February 06, 2017
The election of President Trump, in connection with a Republican controlled House and Senate, has raised expectations of significant tax reform. Based on the President’s stated policies, and congressional blueprints for reform, we have a good idea of key elements that tax reform may entail.
The tax reform that is currently anticipated will radically alter the tax landscape for everyone, but particularly for business owners and high net worth individuals. Tax planning will be redefined, and you may need to make significant changes to your business structure or personal financial planning to optimize your tax situation.
1) Individual tax rates will be simplified and lowered.
It is currently expected that current tax rate structure (which includes 10, 15, 25, 28, 33, 35, & 39.6% tax brackets) will be simplified into three brackets – 12%, 25%, and 33%. Overall, this change would affect all taxpayers, but would represent the largest potential dollar benefit for high income taxpayers with significant amounts of income currently subjected to the top 39.6% tax rate.
2) Corporate tax rates are likely to fall substantially – probably to 15 or 20%
If you are structured as a C corporation, expect a significantly lower tax burden. This change in rates will make C corporations considerably more attractive for closely held businesses, particularly if earnings are primarily reinvested in the business. Investments in C corporations that also meet specific “Section 1202” criteria would make C corporation status even more attractive, since this status could allow the owners to avoid capital gains tax completely on a future sale of the business.
3) Passthrough entities (S corporations and Partnerships) could receive a preferential income tax rate (probably between 15% and 25%)
This change is particularly intriguing, particularly with businesses with significant owner involvement. This change would create new incentives to minimize the wages paid to the owners, as the wages are presumably subject to a top tax rate of 33%, plus payroll taxes, while passthrough income will be subjected to a preferential rate. I’m expecting significant regulation and guidance in this area if this particular provision becomes law.
4) Healthcare related taxes will almost certainly be repealed
Most notably, the 3.8% Medicare tax surcharge on all passive income is expected to be repealed. The repeal of this tax would be a significant tax reduction on passive income sources.
5) Taxation of international income will likely change.
While it is still too early to tell about all specific details, it is likely that the current “worldwide” tax system will be scrapped, and replaced with a “territorial” tax system. The current worldwide system requires American companies to pay U.S. tax on worldwide earnings, with credits permitted for certain foreign income taxes paid on that income. A territorial system would only require that the American company pay taxes in the U.S. based on the income that is earned in the U.S. Secondly, it has been proposed that there will be a new “destination based” border system. This system would not tax exports of American companies, but it would tax the value of any imports into the country. Taken as a whole, a new system should put American companies on equal footing with foreign competitors, who largely benefit from similar tax systems currently.
6) The repeal of the estate tax could occur
If the estate tax is repealed, the estate planning landscape will shift significantly, and all estate plans will need to be carefully evaluated to make sure they are correctly structured. For example, many estate plans have formulary funding amounts based on estate tax exemption amounts, and a repeal of the estate tax could result in unexpected and unintended financial results if there is no longer an exemption amount. Adding to the uncertainty, there is no guarantee that a future administration wouldn’t reinstate the estate tax in the future, so maintaining a close eye on this area is crucial.
These are only some of the highlights of what comprehensive tax reform could change. Stay tuned for more details! Given the scope of the proposed changes, it is imperative that you work closely with your tax advisor to make sure you take full advantage of the shifting tax landscape.
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