On February 21, 2014, then House Ways and Means Committee Chairman Dave Camp (R-Michigan) issued a discussion draft of the “Tax Reform Act of 2014.” The proposed legislation spanned almost 1,000 pages and contained some interesting provisions, including repealing IRC § 1031, thereby prohibiting tax deferral from like-kind exchanges. Not only would taxpayers have been impacted by this proposal, but it would have turned the real estate industry upside down. Qualified intermediaries would have been put out of business. Likewise, title and escrow companies, as well as real estate advisors specializing in exchanges, would have been adversely affected by the proposal.
As reported in my November 2014 blog post, President Obama’s administration wants to limit taxpayers’ ability to defer income under IRC § 1031. In response to former House Ways and Means Committee Chairman David Camp’s proposed Tax Reform Act of 2014, which would have eliminated IRC § 1031 altogether, the Obama administration proposed to retain the code section, but limit deferral with regard to real property exchanges to $1 million per taxpayer each tax year. Personal property exchanges, under the President’s proposal, would go unscathed.
In 2015, President Obama expanded his proposal relative to IRC § 1031 to limit personal property exchanges by excluding certain types of property from the definition of “like kind.” The excluded personal property included items such as collectibles and art. The President’s proposed $1 million real property exchange limitation was left intact.
Fast forward to today. No tax reform legislation has gained enough traction to even come close to being enacted into law. Nevertheless, President Obama’s attack on IRC § 1031 continues. In the administration’s 2017 budget proposal (released a few months ago), the White House expands its quest to limit the application of IRC § 1031. This proposal is identical to President Obama’s original response to former Chairman Camp’s 2014 tax reform proposal, but it goes further. Now, the President is proposing that the $1 million limitation apply to both personal and real property exchanges. In addition, like his 2015 proposal, President Obama wants to exclude certain personal property, collectibles and art, from the definition of “like kind.”
I am not sure any real logic or significant tax policy supports the White House’s latest proposal to limit the application of IRC § 1031. Rather, the proposal appears to be solely aimed at tax revenue generation. According to the Treasury, the proposal, if enacted into law, would increase tax revenues by $47.3 billion over 10 years.
IRC § 1031 is clearly on lawmakers’ radar screens as a means to increase tax revenues. Time will tell whether IRC § 1031 will be repealed or significantly curtailed in its application. Nevertheless, one thing is for sure: IRC § 1031 remains a potential target. Stay tuned!
As I reported late last year (in my November 25, 2014 blog post), former House Ways & Means Committee Chairman David Camp proposed to repeal IRC § 1031, thereby eliminating a taxpayer’s ability to participate in tax deferred exchanges of property. The provision, a part of Camp’s 1,000+ page proposed “Tax Reform Act of 2014,” was viewed by some lawmakers as necessary to help fund the lowering of corporate income tax rates.
The Obama Administration responded to former Chairman Camp’s proposal, indicating its desire to retain IRC § 1031. The Administration, however, in its 2016 budget proposal, revealed its intent to limit the application of IRC § 1031 to $1 million of tax deferral per taxpayer in any tax year. The proposal was vague in that it was not clear whether the limitation was intended to apply to both real and personal property exchanges.
Despite former Chairman Camp’s proposal and the Obama Administration’s response, many commentators believe IRC § 1031 will remain unscathed. In other words, tax reform will not touch it in any material manner. In prior blog posts, I have expressed some doubt that they are correct.
Keep in mind, the repeal of IRC § 1031 is not a new concept. In fact, former Senate Finance Committee Chairman Max Baucus proposed, as part of his cost recovery and tax accounting reform discussion, the repeal of IRC § 1031. Senator Baucus’s proposal was originally published and circulated to lawmakers back in November 2013. Fast forward almost 18 months: lawmakers are still considering the repeal of IRC § 1031.
On March 17, 2015, EY LLP issued a 42-page report entitled the “Economic Impact of Repealing Like-Kind Exchange Rules.” The report, prepared on behalf of the “Section 1031 Like-Kind Exchange Coalition” (“Coalition”) examines the macro economic impact a repeal of IRC § 1031 would have on our economy.
The report reveals some interesting economic data relating to a repeal of IRC § 1031. EY concludes a repeal would result in businesses holding property longer, businesses relying more heavily on debt financing, and a less productive employment of capital into our economy. The results would lead to:
- Our gross domestic product declining by $8.1 billion a year;
- Investment in the economy declining by $7 billion a year; and
- Annual income from labor declining by approximately $1.4 billion a year.
