Since the House of Representatives voted to approve the Fiscal Year 2018 Budget Resolution in late October, Congressional Republicans have been moving quickly to advance the tax reform bill. The Budget Resolution includes instructions for Congress to pass tax reform through reconciliation, a process that permits certain bills to pass the Senate with a simple majority vote. The tax plan includes a significant reduction in the corporate tax rate and broad changes to the individual tax system.
Overview of the House Bill
The House approved its bill on November 16th. Summarized below are a number of provisions in the tax reform bill from the House that may impact retirement plans:
"Rothification" of retirement plan contributions
For months, there had been discussion on Capitol Hill to offset the cost of tax rate reductions by requiring that employee contributions to retirement plans be made on a pretax (i.e., Roth) basis. However, the change was ultimately not included in the House tax bill after substantial pushback from stakeholders. For now, it appears this tax incentive will continue to be available to retirement plan participants going forward.
Small Business Retirement Plan Incentives
The House bill includes an income tax rate cap of 25 percent applicable to businesses using a pass-through entity structure, such as partnerships, S corps, and small business limited liability corporations. This could greatly discourage some small business owners from adopting or maintaining a qualified retirement plan for their employees as these business owners would pay significantly less in taxes with a 25 percent pass-through tax rate as compared to the benefits received from contributing to a qualified retirement plan. Further, earnings generated from the reinvestment of these pass-through amounts would qualify for a 20 percent capital gains tax rate.
American workers depend on workplace retirement plans as a critical part of their future financial security. Fewer employers sponsoring retirement plans could significantly impact the retirement security of millions of workers.
Sections 1503 and 1504 would make a number of helpful changes to hardship distributions, including (1) making Qualified Non-Elective Contributions (QNECs) and Qualified Matching Contributions (QMACs), as well as all account investment earnings, available for hardship distribution, (2) eliminating the 6-month suspension on contributions, and (3) eliminating the need to first take a plan loan.
Section 1505 would extend the rollover period to the due date for filing the employee's tax return for the year, including extensions, for an outstanding loan balance on termination of employment (or plan termination) in order to avoid a taxable distribution.
Section 1502 proposes to lower the in-service distribution minimum age for participants in defined benefit plans and governmental defined contribution plans from age 62 (age 70½ in certain cases) to age 59½.
IRA Contribution / Conversion Recharacterization
Section 1501 would repeal the current tax provision that allows individuals to recharacterize contributions or conversions from a traditional to Roth IRA or vice versa.
Section 1506 – Closed Plan Nondiscrimination Testing
This section addresses nondiscrimination testing and minimum participation relief for certain employers who closed their defined benefit plans.
State and Local Tax Deductions
The bill includes a partial repeal of taxpayer's ability to deduct their state and local tax (SALT) property taxes.
The Senate Tax Proposal
The current version of the Senate's of tax reform legislation includes only minor changes to 401(k) plans and IRAs. Although the full bill text is not yet available, the proposal approved by the Senate Finance Committee generally "continues popular retirement savings programs such as 401(k)s and Individual Retirement Accounts, to help Americans build their retirement nest eggs and prepare for the future."
-Like the House bill, the Senate tax reform bill did not include a provision to mandate that employee contributions to retirement plans be made on a post-tax basis.
-The bill originally contained a "mini-Rothification" proposal that required all catchup contributions made by individuals making $500,000 or more to be a Roth contribution, but that provision was removed after several Senators objected.In addition, the Senate proposal, like the GOP proposal, includes a provision that would extend the rollover period for participant loan offset amounts, and eliminates the IRA recharacterization provisions.
-The Senate proposal also adds relief for improper tax levies on retirement accounts, and special relief for Mississippi River Delta flooding.
-It also conforms the contribution limits for 403(b) plans and governmental 457(b) plans to be in line with 401(k) plans, and applies a single 415 limit for all 401(a), 403(b), and governmental 457(b) plans within a controlled group.It expanded, however, the special tax deduction for owners of pass-through businesses.
-The Senate version allows these business owners to reduce their income by 17.4 percent. However, certain businesses performing professional services like consulting, engineering, law or financial services for example that make more than $75,000 a year ($150,000 for married couples) are excluded from taking the deduction.All state and local tax deductions have been eliminated by the Senate's tax proposal.
The Road Ahead
An aggressive timeline for the bill has been outlined by Congressional Republicans. The House passed their bill this week, and Senate leadership hopes to approve their bill prior to Thanksgiving. The two chambers would then have to resolve their differences. GOP leadership expects Congress to pass the final bill before the winter recess. Until final approval, however, any aspect of the proposed bill could change.
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