A final tax bill appears eminent. The House and Senate agreed to the reconciliation of their competing bills and most people expect it to be passed before the end of the year. On Wednesday December 13, 2017, the Conference Committee issued a reconciliation of the House and Senate proposed tax legislation. A copy of the conference committee report as well as a section by section summary of all the changes can be found on the Ways and Means Committee’s website.
Below are the major provisions of the conference committee bill. For a summary and chart, click here.
• Individual Tax Rates (lower), Standard Deduction (lower), & Personal Exemptions (gone)
The Conference Committee established 7 tax rates ranging from 0% to 37%. Starting in 2018, lower rates will apply to most taxpayers and the standard deduction will double to $12,000 for individuals and $24,000 for married couples. This increased standard deduction is offset by an elimination of the personal exemption. A family of 4 with income under $262,500 will lose $16,200 ($4,050 per person).
• Alternative Minimum Tax – Kept in Place but with much less impact
The AMT will remain for individual taxpayers but should apply to substantially fewer people because of the increased exemption amounts and changes made to itemized deduction (especially in high tax states because of the substantially limited state and local tax deductions allowed starting in 2018).
• Estate and Generation-Skipping Transfer Taxes
The bill doubles the current exclusion from $5M to 10M (with inflation adjustments starting 2010) per person thru 2025.
• Changes Related to Itemized Deductions
- Eliminates the overall limitation on itemized deduction.
- State and local tax deductions are limited to $10,000.
- Eliminates deductibility of all miscellaneous itemized deductions.
- Limits the interest expense on home mortgages to new debt up to $750K.
- AGI limitation for cash contributions is increased from 505 to 60%
- Personal casualty losses will continue to allow this but only for losses occurring in a federally declared disaster area.
- Child Tax Credit increased to $2,000 with $1,400 refundable for income less than $400,000
- • Alimony Payments
Eliminates the deduction for alimony payments for divorce decrees, separation agreements, and certain modifications entered into after 2018.
KROST Insight – In general, if you are:
In AMT in 2017 – you should consider:
- Postponing deductions until 2018
- Postpone Charitable Contributions until 2018
- Postpone Business Deductions until 2018
- Accelerate Income into 2017
- The top AMT rate in 2017 is 28% while the top regular tax rate in 2018 will be 37% so it is possible to get a 9% benefit by deferring deductions. If you are in AMT, state and local taxes deductions will not be much benefit in either 2017 or 2018 while business deductions and charitable deductions could be more valuable in 2018.
Not in AMT in 2017 – you should consider:
- Prepaying as much of your state and local taxes allowed by AMT
- Deferring Income
- Accelerating Deductions
- Accelerating Charitable Contributions
- The top marginal tax bracket in 2017 is 39.6% while the top rate in 2018 will be 37%. This coupled with the itemized deduction phase outs in 2017 push the marginal rate for 2017 to as high as 40.8%.
• Changes to Depreciation
The Conference Committee retained the 39 and 27.5-year lives for non-residential and residential real property, respectively but agreed to increase the Section 179 deduction from $500K to 1M and to an increase from 50% to 100% for Bonus depreciation through 2022. In addition, used equipment would now be eligible for Bonus.
The final bill would also expand the definition of Section 179 to include any of the following improvements to nonresidential real property: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems, and Qualified Improvement Property (this combines the various qualified improvement categories and establishes a 15-year life for this category).
KROST Insight – The combination of all qualified improvements into one category eliminates Qualified Restaurant Property. This results in a 39-year depreciable life for the structural portion of a restaurant build out. Landlord and restaurateurs should consider this when negotiating leases that include tenant improvement allowances.
KROST Insight – For a more detailed analysis of the various real estate and depreciation related provisions, see this article on How Tax Reform Impacts the Real Estate Industry.
