Across the pond, the recent inauguration of Donald Trump as the U.S.’s 45th president combined with Republicans maintaining control of both the House of Representatives and the Senate presents the possibility of perhaps the most significant U.S. tax reform since the Reagan Tax Reform Act of 1986. After marking the 30th anniversary of the 1986 Act and concluding one of the most contentious U.S. elections in recent memory, President Trump is now working towards a forthcoming announcement to provide further details of his quote “phenomenal” tax plan, which he has said shall “bring our jobs back to this country, big league.” Meanwhile, Congress continues to flesh out and debate its proposals for comprehensive tax reform. Although a number of tax reform proposals and conceptual ideas 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 new administration on such reform as proposed by the House Committee on Ways and Means in its A Better Way, Our Vision for a Confident America (the “Blueprint”).
Given the many similarities between Trump’s campaigned-upon tax plan (“the Trump Plan”) and the GOP's Blueprint, as well as Trump’s emphasis on spurring economic growth, it is no wonder that Trump has placed 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 (R-Texas) and his Republican colleagues, put forth the Blueprint for tax reform in early 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.” The House is now working to draft legislation to achieve these ambitious aims. 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 would be a dramatic shift towards a simpler tax system and moving closer to a consumption tax.
The GOP Blueprint proposes lowering the U.S. 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 Update, we delve a little deeper into some of the principles and specifics proposed by both the House’s Blueprint and the Trump Plan, including what U.K. companies with U.S. operations, investments and/or investors should be aware of at this stage of the potential reform process. While the Trump Plan is still in many respects 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).
- Taxing active business income of pass-through entities at the entity level at a 25 percent tax rate (with reasonable compensation paid to employee-owners deductible to the business and taxed to the employee-owners at their marginal individual tax rate) under the Blueprint. Business income of pass-through entities under the Trump Plan may be eligible for taxation at the entity level at a flat rate of 15 percent.
- Eliminating many (mostly unspecified) special interest provisions or preferences (e.g. domestic manufacturing deduction) with the exception of the research and development tax credit.
- Eliminating the corporate alternative minimum tax (AMT) (designed to reduce a taxpayer’s ability to avoid taxes by using certain deductions and other tax benefit items).
- Eliminating depreciation and providing for immediate 100 percent deduction of new investments in both tangible and intangible assets under both plans. However, the immediate write-off under the Blueprint is mandatory whereas the Trump Plan would require a taxpayer election to deduct capital expenditures (at the expense of losing interest deductions as discussed below).
- Allowing interest expense deductions only against interest income with any excess net interest expense carried forward indefinitely and allowed as a deduction against net interest income in future years (under the Blueprint). Or allowing taxpayers to elect to deduct interest expense or capital expenditures, but not both (under the Trump Plan).
- 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.
From an international perspective, there are also some very important proposals affecting U.S. multinationals and their foreign (e.g. U.K.) subsidiaries, including:
- Moving from a “worldwide” tax regime to a “territorial” one, similar to most other countries.
- A proposal by the Blueprint (hotly-debated in recent weeks) 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). It is currently unclear whether Trump favours such a so-called “Border Adjustable” tax, and remains to be seen whether the Blueprint’s proposal can garner sufficient Congressional support to survive in light of certain industry and political pressures.
- 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 to ten-year period.
- Repealing much of the Subpart F rules (a complex set of rules designed to prevent deferral by taxing certain types of income of a U.S. controlled foreign corporation (“CFC”) as the income is earned, rather than when distributed), yet retaining rules providing for current taxation on certain passive activities/investments outside the U.S. conducted/held by a CFC.
Individual Tax Proposals
Both the Blueprint and the Trump Plan call for a simplified tax system with lower tax rates for U.S. 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.
- Generally eliminating personal exemptions and phasing out and/or eliminating itemized deductions with the potential exception of the mortgage interest deduction and the charitable contribution deduction.
- The Blueprint proposes to tax net capital gains and interest income at 50 percent of the individual rate (by allowing a deduction for 50 percent of these items), resulting in effective rates of 6 percent, 12.5 percent and 16.5 percent depending on an individual’s tax bracket. Trump has proposed to retain current law (i.e. to keep the top U.S. capital gains rate at 20 percent).
- Repealing the 3.8 percent net investment income (“NII”) tax imposed as part of the Affordable Care Act (i.e. “Obamacare”) on passive income.
- Eliminating the individual AMT.
- Repealing and/or significantly reducing the impact of the estate and gift tax.
- The Blueprint would continue to tax so-called carried interest (the tax break for private equity fund managers’ profits) at capital gains tax rates. Trump apparently supports taxing carried interest at ordinary rates.
Alvarez & Marsal Taxand Says:
With the new Trump presidency and the Republicans holding a majority in both houses of Congress (241 to 194 seats in the House and 52 to 48 seats in the Senate), going into 2017 the likelihood of significant U.S. tax reform seems as close to becoming a reality since the Reagan era. Given the considerable effort already made by the House Committee on Ways and Means 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 about the federal legislation itself, whether U.S. states would conform to the federal legislation, and how the transition will proceed from the current system to one that is dramatically different. In addition, as with many things inside the Washington, DC Beltway, it is hard to foresee or predict how things may or may not evolve throughout the legislative process. Possibilities such as the Democrats’ ability to filibuster in the Senate or that Republicans will decide to try to push such legislation through via a process known as reconciliation (whereby only a simple majority vote of the Senate would be required) despite the potential long-term implications on the longevity of such reform, could impact the likelihood of the reform making its way through Congress.
While the timing for eventual enactment of the widely anticipated U.S. tax reform remains, at least in part, held hostage by the Washington political process and external lobbyist pressures, in the interim, a close eye should be kept trained on the direction of such reform. U.K. and U.S. cross-border investment and activity may warrant certain tax planning considerations such as deferral of income or acceleration of income between years through changes in accounting methods or other means. Additionally, thought should be given to the timing of U.S. expenditures / dispositions, CFC distributions and intragroup cross-border transfer pricing principles among numerous other considerations. A&M has developed a model intended to help interested organizations determine the potential impact of U.S. tax reform on their business by generating a top-down estimate of how a company can expect to be affected by the various proposals in the Blueprint and Trump Plan. Stay tuned as America (or at the very least its tax code) is made great again.