Tax Reform Moves Forward in House and Senate

On Capitol Hill yesterday both the House and Senate took major steps toward completing the much-anticipated tax reform overhaul.

Following a mid-day pep talk by President Trump, the House on Nov. 16 approved the Tax Cuts and Jobs Act (H.R. 1) by a vote of 227-205. Thirteen Republicans voted against the legislation, and no Democrats voted in favor of it.

Late in the day, after turning away numerous Democratic amendments and engaging in sometimes heated debate, the Senate Finance Committee approved its version of the Tax Cuts and Jobs Act on a straight party-line vote.

Neither bill includes a provision to “Rothify” 401(k) plans, but each does contain a number of other retirement-related provisions, including changes that restrict IRA recharacterization and allow plan loan rollovers.

Focus Shifts to Senate

The full Senate will now consider the Finance Committee’s version of the Tax Cuts and Jobs Act. Senate Majority Leader Mitch McConnell (R-KY) said the Senate would begin consideration of the legislation the week after Thanksgiving.

Senate Finance Committee Chairman Orrin Hatch (R-UT) late Nov. 14 released a modified chairman’s mark that contained mostly good news for retirement plans. Toward the end of last night’s markup, Hatch proposed additional modifications to the mark, which were approved by the Committee.

Mini-Rothification Not Included

At one point there were concerns that Chairman Hatch would include an amendment requiring that all catch-up contributions be Roth only, coupled with an increase in the catch-up contribution limit to $9,000. However, he ended up not adding that amendment.

In addition, the modified Senate mark dropped a proposal that would have prevented an employee from making catch-up contributions for a year if the employee received wages of $500,000 or more for the preceding year.

Also dropped was a proposal that would have imposed the 10% early withdrawal penalty to distributions made prior to age 59½ from governmental section 457(b) plans. The proposal also adopts a provision in the House version that would extend the rollover period for participant loan offset amounts.

Other revisions include a proposal to add a portion of the Mississippi delta flood area to the list is hurricane areas qualifying for hardship, loan and contribution relief. The modifications would also allow an individual to recontribute to an IRA or employer-sponsored plan an amount withdrawn (and any interest thereon) pursuant to a levy and later returned to the individual by the IRS. The contribution would be allowed without regard to the normally applicable limits on IRA contributions and rollovers.

NQDC Provision Dropped

While there was an earlier scare for those who sponsor and/or work with nonqualified deferred compensation plans, the legislation as approved by the House and the Senate Finance Committee does not include changes to the current tax treatment of those plans. Earlier versions of both the House and Senate bills included provisions that would have taxed an employee’s compensation as soon as there is no substantial risk of forfeiture.

Pass-Through Issues

The modifications currently included in the Senate version greatly expanded the special tax deduction for owners of pass-through businesses, such that it now applies to all business owners making less than $500,000, including those performing professional services. The previous proposal had limited the deduction to owners performing professional services with relatively minimal income – a restricted application that had tempered previous concerns as to the provision undermining the incentives to establish and maintain retirement plans.

As we previously reported, the expanded new provision (designed to make it easier for businesses to take advantage of the reduced business rate) seems likely to exacerbate the problem. The ARA also continues to have concerns over the House-approved changes providing a 25% tax rate for pass-through entities as to the possibility of undermining the incentives for small businesses to sponsor a retirement plan, and has been working to address these issues.

Commonalities and Differences

In addition to the provisions highlighted above, both the House and Senate bills include these provisions:

  • Repeal of special rule permitting recharacterization of IRA contributions
  • Extended rollover period for certain plan loan offsets

Included in the House bill only:

  • Reduction in minimum age for allowable in-service distributions
  • Modification of rules governing hardship distributions
  • Modification of rules relating to hardship withdrawals from cash or deferred arrangements
  • Modification of nondiscrimination rules for certain employer-sponsored plans

Included in the Senate bill only:

  • Apply single aggregate limit to contributions for an employee in a governmental section 457(b) plan and elective deferrals for the same employee under a section 401(k) plan or a 403(b) plan of the same employer
  • Length-of-service awards for public safety volunteers
  • Individuals held harmless on improper levy on retirement plans
  • Allow designated beneficiary of an ABLE account to claim the Saver’s Credit for contributions made to his or her ABLE account
  • Relief for retirement plan distributions and modifications of casualty loss deduction for the Mississippi River Delta flood disaster area

What’s Next?

If and when the Senate approves the legislation, the two versions of H.R. 1 would have to be reconciled in a conference committee. President Trump and congressional leaders continue to maintain that the goal is to have a final bill to the President by the end of the year.

By no means, however, is Senate approval a slam dunk. Reports have surfaced that two Senate Republicans are uneasy with the legislation as it is currently drafted. The current breakdown in the Senate is 52 Republicans to 48 Democrats (two independents caucus with the Democrats). Assuming no Democrats support the legislation, it would take only three Senate Republicans to block the legislation.

In addition, there are more stringent budget rules in the Senate that could force a 60-vote point of order, which could derail the legislation or force major changes depending on the final cost estimates.

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