Hill Conferees Come to Terms on Tax Reform Legislation
House and Senate tax negotiators agreed on the final tax reform legislation Dec. 15, but they had to make some additional changes to pick up support from some wavering members. How did retirement plans fare?
Significantly, the retirement plan issues created by proposed tax changes affecting pass-through entities were not fixed in the final bill. However, there were changes to the underlying pass-through provision that somewhat ameliorate the projected impact. First, the fundamental deduction given to business owners on pass-through income was reduced from 23% to 20%, and the income threshold for eliminating the deduction for business owners of certain pass-through service businesses was reduced from $500,000 (adjusted gross income) to $315,000, while the deduction is fully phased in at incomes above $415,000 (for married filers — half that for singles). Additionally, the definition of what constitutes a service business was somewhat loosened, and in the final bill excludes engineering and architectural firms, meaning they will no longer be subject to the phase-out.
Finally, the overall impact of the differential rate for pass-through income on the retirement plan incentives for the business owner is lessened due to the overall reduction in ordinary rates. For example, since the top rate for incomes above $600,000 (for married filers) under the final bill is now 37%, the maximum differential is now 7.4%, whereas it was more than 8% in the Senate bill. Additionally, for those pass-through service business owners below the income threshold of $315,000, their marginal rate will be just 24%, which results in a differential of just 4.8%. The bottom line? The overall impact is less than it was projected to be under the Senate bill. That said, concerns still remain and we will be assessing how to address them going forward.
Additionally, the final bill does not include a provision to “Rothify” 401(k) plans.
“Remember where we started,” noted Brian Graff, CEO of the American Retirement Association. “There were proposals on Rothification, cutting or freezing retirement plan contribution limits, eliminating 403b and 457 plans, and basically eliminating all forms of nonqualified deferred compensation. In the end, we were able to beat back all of those.”
Other Retirement-Related Provisions
The legislation contains several other miscellaneous retirement-related provisions, including:
- Recharacterization: The final bill repeals the ability of individuals to recharacterize a contribution to a Roth to a traditional IRA, effective for tax years beginning after 2017. Under this provision, the special rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA does not apply to a conversion contribution to a Roth IRA. Thus, recharacterization cannot be used to unwind a Roth conversion. However, the conference report explains that recharacterization is still permitted with respect to other contributions. For example, an individual may make a contribution for a year to a Roth IRA and, before the due date for the individual’s income tax return for that year, recharacterize it as a contribution to a traditional IRA.
- Length-of-service awards for public safety volunteers: The final bill raises the maximum amount for a length-of-service award plan to $6,000 and indexes that amount going forward, effective for tax years beginning after 2017.
- Extended rollover period for certain plan loan offsets: The final bill 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). The provision is effective for tax years beginning after 2017.
- Disaster relief: The final bill provides retirement plan and casualty loss relief for any area with respect to which a major disaster has been declared by the President under section 401 of the Robert T. Stafford Relief and Emergency Assistance Act during 2016, beginning on the date of enactment.
Also included are provisions affecting the tax treatment of compensation, employee benefits and other tax issues. The bill will:
- Allow for increased contributions to ABLE accounts and allow Saver’s Credit for ABLE contributions (sunset after 2025), effective on the date of enactment.
- Allow rollovers from Section 529 accounts to ABLE accounts (sunset after 2025).
- Limitation on deduction by employers of expenses for fringe benefits: (1) limits meals and entertainment expenses, including meals for the convenience of the employer; (2) repeals deduction for qualified transportation fringes, including commuting except as necessary for employee’s safety; and (3) clarification of tangible personal property deductible as employee achievement award.
- Provide a tax credit to certain employers who provide family and medical leave (sunset after 2019).
- Modify the limitation on excessive employee remuneration, with a transition rule.
- Impose a 21% excise tax on excess tax-exempt organization executive compensation (certain exceptions provided to non-highly compensated employees, and for certain medical services), effective to tax years beginning after 2017.
- Modify the treatment of qualified equity grants.
- Increase the excise tax on stock compensation in an inversion from 15% to 20%.
- Repeal the fringe benefit exclusion for employer-provided bicycle commuting expenses (sunset after 2025).
- Repeal the exclusion for employer-provided qualified moving expense reimbursements (other than members of the Armed Forces) (sunset after 2025).
Provisions that were previously included in either the House or Senate bills, but are not included in the final legislation, include:
- Reduction in minimum age for allowable in-service distributions.
- Modification of rules governing hardship distributions.
- Modification of rules relating to hardship withdrawals from cash or deferred arrangements.
- Modification of nondiscrimination rules for certain employer-sponsored plans.
- Provision requiring that the cost of any specified security sold, exchanged, or otherwise disposed of be determined on a first-in first-out basis.
If enacted, the Tax Cuts and Jobs Act (H.R. 1) will deliver some of the most extensive changes to the tax code since the Tax Reform Act of 1986.
Overall, the final bill would reduce taxes by $1.456 trillion over the 10-year period 2018-2017, but it sunsets the individual tax provisions in 2026. The final bill will:
- reduce the corporate tax rate to 21% from 35%;
- eliminate the corporate AMT;
- reduce the top individual tax rate to 37% and make other adjustments to the individual tax brackets;
- limit the mortgage interest deduction for new home purchases to $750,000;
- limit the amount that can be deducted for state and local income taxes to $10,000;
- eliminate the Affordable Care Act’s individual mandate to obtain health coverage; and
- reform the U.S. international tax rules on foreign source income.
The final conference report is here
; the Joint Tax Committee revenue table of the final bill is here
; and the summary of the conference report is here
So what are the bill’s prospects for passage? First, it does appear that the Senate has the votes to approve the legislation, an outcome that appeared anything but certain in the days leading up to the unveiling of the final bill on Dec. 15.
As Republican leaders were putting the finishing touches on the final legislation late last week, Sens. Marco Rubio (R-FL) and Mike Lee (R-UT) threatened to vote against it unless their demands were met to increase the refundable amount for the child tax credit. In response, the conferees increased the refundable amount from the earlier proposed level of $1,100 to $1,400 of the new, $2,000 child credit.
Sen. Bob Corker (R-TN), who voted against the original Senate bill, said he will vote for the final bill. In addition, it appears that Sens. Susan Collins (R-ME) and Ron Johnson (R-WI) will also lend their support. Meanwhile, Sens. John McCain (R-AZ) and Thad Cochran (R-MS) have been in the hospital. Cochran is expected to be on hand this week to vote, but indications are that McCain will not. The current split in the Senate is 52 Republicans to 48 Democrats; that will change to 51 to 49 in January, when Senator-elect Doug Jones (D-AL) is sworn in.
Both the House and Senate must approve the final conference report to H.R. 1 (which cannot be amended and must be approved in its final form). Reports suggest the Senate will consider the legislation first. Under budget rules, the Senate may debate the legislation for up to 10 hours.
If all goes as planned by GOP leadership, the House and Senate will approve the final conference report on Dec. 19 or 20 and send the legislation to President Trump for his expected signature by Dec. 23.