Note: This piece discusses TCJA as in was originally passed by the House. The ultimate bill signed by President Trump was much different.
Originally published on Forbes.com.
President Trump has promised us a tax cut for Christmas and it is on its way. The Cuts Cuts Cuts Act. sorry Tax Cuts and Jobs Act, is in play in the House of Representatives. If you actually want to know what it is in it, your best source is the Section-by-Section Summary. The Section-by-Section Summary also includes the scoring. Based on the budget resolution, the scoring needs to net to about $1.5 trillion in decreased revenue. Since there are over five trillion dollars in cuts, somebody has to be getting a steaming pile of you-know in their stocking so somebody else can get a pony.
Some of the gains and losses will net to some extent with the same people. The lower individual rates, standard deduction, elimination of the AMT, and child credit cost $3 trillion. Eliminating the personal exemptions and many of the itemized deductions raise $2.6 trillion. So despite there being some really big numbers sloshing around, they are things that will offset to a greater or lesser extent on many returns. For example, just living in New York City with any sort of a decent salary could be enough to throw you into AMT, because your hefty state and local income tax is an AMT preference. I haven’t started running detailed scenarios, but I’m thinking that for a lot of regular folks, the whole thing will be very close to a wash. Whoop Dee Doo.”According to House Ways and Means propaganda, a typical median-income family of four will receive a tax cut of $1,182 – Whoop Dee Doo.
But some people will be getting ponies. The maximum rate on individual businesses will be a boon to people with substantial flow-through income. Particularly the ones I call the New Gentry and my covivant refers to as the Entitled Children – the heirs to successful businesses who don’t work in the business. Their pony costs $448 billion.
And then there is the largest corporate tax rate cut since, since – since ever. That costs $1.5 trillion Throw in the corporate AMT repeal, elimination of the estate and GST tax, more generous expensing rules and favorable accounting rules, such as the availability of the cash method for companies under $25 million in gross receipts, will add another $268 billion. Who is paying for that? That has been little remarked, so for the few of you who have not had time to go through the Section-by-Section Summary, I’m going to point out some of the losers.
Highly Leveraged Companies With Irregular Earnings
Sections 3301 and 3302 are expected to raise quite a bit – $328 billion (There are not many really big revenue raisers. The Cuts Cuts Cuts Act actually has more sections that raise taxes, than cut them. Section 3301 limits current interest deductions to 30% of the business’s “adjusted taxable income”. Businesses with gross receipts less than $25 million are not subject to the rule. Adjusted taxable income is taxable income computed without regard to business interest expense, business interest income, net operating losses, and depreciation, amortization, and depletion. There would be a five-year carryover on the disallowed deduction.
Net operating deductions would be limited to 90% of taxpayer’s taxable income (Not so coincidentally that was the AMT rule) and carrybacks would no longer be allowed.
It is worth noting that some of the revenue gained by these two provisions will be offset outside the ten year period that the scoring is based on. That is another thing that makes the Cuts Cuts Cuts Act work – kicking the deficit can down the road. I mean, really, what has posterity ever done for us?
Corporations That Make Stuff
The Domestic Production Deduction goes. That raises $95.2 billion. I won’t miss it. I always had this terror that I was forgetting to claim it when I did a return.
Take Me Out To The Ball Game – Maybe Not
When it comes to baseball (and other sports and fun stuff), there is Section 3307, which along with 3308 raises $33.8 billion
Under the provision, no deduction would be allowed 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 (or includible in gross income of a recipient who is not an employee).
Section 3308 adds to the unrelated business income of not-for-profits the cost of providing employees with transportation fringe benefits, on-premises gyms, and other athletic facilities.
Staying with sports, Section 3604 denies tax-exempt status for bonds used to finance stadiums, but that is chump change, a mere $200 million. Denying the exemption to private activity bonds and refunding bonds (whatever they are) raises $56 billion. Mike Novodgradac estimates that the private activity bond change might mean over 800,000 fewer affordable rental homes over the next 10 years.
Those Trade-Ins
When you exchange property used in a trade or business or held for the production of income gain or loss is deferred. This is a really big deal in the real estate industry, but it is not just the real estate industry. Companies involved in car and equipment leasing also take advantage of Code Section 1031 and it is even used by investors in artwork. Not anymore, if the bill passes. Act Section 3303 raises a measly $30 billion by limiting 1031 to real estate. I have to breathe a sigh of relief on that one. Repealing 1031 for real estate would send shock waves into the commercial real estate market which is fed by a pool of 1031 money.
Ironically, for the typical small business person, this might turn into a tax break. 1031 also defers losses. One of the most common 1031 transactions I encounter is the trade-in of a business automobile. Thanks to the luxury auto rule the trade-in value is usually less than the basis in the auto. 1031 defers the loss and over the years and several trade-ins you will see a ridiculous build-up in auto basis.
