October 09, 2017
From the moment that President Trump was elected, there has been an expectation of significant tax reform. The realities of building consensus and getting laws passed – seen in the failure of Obamacare repeal – has tempered general expectations of significant tax reform happening. On the other hand, the current Republican congressional leadership views tax reform as a “must do” politically, so there are decent odds of tax reform happening on the whole.
The most recent tax reform framework will be highlighted in this post – please see fairandsimple.gop for more details on the publicly released framework. The framework is very general, and it is expected that congressional negotiations could significantly change details within this framework. It is also expected that any tax reform will contain many specific nuances that could radically affect your own particular tax situation. As tax reform legislation develops, I will continue to post updates with highlights for review.
1) Don’t expect permanent tax cuts
The Republicans in the Senate currently plan to pass tax reform through the budget reconciliation process, which significantly limits legislation, since any tax reform cannot increase the projected deficit beyond a 10 year budgetary window. Essentially, this means that long-term permanent tax cuts are very unlikely, since they would require bi-partisan action. Either tax reform will need to be revenue neutral, or significant parts of the plan will need to be limited to a 10 year period.
2) Simpler individual tax rates
The 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 35%. 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. The framework leaves open the possibility of an additional surcharge tax for high income taxpayers to keep from shifting the tax burden to those with less income.
3) Simplified individual deductions
All itemized deductions would be eliminated, with the exception of mortgage interest and charitable contributions. The standard deduction would almost be doubled to compensate for this change, with a married couple claiming a $24,000 standard deduction (up from $12,700), and single taxpayers claiming $12,000 (up from $6,350). Personal exemptions would also be eliminated, but the child tax credit would be significantly increased. The Alternative Minimum Tax would be eliminated.
4) Lower business tax rates
The framework outlines a flat 20% tax rate on C corporations, with pass-through entities (such as partnerships and S corporations) subject to a reduced tax rate of 25%. Great uncertainty exists on how this structure would be implemented, as it would incentive high-income taxpayers to convert personal income into business income, so anti-abuse rules are expected. It is also expected that the lower business tax rates would be partially offset by the elimination of many deductions, credits, and exclusions.
5) Changes in business capital incentives
Interest expense deductions for C corporations would be limited, increasing the cost of corporate borrowing. However, businesses would be allowed to immediately deduct investments in depreciable property in full, with no limitations.
6) Foreign income would become subject to “Territorial” tax system
U.S. based companies no longer would pay income tax on income earned overseas, even when the earnings are repatriated to the U.S. However, accumulated foreign earnings would become immediately subject to tax upon enactment of tax reform, most likely with favorable tax rates and spread over multiple years.
7) Estate taxes would be repealed
The framework would eliminate the estate and generation skipping taxes in entirety. Since this tax system only applies to approximately 0.1% of all estates, and would only benefit those with a net worth in excess of ~$5.5 for single persons, and ~$11 mil. for married couples, this particular proposal may prove politically difficult to pass. I’m personally skeptical that permanent estate tax repeal will occur in the tax reform process, due to the political challenges of passing this legislation.
Planning Opportunities
The prospects of tax reform significantly complicates tax planning for 2017. Any tax reform legislation faces significant uncertainty about ultimate passage, and the effective date of any changes is up in the air at this point. With this backdrop, the general tax planning principles of delaying income and accelerating deductions should continue to be generally beneficial for most taxpayers, particularly if tax rates are decreased for 2018 and deductions are limited as proposed.
Perhaps most significant for individual taxpayers is the proposed elimination of most itemized deductions. If tax reform legislation gathers steam as 2017 winds down, it may be prudent for taxpayers to accelerate as many itemized deductions as possible into 2017 (with the possible exception of charitable contributions, which should still be deductible in excess of higher standard deduction limits).
Overall, your best plan is to consult your tax advisor to evaluate the impact of decisions for your own personal situation, including the true impact of moving income or deductions between tax years.
This article is intended to serve as general guidance, and should not be construed as specific tax advice for your situation. Please consult your tax advisor for any specifics on these ideas – there are many nuances and issues that have not been fully elaborated in this article.
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