Tax Legislative Update: Historic Opportunity for Reform?

Transcription

1 Tax Legislative Update: Historic Opportunity for Reform? Thursday, November 30, 2017 Grant Thornton's Year End Tax Event Mel Schwarz Partner (Retired), Washington National Tax Office

2 Breaking down the tax reform bills: How would they affect you and your business?

3 Presenters Mel Schwarz Retired Partner Grant Thornton LLP. All rights reserved. 3

4 Learning Objectives Evaluate the outlook for tax reform Analyze the proposals and how they may evolve and affect businesses Identify the planning opportunities and considerations Grant Thornton LLP. All rights reserved. 4

5 A note on the slides The slides were prepared after legislation was reported by the Senate Finance Committee, but before consideration by the full Senate. Significant changes are possible prior to enactment, which is itself not guaranteed. Grant Thornton's Washington National Tax Office is continuously monitoring the progress of the legislation, and will publish reports as developments warrant. Please go to for our latest update. Grant Thornton LLP. All rights reserved. 5

6 Grant Thornton LLP. All rights reserved. 6

7 Tax Cuts and Jobs Act Separate bills: Same framework but very different processes and results Senate: Mark-up based on "conceptual" language from JCT Text only recently released and still undergoing 'Byrd' scrubbing House: Over 400 pages of legislative text but parts were hastily drafted or changed and there are technical issues and unanswered questions Major pillars similar, but surprisingly little overlap in many areas, including revenue raisers Grant Thornton LLP. All rights reserved. 7

8 Net revenue effects within 10 years HOUSE SENATE Individual changes Business changes International changes Total - $963 billion - $886 billion - $754 billion - $683 billion billion + $154 billion - $1.437 trillion - $1.415 trillion Grant Thornton LLP. All rights reserved. 8

9 Grant Thornton LLP. All rights reserved. 9

10 Revenue effects outside 10 years Key difference: House makes no attempt to comply with reconciliation Senate bill finally unveils the trade-offs needed to prevent revenue loss outside budget window: Adds permanent repeal of the individual mandate (raises $318 billion) Sunsets all individual tax changes except mandate repeal and slower inflation adjustments in tax brackets Adds "sunrise" tax provisions on R&D amortization, NOL limits, international base erosion changes Special provision would repeal these if revenue targets met Most other business tax changes, including 20% rate, made permanent Grant Thornton LLP. All rights reserved. 10

11 How would the tax bill affect you?

12 Rates under TCJA Issue House Senate Individual rate 12% to 39.6% 10% to 38.5% Capital gains and dividend rate 23.8% 23.8% Corporate rate 20% (2018) 20% (2019) Pass-through rate 25% 17.4% deduction Grant Thornton LLP. All rights reserved. 12

13 Individual rate comparison House cuts taxes by adjusting brackets without major changes to rates = $1.09T Senate uses rate cuts and makes only modest adjustment to thresholds for brackets = $1.17T Grant Thornton LLP. All rights reserved. 13

14 FAQs on rates Is there a "zero" bracket? No, this refers to income protected by the doubled standard deduction Current law "zero" bracket actually larger in some cases with personal exemptions Is there a 46% bracket? Only in the House version: 6% surtax applies when income reaches $1 million (single) or $1.2 million (joint) until benefit of 12% bracket is erased Grant Thornton LLP. All rights reserved. 14

15 Key changes AMT repealed in both bills Your 401(k) and IRA are safe! Both bills slow down inflation adjustments for tax brackets One of only two individual changes made permanent in the Senate bill Grant Thornton LLP. All rights reserved. 15

16 Itemized Deductions and Personal Exemptions HOUSE SENATE Standard Deduction $24,400 $24,000 Mortgage Deduction $500K cap, no 2 nd home $1M cap SALT Deduction $10 K of property taxes REPEALED Charitable Deduction RETAINED RETAINED Medical Deduction REPEALED RETAINED Other Itemized Deductions REPEALED REPEALED Personal Exemptions REPEALED REPEALED Grant Thornton LLP. All rights reserved. 16

17 Individual exclusions and incentives HOUSE SENATE Moving Expenses REPEALED (unless military) REPEALED (unless military) Employer Provided Housing Sale of Principal Residence Limited to $50K, phase out above $120K AGI 5 of 8 years, phase out above $500K AGI No change Same as House Dependent Care Assistance REPEALED RETAINED Adoption Assistance REPEALED RETAINED Alimony No exclusion for payment, no income to recipient No change Education-related incentives Mostly repealed and consolidated No change into AOTC Child tax credit Increase to $1,600 Increase to $2,000 (higher phaseout) Grant Thornton LLP. All rights reserved. 17

