning in a calendar year after 2018.

House:  Repealed.

Standard Deduction and Personal Exemptions

Senate:  Effective for taxable years beginning after December 31, 2017, personal exemptions would be eliminated and consolidated into a larger standard deduction -- $24,000 for married taxpayers filing jointly and $12,000 for single filers.  The additional standard deduction for the elderly and the blind would be retained.  The amount of the standard deduction would be indexed for inflation using the C-CPI-U beginning in taxable years beginning after December 31, 2018.  The increased amount of the standard deduction over current law would expire for taxable years beginning after December 31, 2025, but the use of the C-CPI-U would continue.  The repeal of the deduction for personal exemptions would also expire for taxable years beginning after December 31, 2025, and personal exemptions would revert to their form as existed prior to January 1, 2018.

House:  Personal exemptions would be eliminated, with a standard deduction of $24,400 for married taxpayers filing jointly and $12,200 for single filers, effective for taxable years beginning after December 31, 2017.

Business Income of Individuals

Senate:  Effective for taxable years beginning after December 31, 2017, an individual taxpayer generally may deduct 23% of domestic qualified business income from a partnership, S corporation, or sole proprietorship.  The amount of the deduction would be limited to 50% of the taxpayer’s allocable or pro rata share of W-2 wages of the partnership or S corporation, or 50% of the W-2 wages of the sole proprietorship.  W-2 wages of a partnership, S corporation or sole proprietorship is the sum of wages subject to wage withholding, elective deferrals and deferred compensation paid by the partnership, S corporation or sole proprietorship during the calendar year ending during the taxable year.  Only those wages that are properly allocable to qualified business income would be taken into account.  If the amount of qualified business income for a taxable year is a loss, the amount of the loss would be treated as a loss from qualified businesses in the next taxable year. Qualified business income would not include reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered to the trade or business or any guaranteed payments paid to a partner for services rendered, nor would it include certain investment related income, gain, deductions or loss. Under a special rule, the W-2 wage limit would not apply in the case of a taxpayer with taxable income not exceeding $500,000 for married individuals filing jointly ($250,000 for other individuals).  The application of the W-2 wage limit would be phased-in for individuals with taxable income exceeding this $500,000 ($250,000) amount. 

Income from publicly traded partnerships is specifically included as entitled to this special tax treatment.

The deduction would not apply to specified service businesses, except for a taxpayer with income from a specified service business whose taxable income does not exceed $500,000 (married filing jointly; $250,000 for other taxpayers), subject to phase-out.  A specified service trade or business is any trade or business activity involving the performance of services in certain specified fields, including, for example, health, law, engineering, architecture, accounting, actuarial services, athletics, financial services, brokerage services or any trade or business where the principal asset of that business is the reputation or skill of one or more of its employees.  Specifically included are investing and investment management, trading, or dealing in securities, partnership interests or commodities. 

The deduction would also not apply to the trade or business of performing services as an employee.

House:  Effective for taxable years beginning after December 31, 2017, a portion of net income distributed by a pass-through entity (i.e., sole proprietorship, partnership, limited liability company (“LLC”) taxed as a partnership or S corporation) to an owner or shareholder may be treated as “business income” subject to a maximum rate of 25% instead of ordinary individual income tax rates.  The remaining portion of net business income would be treated as compensation and continue to be subject to ordinary income tax rates.  Rules are provided to determine the proportion of business income and to prevent the recharacterization of actual wages paid as business income.  Net income derived from a passive business activity would be treated as business income and fully eligible for the 25% maximum rate.  Under certain default rules, owners or shareholders receiving net income derived from an active business activity (including wages received) would treat 70% of business income as ordinary income and 30% as business income eligible for the 25% rate; alternatively, such owner or shareholders may elect to apply a specified formula based on the business’s capital investments to determine an allocation greater than 30%.  As noted in the case of the Senate proposal, certain personal services businesses would generally not be eligible for the reduced 25% rate on business income with respect to such personal services business, though they would be allowed to use the alternative formula based on the business’s capital investments, subject to certain limitations.

In addition, the bill would provide a special reduced 9% tax rate for the first $75,000 ($37,500 for an unmarried individual) in net business taxable income of an active owner or shareholder earning less than $150,000 ($75,000 for an unmarried individual) in taxable income through a pass-through business, subject to a phase-out.  Businesses of all types would be eligible for this 9% tax rate.  The 9% rate would be phased in – the rate would be 11% for tax years beginning in 2018 and 2019, and the rate would be 10% for tax years beginning in 2020 and 2021.

