United States

New tax reform plan from Trump and Congressional Republicans

TAX ALERT  | 

The White House joined congressional Republican leaders in announcing a new framework for tax reform, which they hope to enact before the end of 2017.  Most of the changes–including major changes to tax rates and new limitations on deductions–would apparently not take effect until 2018.  However, the effective dates are still unclear–with the exception of the effective date for immediate expensing which will apply, if enacted, to investments after Sept. 27, 2017. There may be significant opportunities for taxpayers to structure transactions in the next few months to maximize potential benefits and minimize potential detriments of any new tax rules. 

Of particular note is the possible repeal of state and local tax deductions. Ironically, that could lead some taxpayers to consider accelerating income-generating transactions into 2017, despite the potential for lower federal tax rates in 2018. In addition, the pass-through rate, as announced, appears to apply to “small and family-owned” entities–and not REITs–while the interest deduction limitation appears to only apply to C corporations, although the framework does hint at possibly limiting the interest deductions of other taxpayers. Unquestionably, the complex interaction of multiple, potential tax changes, including state and local changes, will make tax planning even more challenging in the next few months.

The framework released  provides much greater detail than the Trump administration’s last several statements on possible tax reforms, and appears to borrow many of its ideas from the previous plans advanced by House Republicans. A notable exception is that there is no proposal for an explicit tax on imports and a tax subsidy for exports like the border adjustment contained in earlier House Republican proposals. Many details, of course, would need to be worked out in actual legislative language approved by House and Senate tax writing committees, and the full House and Senate. Nevertheless, the core ideas–and the likely political obstacles to their enactment–are in plain view. The following is a summary of the key provisions:

Individual tax provisions

  • No income tax would be imposed on the first $12,000 of income for individual filers ($24,000 for married filers). This would likely be accomplished by roughly doubling the standard deduction and repealing personal exemptions.
  • Above those levels, individual taxes would be imposed at three rates or brackets, 12 percent, 25 percent and 35 percent. As the details are developed and the precise effects on different income groups are identified, a fourth, higher income tax bracket may be added during the legislative process.
  • The mortgage interest deduction and charitable deduction would be retained.
  • Most other itemized deductions would be eliminated. Thus, state and local income, property and other taxes would no longer be deductible. 
  • However, certain tax credits for higher education, work incentives and retirement security benefits are to remain in place.
  • There would apparently be no mandatory conversion of existing retirement plans to Roth-type plans, and no new limitations on traditional retirement plans.
  • The individual alternative minimum tax would be repealed. 
  • The Child Tax Credit would be significantly increased, with the first $1,000 refundable as under current law. In addition, a new $500 non-refundable credit would be allowed for non-child dependents. Changes would also be made to various phase-outs associated with the Child Tax Credit and related provisions.
  • The estate tax, also known as the “death tax,” as well as the generation-skipping transfer tax would be repealed.

Provisions affecting domestic businesses

  • The corporate tax rate would be lowered to 20 percent, and the plan would “aim to eliminate” the corporate alternative minimum tax. In addition, the tax writing committees “may also consider methods to reduce the double taxation of corporate earnings.”
  • A 25 percent rate would apply to certain business income of “small and family-owned business[es] conducted as sole proprietorships, partnerships and S corporations.” Rules would be adopted to ensure that this reduced rate does not apply to income attributable to the personal services of a partner or shareholder in such an entity. 
  • Immediate expensing of new investments in “depreciable assets other than structures made after Sept. 27, 2017,” would be allowed. This provision would apply to investments made in the first five years after the proposal takes effect, and possibly for longer.
  • The deduction for net interest expense incurred by C corporations would be subject to partial limitation. 
  • The “appropriate treatment of interest paid by non-corporate taxpayers” would be subject to consideration by the committees.
  • Many business deductions–including the domestic production activities deduction–would be repealed.
  • However, existing provisions governing low-income housing tax credits and research tax credits would be retained.

International businesses

  • Foreign business operations of U.S. companies would no longer be subject to U.S. tax, under a concept known as “territoriality,” which would be achieved by replacing the existing system with one that provides for a “100 percent exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10 percent stake).”
  • Accumulated offshore business income that was theoretically subject to United States tax under current law, but only upon its repatriation to the U.S., would be subject to U.S. tax, but at a substantially reduced tax rate. Specifically, “accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents,” however, the exact rates have not been disclosed. Additionally, payment of the tax liability associated with this transition would be “spread out over several years,” but exactly how many years has yet to be specified. 
  • The committees are to consider measures to prevent erosion of the U.S. tax base, including taxing the foreign profits of U.S. multinational corporations at “a reduced rate and on a global basis,” as well as the implementation of “rules to level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies.”

There is still a long road ahead for the ultimate passage of any tax reform legislation. This includes passage of relevant budget resolutions in the House and Senate, markup of tax provisions by the House and Senate tax writing committees, passage of tax bills in the full House and Senate, a potential conference to resolve differences between House and Senate bills, and final passage of an identical bill by both bodies, followed by signing by the president. At all stages, the potential overall revenue and budgetary effects, whether the bill raises or lowers taxes and by how much, as well as the relevant effects on different income groups will be highly relevant.

One possibility is that legislation might pass the House Ways and Means Committee, and perhaps the full House, but be stalled in the Senate–as occurred earlier this year with proposed changes to the Affordable Care Act. Another possibility is that a more limited bill–perhaps comprised of a middle-income tax cut and the changes to the treatment of off-shore income–might be enacted, with the rest of the proposed tax reforms left for another day. Still another possibility is complete deadlock, as the perceived “losers” may simply outnumber the perceived “winners” from tax changes of this size and scope. 

The proposed changes that may be most challenging will include the limitations on state and local tax deductions and business interest, both of which could be perceived as highly disruptive, even if there was agreement that these changes would generally be moves in the right direction for the tax system. Many businesses will be concerned with the new interest limitations, and many individuals, particularly in highly populous and high-tax states will object to the limitations on state and local tax deductions.

For more information on tax reform, see our Tax Reform Insight Page.

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