18 Transfer taxes Issue Current Senate $5.49M exemption 40% rate $11.2M* exemption 40% rate Current law House $5.49M exemption 40% rate $11.2M* exemption 40% rate Estate and GST tax repealed $11.2M* exemption and 35% rate for gift tax Exemptions indexed for inflation House version retains step-up in basis even under repeal: Combined with gift tax retention, big disincentive to passing assets during life $172 billion cost of full repeal remains politically sensitive and unlikely Grant Thornton LLP. All rights reserved. 18

19 Business Taxes

20 Corporate rate cut Flat 20% rate: Senate: Effective tax years beginning after 2017 House: Effective tax years beginning after 2018 Appears that fiscal year taxpayers could bifurcate by calendar year under both Delay is a revenue consideration and unpopular with House Supporters argue it provides bigger short-term economic boost because full expensing will be more valuable against the 35% rate Senate version does not reduce the personal service corporation rate to 25% Both versions reduced the dividends received deduction 80% DRD to 65% ~ Still provides 7% effective rate 70% DRD to 50% ~ Effective rate reduced from 10.5% to 10% Grant Thornton LLP. All rights reserved. 20

21 Personal Service Corporations House Bill reduces tax rate to 25% Effective 44% rate if all profits (after compensation and taxes) distributed annually Compare to 38.8% rate on compensation ($260,000 to $1 million) Compare to 43.3% rate on compensation over $1 million Effective 34.5% rate if 50% profits (after compensation and taxes) distributed annually Effective 25% rate if no profits (after compensation and taxes) distributed annually Crossover = distribution of 58% or less of profits after compensation and taxes Senate Bill No provision. Grant Thornton LLP. All rights reserved. 21

22 House pass-through rate cut 25% rate for pass-though business income: Passive owners apply rate on all income Active owners must parse out income considered compensation and subject to top rate of 39.6% 2 methods for active owners: 70/30 safe harbor (creates blended rate of 35.5% in top bracket) Return on capital calculation Election binding for 5 years Professional services: Cannot use 70/30 safe harbor Can use return on capital calculation if result is at least 10% of income Grant Thornton LLP. All rights reserved. 22

23 Return on capital calculation 7 percent + Short-term AFR (1.27%) Return on capital X Tax basis w/o reduction for Bonus depreciation & Section 179 Which assets count? Subject to depreciation under 167 real property Less deductible interest with respect to the activity Grant Thornton LLP. All rights reserved. 23

24 Senate pass-through deduction 17.4% deduction for qualifying pass-through income Limited to 50% of W-2 wages paid What is the effect of the wage limitation? Wage expense needs to be ~ 40% of taxable income for full deduction Wage limit phased into effect once taxable income reaches $250,000 (single) or $500,000 (joint) Deduction creates effective rate of 31.8% against 38.5% top individual rate, 28.9% rate if owner's taxable income $400,000 to $1 million. Grant Thornton LLP. All rights reserved. 24

25 Pass-through income Senate bill Qualifying pass-through income does not include: Wages of an S corporation owner, or Guaranteed payment for services by partners Relies on reasonable compensation standards for S corp owners (no requirement that partners receive any guaranteed payment for services) No distinction between passive and active owners Professional services included only if taxable income: $250,000 if single (deduction phases out over next $50,000) $500,000 if joint (deduction phases out over next $100,000) Grant Thornton LLP. All rights reserved. 25

26 Comparing the pass-through regimes Issue House Senate Passive owners 25% effective rate on all income, 28.8% with NII tax Effective top rate of 31.8% if no wage limit applies Active owner 25% rate applies to narrow slice of income: Either 30% or return on 8% return on capital 70/30 split creates 35.2% rate 31.8% effective rate applies to potentially larger share of income because no artificial expansion of 'compensation' Professional services Potential benefit when return on capital calculation exceeds 10% Benefit only if taxable income below $600,000 (joint) or $300,000 (single) Revenue estimate $596 billion tax cut $362 billion tax cut Grant Thornton LLP. All rights reserved. 26

27 Expensing and cost recovery House and Senate double bonus depreciation for five years: 100% for property placed in service after Sep. 27, 2017 and Jan. 1, 2023 Used property added (if new to taxpayer) Public utilities and real estate ineligible (real estate can elect to use in Senate) House Section 179 expensing increase more generous that in Senate Grant Thornton LLP. All rights reserved. 27

28 Interest deduction Both bills use the OECD concept of limiting interest to 30% of income House 30% of taxable income removing interest, taxes, depreciation, and amortization (EBITDA) Exceptions: Public utilities, real estate, and businesses with <$25 million in gross receipts 5-year carryforward Senate: 30% of taxable income removing investment income, interest, NOL, and pass-through deduction Exceptions: Public utilities, electing real estate, and businesses with <$15 million in gross receipts Unlimited carryforward Grant Thornton LLP. All rights reserved. 28