Limitation on Losses for Taxpayers Other Than Corporations

Senate:  For taxable years of a taxpayer other than a corporation beginning after December 31, 2017 and before January 1, 2026, active business losses in excess of $500,000 for married individuals filing jointly ($250,000 for other individuals) would not be allowed.  Disallowed losses would be carried forward and treated as part of the taxpayer’s net operating loss (“NOL”) carryforward in subsequent years.  NOL carryforwards would be allowed for a taxable year up to the lesser of the carryover amount or 90% of taxable income determined without regard to the deduction for NOLs.  In the case of a partnership or S corporation, the provision would apply at the partner or shareholder level. 

House:  No provision. 

Child Tax Credit

Senate:  Effective for taxable years beginning after December 31, 2017, the child tax credit would be increased to $2000 per child under the age of 18 (under the age of 17 for taxable years beginning after December 31, 2024 and before January 1, 2026).  There would also be a $500 nonrefundable credit for qualifying dependents other than qualifying children.  The threshold at which the credit would begin to phase out would be increased to $500,000 for married taxpayers filing jointly. The refundable portion of the child credit would be limited to $1,000.  To receive the refundable portion of the credit, a taxpayer must include a Social Security number for each qualifying child for whom the credit is claimed on the tax return. Changes being made would expire for taxable years beginning after December 31, 2025, and the child care credit would then revert back to its form as it existed before January 1, 2018.  

House:  The child tax credit would be increased to $1600 per child under 17; alternatively, a credit of $300 would be allowed with respect to a taxpayer (each spouse in the case of a joint return) who is neither a child nor a non-child dependent.  The refundable portion of the child credit would be limited to $1,000.  The family flexibility credit and the non-child dependent credit would be effective for taxable years beginning before January 1, 2023.

Credit for Adoption Expenses

Senate:  Retained.

House:  Retained.

Deduction for Taxes Not Paid or Accrued in a Trade or Business

Senate:  In the case of an individual, state, local and foreign property taxes and local sales taxes would be deductible only when paid or accrued in carrying on a trade or business or in connection with production of income (i.e., deductible in computing income on Form 1040 Schedules C, E or F), other than up to $10,000 of real property taxes ($5,000 in the case of a married individual filing separately) which would remain deductible.  An individual could deduct such taxes if they were imposed on business assets, such as residential rental property.  State and local income tax would not be deductible.  These provisions would expire for taxable years beginning after December 31, 2025, and the state and local tax deduction would then revert back to its form as it existed before January 1, 2018.

House:  The section is similar to the Senate proposal, without the “sunset” provision.

Home Mortgage Interest

Senate:  The deduction for home equity interest would be repealed, effective for taxable years beginning after December 31, 2017 and before January 1, 2026.  This deduction would then revert to its form as it existed before January 1, 2018.

House:  The deduction for mortgage interest on existing mortgages would continue, but for debt incurred after November 2, 2017, interest paid on only $500,000 of principal residence mortgage debt would be deductible.

Charitable Contributions

Senate:  The income-based percentage limit for certain charitable contributions by an individual taxpayer of cash to public charities and certain other organizations would be increased from 50% to 60%, effective for charitable contributions made in taxable years beginning after December 31, 2017 and before January 1, 2026.  

House: Generally the same as Senate, without the “sunset” provision.

Medical Expenses

Senate:  The bill would provide a temporary reduction in the medical expense deduction floor to include costs that exceed 7.5% of adjusted gross income (rather than the 10% under current law). This would apply for taxable years beginning after December 31, 2016 and ending before January 1, 2019. 

House:  The itemized deduction for medical expenses would be repealed, effective for taxable years beginning after December 31, 2017.

Alimony Payments

Senate:  No provision.

House:  The deduction for alimony payments would be repealed.  Similarly, provisions providing for inclusion of alimony payments in gross income would also be repealed.  This provision would apply to any divorce decree or separation agreement executed after December 31, 2017 and to any modification after December 31, 2017 of any such instrument executed before that date if expressly provided for by such modification.

Moving Expenses

Senate:  Subject to a limited exception, the bill would repeal this deduction, effective for taxable years beginning after December 31, 2017 and before January 1, 2026.  It would then generally revert back to its form as it existed before January 1, 2018.

House:  Same as Senate, without the “sunset” provision.  

Personal Casualty and Theft Losses

Senate:  Effective for losses in taxable years beginning after December 31, 2017 and before January 1, 2026, the bill would generally repeal this deduction except for losses incurred as a result of certain federally declared disasters. It would then generally revert back to its form as it existed before January 1, 2018.  Also, special relief rules would apply with respect to 2016 major disasters, as to personal casualty losses and the use of retirement funds.

