The U.S. House of Representatives passed its tax reform bill via a 227-205 vote that would cut the corporate tax rate to 20 percent, although neither the House nor the draft Senate tax reform bill includes a repeal of the medical device tax.

The House bill eliminates the orphan drug tax credit while the working Senate version leaves a portion of this deduction in place, but the orphan drug credit is just one of several differences that will prove challenging for lawmakers to resolve in the weeks ahead.

As is the case with the House bill, the Senate bill drops the top bracket for the corporate tax rate from 35 percent to 20 percent, albeit with a one-year delay, but the two chambers have taken different approaches to the rate for pass-through entities, which include sole proprietorships, limited liability corporations and S corporations. The top rate for pass-through businesses in the House bill is 25 percent, a substantial cut from the high-end rate of 39.6 percent under current law. The Senate approach is to reduce this to 17.6 percent, but Sen. Rob Johnson (R-Wisc.) has indicated that he will not vote for the Senate bill unless the pass-through rate is lower than the cited figure.

Section 3401 of the House version of the Tax Cuts and Jobs Act of 2017 (H.R. 1), would allow the U.S. Treasury to recoup $54 billion over the 10-year budget window (2018-2027) by completely eliminating the deduction for clinical expenses incurred in orphan drug development. The Senate orphan drug provision would disallow roughly $30 billion of such deductions over 10 years, a clawback that relies on several mechanisms, including a reduction in the tax credit to 25 percent of clinical expenses if the sponsor had incurred no such expenses in any of the three previous years.

The two bills differ somewhat in their treatment of the so-called Section 179 small business expensing allowance, with the House boosting the one-year limit from $500,000 to $5 million. The Senate would permit an annual expense of $1 million under Section 179 of the Internal Revenue code, but the difference in phase-out thresholds of the two bills is even more significant, with the House calling for a phase-out of $25 million and the Senate setting a phase-out threshold of $2.5 million.

Both the House and the Senate seek to prod multinational corporations to repatriate some overseas income, the House by allowing a one-time tax rate of 14 percent for cash holdings and a rate of 7 percent for other, less liquid assets. Both the House and the Senate would move toward a territorial tax system in which profits already taxed overseas would not be taxed again in the U.S., but the Senate offers a more generous one-time repatriation rate for liquid assets of 10 percent and a 5 percent rate for other assets. The House and the Senate bills would cap business interest expense deductions to 30 percent of adjustable taxable income, although companies with receipts of $25 million or less would not be subject to such limitations.

Procedural hurdles a factor

The Republican majority in the Senate is almost certain to resort to budget reconciliation rules in order to pass tax reform due to the fact that the 52 seats held by the GOP fall far short of the 60 percent needed to pass bills under regular order. One factor in the seeming certain refusal of Senate Democrats to support the bill is the removal of the penalty for failure to enroll in health insurance.

The Senate bill will face other headwinds stemming from the fact that some features of individual income tax reforms would expire in 10 years, after which those provisions would have to be reauthorized by Congress. The House bill lost 13 GOP votes over a provision that would eliminate the deductibility of state and local taxes (with the exception of personal property taxes, although this deduction would be capped at $10,000), while the Senate version calls for an end to the deductibility of all such taxes. This provision is unlikely to change the dynamic in the Senate, where all six senators from California, New York and New Jersey – the states represented by the 13 GOP defectors from the House tax reform vote – are Democrats.

While Sen. Johnson said he would oppose the Senate bill unless the bill lowered pass-through taxes to below 17.4 percent, he has also signaled that he may relent should his vote prove critical for passage. Senate Finance Committee chairman Orrin Hatch (R-Utah) has vowed to move the bill to the Senate floor for a vote at some point after Thanksgiving, but the differences between the House and Senate bills suggest that a conference committee between the two bodies will require considerable concessions by both sides. Tax reform is generally seen as a nearly impossible lift in an election year, hence the urgency to pass legislation by the end of this year.