- The Senate and House of Representatives voted to approve the tax reform bill.
- The legislation makes major changes to taxes for employers and individuals.
- The bill reduces the corporate tax rate to 21 percent from current 15 to 35 percent rate.
- The Affordable Care Act’s individual mandate tax penalty has been reduced to $0.
- The president signed the bill into law on Dec. 22.
Senate and House compromised on their separate bills; final version looks more like Senate's
On Tuesday, Dec. 19, Congress began a day-long voting process for the tax reform bill, previously referred to as the Tax Cuts and Jobs Act, and ended Wednesday as both chambers voted along party lines to approve it. The president signed the bill into law Dec. 22. On Friday, Dec. 15, the House and Senate conference committee agreed to the compromise on their separate versions of the legislation. Although many items differed in the two chambers' proposed bills, the final conference report more closely resembled the Senate's version.
The Congressional Budget Office (CBO), a nonpartisan agency, scored the tax reform legislation, finding that it would add just under $1.5 trillion to the federal deficit over 10 years. This bar had to be passed for the bill to proceed under Senate budget rules.
Business tax changes
The tax reform bill contains numerous provisions affecting businesses, which take effect in 2018 with no sunset date. If passed, the legislation:
- Reduces the corporate tax to a 21 percent flat rate from today's progressive tiered tax rate, which generally ranges from 15 to 35 percent. This was an increase from the flat 20 percent rate proposed previously in both chambers.
- Repeals the corporate Alternative Minimum Tax.
- Permits deductions for qualified business income for pass-through entities (partnerships, LLCs, sole proprietorships, S corporations) of up to 20 percent. Complex rules and limitations apply. This deduction was lowered (previously 23%) and several rules/thresholds were altered, from what passed the Senate earlier this month. The provision falls under the individual tax code, and thus would sunset in 2026 without additional legislative action.
- Allows a tax credit for certain employers that provide paid family and medical leave to their workforce. The credit ranges from 12.5 percent to 25 percent of wages paid. The amount of the credit incrementally increases from 12.5 percent as the employer's payment under this arrangement exceeds 50 percent of normal wages paid. The credit is only available for wages paid in 2018 and 2019. The bill contains specific criteria and detailed definitions; one clarification carves out the amounts employers must contribute to a paid-leave policy under state or local leave laws. Businesses would need more guidance to sort out some remaining questions, and forms to calculate and file for the credit.
- Disallows business deductions for settlements and costs of settlements that relate to sexual harassment or sexual abuse, if settlements are subject to nondisclosure agreements.
- Repeals the special rule that allows recharacterization of individual retirement account (IRA) contributions between Roth and traditional IRAs. However, there is a carve-out to this rule.
Individual tax provisions
All changes below are effective 2018 and sunset after 2025, unless otherwise noted. For individuals, the tax reform bill:
- Changes withholding rates and tables. Similar to the Senate version, the bill retains seven progressive rates, but the top rate was reduced further in conference. The new rates would be 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent. (The rates in 2017 are 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and 39.6 percent.) Legislators also changed the tables that break down the wages to which each of these rates apply. It's hard to examine the bill's overall impact on taxpayers without understanding the wage ranges in each bracket.
- Almost doubles the standard deduction to $12,000 for single filers, $24,000 for married joint filers, and $18,000 for heads of households. (In 2017 the deductions were $6,350, $12,700, and $9,350, respectively.)
- Repeals personal exemptions. (In 2017, the IRS allowed a $4,050 exemption per family member, including the filer.)
- Increases the maximum child tax credit to $2,000 (previously $1,000) and creates an additional $500 family credit for nonchild dependents. The bill also raises the income level for the credit phase-out, so more taxpayers would be eligible for the maximum credit. Deviating slightly from the House and Senate bill, the conference committee allowed up to $1,400 per child to be refundable.
- Decreases the mortgage interest deduction threshold to $750,000.
- Caps state and local tax deductions at $10,000, but takes into consideration sales, income, and property taxes to reach the cap. Both the House and Senate versions only allowed property taxes.
- Reduces the threshold for deducting qualified medical expenses to pre-Affordable Care Act (ACA) levels. Currently, individuals can deduct qualified medical expenses that exceed 10 percent of adjusted gross income. This provision moves that threshold back to 7.5 percent, but only for the 2017 and 2018 tax years.
- Increases the Alternative Minimum Tax threshold.
- Increases the estate and gift tax exemption to $10 million, twice the current amount.
- Repeals the deduction for moving expenses, except for members of the armed services.
The tax bill affects employee benefits. It:
- Repeals the exclusion for employer-provided qualified moving expenses, except for members of the armed services;
- Repeals the exclusion for employer-provided bicycle commuter expenses; and
- Modifies the rules for excluding employee achievement awards. The change would prohibit items such as cash and gift cards.
Repeal of the ACA's individual mandate (effective 2019)
The ACA contains a requirement where individuals must demonstrate they have qualified health insurance coverage or qualify for an exemption on their tax returns, or face a penalty from the IRS. The tax reform bill negates the ACA’s individual mandate penalty by reducing it to $0 by 2019. Although the tax bill does not repeal the provision, negating the penalty amount essentially has that effect. However, it should be noted that this does not change the filing requirement for the individual mandate. Under the individual mandate, the IRS requires self-insured employers and insurers to report individuals covered by their plan or face penalties. Additionally, other provisions in the ACA, including the employer shared responsibility provision, remain unchanged.
The CBO has estimated that negating the individual mandate penalty would save $338 billion over 10 years, but more than 13 million people would lose health insurance by 2027. Premiums in the individual market would surge an average of 10 percent a year.
What's the impact on employers?
Although many of these changes described apply to the individual section of the tax code, employers will need to adjust their income tax withholding for employees. Employers must implement new withholding tables once the Internal Revenue Service (IRS) releases them. The IRS has indicated that it needs time to evaluate the tax changes, so new tables likely won't be available before January, when the changes take effect. Once the IRS releases the withholding tables, employers will have a transition period in which they can use the old withholding tables while testing the new tables in their payroll systems.
Given the bill's significant shift away from personal exemptions and itemized deductions, it's likely that the W-4 form will also require revision. We don't yet know what employers will have to do if the IRS releases a new W-4. The agency will have to provide guidance on this and many other items for businesses and employees alike.
The final legislation also removed tax-free status from a handful of employee benefits. Employers will need to evaluate the impact of this loss on their workforces and bottom lines.
What happens next
Now that the president has signed the bill into law, implementation of these changes, including additional guidance from the Treasury Department, will be necessary. Many of these provisions will require the IRS to opine on the specifics of the provisions' implementation. The agency's limited resources will challenge it to implement the majority of the bill's provisions by their effective date of 2018.
Employers should also recognize that the federal bill will affect state tax policy. States will need to evaluate whether and how they will adjust their tax codes to the federal policy, depending on how they apply various components of the Internal Revenue Code, federal standard deductions, or exemptions. Some states may need legislation to respond. Given that many of the federal tax changes take hold in January 2018, states may need to move quickly to assess impacts on their budgets and their citizens. This includes withholding changes, W-4s, taxability, credits, and the general tax code rules.
Employers: Ensure your payroll systems are ready for changes
Employers will need to wait until the IRS publishes guidance on the tax reform provisions. However, businesses should ensure that their payroll system can adapt to these changes quickly. Paychex is staying close to the details of the bill and the anticipated deadlines, and is ready to help companies make the necessary adjustments.