House Republicans Release Tax Reform Plan: Ways And Means Committee Chair Brady Suggests Flex Rate Package

By: Jerald David August

As reflected in Tax Notes Today for November 2, 2017, Ways and Means Committee Chair, Kevin Brady, R-Texas, stated that it may not be so easy for the House Republicans to get to a permanent 20% corporate tax rate which is a key, if not the centerpiece, provision of President Trump’s tax reform initiative, and that it may take several steps in the process to get there.

The problem, of course, is the Budget Reconciliation process which on the Senate side prohibits legislation from increasing the budget deficit beyond the budget projection which stands at $1.5 trillion.  Still there is hope that a permanent corporate tax rate can be set at 20% from the beginning the legislation is enacted into law to greatly increase the competitiveness of U.S. based corporations and help stem the tide of inversions, earnings stripping maneuvers and other base erosion efforts on the part of multinational corporations. Reducing the U.S. corporate income tax rate from 35% to 20% is a reform that is long overdue and greatly needed to restore U.S. corporation competitiveness in the global economy.

Representative Brady stated that the GOP bill is estimated to cost $1.51 trillion over a decade. Lawmakers must keep the cost of the bill to $1.5 trillion if they want to pass it along party lines and avoid a filibuster by Democrats under the Budget Reconciliation procedures in the Senate. Concern for going beyond the budget ceiling has prompted a host of changes on the corporate and individual proposals, including a new twist that would limit the mortgage interest deduction by capping it at $500,000. There may be further “cutting here” and “adding there” aspects as the bill is debated by the House and then presumably handed off to the Senate.

So, what are the highlights of the Republican Tax Plan announced today?

Change In Individual Tax Rates

The newly released GOP plan establishes three tax brackets, 12%, 25% and 35%. However, as somewhat of a surprise perhaps, the top rate of 39.6% was kept for the highest-earners which presumably would be set for individual annual taxable income in excess of $1,000,000. If state and local taxes are not deductible against the 39.6% rate, which is where we are with this bill today, there will be an outcry of unfairness from blue state high-income earners, including, but not limited to, physicians, investment managers, architects, lawyers, accountants and other professionals.

The talking point for the reductions in individual income tax rates for the GOP is that this will provide needed tax breaks for low and middle-income Americans.

Other Individual Changes

The House GOP Tax Plan will also do the following:

  1. Increase the standard deduction.  From $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples.

  2. Eliminate special-interest deductions that make filing tax returns more complex, the so-called “postcard return” proposal where there is less itemized deduction returns due to the increased standard deduction and other reforms.

  3. Establishes a new family credit and expands the child tax credit from $1,000 to $1,600 and provides a credit of $300 for each parent and non-child dependent to help all families.

  4. Preserves the child and dependent care tax credit.

  5. Creates incentives for families to save for and better afford college tuition and other educational expenses.

  6. Continues the deduction for charitable contributions.

  7. Preserves the deduction for home mortgage interest expense and maintains the home interest deduction ceiling on newly purchased homes up to $500,000. So there is a bit of a cut-back here.

  8. Allows deductions for state and local property taxes (but not income tax) of up to $10,000. This would adversely affect taxpayers in high property tax states such as New Jersey, New York and California.

  9. Retains existing retirement plan savings options such as IRAs and section 401(k) plans.

  10. Repeals the alternative minimum tax. Presumably this will also be extended to the corporate AMT but there is nothing like the “final language” contained in the legislation.

  11. Phase-out of the Federal estate tax. Doubles the existing $5.5M exemption per person to $11M for lifetime and testamentary transfers and repeals the estate tax in six years. The phase-out presumably would also apply to the generation skipping transfer tax but this is presently uncertain.   The gift tax presumably will be retained as a guard against tax avoidance/evasion strategies. There will be a fair amount of marital formula trusts and wills to revise if this provision is enacted into law.

More Noteworthy Provisions Retained Or Changed

  1. Retained the like-kind exchange rules for real property under section 1031 that was rumored previously to have been on the chopping block. What about section 1033 for involuntary conversions? Presumably unaffected.

