The official process to potentially make the biggest changes to the U.S. tax code since 1986 has begun. As the draft legislation introduced Nov. 2 makes its way through Congress, South Carolina’s legislators are working to assess how the proposed changes will affect the Palmetto State.
Statehouse numbers crunchers are working with various options to try and predict the potential impacts at the state level – what might increase and be a revenue increase for the state, but at what cost to taxpayers, and what might decrease constituting a tax savings to the people.
“There are a lot of moving parts,” said Jeff Thordahl, lobbyist and consultant for Copper Dome Strategies. “There is more uncertainty than usual this year because of the potential changes at the federal level. We don’t know if anything is going to pass, much less what it is.” Until federal legislators make their decision, it will be difficult for South Carolina’s legislators to know how the proposed tax reform will impact the state. While South Carolina typically conforms to federal tax code, sometimes decoupling from a few provisions, the uncertainty in Washington, D.C. is making the decision on conformity very difficult.
“Ultimately, it’s the General Assembly’s decision on whether to adopt everything and conform, or adopt a portion of the legislation and decouple from some provisions. Our position is to encourage them to make a decision as quickly as possible to reduce the uncertainty for tax preparers and taxpayers," Thordal said.
The draft tax reform legislation introduced by the House Ways and Means Committee includes the “Tax Cuts and Jobs Act,” H.R. 1, which features new tax rates, a lower limit on the deductibility of home mortgage interest, the repeal of most deductions for individuals, and full expensing of depreciable assets by businesses. It also would result in a net total revenue loss of $1.487 trillion over 10 years, according to the Joint Committee on Taxation. Movement on the bill could happen fairly quickly; under Senate budget reconciliation rules, the measure needs only 51 votes to pass.
The provisions of the bill affect individuals and businesses alike, changing many familiar mainstays of the current tax code.
The current code’s seven individual income tax brackets would be reduced to four: 12%, 25%, 35% and a final bracket that remains at 39.6%. Single taxpayers with income greater than $500,000 and married taxpayers filing jointly with income greater than $1 million would enter the 39.6% rate. The standard deductions would increase to $12,200 for single taxpayers, and $24,400 for married couples filing jointly.
However, the bill repeals most other deductions, including those for alimony, medical expenses and tax preparation fees. It also eliminates the deduction for state and local income or sales taxes, except in the case of taxes paid in carrying out a trade or business or producing income.
The bill also would repeal the deduction for interest on education loans and the deduction for qualified tuition and related expenses, as well as the exclusion for interest on U.S. savings bonds used to pay qualified higher education expenses, the exclusion for qualified tuition reduction programs, and the exclusion for employer-provided education assistance programs. In addition, the personal exemption is proposed to be eliminated which fo a family of four in 2017 is roughly $16,000.
Many credits are also repealed in the bill, including those for adoption, plug-in electric vehicles and individuals over age 65 and who are disabled. One notable exception is the child tax credit, which increases to $1,600 and is expanded.
Deductions for mortgage interest, however, would be retained. The mortgage interest deduction on existing mortgages would remain the same; for newly purchased residences (after Nov. 2, 2017), the limit on deductibility would be reduced to $500,000 from the current $1.1 million. The overall limitation of itemized deductions would also be repealed.
Estate taxes would be eliminated by 2023 under the bill (the step-up in basis for inherited property would remain), with the current exclusion amount doubling until that time. The Alternative Minimum Tax (AMT) would be repealed.
Under the bill, a portion of net income (generally 30%) from passthrough entities would be taxed at a maximum rate of 25%, instead of at ordinary individual income tax rates. More restrictive rules are proposed for professional service firms (including taxpayers in the fields of law, accounting, consulting, engineering, financial services or performing arts). The AICPA has previously stated that it is important for lawmakers to recognize that professional service firms, such as accounting firms, are an important sector in our economy. They heavily contribute to the nation’s goals of creating jobs and driving better wages. The AICPA has also stressed that tax reform should recognize the importance of consistent tax rates on business income generated from all of America’s passthrough entities.
For businesses, the four current corporate rates would be replaced by a flat 20% rate, with a 25% rate for personal service corporations and a repeal of the corporate AMT. The cash accounting method would be expanded for corporations, with a new limit of $25 million of average gross receipts.
The deduction of net operating losses (NOLs) would be limited to 90% of taxable income, with an indefinite carryforward period. However, for most businesses, carrybacks would no longer be available.
The bill would provide 100% expensing of qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (with an additional year for longer-production-period property). It would also increase the Sec. 179 expensing limitation ceiling and phaseout threshold to $5 million and $20 million, respectively. Both would be indexed for inflation.
In an effort to repatriate offshore earnings and profits (E&P), H.R.1 would require U.S. companies with foreign subsidiaries to include previously untaxed offshore E&P in income. The portion of E&P attributable to cash or cash equivalents would be taxed at a 12% rate; the remainder would be taxed at a 5% rate. U.S. shareholders can elect to pay the tax liability over eight years in equal annual installments of 12.5% of the total tax due.
What is the timeline in D.C.? That is the million dollar question, Thordahl said. “This is classic American politics. It’s believable nothing will happen. Our worst-case scenario is that something passes at the last minute, mucking up our opportunity to get something passed at the state level. We are all over the map on possibilities this year and with such a big impact, the changes will have to be weighed more carefully. If something passes, it will be significant.”
While the full bill weighs in at 429 pages, a 76-page summary is also available. The Senate Finance Committee is reportedly also working on tax reform legislation to be unveiled the week of Nov. 6. As a separate bill, it could be different from H.R.1.
To stay on top of developments and the profession’s advocacy efforts, visit the AICPA’s Tax Reform Resource Center at www.aicpa.org/taxreform.