Tax Reform Bill May Have Impact on C- & S-Corps
On November 2nd, Republican leadership in the U.S. House of Representatives released a wide-reaching tax reform bill, H.R. 1, the “Tax Cuts and Jobs Act.” On November 9th, the House Ways and Means Committee passed a slightly amended version of H.R. 1. The legislation passed the full House yesterday along party lines.
Also on November 9th, Republican leadership in the Senate began releasing details of their own proposal, which varies in significant ways from the House bill. The Senate Finance Committee is debating the proposal this week with a vote by the full Senate expected sometime after Thanksgiving.
The centerpiece of both the House and Senate tax reform bills is a large cut to the corporate tax rate. The current tax rate imposed on C Corporations is tiered with the highest possible rate being 35%. The House bill would generally impose a 20% flat tax on C Corporations. However, businesses engaging in “specified services” activities would be subject to a flat tax of 25%. Specified services activities include financial services and most, if not all, activities related to the sale and servicing of insurance, making insurance agencies organized as C Corporations subject to a 25% tax rate under the House bill. The Senate bill does not make such a distinction and imposes a 20% flat tax on all businesses organized as C Corporations, but the cut would not be effective until 2019.
Importantly for the two-thirds of Big “I” members – who are organized as Subchapter S Corporations, Partnerships and Sole Proprietorships – both the House and Senate proposals make changes to tax rates for pass-through entities. The House bill creates special tax rates for pass-through entities depending on type of income, level of income, and the activities that the business is engaged in. The Senate takes a different approach and creates a tax deduction for certain pass-through small businesses. The result is that some insurance agencies organized as pass-throughs would continue to be taxed at the applicable individual rates, as revised by both bills.
Potential Changes to the Tax Treatment of Insurance Agencies
| Senate Bill
|Imposes a flat tax of 25% on “specified service activities” businesses, which includes
financial services and most, if not all, insurance agencies organized as C corps.
| Imposes a flat tax of 20% on all C corps, starting in 2019.
|The tax rate on any “Qualified Business Income” of owners who are not active in the insurance agency
(i.e. passive income) would be capped at 25%.
In general, at least 30% of income earned by active owners of pass-through entities would be subject
to a 25% rate cap. However, business income earned from “specified services activities” (as defined by
Section 1202(e)(3)(A) of the tax code, which includes financial services and most, if not all, activities
related to the sale and servicing of insurance) would not be subject to the preferential rate unless
the taxpayer could prove to the IRS that 10% or more of his or her income is eligible for the 25% rate,
otherwise higher individual rates would still apply.
Provides for a 9% rate, in lieu of a new 12% individual rate included in the bill, on a portion of net
business taxable income for an active business owner if that individual’s total taxable income received
from the pass-through business is no greater than $150,000 (joint), $112,500 (HOH), or $75,000 (single)
annually. The 9% rate is phased out at $225,000 (joint), $168,750 (HOH) and $112,500 (single). This rate
structure would apply to all types of pass-through businesses, including insurance agencies and
brokerages. The 9% rate is also phased in over 5 years, such that the rate for 2018-2019 is 11%, and
the rate for 2020-2021 is 10%.
The legislation would also modify tax treatment for certain S Corps that convert to C Corps 2 years
following passage of the bill.
|An amendment to the Senate bill filed by the Finance Committee Chairman
states that for “specified services businesses” (as defined by Section
1202(e)(3)(A) of the tax code, which includes financial services and
most, if not all, activities related to the sale and servicing of insurance)
a business owner may deduct 17.4% of “domestic qualified business income”
if his or her annual taxable income does not exceed $500,000 (joint) or $250,000 (single).
The benefit of the deduction is phased out between $500,000 and $600,000
(joint) and $250,000 and $300,000 (single).
The bill would also make changes to how business losses are treated
for passive income.
See the full report from the Big "I" at http://www.insurors.org/pdf/TaxBillsImpact.pdf