David: Welcome to the podcast. I'm David Stewart, editor in chief of Worldwide Tax Daily. Well the tax reform bill is now in what should be its final form. As you may have heard, the tax bill takes the corporate tax rate from 35 percent down to 21 percent and raises the standard deduction while also eliminating personal exemptions. What does this all mean? To help us sort through the final bill, we're joined in the studio by Tax Analysts Vice President of Editorial Operations Jeremy Scott. Jeremy, welcome back.
Jeremy: Thank you for having me.
David: We're recording this on December 18. As of today, the conference bill is due to be voted on by both the House and the Senate by the end of the week. Jeremy, at the beginning of this process, we were promised a major tax reform along the lines of the 1986 tax reform. Is that what was delivered?
Jeremy: No, I don't think we got anything quite like 1986. We didn't get a broad reform of the entire tax code that basically changes virtually every section. I think that what we did get, though, was something maybe a little more comprehensive than people were expecting, given the time table that Republicans announced and given the constraints that they seemed to be under, both politically and because of Senate budget rules. To call this just a tax cut, à la sort of 2001, is probably not fair to the bill; it does touch on a large number of code provisions.
It does dramatically alter the taxation of business income, particularly corporate income with the rate cut and some other changes. It transforms the U.S. international tax system from a worldwide system to sort of a territorial system. There's still elements of the worldwide regime in place, but it is a major change.
So we didn't get 1986-style tax reform, we didn't get everyone files on a postcard-style tax reform that Republicans have sort of been eluding to since the 90s — and actually for some reason, kept bringing up recently, even though they didn't touch the individual side as much as people thought they might — but we did get a bill that affects the U.S. tax system in many ways. It's going to have a lot of intended consequences, it's going to have a lot of unintended consequences. This is something beyond 2001, but it's not quite 1986.
David: So the conference report came out on Friday, December 15. What did we see in that? Any new provisions that hadn't been in either the House or Senate proposals?
Jeremy: There was nothing dramatically new in the bill. It ended up being what you would have expected from the Senate bill being changed to mollify some members of the House. There were also some additions to buy some more Senate support to sort of shore up the Republicans’ majority, particularly since they are vulnerable in the Senate much more so than in the House to losing even a couple of votes. So what you sort of saw was the Senate bill being changed in ways, small ways, but significant ways, in order to get it through both Houses as quickly as possible. Nothing really leaps off the page as dramatically new. They said they were open to new things. At one point, they said they were considering an entirely different passthrough regime than was in either the House or the Senate bill. That's not what happened. Basically, they modified Senate provisions, they tweaked a few other things. They took a couple of small elements from the House bill, and that's how they produced a conference report.
I would say the only major new things that were in there compared to the Senate bill, you did see the change in the SALT cap that you can now deduct up to $10,000 of property or income taxes. The child credit from the House bill is a little bit more generous in refundability. It's a $2,000 credit, $1,400 dollars of it's refundable, which is indexed to inflation, which is more significant than people let on. The mortgage interest deduction crept back in. The Senate did not touch the mortgage interest deduction, the House Bill did. The final bill has a $750,000 cap, not as generous as the Senate, which left it at a million, but not as bad as the House, which had it down to $500,000. The biggest sort of change the Senate had to address was the corporate AMT because the provision they put back in basically swallowed the entire corporate tax system, and so what their solution was, was to just take it back out.
That was a bit of a surprise. I thought they might use the revenue from a form of a corporate AMT to buy them some provisions elsewhere, but they did not do it. So the corporate AMT is gone from the final bill. The individual AMT, however, stayed in — much more generous exemptions and phaseouts from the current AMT. In fact, the phaseouts are much, much higher. But it's still in there to raise revenue and annoy high middle-income taxpayers or taxpayers with a lot of deductions, and I think a lot of Republicans are disappointed about that. Or some Republicans are disappointed the estate tax survived the process, but I never thought it was going anywhere once it stayed in the Senate bill. So again, nothing really new jumps out from the conference bill. It looks a lot like a compromised version of the Senate bill.
David: Okay, so let's get into a little bit of the detail on what does this do to corporate taxes. It seems that a lot of the attention of this bill is focused on corporate tax, so what's going to happen next year?
Jeremy: Yeah, actually, more attention should be focused on the corporate side. Too much political rhetoric and too much of the media's attention has been on the relatively small-scale individual changes and whether or not those benefit middle-income, low middle-income, or high-income individuals. The real action on this bill is the corporate side, and it is going to change the U.S. corporate system.
