Senate tax reform bill contains more changes

The Senate Finance Committee on Thursday evening approved its version of the Tax Cuts and Jobs Act, sending the bill to the full Senate for debate and a vote. The committee had spent the week amending the bill, and the final version includes some changes beyond those included in the chairman’s mark released on Tuesday. 

The Senate is expected to take up the bill after it returns from its Thanksgiving recess.

Here are notable changes in the final version approved by the Senate Finance Committee.


Free File program: The Senate bill would codify and make permanent the IRS’s Free File program.

Whistleblower awards: The Senate bill would provide an above-the-line deduction for attorneys’ fees and court costs paid in connection with any action involving claims under a state false claims act, the SEC whistleblower program, and the Commodity Futures Trading Commission whistleblower program.

The bill would also modify Sec. 7623 to expand the definition of collected proceeds eligible for whistleblower awards.

Carried interests: The Senate bill would impose a three-year holding period requirement before certain partnership interests transferred in connection with the performance of services would qualify for long-term capital gain treatment.


Excessive compensation: Sec. 162(m) limits the deductibility of compensation paid to certain covered employees of publicly traded corporations. Current law defines a covered employee as the chief executive officer and the four most highly compensated officers (other than the CEO). The Senate bill would revise the definition of a covered employee under Sec. 162(m) to include both the principal executive officer and the principal financial officer and would reduce the number of other officers included to the three most highly compensated officers for the tax year. The bill would also require that if an individual is a covered employee for any tax year (after 2016), that individual will remain a covered employee for all future years. The bill would also remove current exceptions for commissions and performance-based compensation.

The bill includes a transition rule, so that the proposed changes would not apply to any remuneration under a written binding contract that was in effect on Nov. 2, 2017, and that was not later modified in any material respect.

Dividends paid: Under the Senate bill, corporations that pay dividends would be required to report the total amount of dividends paid during the tax year and the first 2½ months of the succeeding year, effective for tax years beginning after 2018. Corporations would not be allowed to deduct dividends paid when computing taxable income.

Dividends received: The Senate bill would also reduce the current 70% dividends-received deduction to 50% and the 80% dividends-received deduction to 65%.

Net operating losses: The Senate bill would limit the net operating loss deduction to 80% of taxable income (as determined without regard to the deduction). Net operating losses would be allowed to be carried forward indefinitely, but not carried back (except for certain farming losses). This change would apply to tax years beginning after 2022.

Orphan drug credit: The Senate bill would reduce the current Sec. 45C 50% orphan drug credit to 27.5% and would institute reporting requirements similar to the required for the Sec. 48C qualifying advanced energy project credit and the Sec. 48D qualifying therapeutic discovery project credit.

Employer-provided meals: The Senate bill would disallow an employer’s deduction for expenses associated with meals provided for the convenience of the employer on the employer’s business premises, or provided on or near the employer’s business premises through an employer-operated facility that meets certain requirements. However, the final version of the bill delays this change until tax years starting after 2025.

Amortization of research and experimental expenditures: The Senate bill would require specified research or experimental expenditures to be capitalized and amortized over a five-year period, effective for amounts paid or incurred in tax years beginning after 2025. Specified research and experimental expenditures attributable to research conducted outside the United States would be amortized over a 15-year period. The bill would also institute a new reporting requirement, for tax years beginning after 2024.

Exempt organizations

Excise tax on private college investments: Under current law, private colleges and universities are generally treated as public charities rather than private foundations, and thus they are not subject to the Sec. 4940 private foundation excise tax on net investment income. However, the Senate bill would impose a 1.4% excise tax on net investment income of private colleges and universities that have at least 500 students and aggregate assets of at least $250,000 per student. The assets-per-student threshold will be determined by including amounts held by related organizations, but only to assets held by the related organization for the education institution and to investment income that relates to assets held for the institution


A Detailed Look at Tax Reform: Changes to Deductions and Credits

Tax reform cleared its first major hurdle in Congress on November 16 when the House passed its version of the bill by a 227-to-205 vote mainly along party lines. (No Democrats voted for it.) But the legislation, which would generally be effective for tax years beginning after 2017, still has a long way to go around the track before it hits the finish line.

The bill approved by the House contains many of the measures proposed during the past year by the Trump administration and GOP lawmakers. The following provisions may be of particular interest to your clients.

Individual Tax Provisions

Tax rates: The current tax rate structure of seven brackets would be replaced by just four brackets of 12%, 25%, 35% and 39.6%. (Note that the top rate will remain at 39.6%.)  In addition, a “bubble tax” of 6% would apply to a portion of adjusted gross income (AGI) above $1 million.

