Long anticipated, President Trump and Republican leaders have more recently turned their attention to tax reform, which they view as critical to improving economic growth as well as the economic prospects for lower and middle income taxpayers. While the Republican Party has long called for a tax overhaul, significant uncertainty loomed over what those reforms might entail. In late September, taxpayers gained some insight into potential tax changes, as the administration and Congressional Republicans unveiled the “Unified Framework for Fixing Our Broken Tax Code.”
Individual Tax Reform – Key Proposals
Corporate Tax Reform – Key Proposals
- Reduce the corporate tax rate from 35% to 20%, effectively bringing the U.S. corporate tax rate further in-line with the Organization for Economic Cooperation and Development (“OECD”) average of 22.5%
- Create a maximum rate of 25% for small and family-owned businesses conducted as sole proprietorships, partnerships and S-corporations. Congressional committees will create special rules to prevent high income earners from incorporating as pass-through entities for lower tax treatment.
- Allow businesses to fully expense new capital investments (other than structures) for at least 5 years, effective for new investments made after September 27, 2017
- Repeal the corporate alternative minimum tax (“AMT”)
- Regarding international taxation, switch from a worldwide system to a territorial system. In conjunction with this change, accumulated overseas profits would be deemed to be repatriated and taxed at one of two rates over an unspecified period. [The goal of these changes strives to make U.S. companies more globally competitive while also pushing multinational corporations to redeploy foreign profits into investing and hiring back in the United States.]
Among some of the principal challenges are how to finance the tax cuts and whether such tax cuts should be permanent or temporary.
Financing the Tax Cuts
While claims have been made that tax reform could be structured in such a way as to be revenue- neutral, doing so is a very tall order, as Congress would need to identify sufficient revenue increasing provisions to offset revenue losses from cuts elsewhere. The Tax Policy Center reviewed the preliminary framework and estimated the current proposals would reduce federal revenue by $2.4 trillion over the next decade.
The state and local tax (“SALT”) deduction will likely remain one of the most highly contested provisions with the current proposal calling for elimination. Opposition has come from both sides of the aisle and has naturally been strongest from Congressional leaders who represent high tax states/districts. According to the Tax Foundation, approximately 30% of American households claim this deduction; critics of the deduction, however, note that just 6 states—California, Illinois, New Jersey, New York, Pennsylvania and Texas—claim more than half of the benefit. By some estimates, eliminating this deduction would increase federal revenue by $1.3 trillion over the next 10 years, and therefore, this proposal could be a critical factor in helping to offset revenue losses from other provisions. If this deduction is ultimately retained rather than eliminated, the estimate for lost federal tax revenue over the next 10 years would increase sharply, absent other changes or tradeoffs.
Permanent vs. Temporary Cuts
Legislation cannot increase the deficit beyond the budget window (typically 10 years); as such, any tax plan expected to increase the deficit beyond 10 years would require structuring on a temporary basis to “sunset” in the future. To the extent Republicans wish to make tax cuts permanent, they would need to identify a few trillion dollars of revenue increasing provisions (to more fully offset revenue losses). As an alternate solution, Republican leaders like House Speaker Paul Ryan have noted that legislation could be written to sunset certain revenue-losing provisions, with the hope that a future Congress and president might extend those provisions further.
The aforementioned Tax Policy Center analysis projected that the wealthiest taxpayers would reap the biggest benefit from the proposed changes, approximating that the top 1% would receive a $129,000 tax cut in 2018. In contrast, the same analysis estimates that by 2027 roughly 30% of taxpayers with incomes between $50,000 – $150,000 would pay more taxes due to new limits on certain tax breaks. Given the assertion that the primary benefits of tax reform will benefit lower
and middle class taxpayers, further changes to the initial framework appear likely to avoid the tax burden shifting from higher taxpayers to lower and middle income taxpayers.
The Road Ahead
In order to proceed with tax reform, Congress must next adopt a final 2018 fiscal year budget. Republicans plan on using budget reconciliation procedures which would allow a simple majority in the Senate to pass legislation (instead of the usually required 60 votes). The reconciliation procedure is of critical importance, as Republicans only control 52 of the 100 seats in the Senate and gaining Democratic support could prove challenging. A Senate budget proposal as of late September targets November 13th as a deadline for the House Ways and Means Committee and the Senate Finance Committee to draft tax legislation that would result in no more than $1.5 trillion in lost federal revenue over the next decade.
Negotiations will undoubtedly be hard-fought over the coming weeks as Congress looks to draft legislation aimed at boosting economic growth, while maintaining tax code progressivity and without unduly adding to the deficit. Taxpayers are encouraged to follow tax reform developments, as they could yield year-end tax planning opportunities depending on what deductions or credits might be impacted and how tax rates might compare this year versus next.
Please contact New England Investment and Retirement Group for more information and assistance with your current tax strategy.