TAX CUTS AND JOBS ACT
COMPARISON OF KEY BUSINESS RELATED PROVISIONS OF THE HOUSE AND SENATE BILLS
DECEMBER 7, 2017

Commentary:
            On account that key parts of the Senate's versions passed on such a narrow margin, 51 to 49, we expect the bulk of the Senate provisions to be retained in the conference committee negotiations with the House. Unlike the simple majority needed to pass the forthcoming Conference Committee legislation, any subsequent technical correction act is not likely as it would require 60 votes in the Senate.

Estate, Gift, and Generation-Skipping Transfer Taxes
House
    •     Permanently doubles the basic exclusion amount for estate and gift tax purposes from $5 million to $10 million (indexed for inflation occurring after 2011) for estates of decedents dying and gifts made after December 31, 2017.
    •     Repeals the estate and generation-skipping transfer taxes for estates of decedents dying, gifts made, and generation-skipping transfers made after December 31, 2024.
    •     Reduces the gift tax rate from 40 percent to 35 percent for gifts made after December 31, 2024.
Senate
    •     Doubles the basic exclusion amount for estate and gift tax purposes from $5 million to $10 million (indexed for inflation occurring after 2011) for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026.

2018 Business Income
I. House 25% Reduction of Maximum Tax Rate on Business Income
            1. House - Provides for 70% of non-passive (active) business income to be treated as wages (without changing current law payroll tax treatment) subject to normal rates with the balance of Qualified Business Income of 30% subject to the lower rate. By election covering 5 years, the 70/30 ratio may be substituted with an alternative Capital Percentage. That formula would annually measure the capital percentage based on a rate of return (the Federal short term rate plus 7 percent) multiplied by the capital investments of the business.
            Interestingly enough, personal service businesses would not be allowed to use the 70/30 ratio, but could elect the facts and circumstances Capital Percentage.
            100% of net passive income would be subject to the 25% rate but not investment income (interest, dividends, capital gains, annuities etc...)
            2. House - Subject to a 5 year phase-in and an income phase-out, the first $75,000 of an active owner’s net business taxable income would be subject to a 9-percent rate in lieu of the ordinary 12-percent rate. The benefit phases-out for taxable incomes between $150,000 and $225,000.
            3. House - Repeals the Individual Alternative Minimum Tax (AMT).

Commentary:
            As discussed below, for businesses that currently benefit from the 9% Domestic Production Activities Deduction (DPAD), such as those in construction and manufacturing, it is very possible that the House's repeal of the DPAD will increase their effective income tax rates by .9%. See comment regarding the Senate version below.
            The effective marginal income tax maximum rate would be 36.91% (30% of qualified income x 25% ceiling rate plus 70% x 39.6% ordinary tax rate.)
            The House turns taxation of passive activities on its head by applying the 25% rate to 100% of passive activity income, but only 30% of such income if the taxpayer materially participates (so-called 750 hour, 500 hour, more hours than anyone else and activity grouping election rules.) Though we think the Senate version will survive the Conference Committee, the passive activity rule might be easily gamed by married individuals exchanging ownership and filing separately. Further, in the case of sale gains and positive operating income all of which would be subject to the lower 25% income tax rate when the taxpayer(s) do not materially participate, the US Tax Court placed such onerous evidentiary burdens in order to prove hours of active participation, that in most situations it would be almost impossible for the IRS to dispute a taxpayer's assertions that they are passive owners and do not materially participate.
            The House's proposed repeal of the individual AMT is basically offset by repeal or limitations on the deductibility of many itemized deductions. However, for taxpayers with business credit carryovers such as Energy, Research and Experimentation credits, these carryovers will no longer be limited.

II. Senate - Accomplishes Rate Reduction Via a New 23% Deduction for Qualified Business Income.
            1. Excludes personal service businesses
            2. Definition of qualified business income is similar to House described above.
            3. Deduction is limited to the lesser of Qualified Business Income or 50% of W-2 wages of the business, but only for taxable incomes starting at $250k/$500k single/married, as indexed for inflation.
            4. Qualified Business Income excludes reasonable compensation and guaranteed payments to the taxpayer(s).

Commentary:
            To help avoid enhanced accuracy related penalties, formal disclosure of reasonable compensation should be made with the tax return.
            For businesses without employees, formation of single member S corporations (or partnerships with 1% minority owners) could be a loophole if it is not closed by the Conference Committee. The marginal business income tax rate would be 29.645% (100%-23% times maximum ordinary tax rate of 38.5%)
            Like the House Bill, the 9% Domestic Production Activities Deduction (DPAD), such as those in construction and manufacturing, is repealed for 2018 (except for C corporations in 2019.) In general, the DPAD repeal represents a 3.564% increase in tax rate on the income previously benefiting from the DPAD.
            Unlike the House, the Senate does not repeal the individual AMT, but rather increases in the AMT exemption amount ($109,400/$70,300) and the exemption amount phase-out thresholds ($208,400/$156,300). Commentary. The individual AMT tax rate ranges from 26% to 28%.
            The $250k/$500k single/married limitation threshold means that the smallest of businesses will benefit from the 23% deduction proposal, regardless of amount of employee compensation, if any.
            Many non-business provisions including the AMT revert back to present law after 2025.

