Tax Reform: The Senate Tax Proposal

Tax Reform: The Senate Tax Proposal

Updated December 4, 2017
Tax Reform: The Senate Tax Proposal
The Tax Cut and Jobs Act (H.R. 1) was passed by the
Some items currently excluded from income would be
Senate on December 2, 2017. The bill contains some
included—for example, the employer-provided exclusion
elements of the House tax reform blueprint, the “Better
for moving expenses and gain from sale of a home for those
Way,” released in 2016.
who have lived in their homes less than five years.
Individual Tax Revisions
The bill also uses the chained Consumer Price Index (CPI)
In general, the individual tax revisions would expire after
measure of inflation to index rate brackets and other
2025, except for the change in inflation indexing and the
parameters such as the standard deduction. Although many
reduction in penalties for not having health insurance.
economists believe that this measure is a better measure of
inflation, using it would have the effect of raising taxes
The bill would replace the current seven rate brackets (10%,
compared with using the regular CPI.
15%, 25%, 28%, 33%, 35%, and 39.6%) with tax rates of
10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. The rate
The bill would reduce penalties for not purchasing health
brackets indicate that the 10% rate will apply to about the
insurance to zero.
same amount of taxable income as in current law and that
the income currently taxed at 15% would be taxed at 12%.
Tax Provisions Affecting Businesses
The current top rate of 39.6% applies to taxable income
Some of these provisions would expire after 2025,
above $470,700, but the 38.5% rate in the bill would not
including the deduction for unincorporated businesses.
apply until $1 million of taxable income for joint returns of
married couples ($500,000 for other returns).
The bill would reduce the corporate tax rate from 35% to
20% and allow a 23% deduction for businesses that are
The bill would alter some of the elements related to family
taxed under the individual income tax as pass-throughs,
size and structure by eliminating personal exemptions and
including proprietorships, partnerships, or Subchapter S
allowing a larger standard deduction, $24,000 for joint
corporations (corporations with a small number of
returns and $12,000 for singles for 2018, adjusted for
shareholders that elect to be taxed at individual rates). The
inflation for the following years. The bill would increase
23% deduction sunsets after 2025. The deduction does not
the current child credit of $1,000 by $1,000 (although the
apply to specified service businesses (such as health or law)
additional credit would be nonrefundable). The age limit
except for those under a taxable income ceiling of no more
would be increased by a year to under 18 through 2024. The
than $500,000 for a joint return and $250,000 for others.
maximum share refundable would be indexed for inflation.
The deduction applies to qualified business income and
A nonrefundable credit of $500 for non-child dependents
does not include amounts paid by an S corporation as
would be allowed. The credits would be phased out at
compensation or amounts distributed by a partnership for
higher income levels of $500,000 for joint filers. The
services. For partnerships or S corporations, the deduction
current personal exemption is $4,050 per person for 2017,
is limited to 50% of wages allocable to business income for
and the current standard deductions are $12,700 for joint
those above the taxable ceiling. Business losses that can be
returns and $6,350 for single returns. Exemptions for the
passed through are limited to $500,000 for joint returns and
alternative minimum tax would be increased by 40% (for
$250,000 for others, indexed for inflation.
example, from $78,750 to $109,400 for joint returns).
Under current law, up to $500,000 in equipment can be
For the individual income tax, the bill would broaden the
expensed, phased out after $2 million in spending. The bill
base by disallowing most itemized deductions except for
would increase the limit to $1 million with a phase-out after
mortgage interest (limited to interest on mortgages of $1
$2.5 million. The bill allows all equipment to be expensed
million as in current law but with no deduction for interest
through 2022 with public utility property excluded, with a
on home equity loans), property taxes (up to $10,000),
phase-out of the share expensed over the next four years
charitable contributions deductions, and medical expense
(80%, 60%, 40% and 20%). Nonresidential real property
deductions (lowering the floor from 10% to 7.5% of
and residential rental property could be depreciated over 25
income). The deductions for other state and local taxes,
years. Qualified leasehold, qualified restaurant, and
casualty losses (except for certain disasters), and other
qualified retail improvement property could be depreciated
minor provisions would be eliminated. The moving expense
over 10 years. Deductions for excess interest for
deduction (an above-the-line deduction) would be
corporations would be more limited than in present law.
eliminated (other than for members of the armed forces).
Research and experimentation costs would be depreciated
over five years rather than expensed, after 2025.
The current earned income credit and tax rates on capital
gains and dividends are not changed.
The bill would repeal the Section 199 production activity
deduction. It would disallow carrybacks of net operating
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Tax Reform: The Senate Tax Proposal
loss deductions, allow unlimited carryforwards, and limit
Revenue, Economic, Distributional, and
the deduction to 80% of taxable income after 2023. It
Administrative Issues
would limit or repeal a variety of other deductions and
