The WRMarketplace is created exclusively for AALU members by experts at Greenberg Traurig and the AALU staff, led by Jonathan M. Forster, Steven B. Lapidus, Martin Kalb, Richard A. Sirus, and Rebecca Manicone. WRMarketplace #17-47 was written by Greenberg Traurig Shareholder Jonathan M. Forster.
The AALU WRNewswire and WRMarketplace are published by AALU as part of the Essential Wisdom Series, the trusted source of actionable technical and marketplace knowledge for AALU members—the nation’s most advanced life insurance professionals.
Wednesday, 6 December 2017 WRM#17-47
TOPIC: Decoding Tax Reform: Senate Passes Its Bill – What It Says & What’s Next?
MARKET TREND: The tax reform process took a major step forward with the Senate’s passage of its tax reform legislation. While certain aspects of the final tax bill remain hard to predict as the Senate and House work out their differences, there will be plenty of opportunity for planning under any new tax laws, once enacted.
SYNOPSIS: Over the weekend, the Senate passed its version of the Tax Cut and Jobs Act (“Senate Bill”) making some significant last-minute changes from its prior mark-up (“Prior Senate Bill”), including (1) the retention of the individual and corporate alternative minimum taxes (“AMTs”), (2) an increase in the deduction for qualified business income from pass-through entities from 17.4% to 23%, and (3) an allowance of a state and local income tax (“SALT”) deduction of up to $10,000 for property taxes (similar to the House’s version of the Tax Cut and Jobs Act (“House Bill”)). While we now have more insight into the final frame-work for tax reform, the Senate and House Bills still differ in several key areas, including (1) the individual and corporate AMTs, (2) transfer taxes, (3) taxation of pass-through entity income, (4) individual tax rate/brackets and deductions, and (5) various business and international tax provisions. Significant changes are likely as these bills proceed to joint conference for reconciliation to produce legislation that both the Senate and House can pass.
TAKE-AWAYS: Republicans still have key decisions to make in conference. However, all issues are resolvable, and the expectation in Washington is that a tax bill will be signed into law by the end of the year. Whatever its ultimate form, it’s clear that the envisioned tax reform will impact individuals and businesses at all income levels and make major changes in tax planning. What’s not clear is whether every individual will see a reduced tax bill, as the proposed reforms significantly complicate an already complex tax code. This added complexity, coupled with the uncertainty regarding the sustainability of these changes over time, will make life insurance and legacy planning even more critical for clients to achieve maximum effectiveness in their plans under the new reforms. This should afford a unique opportunity for advisors and their clients to plan for both the short and long-term.
With the passage of the Senate Bill, the tax reform process has taken a critical step forward. Although key details still need to be worked out in joint conference, and AALU continues to spare no effort in working to improve the final bill, Republicans remain on target to enact tax reform legislation by year-end. With that in mind, below is a detailed update of how notable tax provisions of the current House and Senate Bills compare to current tax law.
SNAPSHOT COMPARISON: NOTABLE PROPOSALS
Note under the Senate Bill that: (1) highlighted areas indicate items of change from the prior Senate Bill, and (2) expiring provisions revert to current law at the start of the specified year.
