Last night the Joint Committee on Taxation released a description of Senate Finance Committee Chairman Hatch’s proposed Modifications to the Senate Mark of the Tax Cuts and Jobs Act. Reports in anticipation of the Chairman’s Modifications had described them as intended to reduce the deficit increases otherwise expected under the initial Senate Mark. The JCT also released an updated score last night that reflects the impact of the Chairman’s Modification. In addition to modifying the tax brackets applicable to individuals, increasing the child tax credit, and repealing the individual mandate to obtain health insurance under the Affordable Care Act, the Modification make several noteworthy revisions to the original Chairman’s Mark.
Sunset provisions. All of the reforms affecting individuals under the Senate Mark would expire after December 31, 2025 other than the use of chained-CPI for purposes of the inflation adjustments built into the Code. As a result, the modified individual tax brackets, repeal of the individual Alternative Minimum Tax, 17.4% deduction for pass-through business income, and increase in the estate and gift tax exemptions would not apply in 2026 and later years.
International reform changes. The deduction for GILTI income would be reduced from 50% to 37.5% and the deduction for foreign-derived intangible income would be reduced from 37.5% to 21.875%, in each case for taxable years beginning after December 31, 2025. GILTI income would therefore be taxed by the U.S. at an effective 12.5% rate after 2025, with an 80% credit for foreign taxes paid on such income. FDII would be taxed at an effective 15.625% rate after 2025. The minimum tax on base erosion payments would be increased to 12.5% from 10% in taxable years beginning after December 31, 2025, but taxpayers would receive the benefit of additional credits for purposes of calculating their regular tax liability in those years for purposes of computing the base erosion minimum tax. The Modification provides that these changes would not take effect if federal revenues exceed certain amounts as of September 30, 2026. The Modification also excludes from the “modified taxable income” used to calculate the base erosion minimum tax any amounts paid or incurred for the cost of services (with no markup) if those services meet the requirements for the services cost method under section 482 (other than the requirement that the services not contribute significantly to fundamental risks of business success or failure). Finally, the Modification clarifies that the mandatory deemed repatriation inclusion is reduced by foreign E&P deficits, including qualified deficits, and allows taxpayers to elect to preserve NOLs in lieu of utilizing them to offset the inclusion.
Business reform changes. The deduction for net operating losses would be limited to 80% of taxable income for taxable years after December 31, 2023, but this change would not take effect if federal revenues exceed certain amounts as of September 30, 2026. The Modifications clarify that the 17.4% deduction applicable to qualified business income from a partnership, S corporation or sole proprietorship is limited to 50% of the taxpayer’s allocable or pro rata share of the wages paid by the business during the calendar year that are subject to wage withholding, elective deferrals, or deferred compensation. That limitation would not apply for individual taxpayers with income of less than $250,000 ($500,000 for joint filers) and would be phased out over the next $50,000 of income ($100,000 for joint filers). The Modification further increases the availability of the deduction for taxpayers in specified services businesses with income up to $250,000 ($500,000 for joint filers).
Compensation-related changes. The provision that would have taxed almost all compensation at vesting (when no longer subject to a service requirement), effectively ending the ability to defer compensation (a similar provision was eliminated from the House bill), would be eliminated, as would the provisions that would have created a safe harbor for classification of independent contractors (including for workers in the “on demand” economy) and that would have eliminated the ability of high-wage earners to make catch-up contributions to defined contribution plans. The Modification would allow for the taxation of certain stock options and RSUs granted by private companies to be deferred for up to 5 years (this provision is also in the House bill) and would grandfather certain compensation from the proposed expansion of the $1 million annual limit on the deductibility of executive compensation under Section 162(m) (including the elimination of the performance-based compensation exception).
Changes to R&D deductions. For taxable years after December 31, 2025, specified research and experimental expenditures would be required to be capitalized and amortized ratably, with a substantially longer amortization period applicable for research conducted outside of the United States than within. Specified research or experimental expenditures which are attributable to research that is conducted within the United States would be amortized ratably over a five-year period, whereas such expenditures would be amortized over a fifteen-year period when attributable to research conducted outside of the United States. The Modifications do not define the term “specified research and experimental expenditures,” so it is unclear how the amendments’ requirement that taxpayers amortize specified research and experimental expenditures will affect the current deduction of research or experimental expenditures generally.
Sweeteners. The Modifications introduce several new provisions that are likely designed to secure votes of individual Senators or encourage support from particular business lobbies. Examples include provisions providing for favorable taxation of beer and wine (and mead), granting combat zone tax benefits to members of the armed forces in the Sinai Peninsula of Egypt, exempting farming businesses from the new limitations on the deductibility of interest, expanding the definition of qualified property eligible for 100% expensing to include qualified film, television, and live theatrical productions released before 2023, expanding deductions for costs incurred for replanting edible crops following loss or damage due to casualty, exempting certain payments related to the management of private aircraft from excise taxes on taxable transportation, and new incentives for investment in low-income communities.