Tax reform clears House hurdle, but obstacles remain

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The passage in the House of Representatives of the Tax Cuts and Jobs Act brings the tax reform process closer to completion – but not necessarily any closer to success.

While the House and Senate are following broadly similar approaches to reform, the specific differences between the House legislation (see “Tax Cuts and Jobs Act passes the House”) and the bill the Senate is expected to vote on in the week after Thanksgiving could still prove insurmountable.

What’s more, the differences are also leaving tax professionals unable to advise clients.

“The House and the Senate bills are not that far apart with regard to the corporate and the individual provisions,” said Howard Wagner, managing director at Crowe Horwath LLP. “But they’re very far apart on taxation of pass-through income, and that’s where they’ll have to reconcile their differences.”

“The Senate bill has a 17.4 percent deduction for qualifying pass-through income, while the House bill taxes it at 25 percent,” he observed. “But the House bill has a 70-30 split, and treats active and passive participants differently. For example, suppose I’m a 50 percent investor who is an employee of a pass-through. Only 30 percent of my salary and K-1 income would qualify for the 25 percent rate, while the other 50 percent investor, a passive investor who gets no salary, would receive 100 percent of his income from the business at the 25 percent rate. Capital-intensive businesses can get a greater portion of income eligible for taxation at the default 25 percent rate.”

Another CPA also pointed to the huge differences in the business rates.

“At the heart of the House’s bill is a huge tax cut for corporations,” said Anne Zimmerman, co-chair of Businesses for Responsible Tax Reform and owner of Zimmerman & Co CPAs Inc., an accounting firm in Cincinnati and Cleveland. “This is a benefit for big business that is being financed on the backs of small entrepreneurs. For instance, corporations will still be able to deduct state and local taxes on their profits but the owners of small pass-through businesses, where owners’ business income is passed through to their personal income and taxed accordingly, will not. More than 90 percent of small businesses are structured as pass-throughs.”

The Senate is continuing to debate its bill and Democrats have objected strongly to the Republican bill, pointing to new forecasts from Congress’s Joint Committee on Taxation indicating that millions of middle-class taxpayers will ultimately see their taxes go up under the legislation.

“Although the House passed its version of ‘tax reform’ without a single Democratic vote and despite a loss of a couple handfuls of Republicans, there is no guarantee that the Senate will approve its pending bill or ultimately compromise legislation,” said David De Jong, CPA, Esq., a principal at Rockville, Md.-based Stein Sperling Bennett De Jong Driscoll PC. “Assuming no Democratic defections in the Senate, three ‘nay’ votes by Republicans would defeat the bill (two if the Democrats pick up a Senate seat in Alabama before the final vote). There are Republican concerns in several areas: the Senate bill would eliminate the deduction for all individual state taxes including the property tax as well as the income tax; the Senate bill would delete the individual mandate for failure to have health insurance coverage; and at least one Republican Senator believes that both bills favor large business at the expense of small and midsized business. Whether we have the biggest overhaul of the tax law since the 1986 Act remains uncertain.”

Much will depend on whether there are more than two Republican defections in the Senate.

“The procedural steps being taken this week, including the House passage of the bill and the Senate Finance Committee’s consideration of their version, check off two more major milestones on the road to tax reform,” said Jon Traub, managing principal of tax policy at Deloitte Tax LLP. “Some potholes still lie ahead. Senate passage of the bill is by no means guaranteed, and reconciling the Senate version with the one produced in the House will require real and difficult compromises. Companies are potentially facing implementation issues just around the corner, so would be wise to model and plan for it or risk finding themselves caught flat-footed.”

The American Institute of CPAs praised passage of the bill and pointed to some of the accounting and tax changes. “As a long-time advocate for an efficient and pro-growth tax system based on principles of good tax policy, we commend the House for expanding the number of taxpayers who may use the cash method of accounting,” said AICPA President and CEO Barry C. Melancon in a statement. “We also applaud the decision to maintain the current tax treatment of nonqualified deferred compensation. We are encouraged by the progress made by lawmakers in recent days and believe this vote moves the nation one step closer to a fairer, simpler Tax Code.”

Entrepreneur Mark Cuban, the owner of the Dallas Mavericks, discussed the tax plan during a panel discussion at Thomson Reuters on Wednesday evening. He predicted the tax reforms would not last long. “No matter what happens with the Trump tax plan, it’s not going to be around more than four years, most likely,” he said. "And there's going to be other geopolitical issues that happen in the interim that cause other changes, whether it's demographic or immigration."

Alan Blinder, a professor of economics and economic affairs at Princeton University, presented a long-term view across various presidential administrations going back to 1930. "If you believe that cutting the marginal tax rate leads to growth, nobody’s going to claim that happens in the next five days, or five weeks, or even five months," he said. "It takes time."

“As economists and public policymakers, we don’t know how to solve income inequality,” said economist Dr. Dombisa Moyo. “We have tried policies like tax redistribution in Europe and here. That has not succeeded in stemming the tide of income inequality. We have also tried the supply side model of low taxation and the whole agenda of trying to drive economic growth and close the gap, but that has also not solved the income inequality problem. A broader debate needs to occur around how policy itself has to innovate and change.”

Mark Zandi, chief economist with Moody’s Analytics, who was on the panel with Cuban and Blinder, predicted the tax reform bill would have a negative impact on the housing market. “Taxes matter a lot,” he said.

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