Congress Approves Tax Overhaul
December 20, 2017: Congress has passed a major tax overhaul bill that President Trump will sign into law later this week.
The measure sets the corporate tax rate at 21 percent, a pass-through business deduction rate of 20 percent, and a top individual income tax rate of 37 percent.
Following is a brief summary of those provisions of special interest to advisory firms.
Owners of pass-through business entities (S corporations, LLCs, sole proprietorships, and partnerships) will be able to deduct 20% of their income if they make less than $157,500 filing an individual tax return or less than $315,000, if they file a joint married return.
Above that threshold, owners of service businesses -- including advisory firms, law firms and accounting firms -- are excluded from benefitting from the new 20 percent deduction for pass-throughs.
Private Activity Bonds
A provision that would have eliminated the deductibility of interest from private activity bonds was dropped from the final bill. The tax legislation not only preserves private activity bonds for infrastructure projects, such as hospitals and affordable housing, but also preserves tax-exempt bonds for professional sports stadiums and arenas (which the House bill had proposed to end as of November 2, 2017). Tax-exempt advance refundings and tax exempt credit bonds were, however, terminated as of the end of 2017.
Mandatory FIFO – strongly opposed by the IAA with the support of hundreds of members who contacted Congress about this issue – was deleted from the tax legislation.
The Senate’s tax proposal included a provision that would have required that taxpayers selling, gifting or otherwise disposing of securities in which the taxpayer holds multiple positions to determine cost basis on a first-in, first-out (FIFO) basis.
If enacted, this provision would have forced advisers and other investors selling a security to sell the first lots they bought within an account, rather than being able to choose the most advantageous lot to minimize capital gains or harvest losses.
The portion of an investment fund’s return – usually 20 percent – that’s paid to private-equity managers, venture capitalists, hedge fund managers and certain real estate investors currently qualifies for treatment as capital gains provided the assets are held for one-year.
As of January 1, 2018, a taxpayer's distributive share of partnership gain will be treated as short-term capital gains (which are taxed at higher ordinary income rates) to the extent such gains result from the sale or exchange of an asset held by the partnership for three years or less.
This change in law will apply to all partnership interests that were held (directly or indirectly) by taxpayers (and certain affiliates) that are raising or returning capital and either investing in, developing, or disposing of securities, commodities, rental or investment real estate, cash and cash-equivalents, and options or derivatives on behalf of the partnership. Affiliates of taxpayers subject to the carried interest provision include certain family members, estate planning vehicles and certain service providers of the partnership to whom the taxpayer may transfer a partnership interest.
This three-year holding period requirement does not apply to the extent of investment professionals' capital investments in their own funds. The carried interest provision also provides that the Secretary of the Treasury shall specify the extent to which the three-year holding period requirement does not apply to gains attributable to assets not held for portfolio investment on behalf of third party investors.
Investment Advisory Fees and Tax Preparation
Fees paid to an investment adviser and similar expenses related to money management are deductible under current law provided they exceed two percent of a taxpayer’s adjusted gross income. These fees will no longer be allowable deductions, though this exclusion will expire in 2025.
Under current law, most taxpayers can also deduct amounts paid for tax preparation and similar tax-related expenses, such as software and fees for electronically filing tax forms. Taxpayers will no longer be able to take this deduction.
There are no provisions providing for ‘Rothification’ in the tax reform bill. Along with “mandatory FIFO,” the IAA actively lobbied to preserve the existing treatment of 401(k) plans and thanks all members who responded to our Member Alert and contacted Congress on this issue.
The following provisions relating to retirement plans are, however, included:
- The new law repeals the ability of individuals to recharacterize a conversion contribution to a Roth IRA back to a traditional IRA effective for taxable years beginning after 2017.
- The legislation extends the deadline to avoid having a plan loan be treated as a taxable distribution for individuals who fail to meet the repayment terms of the loan because of their separation from service (or in the event of plan termination) by permitting employees to roll over the loan balance to an IRA/plan by the due date for filing their tax return (including extensions), also effective for taxable years beginning after 2017.
- The new tax law raises the maximum amount for a length of service award plan to $6,000 and indexes that amount going forward, effective for taxable years beginning after 2017.
- The tax package provides special relief for disaster victims resident in any area with respect to which a major disaster has been declared by the President during calendar year 2016. A qualified 2016 disaster distribution is a distribution from an eligible retirement plan on or after January 1, 2016 through December 31, 2017 to an individual whose principal place of abode at any time during 2016 was in a disaster area and sustained an economic loss by reason of events giving rise to a Presidential disaster declaration. A qualified 2016 disaster distribution of up to $100,000 from a qualified retirement plan, section 403(b) plan or IRA is eligible for an exception to the 10-percent early withdrawal tax and may be recontributed to an eligible retirement plan (and be treated like a direct rollover) within 3 years of the distribution. Any income attributable to such a distribution will be included in income ratably over 3 years unless the taxpayer elects not to have that rule apply. Such a distribution is a permissible distribution from a qualified retirement plan, 403(b) plan or governmental 457(b) plan, regardless of whether there is a distributable event. These provisions are effective on the date of enactment.
Commissions and performance-based pay, including stock options, will be included in compensation subject to a $1 million corporate employer deduction cap. Retirement plan contributions will continue to be excluded.
The provision will apply to the principal executive officer, financial officer, and three other highest-paid employees. Once an employee qualified, they will remain a covered employee for all future years.
The provision will not apply to compensation plans established under a written binding contract as of November 2, 2017, even if the employee had the right to participate in the plan but hadn't started participating.
The tax overhaul will allow corporations and partnerships with corporate partners with average gross receipts of as much as $25 million (indexed for inflation) to use cash accounting, under which a business recognizes income and deducts expenses when cash is exchanged instead of having to accrue income and expenses. Cash accounting is already available to all sizes of sole proprietorships, partnerships without a corporate partner, and S corporations.
The measure will also allow farm corporations and partnerships with gross receipts of as much as $25 million to use cash accounting.
Eligible businesses will be able to use cash accounting even if they had inventories. Under current law, businesses with inventory must use the accrual method of accounting for tax purposes.
Technical Corrections in 2018
It is widely expected that there will be a “technical corrections” bill in 2018 that may allow limited reconsideration of certain of these tax issues. The IAA expects to work closely with its members to advance their interests on these matters as the opportunities arise in the New Year.
Contact Neil Simon, IAA Vice President for Government Relations, to share your views or to obtain more information about these or other government relations matters. He can be contacted at email@example.com or at (202) 293-4222.