  2. Exclusion on gain from sale of principal residence is cut back. While the House Tax Plan retains the current exclusion, $500,000 for married filers and $250,000 for others, the benefit would phase out for high income taxpayers, by reducing the exclusion once adjusted gross income reaches $500,000 for married couples and $250,000 for others. As a further change, to qualify for the exclusion the taxpayers must have used the home as their principal residence for five of the prior eight years. Current law requires the taxpayer to have lived there for two of the prior five years.

  3. Repeals itemized deduction for medical expenses which may adversely affect many families incurring large medical expenses.

  4. Repeals the tax credit for adoption.

  5. Repeals the deduction for student-loan interest. That’s going to adversely affect students with high loans to afford the ramped up cost of secondary education.

  6. Charitable contributions are still not going to be treated as “above-the-line” expenditures.

More Provisions Affecting Businesses

  1. Immediate expensing for the full cost of new equipment. Presumably recapture amounts will be taxed as ordinary income. Presumably depreciation on real property improvements will be retained under current rules but perhaps with shorter cost recovery periods.

  2. Pass through owners of “Main Street” businesses will not be taxed greater than 25%. Presumably this 25% maximum rate of income tax rule on owners of pass through entities will not apply to personal service partnerships and sole proprietorships as has been previously suggested. Competition between the corporate tax rate world of 20% and the pass through business world of 25% was indeed a compromise. There is obviously little in the way of effective lobbying for professional service organizations if high-income professionals continue to be taxed at 39.6% or 35%.

  3. Executive compensation. The benefits to performance based criteria to pay certain executives compensation in excess of $1,000,000 will be scrapped. Executive compensation will be deductible only up to $1,000,000 per year. Let’s see the details on this new limitation and see if there are any escape hatches.

  4. Low-income housing credit deals are still available. With a 39.6% tax bracket and no deductibility of state and local taxes, credit deals that are still left will be popular.

  5. Retains the research and development tax credit but with revised rules and conditions.

  6. Tax-exempt bonds would no longer be used to build professional sports stadiums.

  7. Private colleges and universities with assets exceeding $100,000 per student would be subject to a new excise tax of 1.4% on their net investment income. This is a carve out of the UBIT rules no doubt and the provision seems weak on issues of “horizontal equity”, i.e., it may not apply to other section 501(c)(3) entities.

  8. Tightening on allowance of deductible entertainment expenses but the current rules for business meals would be retained.

  9. Global minimum tax for multinational corporations. The bill proposes to have a global minimum tax of 10% to income that American companies earn anywhere in the world. A sort of universal CFC type rule which knocks through the same-country and manufacturing exceptions. Stay tuned for what happens to the global tax of 10%, which is only ½ of the Trump rate so there is still incentive to go offshore at least that would be the initial reaction.

  10. Repatriation of foreign earnings at a maximum rate as low as 5% perhaps 10% depending on final scoring impacts and impact on the $1.5 trillion budget deficit ceiling.

Reaction of Ways and Means Democrats

The other side of the isle may not be real pleased with the non-deductibility of state and local tax rule which is bound to lose even Republican votes, especially blue state Republicans. Democrats may contend that the tax cuts are too “rich” and increase the deficit too much. Still there is that 39.6% which stays as well as the disallowance of much in the way of executive compensation assuming the actual rule to be passed is as “tough” as it purports to be.

There is going to be push-back of course and there is about 18 days to get it passed this term.

There’s plenty of “sausage” to make in DC right now.

"Disclaimer of Use and Reliance: The information contained in this blog is intended solely for informational purposes and the benefit of the readers of this blog. Accordingly, the information does not constitute the rendering of legal advice and may not be relied upon by the reader in addressing or otherwise taking a position on one or more specific tax issues or related legal matter for his or her own benefit or for the benefit of a client or other person.” ©Jerald David August for Kostelanetz & Fink, LLP”