The Insurance Industry
Insurance lobbyists must have been asleep at the switch or something. Nine act sections hit the insurance industry for a total of $32.7 billion. If you read those act section (3701-3709), you probably won’t understand them. Well, I certainly don’t. Here is an example:
Under the provision, P&C insurance companies would use the corporate bond yield curve (as specified by Treasury) to discount the amount of unpaid losses. In addition, the special rule that extends the loss payment pattern period for long-tail lines of business would be applied similarly to all lines of business (but with the 5-year limitation on the extended period increased to 15 years) …
It goes on and on. Fortunately, one of my best friends from Xavier High School, who majored in math before going to law school spent his career as a tax attorney in the insurance industry. This is his opinion on the effect of the provisions which he and three other guys actually understand:
The House bill is similar to Dave Camp’s bill in its approach to life insurers. It is a massive tax increase for the industry] and would make the sale of many products, particularly immediate annuities, longevity insurance and other long-duration products without large cash surrender values unprofitable for companies to sell in their current form. That’s because the deduction for policy reserves is cut so severely. The reserve deduction represents the present value of the future payments the company will have to make. With a severe haircut to the reserve deduction, life insurance companies will pay large amounts of taxes upfront. These taxes will often exceed any profits they may eventually make from these contracts. Companies need to charge the customer enough to cover their future liabilities but they won’t be able to get an offsetting deduction. The result is high upfront taxes on what is essentially large amounts of phantom income from the sale of products that will never produce as much income over the life of the contract as has been assumed upfront by the reserve haircut. The tax hit to the industry is likely to be much higher than shown by the JCT score. There are other changes, like the increase in the so-called DAC tax (IRC § 848), that will make certain contracts, especially annuities, more expensive to purchase. While most industries fare well, life companies are dealt a serious blow under the House bill.
At Christmas The Rabbi Paid Taxes
The Act raises taxes from the highly compensated by currently taxing nonqualified deferred compensation, changing the rules on excessive employee remuneration and putting an excise tax on excess compensation by tax-exempt organizations. All in that is good for $29.1 billion. The reference to rabbis is a tax geek joke. One of the first rulings blessing deferred compensation plans was in favor of a synagogue. Rabbis apparently on average do better compensation wise than Protestant ministers, but you really don’t see them making the big bucks that megachurch pastors and televangelists can pull in. A few of the latter might find their ministries and churches being hit with the excise tax which will also apply to their tax-exempt housing allowances.
And vaguely related to clergy housing Act Section 1401 puts a $50,000 cap on the exclusion for housing provided to employees for the convenience of employers. Clergy on the other hand even have an exclusion for cash provided for housing, the dubious constitutionality of which will soon be under review, again, by the Seventh Circuit. Passage of this provision of the bill might mean that there will be no other housing provision in the Code that does not have a dollar limit. It might be a hint as to what number Congress would pick if it decides to finally act on clergy housing. Military housing allowance vary by region, but the housing allowance for a general or admiral would be in that neighborhood. The provision is such chump change (less than $50 million) that it does not get scored.
Is There A Theme Here?
Some commentary will indicate that the act favors the high income, but I see a different theme here. The really big cuts – the corporate rate reduction, the maximum rate on business income of individuals and the repeal of the estate tax and GST seem to favor those who get wealth without working – the New Gentry or the Entitled Children (I think I might have a poll as to which of those to use). Many people who provide services without using capital don’t get the new preferred rate. And some of those revenue gainers are directed at people who might be quite well off, but are still working for their money. I’m thinking the deferred comp, entertainment expenses and rules that make it more painful to pay high salaries.
This is quite a bit different than the tax reform push in the seventies and eighties. There was a hands the cross the aisle kumbaya moment between Ronald Reagan and Bill Bradley when they commiserated about the very high rate that they had had to pay – Bradley for playing basketball and Reagan for playing the Gipper. Prior to the big rate reduction in 1986, there was a maximum tax on personal service income that made the maximum rate on income you worked for 50%, while the coupon clippers still had to pay 70%.
Then developer Donald Trump did not think lower rates for high-income people was such a hot idea, since dentists no longer had an incentive to invest in affordable housing. Go figure.
Supposedly the limitation on who will get the new maximum 25% rate is to put a “guardrail” alongside of it to prevent people like me from telling you how to game the system, but I’m thinking the Republicans might be moving from being a party of entrepreneurs to a party of rentiers. Maybe they have read Thomas Piketty and are betting he is right. In Capital in the Twenty-First Century, Piketty indicated that the period after 1950 until recently was exceptional in that most wealth that people held was accumulated in their lifetimes. He projects that by 2050 as much as 90% of it will be inherited. Maybe instead of being ruled by machine overlords, our children will be ruled by the New Gentry. Seems like they are already making inroads.