Conference Committee Finalizes Federal Tax Reform Package

The final package modifies several of the provisions that will impact Minnesota cities.
(Published Dec 18, 2017)

(Updated Dec. 23, 2017)

The conference committee appointed to resolve the differences between the House and Senate versions of the pending federal tax bill (H.R. 1, the Tax Cuts and Jobs Act), released its report late on Dec. 15. The report modifies several of the initial House and Senate tax provisions that impact cities and local taxpayers.

The bill includes a number of provisions that will impact cities and their taxpayers. Below is a list of major tax provisions of interest to Minnesota cities. Although the Senate made some minor revisions to the bill on Dec. 20, they did not affect the provisions outlined below. President Trump signed the bill on Dec. 22.

Municipal bonds
Municipal bonds are the primary way state and local governments finance the public infrastructure. The existing tax exemption for interest earned from municipal bonds allows cities to borrow at lower interest rates and save on costs. Congress discussed possible modifications to the interest exemption prior to the release of the initial House and Senate tax bills.

Original House position: The House bill did not alter the tax treatment of interest earned on municipal bonds.

Original Senate position: The Senate bill did not alter the tax treatment of interest earned on municipal bonds.

Conference committee status: The exemption for municipal bond interest is maintained in the conference committee report, which will allow cities to continue to borrow funds at lower interest rates.

Advance refunding bonds
A bond is classified as an advance refunding if it is issued more than 90 days before the redemption of the refunded bond as opposed to a current refunding, which occurs when the refunded bond is redeemed within 90 days of issuance of the refunding bonds. Advance refunding bonds provide flexibility and allow cities to do a one-time refinance on bonds to achieve lower rates and cost savings for taxpayers. This critical tool permits cities to change otherwise fixed costs and respond to economic downturns.

Original House position: The House bill repealed the exclusion from gross income for interest from all advance refunding bonds issued after Dec. 31, 2017.

Original Senate position: The Senate bill also repealed the exclusion from gross income for interest from all advance refunding bonds issued after Dec. 31, 2017.

Conference committee status: The tax exemption for advanced refunding bonds issued after Dec. 31, 2017, is fully eliminated in the conference committee report. This is a negative outcome for cities as it will hamper or prevent cities from being able to refinance existing debt to achieve the greatest savings to taxpayers.

Private activity bonds (PABs)
PABs are a critical source of financing for important qualified projects and programs, including infrastructure, affordable housing, economic development, and much more.

Original House position: The House bill would have repealed the exception from the exclusion from gross income for interest paid on qualified PABs issued after Dec. 31, 2017, thereby including interest on PABs issued after that date, in addition to gross income of the taxpayer, and subject to taxation.

Original Senate position: The Senate bill did not alter the tax treatment of interest earned on PABs.

Conference committee status: Per the Senate position, the tax exemption for PABs is preserved in the conference committee report. This is a positive outcome for cities because maintaining the exemption will allow cities to continue to work with private businesses and individuals to develop projects with public benefits.

State and local tax (SALT) deductions
Currently, tax filers are generally allowed to itemize and deduct taxes paid to state and local governments—including property taxes and state income taxes—whether or not the taxes are incurred in a taxpayer’s trade or business. At the election of the taxpayer, an itemized deduction may be taken for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes. This itemized deduction for state and local taxes prevents federal income taxes from being applied to the portion of an individual’s income used to pay state and local taxes, also known as double taxation.

Original House position: Under the House bill, state, local, and foreign property taxes and state and local sales taxes would have been generally allowed as a deduction only when paid or accrued in carrying on a trade or business and, therefore, the deduction would not be available to individual taxpayers for personal state income taxes or property taxes on the individual’s home. However, the House bill ultimately included an exception to the “trade or business” deduction limitation, which allowed individuals to claim an itemized deduction of up to $10,000 ($5,000 for married taxpayers filing separate returns) for property taxes paid or accrued in a given year.

Although not directly related to the SALT deduction, the House bill also increased the standard deduction from $12,700 for married, joint filers in 2017 to $24,400 for 2018 with annual adjustments thereafter. However, the House bill also repealed the personal exemption that exempted $4,050 for the filer, plus the same amount for the filer’s spouse and each dependent.

Original Senate position: The Senate bill included an exception to the “trade or business” deduction limitation similar to the House bill. However, under the Senate language, the exception to the “trade or business” deduction that allows an individual to deduct up to $10,000 in other state and local property taxes would have expired for taxable years beginning after Dec. 31, 2025.

Similar to the House, the Senate bill would have increased the standard deduction, but suspended the personal exemption until 2026.

Conference committee status: The conference committee agreement differs from the House and Senate provisions by allowing a limited deduction of state and local property taxes not paid or accued in carrying on a trade or business. It also allows a limited deduction for state and local income taxes (or sales taxes in lieu of income taxes). However, the $10,000 limit for married taxpayers applies to the sum of property and income taxes. Similar to the Senate effective dates, the $10,000 deduction exception applies only to taxable years beginning after Dec. 31, 2017, and then sunsets on Jan. 1, 2026.

The conference committee agreement also provides that an individual may not claim an itemized deduction in 2017 on a pre-payment of income tax for a future taxable year in order to avoid the dollar limitation applicable for taxable years beginning after 2017.

Although not directly related to the SALT deduction, the conference report increases the standard deduction from $12,700 for married, joint filers in 2017 to $24,400 for 2018 with annual adjustments thereafter. However, the conference agreement also suspends until 2026 the personal exemption that exempted $4,050 for the filer, plus the same amount for the filer’s spouse and each dependent.

This is a negative outcome for cities. The limitation on the deductibility of SALT could increase the federal tax burden on some individuals, hampering the ability of cities to finance projects with local taxes.

Historic (rehabilitation) tax credit
Current law provides a two-tier tax credit for rehabilitation expenditures to encourage the redevelopment of historic and older buildings. First, a 20 percent credit is provided for qualified rehabilitation expenditures with respect to a certified historic structure. Current law also provides a 10 percent credit for qualified rehabilitation expenditures with respect to qualified rehabilitated buildings, which generally means a building that was first placed in service before 1936.

Original House position: The House bill would have fully repealed the historic tax credit generally effective to amounts paid or incurred after Dec. 31, 2017, with several transition rules for existing rehabilitation projects.

Original Senate position: The Senate bill repealed the 10 percent credit for qualified pre-1936 building rehabilitation expenditures, but retained the 20 percent credit for certified historic structures, with a phase-in modification and several transition rules for existing rehabilitation projects.

Conference committee status: The conference committee agreement generally follows the Senate position with the repeal of the 10 percent credit for pre-1936 structures. The 20 percent certified historic structure credit is maintained, but modified with a phase-in and transition rules for existing rehabilitation projects.

The restructured historic tax credit under the conference report will negatively impact private investments in historic and older buildings, making it harder for cities to redevelop older structures.

New markets tax credit
The new markets tax credit is designed to increase the flow of capital to businesses and low-income communities by providing a modest tax incentive to qualified equity investments made to acquire stock in a corporation, or a capital interest in a partnership.

Original House position: The House bill would have essentially repealed the new markets tax credit as of Jan. 1, 2018.

Original Senate position: The Senate bill did not modify the new markets tax credit.

Conference committee status: The conference committee agreement does not modify the new markets tax credit and allows the credit to be retained until the authorization expires in two years.

This is good for cities because maintaining the new markets tax credit will continue to provide tax incentives for investment in economically disadvantaged communities.

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