The Tax Cuts and Jobs Act: What Practitioners Need to Know

By:
Ben Lederman, CPA
Published Date:
Dec 1, 2017

Coming into its first year, the Trump administration set two major goals—one, to repeal or replace the Affordable Care Act (ACA), also known as Obamacare, and two, to reform the tax code, primarily through tax cuts. After failing to pass ACA repeal several times, Congress and the Trump administration have moved on to tax reform. The House and Senate released bills, both named the Tax Cuts and Jobs Act, with the House voting to pass its version on Nov. 16. While the details of tax reform change daily, the general outline has remained the same for months.

In general, the plans call for a change to territorial taxation from the current worldwide taxation in effect, meaning corporations would pay tax only on profits earned in the United States—although initially, as part of the transition to territorial taxation, there would be a one-time tax on foreign profits held overseas. The plans also generally reduce rates and will allow for fewer deductions, based on the belief that these changes will bring greater economic growth, offsetting the reduction in tax revenue from the rate reduction in part (if not in whole).

On the entity side, the House bill calls for a reduction in the corporate statutory rate to 20% from its current 35%. The House plan would change rates in 2018, while the Senate plan would delay the change until 2019. The corporate alternative minimum tax (AMT) would be repealed. Pass-through income would be taxed at a maximum of 25%, rather than at the owner’s ordinary marginal rate subject to certain restrictions and calculations. Generally speaking, there would be an acceleration in fixed asset expensing—both plans call for enhanced bonus depreciation and section 179 depreciation.

On the individual side under the House plan, the number of brackets would be reduced from seven to three, and the rates for the new brackets would be 12%, 25%, and 35%. The Senate plan keeps the current seven brackets but cuts each bracket’s rate. Personal exemptions would be eliminated under both plans, but the standard deduction would be doubled. The AMT would be repealed. The Senate’s plan differs in that it keeps the current seven brackets but reduces the tax rates.

At first glance, it looks like there is a tax planning opportunity around employment and LLCs. Professionals might want to restructure their employment so that they get paid through an LLC, thus capping their tax rate on some of their income at the pass-through rate of 25% rather than the 35% top rate on ordinary income. Both bills, however, explicitly disallow specified active services, meaning professional activities such as accounting, consulting, and medicine, from taking advantage of this preferred rate.

Itemized deductions would be severely curtailed under both plans. The House bill allows for just three itemized deductions: charity, which would have no changes; mortgage interest, which would be limited after $500,000 instead of the current $1,000,000; and real estate taxes, subject to a $10,000 limit. Republican representatives from the Tri-state area expressed concern that their constituents would be hurt by such a policy, especially with the elimination of the state and local tax (SALT) deduction; however, this did not prevent the bill from being passed on Nov. 16. The Senate bill eliminates SALT entirely but maintains the medical and mortgage deductions as currently established.

The estate tax exemption would be immediately doubled under both plans. The House bill then phases it out over six years, while the Senate plan leaves it in place.

While there was previously discussion of making the plan revenue neutral, the House bill as written (before amendments) is estimated to increase the deficit by $1.7 trillion. The administration claims that growth will increase so substantially that it will entirely pay for tax cuts. Independent analysis, however, is not as confident and predicts that the changes discussed to date will increase the deficit substantially, which might cause deficit hawks in the Senate to oppose any bill that comes to the floor.

In short, the Tax Cuts and Jobs Act hews closely to recent Republican principles—it decreases business taxes in hopes of stimulating wide economic growth. The plan is clearly beneficial for entities, although it is decidedly more mixed for individuals. While the Trump administration has claimed that nobody would see their taxes rise, independent analysis suggests one in three families would see their taxes increase in just the first year the House bill comes into effect.

Representatives of both the legislative and executive branches have said to expect tax reform to be passed quickly. House Speaker Paul Ryan (R-Wis.) has said he believes tax reform can be passed in 2017, and Treasury Secretary Steven Mnuchin has guaranteed that tax reform will pass this year, warning that markets might fall dramatically if it no action is taken. The House has already passed the bill and hopes to have a bill on the President’s desk by year-end.

Notwithstanding the words of Speaker Ryan and Secretary Mnuchin, significant work needs to be done even before a bill reaches the White House. Though the House bill has passed, the bill must clear the Senate as well, and that is likely to be a challenge.