EY makes a very important and practical observation. The report reveals that, while the repeal would help fund reducing corporate income tax rates, individuals and individual owners of pass-through entities, who are helping pay for the corporate rate reduction and who currently participate in a bulk of all exchanges, would not directly benefit from reduction in corporate tax rates. In fact, according to a report published by the Treasury Office of Tax Analysis (“OTA”) in 2014, the bulk of tax deferred exchanges are completed by individuals and entities taxed as partnerships. Looking at tax year 2007, the OTA found total tax deferral from exchanges for the year amounted to $82.6 billion, of which $56.8 billion or 69% was attributable to individuals and entities taxed as partnerships. So, EY’s conclusion appears to be well supported.
According to EY, several industries would be adversely impacted by the repeal of IRC § 1031. These industries not surprisingly include: construction, real estate, transportation and civil engineering.
Obviously, proponents of IRC § 1031 are not convinced that tax reform will leave their code provision unscathed. If such was not the case, the Coalition would not have engaged EY to undertake the study and issue its report. One thing is certain--the debate over IRC § 1031 is ongoing. Will changes to the code section be included in tax reform? Stay tuned!
While it is highly unlikely Santa’s little helpers will deliver to taxpayers a tax reform package by the end of 2014 that is acceptable to the Senate, the House of Representatives and the President, House Ways and Means Committee Chairman, Dave Camp, made one last attempt to move the ball forward. On December 11, 2014, shortly before Chairman Camp’s expected retirement, he formally introduced a bill in the House to adopt into law the Tax Reform Act of 2014 which he authored and circulated in proposed form to lawmakers back in February. Affixed with the label “Fixing Our Broken Tax Code So That It Works For American Families and Job Creators,” the proposal is now formally before Congress.
Our lawmakers uniformly agree that we need tax reform in this country. In fact, more than thirty (30) separate congressional hearings dedicated to tax reform have been held in recent times. There exist at least eleven (11) bipartisan working groups which are exploring tax reform. So, we appear to be headed in the right direction. The billion dollar question continues to be, will we get sufficient consensus among our lawmakers so the tax reform will become a reality?
At about the same time as Chairman Camp introduced his tax reform bill in the House, Senate Finance Committee republican staff released a report, “Comprehensive Tax Reform for 2015 and Beyond.” The report exams the history of tax development and the economic issues associated therewith. Senator Orrin Hatch, who is slated to become the Chair of the Senate Finance Committee in 2015, hopes the report will get the issues on the table and act as an invitation to both parties to roll up their shirt sleeves and work together on these tough and ever important issues.
These developments may be an indication that the impetus for tax reform is picking up steam. Hopefully, the momentum will carry into 2015 and will be strong enough to get the ball across the goal line.
Despite these developments, however, I fear tax reform is still far away from becoming a reality. Chairman Camp’s proposal spans almost 1000 pages and impacts some highly sensitive tax issues important to special interest groups. While his proposed legislation cuts both ways (i.e., has provisions that each party could support), the question continues to be whether adequate consensus can be achieved in Washington to pass comprehensive tax reform legislation. Time will tell.
House Ways and Means Committee Chairman Dave Camp (R-Michigan) issued a discussion draft of the “Tax Reform Act of 2014” last week. The proposed legislation spans almost 1,000 pages and contains some interesting provisions, including, without limitation, the following:
Individual Taxpayer Provisions
- Consolidation and simplification of individual income tax brackets. The current seven tax brackets would be consolidated into three brackets—namely, a 10% bracket, a 25% bracket and a 35% bracket. High-income taxpayers would be subject to a phase-out of the tax benefit of the 10% bracket. In addition, the special rate structure for net capital gains would be repealed. In its place, non-corporate taxpayers could claim an above-the-line deduction of 40% of adjusted net capital gain.
- Expand the standard deduction (to $22,000 for joint filers and $11,000 for individuals) and modification of available itemized deductions, including:
- Repeal of the 2% floor on itemized deductions and the overall limitation on itemized deductions.
- Reduce the itemized deduction for home mortgage interest to $500,000.
- Repeal of the deduction for personal casualty losses.
- Repeal of the deduction for unreimbursed medical expenses.
- Repeal of the deduction for state and local taxes not paid in connection with business or investment.
- Simplification of the rules surrounding charitable deductions.
- Repeal of the exclusion for employee achievement awards.
- Repeal of the deduction for moving expenses.