It's not a complete overhaul. We're not moving to a VAT or anything like that, but this is going to be a very different U.S. corporate tax system, starting next year because we are not delaying it. The Senate bill originally delayed it until 2019. Nope, it's going into 2018.
The corporate tax rate dropping so dramatically changes a lot of incentives. Going from 35 percent to 21 percent is going to affect everyone's decision-making process within tax and mergers and acquisitions departments all around. You are no longer going to get such an enormous penalty from being located in the United States. That's a big deal.
Going to a territorial system — that's a big deal. It is not quite the territorial system that many people were hoping for; there are lots of elements of trying to capture worldwide income. Some of these in the form of the anti-base-erosion provisions, some of this is in the deemed repatriation tax, which actually emerged higher in the compromise bill, 15.5 percent for cash, 8 percent for non-cash. That's nowhere near what they were talking about earlier this year. So that's probably disappointing to a lot of multinationals. But frankly, if someone had to pay for a corporate rate cut, multinationals with billions of dollars stored offshore are not a bad audience politically or economically to hit.
So it's going be a different tax system. You're going to be dealing with the interest deduction limitations. You're going to be dealing with the consequences of, like as I was saying earlier, the excise taxes on the base erosion side. We will see how this affects — I think planning is difficult to anticipate at this time, but I feel like in two or three years you're going to see a lot different decisions being made in tax departments, and tax administrators are going to have to react to it. Ultimately, Congress will probably have to react to it. Any time you put a bill together in sort of the few weeks that they put this major tax provision together, the unintended consequences are ultimately going to have to be addressed, and that's going to be something we're going to be hearing about for the next few years.
David: Now you mentioned that there were these base erosion measures in the bill. I saw that several European Union finance ministers have come out and raised concerns about this bill. And there may be a question of whether the base erosion measures comply with WTO rules. Is that likely to change anything in U.S. policy?
Jeremy: No, it is unlikely that Republicans in Congress are all that concerned about the WTO compliance portions of the bill. It is probably not WTO compliant, and I don't think that really mattered to them when they were drafting it, and I don't think it's going to matter to them once they pass it. What will happen is there will be complaints made by our trade partners. These types of complaints in the WTO take forever to be adjudicated. And I think that they will just accept the fact that Europe is going to complain, tell Europe we are not changing anything, and then they may end up having to compromise or change something, years down the road. But honestly, for the gentleman in charge of U.S. tax policy right now, they'll be long gone or power will have changed hands by the time anyone has to address the WTO portions.
David: Okay, now turning to the individual provisions. The press release about this bill says that the typical family of four making the median income of $73,000 will receive a $2,000 tax cut. Does this really make a huge difference for individual taxpayers?
Jeremy: It very much depends upon what type of taxpayer you are. If you are a taxpayer who is earning a decent amount of money, paying income taxes but not itemizing, you're going to see a tax cut. You're going to see probably a fairly significant tax cut, and that's because of the doubled standard deduction and the fact that even though the Senate retained the seven brackets and even though the conference bill retains the seven brackets, all of them are getting pushed down a couple of points. So that type of taxpayer could see a significant tax change. If you're a middle-income, upper middle-income taxpayer who was itemizing, particularly if you were itemizing using the state and local income tax deduction, you probably aren't going to see a major tax change. And that's because you don't get to take advantage of the doubled standard deduction.
The rate changes, while significant because you're changing all seven brackets, don't add up to a ton, and so your tax change is going to be a lot smaller. If you're a taxpayer who does not have children and itemized, you probably are going to see almost no positive tax changes. And the reason for that is they got rid of the personal exemptions, limited the SALT deduction, and sort of what you got in exchange for that was an expanded child credit. If you don't have children, you can't take advantage of expanded child credits. So the loss of personal exemptions is going to hit you. You're not going to see a huge change. You may even be one of the taxpayers that ends up paying a little bit more over time or even a little bit more in the first year. They admitted finally toward the end they can't guarantee that every taxpayer in every situation is going to get a cut. So again, how the individual provisions affect you is going to be highly dependent on your tax situation. The more you can take advantage of the doubled standard deduction, the less you were taking advantage of some of the itemized deductions that changed, the better off you're going to be.
Some people who were hit by the AMT, they're going to feel amazing after this bill because they did change the AMT. It's going to hit fewer people. Any time someone gets away from the AMT, their tax complexity changes dramatically towards simplification. And so I imagine there will be a lot of happy taxpayers who have had to deal with the AMT who don't have to deal with in the future who will very much enjoy the results of this bill. But again, that's a relatively small number of people. We already had had an AMT fix as a result of the ATRA in 2012, so again, not a huge number of people. A lot of the individual changes are kind of like rearranging the deck chairs on the Titanic. It's not that significant of a change.
