United States

Full Senate passes tax reform bill with last minute changes

TAX ALERT  | 

The Senate passed its version of tax reform, the Tax Cuts and Jobs Act, in the early morning hours of Saturday, December 2, after making a number of significant changes to gain additional votes. The text of the Senate bill can be found here. The next step is expected to be a conference between the House and Senate–both controlled by Republicans–to resolve their differences, which in some cases are significant. The identical bill language must be agreed to by both bodies before the bill can be sent to the President for his signature.

The bill that passed the full Senate reflects a number of amendments to the Finance Committee version, some of which bring the Senate bill closer into alignment with the House proposal, and suggesting an increased likelihood that the two bodies will be able to quickly reach agreement. The major changes that appear to bring the Senate and House bill closer together include:

  • Preserving the individual deduction for up to $10,000 of property tax deductions, as allowed under the House bill.
  • Increasing the deduction for pass-through business income from 17.4 percent to 23 percent. The 23 percent deduction approximates a top income tax rate on qualifying pass-through business income of close to 30 percent (that is, taxing 77 percent of income at the Senate’s top 38.5 percent rate produces an effective rate of 29.65 percent). In comparison, however, the House bill provides for a still more generous top pass-through rate of 25 percent. On the other hand, for ‘active’ investors that can only apply the House 25 percent rate to 30 percent of their income, and a 39.6 percent rate to the remaining 70 percent, the effective rate could be above 35 percent. The important point is that major differences exist that vary based on facts and circumstances. 
  • Setting the tax rate for repatriated earnings to 14.5 percent (for earnings held in cash) and to 7.5 percent (for other earnings). The corresponding House tax rates are 14 percent and 7 percent, respectively.

Other significant changes to the Senate bill include:

  • Retaining the individual and corporate Alternative Minimum Tax (AMT), with some modifications to the individual AMT. The House bill would repeal both taxes in their entirety.
  • Replacing the immediate expiration of the bill’s allowance of 100 percent expensing, originally planned for 2023, with a phase-out beginning in 2023, thus extending enhanced expensing beyond the original period (the phase-out operates to annually decrease the expensing percentage by 20 percent each year beginning in 2023 and running through 2027).

As a result of the final amendments, the overall cost of the Senate bill has changed as well. The Joint Committee on Taxation (JCT) released an estimate of the revenue effects of the modifications to the passed Senate bill.

  • Notably, the cost of the pass-through tax cuts in the Senate versions are now closer to that of the House, $476 billion for the Senate compared to $600 billion for the House. However, the Senate bill continues to retain a provision, absent from the House bill, limiting ‘active losses’ of some pass-through businesses. That raises approximately $137 billion from the pass-through sector and leaves a significant overall gap of over $260 billion between the House and Senate as to the magnitude of the overall tax cut for pass-through businesses.
  • In addition, as the repatriation tax rates are now more aligned, the resulting revenue raised by the repatriation provisions of the Senate bill will be $297 billion, almost the same as the JCT estimate of the House bill which comes in at $293.4 billion.

Assuming a conference is convened and reaches agreement on final legislation, that final bill may simply reflect a compromise on the remaining items in dispute, or it may introduce entirely new ideas or provisions.

The final Senate vote was 51-49 in favor of passage. Every Senate Democrat voted against the bill, and every Senate Republican voted for the bill except for Sen. Bob Corker (R. Tenn.) who cited his concern with its effect on the deficit. As has been widely reported, the bill will cut taxes by approximately $1.5 trillion over the next 10 years.  

The focus of the cuts is a reduction in domestic corporate income taxes. Whether the bill should provide greater benefits for pass-through businesses and individuals were major issues in the Senate debate. The bill would also make major changes to the treatment of foreign subsidiaries of U.S. corporations, which supporters believe will facilitate the ‘repatriation’ of previously untaxed foreign earnings from prior years. Supporters of the bill argue that the repatriation provisions and the tax reductions for U.S. businesses will lead to overall positive effects on economic growth, and that the taxes on that increased economic activity will recoup a good portion of the bill’s nominal cost. As the close vote indicated, however, there are also many critics of the legislation.

RSM will continue to provide updates regarding developments in the legislative process, as well as regarding the potential impact of the final legislation on specific industries, entity types, and specific fact patterns.

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