- Reinstating the former provision allowing the cost of over-the-counter medications to be reimbursed through tax-favored health accounts.
- Consolidation and simplification of tax benefits for higher education. A single educational tax credit of up to $2,500 annually would be made available that could be used for up to 4 years; however, the current deductions for educational expenses and interest on student loans would be repealed.
- Elimination of the income limitations on Roth IRAs and prohibiting new contributions to traditional IRAs and non-deductible traditional IRAs—effectively forcing all new IRA contributions to be Roth contributions.
- Repeal of the exception to the 10% early withdrawal penalty for withdrawals from retirement plans and IRAs used to pay first-time home buyer expenses (capped at $10,000).
- Elimination of the deduction by the payor for the payment of alimony and elimination of the inclusion in income by the recipient.
- Repeal of the individual AMT.
- IRC Section 1031 would be repealed. Consequently, tax deferral from like-kind exchanges would no longer be permitted.
- Simplification of rules surrounding in-service distributions, hardship withdrawals and required minimum distributions from retirement plans.
- Encouraging Roth contributions in 401(k) plans by requiring all 401(k) plans to offer Roth accounts and requiring larger plans to treat all employee contributions as Roth contributions once an employee had contributed one-half of the annual contribution limit.
Business & Corporate Taxpayer Provisions
- Repeal of the corporate AMT.
- Creation of a flat corporate tax rate of 25% (phased in over 5 years), applicable to business and personal service corporations alike.
- Code Section 351 would be amended so that contributions of capital to a corporation in excess of the fair market value of the stock issued would be taxable to the recipient corporation. This provision would also extend to any non-corporate entity.
- Limitations on the deductibility of NOLs by C corporations would be implemented.
- Code Section 179 expensing would be made permanent at the 2008-2009 levels.
- Code Section 197 amortization of goodwill would be extended from 15 years to 20 years.
- The deductions for meals and entertainment expenses, which are currently limited to 50%, would be eliminated with respect to entertainment. A 50% deduction for meals directly related to the conduct of a trade or business would remain intact.
- Repeal of a significant number of business tax credits.
- Simplify accounting method rules—businesses with average annual gross receipts of $10 million or less would be allowed to use the cash method of accounting, while businesses with average annual gross receipts over $10 million would be required to use the accrual method of accounting. The large portion of the current array of exceptions and nuances relative to adopting an accounting method would be eliminated.
- Interest charge rules would attach to all installment sales in excess of $150,000.
- The LIFO inventory method of accounting would be eliminated.
- Dividends received from a foreign subsidiary would be excluded from the definition of personal holding company income.
- The S corporation built-in gains tax recognition period would be permanently set at five (5) years.
- The passive income threshold for the application of Code Sections 1362(d)(3) and 1375 would be increased from 25% to 60%.
- Non-resident aliens would be allowed to be beneficiaries of ESBTs.
- The time for making an S election would be extended until the due date of the Form 1120s (with extensions).
- The rules relating to guaranteed payments from a partnership to a partner would be repealed.
- The technical termination of a partnership by the transfer of 50% or more of the interest in the partnership would be repealed.
- “Carried interest” in investment partnerships would be treated as ordinary income.
- A worker classification safe harbor would be created based upon objective criteria. Limited withholding obligations on the part of the service recipient would be required.
Miscellaneous Administrative Changes
- A C corporation would be required to file its tax return on or before April 15. On the other hand, partnerships and corporations would be required to file their tax returns on or before March 15.
- Most compliance penalties are increased.
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The above summary is not exhaustive. It does, however, illustrate the types of broad-sweeping changes Chairman Camp has in mind. Most lawmakers do not expect a tax overhaul of this nature to become law this year. Rather, the consensus in Washington is that discussions on tax reform will continue into 2015 before any bill is presented for a vote in either the House or the Senate. It is doubtful that we will see any proposed legislation enacted into law until 2016. Stay tuned! I expect we will see a great deal of commentary on tax reform in the upcoming months.
For a discussion of Chairman Camp’s proposal, please read here.
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Evaluating the Built-in Gains Tax for C to S Conversions After TCJA," New York University Summer Institute in Taxation – Advanced Conference on Subchapter SNew York, NY, 7.26.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationNew York, NY, 10.21.18-10.26.18
- "The Tax Cuts and Jobs Act – What It May Mean to Your Clients," Estate Planning Council of Portland Mini-SeminarPortland, OR, 11.7.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationSan Diego, CA, 11.11.18-11.16.18