House:  Similar to Senate except for the special relief rules noted, without the “sunset” provision.

Tax Preparation Expenses

Senate:  While not specifically addressed, tax preparation expenses would be covered by the miscellaneous itemized deduction provision described immediately below.

House:  Tax preparation expenses would be nondeductible, effective for taxable years beginning after December 31, 2017.

Miscellaneous Itemized Deductions Subject to 2% Floor

Senate:  All miscellaneous itemized deductions subject to the 2% floor under current law would generally be repealed.  This provision would apply to taxable years beginning after December 31, 2017 and before January 1, 2026.  It would then revert to its form as existed prior to January 1, 2018.

House:  No provision.

Limitation on Itemized Deductions

Senate:  Repealed, for taxable years beginning after December 31, 2017 and before January 1, 2026.  The provision would then revert to its form as existed prior to January 1, 2018.

House:  Same as Senate, without the “sunset” provision.

Expenses Attributable to Trade or Business of Being an Employee

Senate:  No provision.

House:  Effective for taxable years beginning after December 31, 2017, the bill would deny a deduction for expenses attributable to the trade or business of being an employee.  Working condition fringe benefits currently excluded from income would continue to be excluded.

Modification of Exclusion of Gain from Sale of a Principal Residence

Senate:  Under existing law, an individual taxpayer may exclude up to $250,000 ($500,000 if married filing jointly) of gain realized on the sale or exchange of a principal residence if the taxpayer has owned and used the residence as a principal residence for at least two of the five years ending on the date of the sale of exchange, subject to certain qualifications.  Under this provision, the two-of-five year rule would be modified to a five-of-eight year rule, subject to certain qualifications.  A taxpayer may benefit from the exclusion only once every five years.  This modification would apply for sales or exchanges after December 31, 2017 and before January 1, 2026. The exclusion of gain under this provision would then revert back to its form as it existed before January 1, 2018.

House:  The provision is similar to the Senate version (without the “sunset” provision), with the added restriction that the exclusion phases out one dollar for each dollar by which the taxpayer’s average adjusted gross income exceeds $250,000 ($500,000 for joint filers) for the taxable year and the two preceding taxable years.

Qualified Moving Expense Reimbursement and Deduction for Moving Expenses

Senate:  The exclusion from gross income and wages for qualified moving expense reimbursement and the deduction for moving expenses (except for certain Armed Forces-related moving expenses and reimbursements) would be repealed, for taxable years beginning after December 31, 2017 and before January 1, 2026.  The provisions would then revert back to their form as they existed before January 1, 2018.

House:  Substantially the same as Senate, without the “sunset” provision.  

Adoption Assistance Programs

Senate:  Not addressed.

House:  Effective for tax years beginning after December 31, 2017, the exclusion for adoption assistance programs would be repealed.

Education Incentives

Senate:  Generally not addressed.

House:  The many existing provisions on education incentives would be consolidated and simplified, effective generally for taxable years beginning after December 31, 2017.  Certain deductions and exclusions would be repealed.  Currently, allowable deductions for certain interest on education loans and for qualified tuition and related expenses would be repealed.

Estate and Gift Tax Exemption

Senate:  The estate and gift tax exemption would be doubled, accomplished by increasing the basic exclusion amount from $5 million to $10 million.  The $10 million exclusion amount is indexed for inflation after 2011 ($10.98 million for 2017).  The proposal would be effective for decedents dying, generation skipping transfers and gifts made after December 31, 2017.  The proposal does not indicate a future repeal of these taxes.  The increase in the basic exclusion amount would expire for decedents dying and gifts made after December 31, 2025, and it would revert back to the amount provided prior to January 1, 2018.  

House:  Similar to the Senate, the House bill would increase the basic exclusion amount to $10,000,000 (with inflation adjustments), effective for decedents dying and gifts made after 2017.  Beginning after 2024, the estate and generation-skipping transfer tax would be repealed while maintaining a beneficiary’s step-up basis in estate property.  Beginning in 2025, the gift tax would be lowered to a top rate of 35%.

Affordable Care Act Individual Shared Responsibility Payment

Senate:  Under the terms of the Affordable Care Act, individuals must be covered by a health plan that provides at least a specified minimum coverage or be subject to a tax (penalty) for failure to maintain the coverage (often referred to as the “individual mandate’), subject to certain exemptions.  This proposal would eliminate that payment, i.e., would reduce the amount of the shared responsibility payment to zero.  This would apply to health care coverage status for months beginning after December 31, 2018.

House:  No provision.