29 Interest deduction considerations 'Trade-off' for full expensing not particularly well-matched Expensing is temporary but this provision is permanent Hits leveraged or down-year taxpayers not necessarily using more expensing Many businesses using full expensing not necessarily hit Grant Thornton LLP. All rights reserved. 29

30 Real estate cost recovery Senate bill: Shortens the recovery business for both commercial and residential buildings to 25 years Streamlines the definition of qualified leasehold improvement and retail improvement and shortening the recovery period to 10 years Grant Thornton LLP. All rights reserved. 30

31 R&D amortization House bill would repeal 174 deduction for R&D costs and requite 5-year amortization (includes software development) Senate version is "sunrise" provision not taking effect until 2026 that would be repealed before effective if revenue targets are met Big deal if becomes effective Many taxpayers don't currently identify 174 deduction expenses and would be required to perform studies Discourages internal software development becomes cost can be recovered over three year if purchased Grant Thornton LLP. All rights reserved. 31

32 AMT and NOL House and Senate Corporate AMT repealed, but NOL limit retained outside of AMT Can use your unused credits over the next four years as refundable if needed! NOLs Can offset only 90% of taxable income in any year: AMT rule outside or AMT NOL carrybacks eliminated but carryforwards are indefinite House bill: Indexes carryforwards to inflation at 4% + short-term AFR Senate bill: Includes 'sunrise' provision: 90% limit becomes 80% in 2023 unless revenue targets met Grant Thornton LLP. All rights reserved. 32

33 Small business accounting methods Gross receipts test increased from $5M to $25M (House) or $15M (Senate) for: Cash method for corporations Section 447 method for corporations engaged in farming Exception from UNICAP Special rules for long-term construction contracts (long-term manufacturing contracts not included Taxpayer meeting gross receipts test may account for inventory as non-incidental materials and supplies Deduct when: Consumed or Deducted on applicable financial statement Grant Thornton LLP. All rights reserved. 33

34 Senate bill: Active loss limits Raises $137 billion with new limit on ability to deduct losses against other kinds of income Essentially expands passive loss rules to deny deductions for active losses exceeding $500,000 for joint filers and $250,000 for other taxpayers Pure revenue raiser: Curbing real estate tax shelters was policy reason behind original passive loss rules Grant Thornton LLP. All rights reserved. 34

35 House bill: Contributions to capital Contributions to capital would be included in income to the extent they exceed FMV of stock received If no stock received, entire contribution included in income Basis of contributed property would be the amount of income recognized under provision if greater than transferor's basis plus transformer gain Grant Thornton LLP. All rights reserved. 35

36 Other Key Business Provisions HOUSE SENATE Section 199 REPEALED after 2017 REPEALED after 2018 Like kind exchanges Limited to real property Limited to real property not held primarily for sale Employer provided child care credit REPEALED RETAINED Work Opportunity Tax Credit REPEALED RETAINED New Markets Tax Credit REPEALED RETAINED Rehabilitation credit REPEALED Retained with changes Grant Thornton LLP. All rights reserved. 36

37 Other Key Business Provisions HOUSE SENATE Insurance reforms $43 billion in revenue raising changes Private activity bonds REPEALED RETAINED Deduction for remaining 50% of REPEALED REPEALED meals and entertainment Enhanced oil recovery credit REPEALED RETAINED $27 billion in revenue raising changes Credit for producing oil and gas from marginal wells Alternative energy provisions REPEALED Extends 48 credit for currently expired property but reduces 45 credit rate RETAINED No provision Grant Thornton LLP. All rights reserved. 37

38 Notable omissions in bills R&D credit retained No repeal of 3.8% tax on net investment income No repeal of medical device excise tax LIFO survives Cash method of accounting survives and improves No mark-to-market for derivatives Grant Thornton LLP. All rights reserved. 38

39 Compensation and benefits

40 Limited deduction for compensation House and Senate strengthen restrictions on deduction for public company executive pay under 162(m) Repeal exception for performance-based compensation or commissions Applies to CEO, CFO, and top three: One covered, always covered so can have more than five if continue to employ (or pay) executives no longer meeting threshholds Senate bill provides transition rule: Changes do not apply to vested compensation paid in the future that is provided for under a contract that was in effect on Nov. 2, 2017 Grant Thornton LLP. All rights reserved. 40

41 Equity grants New qualified equity grants proposed in House and Senate bill New ability for employees of private companies to defer income on stock options and restricted stock units 80% of U.S employees must receive grants Not applicable to CEO, CFO, 1% shareholder or four highest paid Grant Thornton LLP. All rights reserved. 41