III. Flat C Corporation Rate Reduced to 20%
            1. House is effective for tax years beginning after 2017 and includes repeal of the Corporate AMT. Personal Service Corporations would have a 25% rate, down from 34%.
            2. Senate is effective for tax years beginning after 2018. The Flat rate would not apply to Personal Service Corporations.
            3. Both House and Senate include provisions limiting the benefit of the dividends received deductions with the 2017/2018 effective date regime.

Commentary:
            Active (not passive) S corporation businesses converting to C corporation status (in order to take advantage of building up working capital at such a low rate) would retain their ability to distribute previously taxed accumulated earnings (so-call accumulated adjustment account or AAA.)
            The Senate bill does not repeal the Alternative Minimum Tax applicable to C corporations. In general, AMT applies to C corporations with average gross receipts in excess of $7.5 million and, among other items, treats the difference between financial statement income and taxable income as an item of AMT adjustment.

Depreciation Under Section 168:
            1. House and Senate: Section 168(k) bonus depreciation would rise to 100% for "new" qualified property placed in service after September 27, 2017 and, in general, before January 1, 2023.
            House Only - "Used" property acquired by purchase, but excluding those businesses subject to interest expense limitation described below.
            2. Both increase by a factor of 2x the listed vehicle depreciation allowance.
            3. Senate only [Section 13204]: Effective for property placed in service after 12/31/2017, shortens the 39 and 27.5 real estate recovery periods to 25 years.

Depreciation under Section 179 - Expensing of Equipment
            1. House - Effective 2018-2022, current law limitations increased to $5 mil, $20 mil aggregate, and expanded to also apply to certain efficient heating and AC systems retroactive to 11/2/2017.
            2. Senate - Effective for tax years beginning after 2018, limitations increased to $1 mil, $2.5 mil aggregate.
            3. Senate - Placed in service in taxable years beginning after December 31, 2017, by election, commercial real estate improvements to roofs, HVAC, fire protections and security alarms.

Net Operating Loss (NOLs) Limitations
            In general, both House and Senate limit NOLs to 90% and bar carry backs, particularly for losses caused by above depreciation liberalization. Effective dates are tax years beginning after December 2017. Senate proposal includes a phase-in limitation expanding the 90% to 80%. Also see the Senate's $250k/$500k limitation on excess business losses treated as NOL carryovers.

Interest Expense Limitations [IRC Section 163(j)] Effective tax years beginning after 12/31/2017
            1. House and Senate - Interest expense deduction for most businesses with gross receipts in excess of the following thresholds are limited to 30% of adjusted taxable income.
                a. House $25 mil. Disallowed interest carried over 5 years on a FIFO basis.
                b. Senate $15 mil. No restrictions on carry over of disallowed interest.
                c. Senate allows election to deduct 100% if accompanied by ADS depreciation election.

House Only IRC Sec 48 and 25D:
            30% investment tax credit (ITC) for certain Energy Investments (including solar and wind) phased out starting in 2020. Similarly, there is a retroactive extension for residences.
            The 10% ITC applicable to geothermal installations is eliminated in 2027.

Repeal of 9% Domestic Production Activities Deduction [IRC Section 199] (excludes Puerto Rico)
            1. House - Effective tax years beginning after 2017.
            2. Senate - Effective tax years beginning after 2017 for non-corporate taxpayers and to C corporations after 2018.

Like-Kind Exchanges of Real Property [IRC Section 1031]
            Effective for 2018 exchanges, both House and Senate, in essence, repeal like-kind-exchanges for everything but real estate.

Methods of Accounting
            Exempting small business with average receipts of less than $25 million in the House and $15 million in the Senate:
            1. Cash Method of Accounting - Both retain the non-corporate use of cash basis method of accounting and expands the current $5 million corporate limitation.
            2. Non-incidental Materials and Supplies - Both proposals exempt small businesses from Uniform Capitalization Rules with financial statement conformity.
            3. Accounting for long-term contracts - Both proposals expand the exception for small construction contracts from the requirement to use the percentage of completion method.

Partnership Profits Interests
            Both Senate and House include a new provision extending the 1 year long term capital gain holding period to 3 years for the sale of profits interests. These interests are frequently issued to non-capital contributing members of partnerships who instead provide services and often are accompanied by Section 83(b) elections.

Commentary:
            There is an exclusion for interest held by corporations, but due to a 3 year look back rule it is unclear whether holding such interest through an S corporation would circumvent that outcome, if such interest where transferred before enactment.

Repeal of Section 174 Expensing of Research and Experimentation Expenses.
            With effective dates after 2022 and 2025 (House and Senate respectively), the new tax proposals include mandatory 60 month amortization of R&E expenses. Currently, that is not required for materially participating owners.

