Washington Insights - Winter 2018
Jan. 4, 2018 | By Jon Vogler
Comprehensive tax reform bill enacted
The most sweeping tax reform bill in decades was passed by the House of Representatives and the Senate last week. It was signed into law by President Trump on Dec. 22, 2017.
In this edition of Washington Insights, we explore several retirement-related developments tied to the bill, including:
- The major provisions of the new law, including retirement-related planks.
- Those items rumored to be included at the start of the tax reform process, as well as those retirement sections which were in earlier versions of the House and Senate bills but which didn’t make it into the final cut.
- A provision concerning pass-through income which may affect the incentives of certain small business owners to sponsor a retirement plan.
- Other education savings and employee benefit provisions included in the new law.
Overall, the final bill will reduce taxes by almost $1.5 trillion over the 10-year period between 2018 and 2027, though it sunsets the individual tax provisions in 2026. Among other items, the final bill:
- Reduces the corporate tax rate to 21% from 35%.
- Eliminates the corporate alternative minimum tax.
- Reduces the top individual tax rate to 37% and makes other adjustments to the individual tax brackets.
- Limits the mortgage interest deduction for new home purchases to $750,000 (although the current $1 million cap for existing mortgages is grandfathered in).
- Limits the amount that can be deducted for state and local income taxes to $10,000.
- Excludes the forced “first in, first out” treatment for selling securities that was part of the Senate bill.
- Adjusts the deduction for unreimbursed medical expenses.
- Almost doubles the standard deduction for individuals while eliminating the personal exemption.
- Allows businesses to immediately write off the full cost of new equipment for the next five years.
- Limits the deduction for net business interest expense to 30% of the taxpayer’s adjusted taxable income.
- Provides a 20% tax deduction for pass-through income, subject to some limitations.
- Doubles the estate tax threshold.
- Eliminates the Affordable Care Act’s individual mandate to obtain health coverage.
- Reforms the US international tax rules on foreign source income.
Several retirement provisions were rumored to be included under tax reform prior to the beginning of the process, but did not appear in either the House or Senate bill. These include: (a) “Rothification” (placing a cap as low as $2,400 on how much employees could save in their workplace retirement plans on a pre-tax basis); (b) cutting or freezing retirement plan contribution limits; (c) eliminating 403(b) and 457(b) plans; and (d) eliminating all forms of nonqualified deferred compensation. The retirement industry is gratified that these “floated” revisions did not find their way into tax reform legislation, since they would have likely resulted in diminished retirement savings.
Below are retirement-related planks which are in the new law:
- Roth recharacterization: The final bill repeals the ability of individuals to recharacterize or unwind a conversion to a Roth individual retirement account (IRA), effective for taxable years beginning after 2017. Taxpayers will continue to be able to recharacterize contributions to one type of IRA (traditional or Roth) as a contribution to the other type of IRA before the individual’s income tax return due date (including extensions).
For Roth conversions occurring in 2017, taxpayers will have until the tax return deadline with extensions (i.e., Oct. 15, 2018) to unwind the conversion, according to informal guidance from the Treasury Department and the IRS.
- Extended rollover period for certain plan loan offsets: Currently, if an employee has taken out a loan from their retirement plan and has an outstanding balance when leaving the company, they have up to 60 days to roll over the outstanding loan balance to an IRA/retirement plan to avoid having the loans treated as taxable distributions. The tax bill extends this rollover period to the due date (plus extensions) for filing their tax returns. The provision is effective for tax years beginning after 2017.
- Disaster relief: The legislation allows 401(k) and other eligible retirement plans to help victims of federally declared major disasters occurring in 2016 by allowing “qualified 2016 disaster distributions” of up to $100,000 per individual prior to Jan. 1, 2018. Such distributions are not subject to the 10% additional tax on early withdrawals.
In addition, income attributable to a qualified 2016 disaster distribution may be included in income ratably over three years, and the amount of the distribution may be recontributed to an eligible retirement plan within three years. Amounts recontributed within the three-year period are treated as rollovers, and individuals may file amended returns to claim refunds of the tax attributable to amounts previously included in income.