42 Carried interest Both House and Senate added provision on carried interest: Carried interest is a right given to a fund manager to receive a percentage of profits Income from a carried interest takes the form of a capital gain as the fund sells investment assets For investment and real estate businesses, the asset holding period would be increased to three years for long-term capital gain treatment for tax years beginning after Dec. 31, 2017 Grant Thornton LLP. All rights reserved. 42

43 Outlook for enactment

44 Grant Thornton LLP. All rights reserved. 44

45 Will this make it into law? House passed bill 227 to 205: Relatively comfortable margin gives them wiggle room, but some members with concerns voted yes only to advance process after Speaker Ryan promised conference Senate Finance Committee approved its mark-up 14-12: Goes to Budget Committee and then Senate floor for vote expected this week Difficult to predict Senate vote with so little margin for error Sen. Ron Johnson, R-WI, opposes based on pass-through issue Sen. Susan Collins, R-ME, has concerns about including ACA changes Changes may be needed to secure floor passage Grant Thornton LLP. All rights reserved. 45

46 What are the biggest hurdles to enactment? Changes made to comply with reconciliation are controversial: Expiration of most individual changes means individuals face a revenue increase outside the budget window that funds permanent corporate changes JCT distributional analysis after individual mandate repeal shows large tax increase for taxpayers with <$30,000 in income Republicans have been sensitive to accusation they will raise taxes on lowincome taxpayers to fund corporate and high-income tax cuts Resolving differences between House and Senate bills May be difficult to satisfy both Senate moderates and House conservatives Grant Thornton LLP. All rights reserved. 46

47 What's the timeline? House bill released Nov. 2 House passes bill and Senate finishes mark Nov. 16/17 Chambers reconcile bills Expected early Dec. Senate bill released and House Ways and Means approves theirs Nov. 9 Senate passes bill Expected the week of Nov. 27 Enactment As early as late December or Q Grant Thornton LLP. All rights reserved. 47

48 Time to care? Success not guaranteed, but tax reform is now the top Republican priority and best hope for signature legislative achievement before mid-terms Moving quickly: It's time to take this seriously Grant Thornton LLP. All rights reserved. 48

49 Planning considerations

50 Planning considerations short-term? Immediate need to assess the Financial Statement implications under ASC 740 Pricing deferred items, International tax, Valuation allowance changes, disclosures Timing? Period of enactment Use deductions now against higher rates, defer income into future years when rates might be lower (keep in mind Senate effective date): Bonuses, benefits, and other compensation Accounting methods Fixed assets Defer earnings in CFCs Grant Thornton LLP. All rights reserved. 50

51 Planning considerations long-term? Entity choice Pass-through vs. C-Corp what makes sense in the new world? International restructuring DRD, Subpart F, Base Erosion taxes Debt v. equity investment Limited ability to use leverage impacts on capital structure Estate planning Time to revisit/refresh you thinking around estate plans Grant Thornton LLP. All rights reserved. 51

52 Comments? Questions?

53 Disclaimer This Grant Thornton LLP presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered For additional information on matters covered in this presentation, contact your Grant Thornton LLP adviser

54 Disclaimer * * * * * * * * * * * * * * * * * * * * * * IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the U.S. Internal Revenue Service, we inform you that any U.S. federal tax advice contained in this PowerPoint is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding penalties under the U.S. Internal Revenue Code or (b) promoting, marketing or recommending to another party any transaction or matter addressed herein. * * * * * * * * * * * * * * * * * * * * * The foregoing slides and any materials accompanying them are educational materials prepared by Grant Thornton LLP and are not intended as advice directed at any particular party or to a client-specific fact pattern. The information contained in this presentation provides background information about certain legal and accounting issues and should not be regarded as rendering legal or accounting advice to any person or entity. As such, the information is not privileged and does not create an attorney-client relationship or accountant-client relationship with you. You should not act, or refrain from acting, based upon any information so provided. In addition, the information contained in this presentation is not specific to any particular case or situation and may not reflect the most current legal developments, verdicts or settlements. You may contact us or an independent tax advisor to discuss the potential application of these issues to your particular situation. In the event that you have questions about and want to seek legal or professional advice concerning your particular situation in light of the matters discussed in the presentation, please contact us so that we can discuss the necessary steps to form a professional-client relationship if that is warranted. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein Grant Thornton LLP, the U.S. member firm of Grant Thornton International Ltd. All rights reserved. Printed in the U.S. This material is the work of Grant Thornton LLP, the U.S. member firm of Grant Thornton International Ltd.