Senate Finance Committee Passes Tax Reform

On November 16, the Senate Finance Committee approved its version of tax reform. While more changes to the Senate version are expected, there are several key differences between the Finance Committee’s tax bill and the House’s. here are some highlights:

One major difference is that the Finance Committee offers a 17.4% deduction for the non-wage portion of pass-through business income (i.e., from partnerships and S corporations), which gets phased out as income levels exceed certain thresholds and provides a special exception for service income below $150,000 for joint filers ($75,000 for everyone else). You may recall that the House version would tax pass-through business income at a 25% rate, but presume that only 30% of the income from the pass-through entity is subject to the reduced rate (except for lawyers, accountants, doctors, engineers, financial advisers, and other professionals, who would not be able to use the lower rate). An amendment was made to the House bill directing the 25% to small business pass-through owners.

Like the House bill, the Finance Committee lowers corporate tax rates to 20%, but delays the rate reduction to 2019. The Finance Committee has seven different tax brackets with the highest rate being 38.5% for married, joint filers earning at least $1,000,000, while the House bill has four brackets and retains the 39.6% rate for joint filers earning at least $1 million.

State and local tax income and property tax deductions disappear completely under the Finance Committee bill, while the House retains the ability to deduct real property tax up to $10,000.

The Finance Committee preserves the ability of small businesses to deduct net interest expense up to 30% of earnings before interest and taxes. The House bill has a similar limitation, but its limit is based on EBITDA (adding depreciation to the limit) and exempts business with less than $25 million and all automobile dealers.

The Finance Committee bill permits expensing capital investments in capital investments within specified limits; the House bill has similar provisions, which expire after 5 years.

The Finance Committee bill preserves the home mortgage interest deduction for first and second mortgages within current limits. The House Bill sets a maximum of $500,000 for newly purchased homes (half of the current limit).

Both bills double the size of the current estate, GST and gift tax lifetime exemption (currently set to rise to $5.6 million in 2018, which would increase to $11.2 million per person), with only the House bill repealing the estate and generation skipping transfer tax at the end of six years.

Importantly, the the amended version of the Finance Committee bill repeals all of the individual income tax cuts in Title I of the bill at the end of 2025. These include rate reductions, elimination of the personal exemption, the reduced rate on pass-through business income, and elimination of the alternative minimum tax. In essence, the tax code (which is purportedly being simplified by the tax reform efforts of the House and Finance Committee) would be restored to its original state (and all of its current complexities) on January 1, 2018, except for provisions that index for inflation.

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