Tax Reform: H.R. 1, Tax Cuts and Jobs Act

Tax Reform: H.R. 1, Tax Cuts and Jobs Act

Updated November 17, 2017
Tax Reform: H.R. 1, Tax Cuts and Jobs Act
The proposed tax reform, Tax Cuts and Jobs Act, H.R. 1,
three years. The credit for the elderly and disabled and for
was referred to the House Ways and Means Committee on
electric vehicles would be repealed, although the former
November 2, 2017, and, following a mark-up, was ordered
would be restored after 2020.
reported on November 9, 2017. H.R. 1 passed the House on
November 16, 2017. The bill contains some elements of the
Education benefits would be modified and reduced in size
2016 House tax reform blueprint, the “Better Way.”
by eliminating deductions for interest on student loans and
modifying and combining other provisions (such as tax
Individual Tax Revisions
credits and education savings accounts). Some items
The bill would replace the current seven rate brackets (10%,
currently excluded from income would be included; for
15%, 25%, 28%, 33%, 35%, and 39.6%) with four brackets,
example, some employer fringe benefits and gain from sale
with tax rates of 12%, 25%, 35%, and 39.6%. The rate
of a home for those who have lived in their homes less than
brackets indicate that income currently taxed at the first two
five years. The gain on home sales exclusion would be
rates would be taxed at 12%. Most taxable income in the
phased out dollar-for-dollar for individuals with earnings
25% and 28% brackets would be taxed at 25%. The current
over $500,000 ($250,000 for single returns). Some minor
top rate of 39.6% applies to taxable income above $470,700
changes would be made in the treatment of pensions and
but would not apply until $1 million of taxable income in
individual retirement accounts.
the bill. The benefit of the 12% bracket, compared to the
39.6% rate, will be phased out for incomes over $1.2
The bill also uses the chained Consumer Price Index (CPI)
million.
measure of inflation to index rate brackets and other
parameters, such as the standard deduction. Although many
The bill would alter some of the elements related to family
economists believe this measure is a better measure of
size and structure by eliminating personal exemptions,
inflation, using it would have the effect of raising taxes
allowing a larger standard deduction ($24,000 for joint
compared with using the regular CPI.
returns and $12,000 for singles for 2017, adjusted to
$24,400 for joint returns and $12,200 for single returns in
Tax Provisions Affecting Businesses
2018), and increasing the current child credit of $1,000 by
The bill would reduce the corporate tax rate from 35% to
$600 (although the addition credit would be
20% and provide for a maximum 25% tax rate for small and
nonrefundable). A nonrefundable credit of $300 for
family-owned businesses that are taxed under the individual
nonchild dependents and the taxpayers (two credits for a
income tax as pass-throughs. It would also phase in a lower
joint return) would be allowed, although the taxpayer credit
9% rate in lieu of the 12% rate, which would be phased out
expires after 2022. (The current personal exemption is
with income. Pass-throughs are organized as
$4,050 per person for 2017, and the current standard
proprietorships, partnerships, or Subchapter S corporations
deductions are $12,700 for joint returns and $6,350 for
(corporations with a small number of shareholders that elect
single returns.) The credits, including the current $1,000
to be taxed at individual rates). For active investors the
child credit, would be phased out at higher income levels of
lower rate would apply only to capital income, designated
$115,000. The alternative minimum tax would be repealed.
as 30% of earnings. However, an alternative measuring of
capital income as 7% plus the federal short-term rate times
For the individual income tax, the bill would broaden the
assets could be used for capital-intensive firms. Passive
base by disallowing most itemized deductions except for
investment would be considered capital income.
mortgage interest (limited to interest on mortgages of
$500,000 rather than $1 million), charitable contributions
Under current law, up to $500,000 in equipment can be
deductions, and state and local taxes on real property (up to
expensed, phased out after $2 million in spending. The bill
$10,000). The deductions for state and local income taxes,
would increase the limit to $5 million with a phase out after
medical expenses, employee business expenses, casualty
$20 million. The bill allows all equipment to be expensed
losses (except for specified national disasters), and other
through 2022. Deductions for excess interest for
minor provisions would be eliminated. Some above-the-line
corporations would be more limited than in present law.
deductions are eliminated, including moving expense
deductions (other than for members of the armed forces)
The bill would require research and experimental
and alimony (although alimony will be taxed to the
expenditures to be deducted over five years rather than
recipient, and current divorce decrees will not necessarily
expensed (deducted immediately). It would repeal the
be covered).
production activity deduction. It disallows carrybacks of net
operating loss deductions, pays interest on unlimited
The current earned income credit and tax rates on capital
carryforwards, but limits the deduction to 90% of taxable
gains and dividends are not changed, although capital gains
income. It would limit or repeal a variety of other
rates would be available for carried interest only if held for
deductions and credits (e.g., the orphan drug credit, certain
https://crsreports.congress.gov

