2017 Tax Reform Bill's Business Impacts
When it comes to tax reform, Congress is looking to bring business home for the holidays. Both the House and the Senate have recently passed major tax reform bills that are poised to have a significant impact on business growth and, hopefully, U.S. global competitiveness. The most prominent change is a reduction of the corporate tax rate and implementation of a territorial taxation system. However, the bills also amend a number of business tax laws including treatment of pass-through income, capital deductions and the Alternative Minimum Tax (AMT). Currently, the House and the Senate are reconciling the difference between the two bills and seeking to finalize the legislation before Christmas. The following is a breakdown of the major elements of both the House and the Senate bills as they exist today. We will continue to monitor the changes as the bills progress.
Corporate Tax Rate ("C" Corporations Only): Both the House and the Senate bills eliminate the current graduated income tax rates from 15% to 35% for businesses taxed as "C" corporations and instead institute a flat tax rate of 20% regardless of taxable income. Currently, the House bill makes the change immediate while the new rate would not take effect until 2019 under the Senate bill. Absent some feature in the final legislation addressing corporations with less than $50,000 in net taxable income, those businesses could face an increase.
Pass-Through Income: Both the House and the Senate bills contain either deductions or favorable rates which, for compliant pass-through income businesses (mainly those other than "C" Corporations), can result in lower taxes. However, a number of considerations such as type of entity, type of business, income, caps, and rates factor into the final calculations. Indeed certain professional service organizations such as law, accounting and other service organizations may not qualify for certain of the benefits. There will be more on this as the Joint Committee homogenizes the new legislation.
Alternative Minimum Tax: The House bill proposes to eliminate the corporate AMT while the Senate bill retains it without any changes.
Dividends-Received Deduction: Corporations are currently allowed to deduct 70% of the dividends they receive from other corporations. If a corporation owns over 20% but less than 80% of the dividend-paying corporation, it can deduct 80% of the dividends received. Both bills reduce the allowable deduction from 70% and 80% to 50% and 65%, respectively. If the corporation owns over 80% of the dividend-paying corporation, it can deduct 100% of the dividends received. Neither bill will change the range for the 100% dividend deduction. The Senate reduction would not go into effect until 2019, along with the corporate income rate change.
Section 168k (Bonus Depreciation): Generally, the House bill would increase the first-year depreciation deduction under section 168k (bonus depreciation) from 50% to 100% and expand the category from new equipment and machinery to used and new equipment and machinery. The increase and expansion would be effective for property put in service after September 27, 2017 but before 2023. The Senate bill would also increase the bonus depreciation to 100% for property put in service after September 27, 2017, but the Senate version would only apply to new equipment. Like the House bill, the Senate bill would allow 100% bonus depreciation for five years, but then would gradually phase out the bonus depreciation by 20% a year over five years.
Section 179 Expensing: Generally, the current tax law allows businesses to deduct up to $500,000 of the cost of equipment acquired and put into service during the tax year. The House bill temporarily increases the small business expense cap from the previous limit of $500,000 to $5 million. Then, existing limits would go back into effect after five years. The Senate also increases the expense cap, but only up to $1 million. The Senate bill also allows full expensing of equipment and machinery for five years, but then phases out the provision over the following five years. The Senate bill also shortens depreciation of real property to 25 years instead of 27.5 or 39 years.
Entertainment Expenses: Both bills eliminate all entertainment expense deductions for business. The current system allows a 50% deduction.
Business Interest Expense: Both the House and the Senate bills generally cap the deduction for business interest expense to an amount equal to the taxpayer's business interest income plus 30% of the taxpayer's "adjusted taxable income" for the taxable year. The two bills differ in how exactly "adjusted taxable income" is calculated-a difference the Joint Committee must address in reconciling the two bills.
Net Operating Loss Deduction: Both the Senate and House limit the net operating loss deduction to 90% of taxable income. The Senate bill would decrease the limit to 80% in 2023, with potential to eliminate the deduction in 2025. The bill would also eliminate the carry-back provision. The House bill would not further reduce the limit and would retain the carry-back provision for certain small businesses and farms for a maximum of one year. The House bill would increase the carry forward period from 20 years to indefinitely.
Cash Accounting Rules: Both bills increase the eligibility of businesses to utilize the cash accounting rules to simplify their accounting. The Senate bill increases the limit from $5 million average annual revenue up to $15 million, while the House bill increases it to $25 million.
U.S. Multinational Taxation: Additionally, both bills seek to change the rules of how U.S. multinational businesses are taxed, changing the current "worldwide" system to a "territorial" system, along with specific anti-abuse rules and base-erosion rules to prevent manipulation of the system. Further, both bills include "deemed repatriation" provisions to require multinational businesses to pay a one-time tax rate (approximately 14% for liquid assets and 7% for illiquid assets) on their existing overseas profits.