As seen with ACA repeal, while the GOP senators might agree in principle, they do not necessary agree on a specific policy or plan. Deficit hawks in the Senate, such as Bob Corker and Jeff Flake (R-AZ) have suggested that they will reject any bill that increases the deficit. Arizona’s John McCain voted against President Bush’s tax cuts, showing an aversion to the policy, and was the deciding vote in ACA repeal, showing a willingness to go against party leadership. Senators Susan Collins and Lisa Murkowski, of Maine and Alaska respectively, rejected the party line and voted against ACA repeal as well, though both have indicated that they will ultimately vote for this bill in spite of the provision calling for the repeal of the ACA’s individual mandate. Robert Portman (OH) has said he can’t vote for the bill in its current form because LLCs will not be treated as favorably as corporations, although he has said in recent days that he is confident the Senate will pass the bill. With just a two seat majority, any combination of three Republican senators can stop tax reform in its tracks. While the White House is courting various Democrats representing Republican states, such as Missouri’s Claire McCaskill and West Virginia’s Joe Manchin, I suspect that ultimately the Democrats will remain united as a party and vote against the bill en masse, given President Trump’s unpopularity. With the GOP only able to lose just two votes to pass the bill via reconciliation, the bill’s passage seems tenuous but grows more likely by the day.

If a bill is not passed by year-end, do not expect a bill to be passed quickly in 2018. With midterm elections coming up, legislators’ priorities will shift to re-election campaigns and avoiding any controversial votes. Republicans could easily be cast as giving cuts to the rich. Democrats likewise would be called obstructionist and unwilling to cut taxes for the middle class. No senator or representative wants to defend their record more than is necessary, so I’d expect them to avoid difficult votes where possible—including on tax reform.

Between personal and corporate reform, corporate reform seems more likely to pass. The high corporate statutory rate holding back growth has been a Republican talking point for years. Further, the Trump administration has expressed concern that foreign profits cannot be repatriated because of what they suggest are punitive tax rates. The one-time tax on foreign profits would, by the administration’s analysis, free this cash to be brought back into the United States for investment and wage increases. Given how much the current administration wants to spur GDP and wage growth, I believe they’ll put their weight behind cutting the corporate rate.

Individual tax reform touches every individual citizen and many nonresidents, each of whom have different interests and would benefit from different changes to tax law. Incredible sums of money are also being spent on lobbying and advertising to try to save various deductions and tax credits on which both industries and individuals rely. The money being spent will help sway public opinion and is unlikely to make the bill any more popular than it is.

Advertising is already painting this bill as a tax cut for the wealthy at the expense of the middle class. Tax reform that cuts rates is necessarily going to reduce rates for high net worth individuals. The AMT and estate tax are seen as taxes on the upper class, and cutting those taxes—especially the estate tax—is being framed as a giveaway to wealthy political donors. Even as GOP reduces deductions available to the rich, the Democrats can and will use the tax cuts as part of attack ads as we move into the 2018 midterm elections.

These challenges will come up in both corporate and individual tax reform, but I think they can be overcome. Given the GOP and Trump administration’s shared belief that a corporate tax rate reduction will spur tremendous growth, Congress might find a way to pass a corporate reform bill.

Momentum is building towards the bill’s passage in the Senate and the GOP is under tremendous pressure to pass a bill. In part, this is because the GOP has not passed significant legislation yet and, therefore, senators lack strong records on which to run for re-election. This is also in part because donors are threatening to withhold future donations unless the tax cuts are passed. Day by day, more and more senators say they will vote in favor of this bill. The margin may be slim, but passage is no longer the remote possibility it seemed just a month ago.

What should we keep an eye on? The reduced pass-through rate is going to tempt many clients to funnel ordinary income through LLCs. As professionals, we will have to become familiar with the rules surrounding the 25% preferred business rate to help our clients understand the applicability of this rate to their specific situation. The elimination of the SALT deduction might encourage clients to prepay taxes this year while a deduction still exists—although with the AMT still in effect, there’s no guarantee that this is a viable strategy for all clients. I have already had clients prepay taxes and accelerate income prior to speaking with us in hopes of taking advantage of the SALT deduction, only to realize that they are in AMT and will not benefit from these actions.

We will also need to work with clients regarding estate planning. While the tax will generally impact a narrower group of clients, taxpayers and practitioners need to make sure that they do not move too quickly by making changes to their plans that would be detrimental if current law remains in force. Remember that tax reform is not a certainty.

With all of that said, what should tax practitioners tell clients? I would suggest telling clients that tax reform might be a priority for the Trump administration, the Republican House, and the Republican Senate, but that the provisions they have heard so much about are not yet law. Keep in mind that even if the Senate passes its bill, the two houses must reconcile the bills and pass the jointly-created bill before it can be signed into law. With so much still in flux, it would be irresponsible to suggest planning around potential changes. There is simply too much we don’t yet know to make definitive plans. You should also remind taxpayers that the details of the tax reform plan can and will change quickly—so stay tuned.


ledermanBen Lederman, CPA, is a senior in the private client services practice at CohnReznick, LLP. He is also a member of the NYSSCPA’s Personal Financial Planning Committee. He can be reached at Ben.Lederman@CohnReznick.com.

 
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