November 17th Tax Reform Update
On Thursday, November 16, the House of Representatives passed the Tax Cuts and Jobs Act. The House version of the Act will next go to the Senate for consideration.
However, the Senate Finance Committee completed its markup of the Senate’s version of the Tax Cuts and Jobs Act late on Thursday, November 16. There remain significant differences between the two bills, and it does not appear that either version of the Act will pass both chambers of Congress before Thanksgiving. In fact, the Senate will likely not consider its version of the Act until after the Thanksgiving break.
During the Senate Finance Committee’s markup session, a controversial section was added, which would repeal the Affordable Care Act’s individual mandate. As a result of the markup, one Republican Senator has already stated that he will not vote to pass the Act as written, and at least four other Republican Senators are raising concerns and have not offered support for the Act. The Republicans hold a slight majority of 52-48 in the Senate, and with one Republican Senator already voicing opposition, any additional opposition from Republican Senators may put tax reform in serious doubt for this year.
Many experts are raising concerns regarding the treatment of pass-through income for partnerships (including LLCs taxed as partnerships) and S Corporations, as compared to the flat 20% rate on corporate income for C Corporations, and the differences between each chamber’s proposal.
The House’s version of the Act lowers the maximum rate on distributions from a pass-through entity treated as business income to 25%. However, partners or S Corporation shareholders receiving distributions from active business activities would be required to treat the distributions as 30% business income and 70% wages, with the wage portion taxed at the individual’s ordinary rates, unless a more favorable ratio exists based on capital investment. Passive owners and shareholders would treat 100% of the distributions as business income, subject to the maximum 25% rate. Additionally, a 9% tax bracket (in lieu of the lowest individual 12% bracket) was created for business income of active owners and shareholders earning less than $150,000 in taxable income from a pass-through business. The 9% rate would be phased out at income levels exceeding $225,000, and the legislation also phases-in the lower rate over four years (11% for 2018/19, 10% for 2020/21). While the 25% rate does not apply to personal services pass-through entities such as the practice of law, medicine, or accounting, the 9% rate applies to all types of businesses.
The Senate’s bill does not lower the maximum rate but instead approaches pass-through income by providing a deduction to individuals with domestic qualified business income from a partnership, S Corporation, or sole proprietorship. Qualified business income is limited and does not include personal services, performing arts, athletics, financial services, engineering, or architecture, unless the taxpayer’s income does not exceed $500,000. The deduction would be equal to 17.4% of the qualified business income from such pass-throughs, and be limited to 50% of allocable W-2 wages paid by the entity for a taxpayer who has qualified business income. The limitation only applies to individuals with more than $500,000 in taxable income. This deduction would expire at the end of 2025 in the Senate’s bill, along with all other individual tax cuts.
The Tax attorneys at Koley Jessen are keeping a close watch on Tax Reform. Please contact us with any questions.