Whatever your political affiliation might be, the recent election of Donald Trump to be the U.S.’s 45th president and the Republicans maintaining control of both the House of Representatives and the Senate presents us with the possibility of perhaps the most significant tax reform since the Reagan Tax Reform Act of 1986. After recently marking the 30th anniversary of the 1986 Act and concluding one of the most contentious elections of our lifetimes, President-elect Trump is now working to pull together his administration and establish its priorities for the first 100 days and beyond while Congress continues to flesh out its proposals for comprehensive tax reform. Although a number of tax reform proposals are circling in Congress, the House Republicans led by Speaker Paul Ryan (R-Wisconsin) have been working since early 2016 to prepare to work with the incoming president on such reform with the proposal put forth by the House Ways and Means Committee in its A Better Way, Our Vision for a Confident America (the “Blueprint”).
Given the many similarities between Trump’s tax plan (“the Trump Plan”) and the GOP’s Blueprint, as well as Trump’s likely emphasis on spurring economic growth, it is likely that Trump will put tax reform high on his list of priorities. The House, under the leadership of Speaker Paul Ryan and the Ways and Means Committee Chairman Kevin Brady of (R-Texas) and his Republican colleagues, put forth the Blueprint for tax reform earlier in 2016 with the stated goals of “creating jobs, growing the economy, raising wages by reducing rates, removing special interest carve-outs, and making our broken tax code simpler and fairer” and is working to draft legislation by early 2017. Any reform along the lines of the Blueprint or the Trump Plan would mark the largest corporate tax rate cut in U.S. history and a dramatic move towards a simpler tax system and closer to a consumption tax.
High-level, the GOP Blueprint proposes lowering the corporate tax rate from 35 percent to 20 percent (versus 15 percent under the Trump Plan), along with modifying the taxation of pass-through entities and sole proprietorships. For individuals, the Blueprint and the Trump Plan provide for three reduced individual income tax rates — 12 percent, 25 percent and 33 percent.
In this edition of Tax Advisor Weekly, we delve a little deeper into some of the principles and specifics proposed by both the House’s Blueprint and the Trump Plan. While the Trump Plan in many respects is short on detail, the similarities in principle with the House’s Blueprint provide a pretty clear picture of the key points of expected draft legislation, with the Blueprint likely being the foundation.
Business Tax Proposals
Both the Blueprint and the Trump Plan propose lowering of the corporate income tax rate and broadening the tax base. Some of the key aspects of the proposals include:
- For corporations, lowering the income tax rate from 35 percent to 20 percent (under the Blueprint) or to 15 percent (under the Trump Plan)
- For pass-through entities, taxing active business income at a 25 percent tax rate and reasonable compensation paid to employee-owners deductible to the business and taxed to the employee-owners at their marginal individual tax rate.
- Eliminating most of the special interest provisions or preferences (e.g., domestic manufacturing deduction) with the exception of the R&D tax credit.
- Eliminating the corporate alternative minimum tax (AMT).
- Providing for immediate 100 percent deduction of new investments in both tangible and intangible assets.
- Allowing interest expense deductions against interest income to the extent of interest income. Any net interest expense may be carried forward indefinitely and allowed as a deduction against net interest income in future years.
- Allowing net operating losses (NOLs) to be carried forward indefinitely while eliminating carrybacks. However, NOL carryforwards may only offset 90 percent of current year taxable income.
On the international side of things, there are also some very important proposals, including:
- Moving from a “worldwide” tax regime to a “territorial” one, similar to most other countries.
- Providing that exported goods, services and intangibles would not be subject to tax, while imported goods, services and intangibles would be subject to tax (in effect, a destination-based taxation system that is closer to a consumption-based tax regime).
- Providing for a 100 percent exemption for dividends from foreign subsidiaries.
- A one-time “deemed” repatriation tax on funds or assets held outside the country by U.S. companies (proposed rates vary from 3.5 to 10 percent) with the possibility of providing for payment of such tax liability over an eight-year period.
- Repealing much of the Subpart F rules, yet retaining the foreign personal holding company (FPHC) rules on certain passive activities outside the U.S.
Individual Tax Proposals
Both the Blueprint and the Trump Plan call for a simplified tax system with lower tax rates for individuals and families. Some of the key aspects of the proposals include:
- Reducing the number of tax brackets from seven to three, with the three brackets being 12 percent, 25 percent and 33 percent (down from the current highest bracket of 39.6 percent).
- Increasing the standard deduction considerably while reducing itemized tax deductions. The standard deduction would increase to $24,000 for married individuals filing jointly, $18,000 for single individuals with a child, and $12,000 for other individuals (up from $12,700 and $6,350 standard deductions currently in effect for married individuals filing jointly and individuals). These amounts would be adjusted for inflation.
- Capping the itemized deduction to $100,000 for single individuals and $200,000 for married individuals filing jointly.
- Eliminating personal exemptions and all itemized deductions except the mortgage interest deduction and the charitable contribution deduction.
- Increasing the earned income tax credit (EITC).
- Taxing net capital gains and interest income at 50 percent of the individual rate, resulting in effective rates of 6 percent, 12.5 percent and 16.5 percent depending on an individual’s tax bracket.
- Repealing the 3.8 percent net investment income (NII) tax imposed on passive income.
- Eliminating the individual alternative minimum tax (AMT).
- Repealing the estate and gift tax, but disallowing the “step up” in basis upon death for certain estates.
- Taxing carried interest as ordinary income, rather than at the current 20 percent rate.
Alvarez & Marsal Taxand Says:
With one of most negative and contentious campaigns and presidential elections now behind us, the make-up of a Trump administration is slowly coming a little clearer into view. Meanwhile the “lame duck” Congress will be considering certain tax extenders and provisions. With the new Trump presidency and the Republicans holding a majority in both houses of Congress (239 to 192 seats in the House and 51 to 48 seats in the Senate), going into 2017 the likelihood of significant tax reform seems as close to becoming a reality since the Reagan era. Given the considerable effort already made by the House Ways and Means Committee set forth in its Blueprint for tax reform it is likely that this will serve as the foundation for any such reform, with input from President Trump.
Although the Blueprint lays out the foundation for sweeping tax reform, many questions remain, including many specifics of the legislation itself, whether states would conform to the federal legislation, and how the transition will proceed from our current system to one that is dramatically different. In addition, as with many things inside the Beltway, it is hard to foresee or predict how things may or may not evolve throughout the legislative process, including the likelihood of such reform even making its way through Congress given the Democrats’ ability to filibuster in the Senate or the possibility that Republicans will decide to try to push such legislation through via reconciliation (whereby only a simple majority vote of the Senate would be required) despite its potential long-term implications on the longevity of such reform.
As with most presidencies, it is important to remember that the political window for enacting change can be short and outside events can often alter or dictate the agenda. Therefore, for tax reform to become a reality, it will be important for Congress and the incoming President Trump to take action early in 2017.
In the interim, we will be keeping a close eye on the likelihood and direction of such reform, as it may warrant certain year-end tax planning considerations such as deferral of income or acceleration of income between years through changes in accounting methods or other means. Over the coming weeks, we will be providing further analysis and commentary regarding the implications on various stakeholders, industries and the like from any forthcoming tax reform legislation as well as other tax-related actions that could occur under a Trump presidency (e.g., changes to certain regulations such as the recent Section 385 regulations). More to come...