INDIVIDUAL TAX |
|||||||||
Select Provisions | Current Law | House Bill |
Senate Bill |
||||||
Single |
Joint | Single | Joint | Single |
Joint |
||||
10% |
$0-$9,525 |
$0-$18,650 |
12% |
$0-$45,000 |
$0-$90,000 |
10% |
$0-$9,525 |
$0-$19,050 |
|
Income Tax Rates & Brackets* |
15% |
$9,525–$38,700 |
$18,650-$75,900 |
25% |
$45,000-$200,000 |
$90,001-$260,000 |
12% |
$9,525-$38,700 |
$19,050-$77,400 |
25% |
$38,700-$93,700 |
$75,900-$153,100 |
35% |
$200,000–$500,000 |
$260,001-$1,000,000 |
22% |
$38,700–$70,000 |
$77,400-$140,000 |
|
28% |
$93,700- |
$153,100- |
39.6 |
$500,000 |
$1,000,000 and |
24% |
$70,000- |
$140,000- |
|
INDIVIDUAL TAX |
|||||||||
Select Provisions |
Current Law | House Bill |
Senate Bill |
||||||
% |
$195,450 | $233,350 | %** | and over | over | $160,000 | $320,000 | ||
33% | $195,450-$424,950 | $233,350–$416,700 | **On income over $1 million ($1.2 million, joint), 12% bracket is phased-out by applying 6% surcharge until tax savings from first bracket are recouped (e.g., added 6% on $1 million – $1.2 million (single) and $1.2 million -$1.614 million (joint)). | 32% | $160,000-$200,000 | $320,000–$400,000 | |||
35% | $424,950-$426,700 | $416,700–$470,700 | 35% | $200,00 0-
$500,00 0 |
$400,000–$1,000,000 | ||||
39.6% | $426,700 and over | $470,700 and over | 38.5% | $500,000+ | $1,000,0 0+ | ||||
Capital Gains Rates | 0%, 15%, and 20% |
Same as current law |
Same as current law |
||||||
AMT | On income over certain thresholds (e.g., $54,300 (single) and $84,500 (joint))* |
Repealed |
Retains AMT with increased thresholds (e.g. $70,300 (single) and $109,400 (joint))* | ||||||
Income from Pass- Through Entities | Taxed at individual income tax rates | 25% maximum tax rateon “business income” of active businesses (not income paid for work of owner)
Owners receiving distributions can elect to: (1) treat 30% as business and 70% as wage income or (2) determine ratio of business to wage income based on capital investment |
23% deduction for individual taxpayers on domestic “qualified business income” from pass-through entities, subject to various restrictions and limitations. Wages paid to owners and certain income from specified services businesses are excluded from deduction. | ||||||
Distributions from passive business activities treated as 100% income |
|||||||||
INDIVIDUAL TAX |
|||
Select Provisions |
Current Law | House Bill |
Senate Bill |
Standard Deduction* | $6,350 (single)
$12,700 (joint) |
$12,200 (single)
$24,400 (joint) |
$12,000 (single)
$24,000 (joint) |
Personal Exemption | $4,050* | Repealed | Repealed |
SALT
Deduction |
Allowed | Allowed only for individual state and local property taxes up to $10,000 | Same as House Bill |
Mortgage Interest Deduction | Allowed on loans up to $1 million on a principal and second residence and on interest on up to $100,000 of a home equity line | Reduces deduction limitation to $500,000 for debt on principal residence only as of 11/2/2017 | Same as current law except deduction for home equity indebtedness is repealed |
Gain on Sale of Principal Residence | Exclusion allowed for gain of up to $250,000 (single) / $500,000 (joint) on sale of a residence used as principal residence for 2 of last 5 years | Same exclusion amount as current law but (1) use of principal residence must be for 5 of last 8 years and (2) phases out for taxpayers with average annual adjusted gross income over 3 years exceeding $250,000 (single) / $500,000 (joint) | Same exclusion amount as current law except use of principal residence must be for 5 of last 8 years (new use restriction does not apply if residence under contract before 1/1/2018) |
Taxation of Sales of Individual Stock | For shares purchased at different times/costs, taxpayer can select which shares to sell first | Not addressed | Applies a first-in/first-out (FIFO) rule where shares bought first (often at a lower cost) are deemed sold first, likely accelerating gain recognition |
Individual Mandate | Individuals must have minimum health insurance coverage or pay a penalty | Not addressed | Repeals the individual mandate as of 2019 (does not expire in 2026) |
*Subject to annual inflation indexing.
TRANSFER TAX |
|||
Select Provision |
Current Law | House Bill | Senate Bill (Expire as of 2026) |
Gift Tax |
40% top rate $5 million exemption* ($5.49 million in 2017; $5.6 million in 2018) |
Top rate drops to 35% in 2025
Doubled exemption ($10 million)* starting 2018 |
Top rate remains 40%
Doubled exemption ($10 million)* starting 2018. Upon expiration, exemption would revert to $5 million, as inflation adjusted to 2026 |
Estate Tax1 | 40% top rate
$5 million exemption* ($5.49 million in 2017; $5.6 million in 2018) |
Top rate remains 40% until 2025
Doubled exemption ($10 million)* starting 2018 Full repeal starting 2025 |
Top rate remains 40%
Doubled exemption ($10 million)* starting 2018. Upon expiration, exemption would revert to $5 million, as inflation adjusted to 2026 |
GST Tax2 | 40% flat rate GST exemption equals gift/ estate tax exemption under IRC §2010(c) | Rate remains 40% until 2025
Doubled exemption ($10 million)* starting 2018 Full repeal starting 2025 |
Rate remains 40%
Doubled exemption ($10 million)* starting 2018. Upon expiration, exemption would revert to $5 million, as inflation adjusted to 2026 |
Basis Step Up at Death | Yes | Yes | Yes (would not expire in 2026) |
*Subject to annual inflation indexing.