Standard deduction: The bill essentially doubles the standard deduction from $6,350 to $12,200 for single filers and from $12,700 to $24,400 for joint filers. Combined with other proposed tax law changes, many more taxpayers will be claiming the standard deduction in lieu of itemizing deductions.

Personal exemptions: Currently, a taxpayer is entitled to claim a personal exemption of $4,050 for himself or herself, a spouse and each qualified dependent. The bill eliminates all personal exemptions.

Itemized deductions: The bill repeals most itemized deductions while preserving tax breaks for charitable donations and disaster-area casualty losses. The deduction for mortgage interest would be reduced to cover $500,000 of acquisition debt, down from $1 million, but interest deductions for existing loans would be grandfathered. The state and local tax deduction, a lightening rod for controversy in high-tax states, would be limited to property taxes of up to $10,000.

Child tax credit: The child tax credit for children under age 17, which is currently $1,000, would be increased to $1,600, subject to certain restrictions. However, the extra $600 would not be refundable, unlike the $1,000 base credit.

Alternative minimum tax: The alternative minimum tax (AMT), which was designed to affect only the wealthiest taxpayers but has been a thorn in the side of millions of others, would be completely repealed.

Family tax credit: The new legislation would create a new $300 nonrefundable tax credit for each taxpayer as well as any non-child dependent such as an older child or an elderly relative. However, the credit would have a short shelf life and would expire after five years.

Recharacterizations: Although most retirement plan rules would remain intact, the House bill repeals the rule allowing a taxpayer to recharacterize a Roth IRA back into a traditional IRA. Typically, recharacterizations are used when the value of the taxpayer’s account drops. 

Business Tax Provisions

Corporate tax rates: One of the main tent poles in the new legislation is a reduction in the top corporate tax rate from 35% to 20%. After much debate, lawmakers made the corporate tax rate permanent.

Repatriation tax: Under the House-approved bill, a one-time tax of 14% would apply to existing foreign profits being held in offshore accounts. In addition, foreign profits invested in non-cash assets offshore would be taxed at the rate of 7%. The law gives companies up to eight years to pay up.

Pass-through entities: Currently, profits funneled through pass-through entities like S corporations and partnerships are taxed at individual tax rates as high as 39.6%. The new bill would limit the top tax rate on these earnings to 25%. It would also provide a lower rate of 9% for businesses earning less than $75,000.

Business deductions and credits: The new bill would add several key tax benefits for businesses while removing certain deductions and credits. For instance, it would effectively allow 100% Section 179 expensing of business property for a five-year period, but repeal the Section 199 manufacturing deduction and Work Opportunity Tax Credit (WOTC).

Finally, the new law would repeal the federal estate tax, a long-time target of GOP legislators, but not in one shot. The repeal would not completely take effect until 2024 and would be combined with a doubling of the estate tax exemption. Under current law, the exemption is $5 million (indexed to $5.49 million in 2017).

It’s still too early for your clients to take action based on these provisions, but the proceedings should continue to be monitored closely. Keep your clients informed about any significant developments.


House passes tax reform bill (11-16-17)

House passes tax reform bill (11-16-17)

In a 227-205 vote today, the House passed the tax reform bill (the Tax Cuts and Jobs Act (H.R. 1)). The next hurdle will be passage of the Senate bill.

Here are a few of the differences between the bills:

  • The Senate bill's maximum individual rate is 38.5%, while the House bill's maximum is 39.6%; 
  • The Senate bill has no itemized deduction for property taxes, while the House bill allows up to $10,000;
  • The Senate bill's principal residence mortgage interest loan balance limit remains at $1 million with no equity debt allowed, while the House bill reduces the loan balance to $500,000 on the principal residence only with no equity debt allowed;
  • Under the Senate bill, sole proprietorships, partnerships, and S corporations may deduct 17.4% of their domestic qualified business income, while the House bill has a complex rate structure for these businesses; and
  • Under the Senate bill, there is a flat 20% corporate rate, including personal services, while the House bill has the same corporate rate but taxes personal service businesses at 25%.

House Ways and Means approves amended Tax Cuts and Jobs bill

The House Ways and Means Committee voted 24–16 on Thursday to send the Tax Cuts and Jobs Act, H.R. 1, to the full House for a vote. However, the bill, as marked up by the committee, contains many changes from the original version of H.R. 1 released last week. Reportedly, some of these changes were made to reduce the 10-year cost of the bill, and according to a preliminary estimate by the Joint Committee on Taxation, the net effect of the bill as marked up would be to reduce federal revenues by $1.437 trillion over 10 years.