• Tax Rate Reduction and Repeal of Alternative Minimum Tax (AMT) for Corporations
Corporations are a big winner in the conference bill as they will see a reduction in the corporate tax rate to 21% for tax years beginning on or after January 1, 2018. The bill also contains special provisions that let U.S. companies repatriate their foreign earnings back into the U.S. at a reduced tax rate (15.5% for cash assets and 8% for illiquid assets). Furthermore, the Alternative Minimum Tax (AMT) will be repealed for corporations.
KROST Insight – These provisions should lead to an increased use of C corporations over pass-through entities going forward. They will be especially helpful for businesses that are capital-intensive, intend on growing, and have a longer-term horizon before any sale of the business is considered.
KROST Insight – These provisions may also lead to more Personal Service Corporations (PSC). The new provision eliminates the special tax rate for PSC. Historically, there has been little incentive to leave profits in a PSC. With a new reduced rate of 21%, it may make sense to leave excess investible assets in the corporation until future years. The added investable cash would compound faster and when it is eventually distributed to shareholders, it would be taxable at 23.8%. Further analysis is required to see it this results in a better long-term return.
• Pass-Through Entities – New 20% Deduction
Businesses use structures like partnerships, limited liability companies (LLCs), or S corporations to pass income through to the owners without paying tax at the entity level. Income is taxed at individual rates. Under the conference bill, owners of pass-through entities and sole proprietors (“taxpayers other than corporations”) will be able to deduct 20% of their Qualified Business Income, subject to certain wage limits and exceptions. The 20% deduction for those in personal service businesses (doctors, attorneys, accountants, financials advisors, etc.), will phase out beginning with taxable income over $315,000 for married couples or $157,500 for single filers. This provision expires after tax years beginning in 2025.
KROST Insight – This provision should encourage investment in capital‐intensive businesses as well as small businesses in personal service industries. While the bill was originally intended to encourage job creation, the conference committee made a last-minute revision to the bill that would allow certain real estate businesses to participate in this deduction, even such businesses that have few or no employees (rental real estate).
• Cash Method of Accounting
The Gross Receipts threshold to use the Cash Method of Accounting goes from $5M to $25M (indexed for inflation) for tax years beginning after December 31, 2017.
• Business Interest Expense Limitation
Certain businesses are limited to the amount of interest that can deducted per year. The interest deduction is limited to 30% of adjusted taxable income before interest expense. For tax years beginning before 2022, the limitation is computed using adjusted taxable income before deductions for section 199, depreciation, amortization, and depletion (in addition to interest expense). Excess interest expense carries over to future years, indefinitely. Businesses with average annual gross receipts of $15 million or less are exempt from the limit. The bill also allows certain real property trades or businesses and certain farming activities to elect out of these provisions with modifications
• Net Operating Loss Deduction
NOL deductions would be limited to 80% of taxable income for losses arising in tax years beginning after December 31, 2017. NOL carryback is eliminated (except for farming which would be permitted a 2-year carryback) but unused NOL can be carried forward indefinitely.
• Domestic Production Activity Deduction
The final bill repeals the 9% deduction provided by IRC Section 199 known as the Domestic Production Activity Deduction.
The bill did not address the IC-DISC provisions meant to encourage export sales but effectively eliminated the opportunity for corporate taxpayers by the C corporation rate reduction to 21%.
Krost Insight – While IC-DISC’s are no longer a viable planning vehicle for C corporations, they will continue to be a potential tax savings opportunity for pass thru entities and their individual partners and S corporation shareholders.
• Accounting for Inventories
Taxpayers with average gross receipts of less than $25M (up from $10M) can either treat inventories as materials and supplies that are not incidental or they can conform with their financial statement accounting treatment.
• UNICAP for Inventories
The conference bill will increase the exemption (requiring the capitalization of overhead expenses related to manufacturing and production) from average gross receipts of less than $25M (up from $10M).
• Accounting for Long-term Contracts
The requirement to use the percentage of completion on long term contracts (to be completed within 2 years) will become applicable to businesses with gross receipts in excess of $25 (up from $10M).
KROST Insight – Effective for tax years beginning after December 31, 2017, these provisions are a good example of the bills attempt to simplify the administrative tax and accounting burden of complicated tax rules.