Retirement provisions that are not included in the final legislation, but which were previously included in either the House and/or Senate bills, include:
- Reduction in minimum age for allowable in-service distributions.
- Modification of rules governing hardship distributions.
- Modification of nondiscrimination rules for certain employer-sponsored plans.
- Elimination of catch-up contributions for high earners.
- Consolidation of 403(b)/457(b) plan limits.
- Acceleration of taxation of nonqualified deferred compensation.
The final bill does include a provision that could impact whether or not small businesses host retirement plans. As noted above, it provides a 20% tax deduction for pass-through income. That means that pass-through businesses, like S corporations, would pay a lower tax rate by excluding as much as 20% of their business income from taxation. Retirement plan contributions are generally deducted against the S corporation’s business income, which under this provision, would be much lower than the income tax rate S corporation owners pay on retirement savings when they retire (37%, for the most highly compensated owners). This would reduce the attractiveness of the deduction and could affect the business owners’ decision whether to sponsor a retirement plan for their employees and themselves in the first place.
One possible solution to this unintended dilemma would be to give business owners the deduction against their personal income, which is at a higher rate, so that they have the ability to offset and deduct that against the same income at the same rate that they were charged when the money comes out in retirement. The retirement industry hopes for a comparable “fix” in any technical corrections bill which might be under consideration for adoption early next year to clarify certain items within the new law.
Other employee benefit provisions
Also included in the final bill are some key education savings, employee benefit and other tax provisions. Most notably, the bill:
- Permits limited distributions from 529 plan accounts to cover tuition incurred during the taxable year in connection with the designated beneficiary’s enrollment or attendance at a public, private or religious elementary or secondary school. Distributions are limited to not more than $10,000 on a per-student basis, rather than a per-account basis. The provision applies to distributions made after 2017.
- Permits amounts from 529 plan accounts to be rolled over to an Achieving a Better Life Experience (ABLE) account without penalty, provided that the ABLE account is owned by the designated beneficiary of that 529 plan account, or a member of the designated beneficiary’s family.(Amounts in ABLE accounts can be used on a tax-favored basis to pay for expenses for individuals with disabilities.)
- Allows for increased contributions to ABLE accounts and allows Saver’s Credit for ABLE contributions, effective on the date of enactment.
- Limits deductions by employers of expenses for fringe benefits. Specifically, the bill limits deductions of entertainment expenses and meals for the convenience of the employer, repeals deductions for qualified transportation fringes (including commuting except as necessary for the employee’s safety) and clarifies tangible personal property deductible as an employee achievement award.
- Provides a tax credit to certain employers who provide family and medical leave.
- Repeals the exclusion for employer-provided qualified moving expense reimbursements (other than for members of the armed forces).
The new tax reform law is comparable in scope to the landmark Tax Reform Act of 1986. While the time period from introduction to enactment of the latter took well over a year, the new law was put forth and passed within about two months. Whether the relative speed with which Republicans moved the new law through will have any bearing on its ultimate impact remains to be seen. From a retirement perspective, the new law did not have the draconian effect many feared with respect to savings incentives for most plan sponsors and the ability of individuals to save on a pre-tax basis (both of which are valued hallmarks of the American retirement system).
Source: ASPPA Net, “Hill conferees come to terms on the tax reform legislation,” Ted Godbout and Nevin Adams, Dec. 18, 2017
Source: Employee Benefit Advisor, “Breaking down retirement provisions in the tax reform bill,” Paula Aven Gladych, Dec. 20, 2017
Source: Investment Company Institute, “Tax legislation passed by Congress,” Dec. 21, 2017
Source: PlanSponsor, “Tax bill impacts provisions of ERISA plans,” Lee Barney, Dec. 22, 2017
The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
This is not intended to be tax advice. The information presented is based on current interpretation of federal tax law. State income tax laws may differ. Please consult your tax advisor for detailed information. Invesco representatives are not tax advisors.
Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It is not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding tax penalties that may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax advisor for information concerning their individual situation.