Some people are going to see relief, some people are going to see small relief, many people are going to probably not even notice it. So the real action in this bill was not on the individual side.
David: Okay, let's talk about the passthroughs portion of the bill. It would offer a reduced tax rate to, as they say, small businesses, but I take it, this would create some tax planning and avoidance opportunities.
Jeremy: Yeah, this is probably where a lot of tax planners are focusing their attentions right now. They went with the Senate approach of a 20 percent passthrough deduction. That's a little less generous than what the Senate was originally doing. I think they had gotten up to 23 percent in the final bill that passed the Senate. It scaled back down to 20. The reason they scaled it back is because they ended up lowering the individual rates a little bit more in the final bill so they thought they could trade off there. Defining what qualifies for this deduction, defining what does not qualify, this is where the real tax administration effort is going to be made. These are where the guardrails are so important. This is where regulations, notices are going to come into play. And there is going to be a lot of attention here. Eventually, I feel like they're going to have to address this in more detail than this bill does. This is where you might see technical corrections, and this is where you might see things next year or even beyond, depending on who controls Congress, trying to plug some of the holes this deduction creates.
And the reason is everybody is going to be trying to qualify to get this preferential rate because the differential is so high. When you have a 37 percent top individual rate and then you're getting this 20 percent passthrough deduction, this is a big deal, and people are going to try to plan into this deduction. If you were a W-2 taxpayer with some flexibility in how you earned your money, maybe now you try to be the taxpayer that's being paid as a partnership, being paid as a passthrough, so you can get some of your income to qualify for the deduction. So yes, many planning opportunities are here. I think you're going to see a lot of attention from lawyers, accountants, the Big Four, tax firms. I think this is where they're going to be focusing a ton of effort in sort of finding how you can create the most tax advantaged structures in the future, and I think that that's going to be something that Treasury and the IRS are going to be hard-pressed to completely contain.
And so we will see what happens, but I really expect the passthrough provision to ultimately be one of the more significant things to come of this just because of the unintended consequences that it might create.
David: Alright, so let's say that this bill, as expected, passes the House and Senate and is signed this week. What can we expect going forward? What next change should we be looking for?
Jeremy: Well, this is kind of it for a major legislative effort, particularly, obviously, for 2017. But this might also be sort of the last major legislative effort that this Congress makes, even though it is technically extending for a whole year. There has been talk that they will be open to doing technical corrections next year if the Republicans can get Democratic support. That's going to be very difficult. As we learned from the Affordable Care Act, when a party completely is opposed to a bill, they aren't that inclined to help the majority party fix it. And so I think that technical corrections may be a little bit of wishful thinking at this point, but that is the next thing that the Senate or that Senate leaders talked about doing in the future. Also, Ways and Means Chair Kevin Brady said this isn't necessarily the final thing; we can always correct it next year.
I think this is the final thing, I think this is what people are going to have to live with for quite some time, and I think it's definitely what Treasury and the IRS are going to have to live with. So the real action next year after the president signs this, I think is going to be on the administrative side. It's going to be people trying to influence the regulations that come out as a result of this bill. It's going to be Treasury and the IRS struggling to draft regulations to enforce provisions in this bill.
And then I think on the policy side, you may see less on the tax side and more on the healthcare side — repealing the Affordable Care mandate but not doing anything else with the other provisions. We don't know what that's going to do. We don't know how that's going to affect health insurance markets. We don't know what Republicans are going to do in response to the effect of higher premiums or people losing their insurance, voluntarily or involuntarily. And so I think you're going to see healthcare action next year, maybe a little bit more than tax action, but again, we don't know.
Remember, the Republican majority is going to decrease from 52 to 48, to 51 to 49, early next year because of the Alabama result, and 51 to 49 is not really a workable majority in the Senate. Definitely it puts you further away from getting 60 votes to do things outside reconciliation. So major legislative action is going to be incredibly difficult, and so I think this will be the bill we have to live with, and the action's going to be on the implementation side.
David: Jeremy, if listeners would like further information, where can they go?
Jeremy: We have a lot of material on taxnotes.com, which is where we're doing most of our coverage, and some of that is available for free, for even nonsubscribers, outside of our paywall. And we have even more material available for nonsubscribers on taxanalysts.org.
David: That's it for this week. You can follow me on Twitter @TaxStew, that's S-T-E-W. If you have any comments, questions, or would like to suggest a topic for a future episode, you can email us at podcast@taxanalysts.org. Be sure to subscribe on iTunes or Google Play to make sure you get the next episode of Tax Notes Talk.
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