Both House and Senate Proposals modify exclusion of gain from sale of a principal residence by narrrowing the holding period requirement that a taxpayer must live in the residence for 5 out of the 8 prior taxable years with the exclusion applying only to 1 residence every 5 years. The House's version is even more restrictive and includes a modified adjusted gross income test of $250k/$500k, single/married.

Both House and Senate Proposals contain significant changes to taxation of foreign income and foreign persons including look-through rules for related controlled foreign corporations (CFCs).

Both House and Senate include proposal for an excise tax based on investment income of private colleges and universities. There are also significant changes to UBIT rules.

Selective Important Miscellaneous House (only) Provisions
            1. Repeal of deduction for alimony payments (and corresponding inclusion in gross income) generally for decrees issued after 2017.
            2. Limitation to so-called security guard housing - Limit income and FICA tax exclusions to $50,000 (phased out based on compensation level) for employer-provided housing.
            3. Sunset $5,000 income and FICA tax exclusions for dependent care assistance programs—exclusion ends December 31, 2022.
            4. Disallows deduction for expenses associated with entertainment activities, membership dues, de minimis fringes that are primarily personal in nature, and facilities associated with any of these. Repeals present-law exception for expenses associated with recreational, social, or similar activities primarily for the benefit of rank-and-file employees. Disallows deduction for expenses associated with entertainment meals, including meals in connection with recreational, social, or similar activities primarily for benefit of rank-and-file employees.
            5. Applicable to Corporations and Partnerships - Under the House provision, the gross income of a corporation or partnership would include contributions to its capital, to the extent the amount of money and fair market value of property contributed to the entity exceeds the fair market value of any ownership interest that is issued in exchange for such money or property. The provision would be effective for contributions made and transactions entered into after the date of enactment. The provision is intended to remove a Federal tax subsidy for State and local governments to offer incentives and concessions to businesses that locate operations within their jurisdiction (usually in lieu of locating operations in a different State or locality). Commentary: Though not the intent of the provision, this could preclude the owners from contributing capital for the purpose of paying off entity level liabilities due to themselves. This is significant for partners holding promissory notes with tax basis below the face value of the notes. Likewise, such entities may not be able to escape ordinary income tax treatment on debt forgiveness income from the discharge of such liabilities occurring either voluntarily or as a consequence of having no assets to pay such indebtedness.
            6. Self-created Patent, Invention, Model or Design. Whether or not patented or secret formula or process, both the House and Senate proposals bar capital asset treatment. Rather, gain or loss from the disposition of self-created assets, similar to copyrights of literary, musical or artistic compositions, would be ordinary in character. However, the election to treat as capital asset with respect to musical compositions would continue. The provision would be effective for dispositions of such property after 2017. Similarly, the special capital gain rule for sale or exchange of patents would be repealed. Commentary: Holders of such assets might consider an installment sale of such assets into an S corporation on or before December 31, 2017.
            7. Repeal of technical terminations of partnerships (Section 708).
            8. Repeal of deduction for certain unused business credits. Commentary. In many cases, the House's repeal of the individual AMT, if also enacted, would likely result in those credits being allowed.
            9. Modification of credit for portion of employer social security taxes paid with respect to employee tips.
            10. Modification of the energy investment tax credit and the extension and phase-out of residential energy efficient property credit.
            11. Termination of private activity bonds.

Selective Important Miscellaneous Senate (only) Provisions
            1. Limitation on Deduction of Excess Business Losses of Non-Corporate Taxpayers - Effective for years beginning after 2017 and before January 1, 2016, the amount by which the aggregation of income and deductions from all trades or businesses (after applying Passive Activity Rules of Section 469) nets to a loss which exceeds 250k single, 500k married (indexed for inflation), are disallowed and carried over as a Net Operating Loss. Commentary: This provision of the Senate proposal will result in the limitation of net business losses from offsetting more than 250k/500k of investment income (interest, dividends, net capital gains, certain annuity income etc...).
            2. Eliminates ACA individual shared responsibility payment for failure to obtain required health coverage.
            3. Disallows deduction for expenses associated with entertainment activities, membership dues, and facilities associated with any of these. Disallows deduction for expenses associated with entertainment meals. Applies 50-percent deduction limitation to expenses associated with providing meals for the convenience of the employer on the employer’s business premises, or on or near the employer’s business premises through certain employer-operated eating facilities; further expands deduction disallowance to 100 percent after December 31, 2025.
            4. Prohibition on cash, gift cards, and other non-tangible personal property as deductible employee achievement awards.
            5. Modification of the definition of the $250,000 substantial built-in loss in the case of transfer of partnership interest.
            6. Force average costing of specified securities determined without regard to identification. Commentary: If you own batches of securities with both high and low basis, you may consider selling the high basis securities before December 31, 2017 and reinvesting in another investment to avoid the averaging of low and high basis in to a single average.
            7. Action Section 13801 through 13808 contains significant benefits for craft brewers and distillers.
            8. Modification to source rules involving U.S. Virgin Islands.


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