How the GOP Tax Bill May Affect Businesses

Corporations would enjoy a lower flat tax rate while individual owners of pass-throughs would also see a lower rate, but with more complex terms.

After months of fanfare about tax reform, House GOPers have finally released a tax bill, cutting rates for businesses and most individuals and nixing or paring back many popular tax breaks.

But don't take the House proposals as gospel. They're bound to change as lobbying groups pick apart each of the revenue raisers in the package. Additionally, because of divisions among Republicans, fixes will be required to get more members on board without alienating others. No Democrats will sign on, so Republican unity will be essential. Plus, the Senate is feverishly working on its own tax bill, which will differ from the House's opening bid. And the president's Twitter-speak on specific tax proposals isn't helping the cause.

Although we still expect passage of tax cuts sometime in early 2018, it's going to be a bumpy ride, somewhat akin to the health reform saga. A big sticking point: The impact on the federal deficit. Senate fiscal hawks could end up balking if the tax cuts threaten to add too much to the national debt.

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With that, let's turn to details of some of the business-tax provisions included in the House bill, the vast majority of which would apply to tax years beginning after 2017.

The House bill would dramatically reform the taxation of businesses. Corporations would pay tax at a flat 20% rate, down from 35% now. This lower rate would be permanent and would begin in 2018 with no phase-in. Personal services corporations would be subject to a flat 25% corporate rate. The corporate alternative minimum tax would be scrapped, too.

The tax rate that individual owners of pass-throughs would pay is complex. That's because the proposed 25% top rate is subject to lots of special rules to help prevent gaming of the tax system, since it's lower than the top individual rate.

The rules cover sole proprietors and owners of S corporations, partnerships and LLCs. Income from passive business activities would qualify for the 25% rate in full. The convoluted material participation rules for passive activities under current tax law would apply in figuring whether a person is active or passive with regard to an activity.

Active business owners would use a default 70-30 wages-to-profits ratio that would tax 70% of income at individual rates and 30% at the 25% pass-through rate. Or they could elect a specified formula. The election would be binding for five years. Capital gains and dividends that pass through would retain their character.

Folks in personal service businesses generally can't use the 25% rate. This includes lawyers, accountants, consultants, engineers, doctors and more. Tax pros will be in high demand to help their clients navigate all the rules.

Enhanced write-offs for business asset purchases are included in the bill, including 100% bonus depreciation for many assets put into use during the year. But there's a catch. This business tax break is temporary, lasting for only five years. Also, the cap on expensing business assets would skyrocket to $5 million.

Many key breaks would be eliminated or pared back: business entertainment, the 9% domestic production deduction and the rehab and work opportunity tax credits. Plus, net operating losses could offset only 90% of taxable income, and NOL carrybacks would be prohibited. Tax-deferred like-kind swaps would be limited to real property.

There are no changes to the credits for R&D or low-income housing. Nor is there a provision for hedge fund managers to report gains as ordinary income.

The deduction that firms claim for interest paid on debt would be limited. Their net interest write-offs would be capped at 30% of income before taking NOLs, interest, depreciation and amortization. Disallowed interest could be carried forward for five years. Businesses with $25 million or less of average gross receipts, real estate companies and certain regulated public utilities would be exempt.

The package includes a revenue-raising proposal on U.S. multinationals: A one-time low tax on previously untaxed income that firms hold abroad. The rate would be 12% on foreign cash holdings and 5% on other reinvested profits. Companies can spread payment of this tax in equal installments over eight years.

A slew of other provisions affect U.S. multinationals. They include a partial move to a territorial system so generally only income within U.S. borders is taxed, and anti-abuse rules to prevent companies from shifting their income abroad.

Joy Taylor
Editor, The Kiplinger Tax Letter

Joy is an experienced CPA and tax attorney with an L.L.M. in Taxation from New York University School of Law. After many years working for big law and accounting firms, Joy saw the light and now puts her education, legal experience and in-depth knowledge of federal tax law to use writing for Kiplinger. She writes and edits The Kiplinger Tax Letter and contributes federal tax and retirement stories to and Kiplinger’s Retirement Report. Her articles have been picked up by the Washington Post and other media outlets. Joy has also appeared as a tax expert in newspapers, on television and on radio discussing federal tax developments.