Here is a list of changes in the version of the bill that the House will consider:

  1. The amended bill would provide for a new 9% rate on the first $75,000 in net business taxable income passed through to an active owner or shareholder earning less than $150,000 in taxable income. The 9% rate would be phased out as taxable income approaches $225,000. The lower rate would be phased in over five years: It would be 11% in 2018 and 2019, 10% in 2020 and 2021, and 9% starting in 2022.
  2. The current law rules on self-employment income received from a passthrough entity would be preserved.
  3. The adoption tax credit would be preserved in its current form.
  4. Taxpayers would be required to provide Social Security numbers for children before claiming the enhanced child tax credit.
  5. Rollovers between Sec. 529 education savings accounts and Achieving a Better Life Experience (ABLE) Sec. 529A accounts would be permitted.
  6. The exclusion for qualified moving expense reimbursements would be reinstated but only for members of the Armed Forces on active duty who move because of a military order.
  7. The amendment would lower the dividend-received deduction from 80% to 65% and the 70% rate to 50%.
  8. The amendment would change the limitation on deducting interest by businesses, but only for floor plan financing indebtedness (short-term debt used by retailers to finance high-cost items such as cars). Full expensing would not be available to these types of businesses.
  9. The amendment would modify the treatment of S corporations that convert to C corporations after the bill is passed by allowing any Sec. 481 adjustment to be taken into account over a six-year period (Sec. 481 adjustments usually must be taken into account over four years).
  10. For tax years after 2023, taxpayers would be required to amortize Sec. 174 research and experimentation expenses over five years (15 years for research outside the United States).
  11. The amendment would disallow a current deduction for litigation costs advanced by attorneys representing clients on a contingent basis until the contingency is resolved.
  12. The amendment would preserve current law treatment of nonqualified deferred compensation.
  13. The amendment would clarify that holders of restricted stock units cannot make Sec. 83(b) elections.
  14. The amendment would change the 12% and 5% rates on repatriated foreign income to 14% and 7%.
  15.  The amendment would eliminate the markup on deemed expenses for foreign purposes, permit a foreign tax credit of 80% of the foreign taxes paid, and make other changes to the foreign tax credit calculation provisions in H.R. 1.
  16. The amendment would subject to the 1.4% excise tax on investment income endowment funds held by organizations related to the universities and provide an exclusion from the excise tax for any educational institution unless the fair market value of the institution's assets (other than those assets used directly in carrying out its exempt purpose) is at least $250,000 per student.
  17. The amendment would change the repeal of the Johnson amendment to clarify that all Sec. 501(c)(3) organizations (not just religious organizations) are permitted to engage in political speech if the speech is in the ordinary course of the organization's business and the organization incurs de minimis expenses related to the political speech. 
  18. The amendment would require earned income tax credit claims to properly reflect any net earnings from self-employment, require employers to provide additional information on payroll tax returns, and provide the IRS with additional authority to substantiate earned income amounts.
  19. The amendment would reinstate the $5,000 exclusion from income for employer-provided dependent care assistance through 2022 for children under 13 or spouses or other dependents who are unable to care for themselves.
  20. The amendment would reinstate capital gain treatment for self-created musical works.
  21. The amendment would require partners to hold their partnership interest received for performing services for three years to qualify for capital gain treatment.
  22.  Employees who receive stock options or restricted stock units as compensation for services and later exercise them would be allowed to elect to defer recognition of income for up to five years, if the corporation's stock is not publicly traded.
  23. The amendment would change the foreign base erosion rules.


Use This Hack to Get the Most Out of Social Security

Getting the most out of Social Security is all about waiting as long as possible to start filing for benefits, right?

Not quite--especially if, as a business owner, you get to decide how you are paid.
You can actually live on a lot more money in retirement if you make some changes right now to your salary and take some steps to adjust your current tax bills, says Matthew Allen, a co-founder of New York City-based Social Security Advisors.

"Self-employed people generally have more flexibility in how to structure their income," he says. "That gives you a lot of good opportunities because of the way Social Security benefits are calculated."