The Joint Committee on Taxation (JCT) has estimated a 10-
credits (e.g., the orphan drug credit, credits for
year revenue loss from FY2018 to FY2027 of $1.448
rehabilitation, and deductions for meals and entertainment
trillion from the bill, with a gain in 2027.
and transportation fringe benefits, and FDIC payments). It
would retain the research credit and the low-income
The bill would appear to reduce some distortions in the
housing credit and allow like-kind exchanges for real estate
current system, such as that between debt and equity, and
but not for other property. It would restrict a number of
across different asset types. A macroeconomic analysis of
provisions for insurance companies.
the bill as originally reported out of committee showed an
offset of 32% of the revenue loss from economic growth of
The corporate alternative minimum tax is retained.
0.08% per year.
International Business Tax Provisions
A territorial tax would tend to increase profit shifting,
Under current law, worldwide income of U.S.
although the base erosion provisions aimed at reducing it
multinationals is taxed, but the tax on earnings of foreign
could offset that effect to some extent. The change
subsidiaries is delayed until the income is repatriated (paid
eliminates the disincentive to repatriate foreign source
as dividends to the U.S. parent). Firms may take a credit
income. The effects on capital inflows from abroad are
against U.S. tax for taxes paid to foreign jurisdictions,
uncertain in direction, because lower rates and expensing
although these credits are limited to U.S. tax due. Credits
reduce the tax on equity capital but also reduce the subsidy
from high-tax jurisdictions can be used to offset U.S. tax on
for debt, an effect that would be increased if some interest
income from low-tax jurisdictions (cross-crediting). U.S.
deductions are disallowed.
firms have accumulated a large amount of untaxed earnings
abroad, including a significant share held in cash and cash-
The JCT has provided estimates of effective tax rates by
like assets.
income before and after the tax change for the bill as
reported out of the Finance Committee. Converting these
The bill moves toward a territorial tax (where foreign
estimates to percentage changes in income after tax for
source income would not be subject to regular U.S. tax).
2019, the overall increase in after-tax income is 2%. For
The bill also has a deemed repatriation of existing
incomes under $40,000, it ranges from 0.3% to 0.8%. For
accumulated income subject to tax of 14.5% for cash and
incomes of $40,000 to $50,000, it is 1.1%. For incomes of
7.5% for earnings invested in illiquid form. (A tax of 35%
$50,000 to $200,000, it is 1.5% to 1.8%. For incomes from
is imposed retroactively if a firm inverts within 10 years.) A
$200,000 to $500,000, it is 2.9%. For incomes of $500,000
territorial tax encourages more profit-shifting (artificially
to $1 million, it is 4.5%. For incomes over $1 million, it is
moving profits abroad), and the bill would tax, on a current
3.1%.
basis, global intangible low taxed income (GILTI) in excess
of 10% of assets. Foreign derived intangible income,
For 2027, the JCT estimates no overall increase in after-tax
including GILTI, would be eligible for a 37.5% deduction,
income. For incomes under $50,000, it ranges from -0.3%
with the deduction for foreign derived intangible income
to -1.5% (higher taxes). For incomes from $50,000 to
reduced to 21.875% after 2025. The bill would also deal
$500,000, it ranges from -0.1% to 0.1% (a negligible
with profit-shifting by limiting the share of global interest
change). For incomes from $500,000 to $1 million, after tax
deducted by firms with foreign affiliates to 110% of their
income increases by 0.4% and for incomes over $1 million,
share of assets (phased in over four years beginning at
it increases by 0.6%. The smaller benefits or increased
130%). The proposal also provides a special rule to limit
taxes over time reflect, in part, the inflation adjustment, as
the value of intangible property distributed to the U.S. firm.
well as the sunset of individual tax changes.
A 10% tax, increased to 12.5% after 2025, is imposed on
deductible payments to related foreign parties by U.S. firms
Equity and fairness concerns might also be raised about the
(the base erosion and anti-abuse tax), with some exceptions
elimination of itemized deductions for casualty losses and
for service payments.
employment and investment expenses that can result in an
overstatement of income for affected taxpayers. Equity
The foreign tax credit would be largely eliminated but
issues might also be raised about allowing state and local
would be retained for income subject to taxation, including
income tax deductions for corporations and not individuals.
branch income and income taxed under anti-abuse rules,
although a separate limit on the foreign tax credit would be
Some parts of the bill will simplify the tax code. The share
applied to branch income and to GILTI (so that cross-
of taxpayers (currently about a third) that itemize will likely
crediting—that is, using excess credits from one type of
be reduced significantly due to the restrictions on itemized
income to offset U.S. tax due on another type—could not
deductions and the increase in the standard deduction. The
occur).
deduction for capital income of pass-throughs may lead to
complications as individuals try to re-characterize income
The Estate and Gift Tax
to be eligible for the deduction.
The current estate tax exemption of $5.49 million (which is
adjusted for inflation) would be doubled, with the increase
Jane G. Gravelle, Senior Specialist in Economic Policy
expiring after 2025.
IF10774
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Tax Reform: The Senate Tax Proposal

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