CORPORATE TAX |
|||
Select Provision |
Current Law | House Tax Bill |
Senate Tax Bill (Permanent Changes) |
C Corp. Rate | 35% max rate (flat rate for personal service corporations (PSCs)) | 20% flat rate (25% for PSCs) effectivestarting 2018 | 20% flat rate (including for PSCs) effective starting 2019 |
Corporate AMT | Applied to C corporations | Repealed | Retains current AMT |
RESOLVING DIFFERENCES
Differences between the House and Senate Bills must now be resolved in joint conference to produce a bill that can pass both chambers. Key areas of disagreement that must be addressed include: (1) the individual and corporate AMTs, (2) gift, estate, and GST taxes, (3) taxation of pass-through entity income, (4) individual tax rate/brackets and deductions, and (5) various business and international tax provisions. We are likely to see changes in several of these areas.
GEARING UP
With tax reform and 2018 fast approaching, advisors are likely already geared up for year-end planning with their clients. Right now, the focus should remain on planning items that continue to make sense with or without tax reform, including: (1) acceleration of deductions and credits and deferral of income, (2) charitable planning; (3) annual gifts, (4) completion of purchases of life insurance coverage to preserve flexibility and pricing; and (5) the laying of groundwork for reviews of existing legacy plans to adapt to new tax provisions.
TAKE-AWAYS
Republicans still have key decisions to make in conference. However, all issues are resolvable, and the expectation in Washington is that a tax bill will be signed into law by the end of next week. Whatever its ultimate form, it’s clear that the envisioned tax reform will impact individuals and businesses at all income levels and make major changes in tax planning. What’s not clear is whether every individual will see a reduced tax bill, as the proposed reforms significantly complicate an already complex tax code. This added complexity, coupled with the uncertainty regarding the sustainability of these changes over time, will make life insurance and legacy planning even more critical for clients to achieve maximum effectiveness in their plans under the new reforms. This should afford a unique opportunity for advisors to engage with clients to plan for both the short and long-term.
DISCLAIMER
This information is intended solely for information and education and is not intended for use as legal or tax advice. Reference herein to any specific tax or other planning strategy, process, product or service does not constitute promotion, endorsement or recommendation by AALU. Persons should consult with their own legal or tax advisors for specific legal or tax advice.
Notes
1 Note that the potential for an increase and then drop in the available federal estate tax exemption has previously raised the issue of “clawback,” which arguably results in greater estate tax liability if lifetime gifts are made using a higher unified gift/estate tax exemption, but the donor later dies when the unified gift/estate tax exclusion has decreased. The issue was significantly discussed in 2012, before enactment of the American Taxpayer Relief Act of 2012, when it appeared that the federal gift and estate tax exemption would decrease from $5.12 million to $1 million. Although this result did not seem to reflect the legislative intent at the time and many commentators eventually came to the conclusion that clawback would not occur, Congressional or IRS clarification likely would have been needed or desired to confirm this outcome. The Senate Bill, however, seems to provide a proactive resolution of this issue in §11061(b) (“Modifications to Estate Tax Payable to Reflect Different Basic Exclusions Amounts”) by giving the IRS authority to prescribe regulations to address any difference between the basic exclusion amount at the time of any gifts by a decedent and the basic exclusion amount at the decedent’sdeath.
2 The GST tax exemption is defined statutorily to match the “basic exclusion amount” set for the unified gift and estate tax under IRC §2010(c) (i.e., $5 million, as adjusted annually for inflation). As a result, the Senate Bill’s proposed changes to IRC §2010(c), which would double the basic exclusion amount for gift and estate tax purposes, also would automatically apply for GST tax purposes.