The main tactic that Allen lays out below isn't over­whelmingly complex: Start replacing some of your salary with dividends, as long as you have a legitimate business reason to do so. (There's no required schedule for dividends, but you may wish to take them quarterly, for regular cash flow.) Meanwhile, boost your contributions to retirement savings accounts.
It's a simple enough change--but it's not a very obvious strategy until you understand how the Social Security and income tax systems work, and how the two interact.

What your current salary means

To survive in retirement, you'll obviously have to replace some of your current wages with other sources of income, including savings or pensions or government benefits. Social Security, of course, is the nation's cornerstone retirement safety net; it provided some 50.3 million retirees and survivors, or about 15 percent of Americans, with benefits in 2016. If you're planning on relying on Social Security, you probably already know that the amount you'll get at retirement varies depending on how much you've earned and paid into the system. What is less well advertised is that Social Security's benefit formula favors lower-income retirees, the assumption being that those who haven't earned high wages don't have much in savings.

Since low-wage workers are less likely to have other sources of retirement income, Social Security's graduated benefit formula gives them the highest "wage replacement" rates. Specifically, those who earned average monthly wages of $885, or $10,620 per year, get 90 percent of those wages replaced by Social Security benefits. But the replacement rate drops as you earn more, falling to just 15 percent for those earning more than $64,000 per year.

In other words, if you earn an average of $10,620 in each of the 35 years that Social Security will use to calculate your benefits, you'll be due a monthly Social Security payment of $796.50 at normal retirement age.

But if you earn 10 times that much--and pay 10 times as much in employment taxes--your monthly benefit would increase only by 3.5 times, to $2,747.92.

Can you pay yourself dividends instead?

Here's where your current tax bill comes in. You're paying Social Security taxes only on your salary, or earned income; dividend and investment income is exempt. So, as Allen suggests, you can minimize your employment tax by paying yourself partly through dividends, rather than through regular wages.

However, because this strategy will reduce your future Social Security income, it is wise to boost contributions to your retirement plans at the same time.

Let's say your business earns you $100,000 annually, of which you contribute $10,000 to your retirement plan. If you take the rest of your earnings in wages, you'll pay roughly 33 percent in employment and income taxes. But if you take $15,000 as dividends and increase your retirement contributions by $5,000 annually--thus cutting your wages by $20,000 a year--your overall tax rate drops to roughly 27 percent, for wages and dividends combined. In both cases, your after-tax take home is around $60,000--but if you adopt the latter strategy, you'll save about $5,000 in taxes each year.

Then, when retirement rolls around, you'll get slightly less in monthly Social Security benefits--about $316 per month in this example. But you'll also have dramatically more saved for retirement: about $750,000 more, assuming a 7 percent average return over 35 years. That's enough to pay you $3,322 per month for 35 years--about $3,000 more than you "lost" in Social Security benefits.

Make your dividends count

There's one big caveat. You need legitimate reasons to pay yourself dividends, rather than simply wages, for this to pass muster with the Internal Revenue Service, says Philip J. Holthouse, partner with the Los Angeles accounting firm Holthouse Carlin & Van Trigt. Otherwise, the IRS is likely to challenge your strategy and "recharacterize" your income as wages, levying the appropriate taxes and penalties in the process. And a tax court may agree.

So what are legitimate reasons to pay yourself dividends rather than wages? When a portion of your company's profits are derived from something other than your work as a "key employee."

If you employ anyone other than yourself (and any co-owners), or if you invest in machinery or equipment that is responsible for generating a portion of your company's revenue, it's considered reasonable to take wages for your work and dividends for the profit that was derived from your other employees or company assets.

There's no set formula for determining what portion of your income should be claimed as wages versus dividends. But realize that you may have to justify whatever formula you choose, so you should have a reasonable approach. You could research competitive wages in your industry and take any excess profit over that amount as a dividend, for instance. Or if you're able to directly attribute revenue to employees--or assets--that could work too.

However, the more of the company's earnings you take as dividends versus wages, the more likely you are to be questioned by the IRS, warns Holthouse. And if you run your business full time, you always have to pay yourself at least some wages.

"The idea that you could earn no wages from a business where you work full time has been pretty universally rejected by the IRS and the courts," says Holthouse. "Otherwise, if you have an argument with economic substance, you could very well win. It gets very fact-specific."

Given that this sort of dividend-income strategy could pique IRS scrutiny if misused, you may want to consult a tax professional before adopting it.

"Social Security is essentially one big math problem layered with 2,000 different rules," says Allen. However, he adds, many couples could end up collecting around $1 million in benefits over their lifetimes: "I can't think of anything else where it's as important to get it right the first time around."