Comparing the House and Senate versions of the Tax Cuts

The Joint Committee on Taxation released a report Thursday comparing the House and Senate versions of the Tax Cuts and Jobs Act, highlighting differences that include where tax brackets begin, the standard deduction, maximum rate on business income of individuals and the child tax credit.

For personal income tax, the House version of the tax bill consolidates the current seven income tax bracket rates to four but keeps the top marginal rate at 39.6 percent. The Senate version, on the other hand, keeps the seven brackets but reduces the top marginal rate to 38.5 percent. The House and Senate also both have slightly different rates for the standard deduction.

The House and Senate bills also treat pass-through income differently. The House bill introduces a top rate of 25 percent for members of pass-through entities while individual tax rates can go as high as 39.6 percent. The lower rate would apply to only 30 percent of income that can be categorized as qualified business income. The remaining 70 percent would be attributable to wages or labor income and be taxed at individual rates — a mechanism put in place to prevent tax avoidance maneuvers to characterize personal wages as business income. The Senate’s tax bill introduces a 23 percent deduction for pass-through income, bringing the top effective rate to 29.6 percent.

Both the Senate and House increase the child tax credit, but while the House increases it to $1,600, the Senate increases it to $2,000. The phase-out amount for joint filers comes at $230,000 for joint filers in the House version and at $500,000 in the Senate version. The House version creates a $300 per-person nonrefundable family tax credit for those not eligible for the child tax credit that would expire by 2023, whereas the Senate version would create a $500 nonrefundable tax credit for non-child dependents.

The House also repeals the alternative minimum tax for corporations and individuals, while the Senate retains both alternative minimum taxes but increases the exemption rate for individuals.

For homeowners, the House lowers the limitation on qualifying indebtedness for the mortgage interest deduction to $500,000, grandfathering in indebtedness incurred on or before Nov. 2, 2017, at $1 million. The Senate version keeps the mortgage interest deduction for new debt but eliminates the deduction for home equity interest indebtedness.

On the health care side, the House bill repeals medical expense deductions while the Senate retains them and decreases the floor for the medical expense deduction to 7.5 percent from 10 percent for taxable years 2017 and 2018. The Senate also reduces the penalty for failure to obtain health coverage under the Affordable Care Act to $0, while the House version doesn’t touch the penalty under the individual mandate.

The House version increases the estate tax exemption from $5 million to $10 million, reduces the gift tax rate from 40 percent to 35 percent for gifts made after Dec. 31, 2024, and repeals the estate and generation-skipping transfer taxes for estates of decedents dying, gifts made, and generation-skipping transfers made after Dec. 31, 2024. The Senate version doubles the basic exclusion amount for estate and gift tax purposes from $5 million to $10 million.

Martin J. Milita

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Inversion Regs Cast Wider Net

The U.S. Department of the Treasury on Monday issued rules to curb tax-motivated inversions, and while much of the immediate attention focused on how they would affect the proposed Pfizer-Allergan merger, the regulations could ensnare other kinds of cross-border deals or even domestic transactions.

The regulations issued Monday formalized notices put out by the Treasury in 2014 and 2015 saying the administration would write rules to make it more difficult for companies to merge with competitors in low-tax jurisdictions. The regulations included new measures not mentioned in the previous announcements, such as a provision to prevent companies from getting around existing inversion rules by acquiring multiple companies over a short time, as Allergan Inc. has done.

The Treasury also issued proposed regulations to combat the practice of earnings stripping, one of the primary ways inverted companies reap tax benefits from inversions and which involves saddling domestic affiliates with debt and taking a U.S. tax deduction on the interest.

The government may have written the rules to target inversions, but the more than 300 pages of regulations touch on so many different sections of the tax code that other transactions could be caught up as well.

Firms may have to take another look at deals going back more than a year and a half to see if they comply with the rules. The regulations implementing the 2014 notice apply to transactions completed on or after Sept. 22, 2014, while the regulations formalizing the 2015 announcement apply to acquisitions completed on or after Nov. 19, 2015. The new measures introduced Monday apply to transactions completed on or after April 4.

The proposed earnings-stripping regulations in particular have a wide scope that goes well beyond inversions and would encompass debt transactions that are commonly used by multinational or domestic groups of related corporations.

Under the proposed rules, the IRS said it would treat as stock certain transactions that would otherwise be considered debt, such as instruments issued by a subsidiary to its foreign parent in a shareholder dividend distribution or instruments issued in connection with some acquisitions of stock or assets from related corporations in transactions economically similar to dividend distributions.

The proposed regulations specifically mention a court case from 1956, Kraft Foods Co. v. Commissioner, in which the Second Circuit considered a domestic corporate subsidiary that issued indebtedness in the form of debentures to its sole shareholder, which was also a domestic corporation, in the payment of a dividend. In the case, the government argued that the transaction may have been a sham and should have been treated as stock, but the court sided with Kraft, saying the debentures should be respected as debt.

In the proposed regulations, the IRS said going forward it would treat a debt instrument issued in fact patterns similar to that in Kraft as stock, thus unsettling well established law.

The breadth of the regulations will have implications well beyond inversions and will affect not only foreign companies and inverted companies but U.S. companies as well, Bazar said.