Tax Reform: H.R. 1, Tax Cuts and Jobs Act
energy credits, credits for rehabilitation, the work
have mixed effects on taxes across asset types (equipment
opportunity tax credit, and credits and deductions for
investment would be more favored relative to investment in
employee benefits). It would retain the research credit and
structures than is already the case, as long as it is expensed,
the low-income housing credit and allow like-kind
but be brought closer to the treatment of some intangible
exchanges for real estate but not for other property. It
investments).
would restrict a number of provisions for insurance
companies.
The economic effects of the tax cut would likely be small in
the longer run and eventually contractionary through the
International Business Tax Provisions
crowding out of investment from increased debt, although
Under current law, worldwide income of U.S.
there may be some increase in output in the short term from
multinationals is taxed, but the tax on earnings of foreign
demand stimulus.
subsidiaries is delayed until the income is repatriated (paid
as dividends to the U.S. parent). Firms may take a credit
A territorial tax would tend to increase profit shifting,
against U.S. tax for taxes paid to foreign jurisdictions,
although the base erosion provisions aimed at reducing it
although these credits are limited to U.S. tax due. Credits
could offset that effect to some extent. The change
from high-tax jurisdictions can be used to offset U.S. tax on
eliminates the disincentive to repatriate foreign source
income from low-tax jurisdictions (cross-crediting). U.S.
income. The effects on capital inflows from abroad are
firms have accumulated a large amount of untaxed earnings
uncertain in direction, since lower rates and expensing
abroad, including a significant share held in cash and cash-
reduce the tax on equity capital but also reduce the subsidy
like assets.
for debt, an effect that would be increased if some interest
deductions are disallowed.
The bill moves toward a territorial tax (where foreign
source income would not be subject to regular U.S. tax).
The JCT has provided estimates of effective tax rates by
The bill also has a deemed repatriation of existing
income class before and after the bill. Converting these
accumulated income subject to tax of 14% for cash and 7%
estimates to percentage changes in income after tax for
for earnings invested in illiquid form. A territorial tax
2019, the overall increase in income after the current
encourages more profit-shifting (artificially moving profits
federal income tax is 1.6%. For incomes under $40,000, it
abroad) and the bill would tax, on a current basis, half of
ranges from 0.5% to 0.8%; for incomes of $40,000 to
high-income earnings in excess of a return (7% plus the
$50,000, it is 1%; for incomes of $50,000 to $500,000, it
federal short-term rate) on tangible assets. The bill would
ranges from 1.4% to 1.6%; for incomes of $500,000 to $1
also deal with profit shifting by leveraging and other
million it is 2.2%; and for incomes over $1 million it is
approaches, such as the payment of high royalties from U.S.
3.9%.
firms to foreign affiliates, by limiting the share of global
interest deducted by firms with foreign affiliates to 110% of
For 2027, the overall increase in income is 0.6%. For
their share of income and imposing a 20% tax on deductible
incomes under $40,000, it ranges from 0% to 0.5% (the
payments of U.S. firms to foreign affiliates unless they elect
$20,000 to $40,000 group has no tax reduction); for
to treat the income as U.S. source.
incomes from $40,000 to $50,000, 0.2%; for incomes from
$50,000 to $500,000, from 0.5 to 0.8%; for incomes from
The foreign tax credit would be largely eliminated, but
$500,000 to $1 million, 1.0%; and for incomes over $1
would be retained for income subject to taxation, including
million it is 2.2%. The smaller benefits over time reflect, in
branch income and income taxed under anti-abuse rules
part, the inflation adjustment.
already in existence. The credit would be allowed for the
high return earnings (taxed at 10%) for 80% of foreign tax
Equity and fairness concerns might also be raised about the
credits, with this income separated to prevent cross
elimination of the medical expense deduction, since
crediting, and against the tax on payments for 80% of
taxpayers with extraordinary medical expenses generally
credits.
have a lower ability to pay. Eliminating itemized
deductions for casualty losses, employee business expenses,
The Estate and Gift Tax
and investment expenses result in an overstatement of
The current estate tax exemption of $5.49 million (which is
income for affected taxpayers.
adjusted for inflation) will be doubled, and repealed after
2024. Stepped up basis (which allows the heir to exclude
Some parts of the bill will simplify the tax code. The share
any gain accrued to the estate during the decedent’s life)
of taxpayers (currently about a third) who itemize will
would be retained. The gift tax would be retained with the
likely be reduced significantly due to the restrictions on
doubled exemption and a lower rate of 35% (from 40%).
itemized deductions and the increase in the standard
deduction. The elimination of exclusions of fringe benefits
Revenue, Economic, Distributional, and
could complicate compliance, but the elimination of an
Administrative Issues
array of deductions and credits could reduce it. The low tax
The Joint Committee on Taxation has estimated a 10-year
on capital income of pass-throughs may lead to
revenue loss from FY2018 to FY2027 of $1.437 trillion
complication as well.
from the bill.
Jane G. Gravelle, Senior Specialist in Economic Policy
The bill would appear to reduce some distortions in the
current system, such as that between debt and equity, and
IF10772
https://crsreports.congress.gov

Tax Reform: H.R. 1, Tax Cuts and Jobs Act

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