The Tax Cuts and Jobs Act - Be careful what you wish for

My Starbucks coffee cup design tells me that the holiday season is upon us. It reminds me of a saying that I often hear around this time, “Be careful what you wish for.” We may hear this more in Washington in the days ahead with the recently released House Republican tax reform bill. Many politicians and lobbyists were quick to come out to attack the new bill based upon their specific representative group or constituents. In the meantime many more people are trying to analyze the real impact upon U.S. taxpayers and the U.S. economy, and many tax professionals are wading through the bill to determine the impact on various taxpayers and specific industries and related planning opportunities.

We at Schneider Downs are focused on keeping our readers, clients and friends of the firm informed on specific items in the bill and news regarding potential changes. As such we are going to publish many articles and informative examples over the coming weeks as the bill works its way through the process to become law. As a reminder of the steps the bill must go through to become law see our article “How Tax Reform Proposals Become Law.” Please visit the tax reform blog over the coming weeks and months until the final law is signed.

Below are just a few of the items and areas in the released legislation that we found interesting.

Tax rate brackets

The reduced number of brackets has always been a hot topic for the GOP related to simplification of the tax code. Now that the proposed rates are published, we found it interesting that there would be a fourth rate bracket which contains a phase out of the lower tiered income tax bracket benefit. The bill would phase out the tax benefit of the 12% bracket, measured as the difference between what the taxpayer pays and what the taxpayer would have paid had the income subject to the 12% bracket instead been subject to the 39.6% bracket. This tax benefit is phased out at a rate of $6 of tax savings for every $100 of adjusted gross income in excess of $1,000,000 (single filers) or $1,200,000 (joint filers). This feels like a fifth tax bracket. So, we really went from seven brackets to five brackets, and I would argue that simplification did not happen.

Now that we know the rates, everyone can calculate if they would pay more or less taxes under the new bill versus the current law. If you are in the high-income tax amounts, does it seem easier to calculate your tax?

So, without further suspense, below is the tax rate table for joint and single filers:

Mortgage interest deduction limitations

Current law limits the deductibility of mortgage interest to the amount of interest on the first $1 million of qualified mortgage debt. The bill changed the $1 million limit to $500,000 of interest on qualified mortgage debt. The bill is written to apply the new limit on only the newly issued mortgage debt.

Denial of deduction for expenses attributable to the trade or business of being an employee

If your employer does not fully reimburse you for job-related expenses, you no longer get the tax deduction on your personal return. Many companies have policies that do not reimburse fully to the IRS mileage amounts or do not reimburse for small expenses. The bill also takes aim at the “above the line” maximum $250 tax deduction for teachers who purchase school supplies that are not reimbursed by their schools. Consequently, employees may be subject to a tax increase based upon management reimbursement discretion.

Business-related deduction - Interest expense

We heard and discussed in prior articles that there was going to be a limitation on the deductibility of net interest expense. The bill limits the interest expense deduction to 30% of adjusted taxable income. Adjusted taxable income is a business's taxable income computed without regard to business interest expense, business interest income, net operating losses, and depreciation, amortization, and depletion. Any interest amounts disallowed under the provision would be carried forward to the succeeding five taxable years and would be an attribute of the business (as opposed to its owners).

Pass-through entities that have net interest expense that exceeds the 30% limitation of the adjusted taxable income would disclose the amount of available for the partner/shareholder to apply towards the individuals other investments with excess adjusted taxable income investments. The five year carryover time period is also applicable for the partner/shareholder.

There is an exception for small businesses, as defined as having under $25 million in receipts that would allow for full deduction of the total interest expense.

Business related deduction - Entertainment, etc. expenses

The bill disallows any deduction for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes. In addition, no deduction would be allowed for transportation fringe benefits, benefits in the form of on-premises gyms and other athletic facilities, or for amenities provided to an employee that are primarily personal in nature and that involve property or services not directly related to the employer's trade or business, except to the extent that such benefits are treated as taxable compensation to an employee. The concept of disallowing a business deduction because the IRS has trouble validating its business purpose is something that is new to the tax code. Also, it has always been viewed that employee athletic facilities have been a health care cost-saving opportunity that has benefited the employers by controlling costs and consequently helped working class Americans at the same time.

With over 400 pages to the bill, expect much more analysis and discussion. We will attempt to give you the most information to plan for potential tax changes. In the meantime, contact your representative in Congress with concerns and complaints regarding the tax provisions in the bill. This bill represents the beginning of the formal bill drafting process, and we expect many changes to the bill, although we now definitely have more insight into the details and thought process under current tax reform. The Senate timetable may make for some lively Thanksgiving dinner conversation, or everyone may just be watching their Twitter account. Remember, be careful for what you wish for. 

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