One of the new provisions in Monday’s regulations would target so-called serial acquirers who purchase multiple U.S. companies in quick succession to get around an existing rule that penalizes inversions in which the former stockholders of the U.S. company retain at least 60 percent ownership in the newly combined foreign company. If the former stockholders retain at least 80 percent ownership of the new company, the transaction is completely disregarded for U.S. tax purposes.

In the regulations, the Treasury said it was concerned that a serial acquirer could subvert the rule by issuing stock with each successive purchase of a U.S. company, thereby increasing its ownership and enabling acquisition of an even greater domestic company without crossing the 60 percent threshold. To that end, the regulations exclude from that ownership calculation stock that is issued by a foreign corporation in connection with the acquisition of U.S. entities in the prior three years.

 

Tax Plans & Presidential Candidates

There appears to be at least a theoretical agreement among all Presidential candidates’ that the current Federal tax system is broken — measured by its complexity, inefficiency and disorder.

The field of presidential candidates in both parties is diverse and possibly evolving— as is the eventual tax agenda for 2017 after the election of a new president in November 2016. Obviously, the congressional elections in November 2016 will also have a significant bearing on the specific issues that eventually comprise the tax agenda in the new Congress. Understandably, most candidates have not provided many specifics of their tax reform plans, but a general consensus for comprehensive tax reform appears to be developing on both sides of the aisle.

A number of Republican candidates favor some version of a “flat” tax rate on personal income, with proposals ranging from 10 to 15 percent based on income levels. Sen. Marco Rubio’s (R-Fla.) proposal would implement a 15 percent rate on middle-class earners, with a rate of 35 percent for higher-income taxpayers. Similarly, Sen. Rand Paul of Kentucky has proposed a 14.5 percent “flat and fair” tax rate that would apply to all earners and businesses, with the first $50,000 of family income untaxed. Sen. Ted Cruz of Texas has said that he supports a flat tax, but he has not provided details as to a specific rate level. Neurosurgeon Ben Carson has proposed a flat tax rate of 10 percent.

Another priority for Republican candidates appears to be lowering the corporate tax rate to encourage investment in the United States and the repatriation of foreign earnings. Proposals by Rubio and New Jersey Gov. Chris Christie would reduce the maximum corporate rate to 25 percent, while former Texas Gov. Rick Perry has proposed a 20 percent rate. Other candidates support lowering the corporate rate but have not given a specific tax level. As stated above, Paul’s plan would apply a 14.5 percent rate to businesses, as well as individuals.

The candidates generally agree that taxes on capital gains and dividends should be lowered or eliminated. In addition, many proposals assert that any revenue loss from reducing tax rates should be offset by restricting or eliminating various tax deductions, with the exception of charitable donations and mortgage interest.

Clinton remains the front-runner of the Democratic field. While she has not released a specific tax plan, Clinton has expressed support for lowering the tax burden on middle-class taxpayers. In addition, Clinton has indicated that, if elected, she would close several business tax “loopholes,” including the current tax treatment of carried interest. Clinton has also stated that she opposes the current tax incentives for oil and gas companies and would seek to end them. That said, she has expressed support for implementing tax incentives to encourage profit-sharing between businesses and their employees and has proposed a $1,500 tax credit for businesses that hire apprentices. Recently, Clinton proposed a comprehensive college affordability plan, financed by a 28 percent cap on itemized deductions similar to the budget proposal advanced by President Barack Obama.

Sen. Bernie Sanders, I-Vt., appears to be narrowing the gap with Clinton in several national and state-specific polls. With respect to Sanders’ tax policy positions, he has proposed to increase and restructure the estate tax, beginning with a 45 percent rate on estates worth up to $7 million, a 50 percent rate on those worth $7 million to $10 million, and a 55 percent rate on those worth $10 million to $50 million. In addition, Sanders has expressed support for an additional 10 percent surtax on estates valued at more than $1 billion. Sanders has also sponsored legislation that would change the current tax rules for corporate inversions and earnings stripping by foreign companies, and another bill that would prohibit U.S. corporations from deferring federal income taxes on profits of offshore subsidiaries. Like Clinton, Sanders opposes current tax incentives for the oil and gas industry.

Other Democratic presidential candidates, such as former Maryland Gov. Martin O’Malley and former Sens. Jim Webb of Virginia and Lincoln Chafee of Rhode Island, have all expressed support for lowering individual tax rates generally while not advancing any specific tax plans. The one exception was an open letter written by O’Malley to the financial sector on July 9, 2015, outlining steps that he would take to prevent another major banking crisis. In that letter, he proposes a tax on financial instruments to discourage high-frequency trading and a separate financial transaction tax to discourage speculation.

Martin J. Milita, Jr. Esq., is senior director at Duane Morris Government Strategies, LLC

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Duane Morris Government Strategies (DMGS) supports the growth of organizations, companies, communities and economies through a suite of government and business consulting services. The firm offers a range of government relations and public affairs services, including lobbying, grant writing; development finance consulting, media relations management, grassroots campaigning and community outreach. Milita works at the firm’s Trenton and Newark New Jersey offices.