Press Room: Tax Release

November 10, 2016

President-Elect Donald Trump – What Does This Mean for Tax Reform?

Now that the election results are in, tax reform is sure to be at the top of the agenda for the new President-elect Trump and Republican-led Congress. What type of policies could conceivably be enacted as part of tax reform legislation in 2017? Trump put forth his vision for tax reform during the campaign. The House Republicans released their own Blueprint for Tax Reform (Blueprint) in June in which they propose to move toward a consumption-based tax system for business income which bears similarity to a value-added-tax (VAT) system. Members of Congress have completed significant work to set the stage for tax reform, including release of various discussion drafts with legislative language. Individuals and businesses should immediately begin to prepare for the likelihood that significant tax legislation will be swiftly passed in 2017.

Key Republican Tax Policy Proposals

Individuals

Trump and the House Republican Blueprint propose to decrease the number of individual tax brackets to three, at 12%, 25%, and 33%. Both propose to eliminate the alternative minimum tax. The Blueprint would eliminate all itemized deductions other than the mortgage interest deduction and charitable giving deduction. Trump proposes to cap the amount of itemized deductions at $200,000 (which would reduce the amount of charitable contributions that could be tax deductible).

Investment Income

Trump proposes to sustain the present law top capital gain rate of 20% for assets held more than one year and to repeal the Affordable Care Act, including the 3.8% tax on net investment income (thus reducing the top rate from 23.8% under present law to 20%). He proposes to tax carried interest as ordinary income, but his campaign has not specified whether carried interest is subject to individual or business income tax rates.

House Republicans propose a different approach for taxing investment income. The Blueprint would tax interest income, dividends and capital gains as ordinary, but would allow a 50% exclusion for this income. This is equivalent to a top bracket rate of 16.5% for investment income. Providing a preference for interest income equivalent to that for capital gains and dividends represents a significant change from present law for investors.

Estate and Gift Tax

Under the current law, generally there is a 40% tax on the value of estates in excess of $5.45 million and beneficiaries of the estate are afforded a stepped-up-basis to fair market value in the inherited assets. Both Trump and the Blueprint propose to repeal the estate and gift tax. However, Trump proposes to repeal stepped-up basis by providing carry-over basis in inherited assets from estates in excess of $5 million (single) or $10 million (married couples).

Business Taxation

Trump has called for a broader tax base and proposes to reduce the top corporation tax rate from 35% to 15% and provide pass-through entities the same 15% rate. He also proposes to allow businesses to either immediately expense new business investments or deduct business interest expense, but not both. Trump proposes a one-time deemed repatriation of previously untaxed foreign earnings at a 10% discounted rate and to end the deferral regime on corporate income earned abroad.

The House Republican Blueprint would shift the taxation of business income to a consumption-based approach focused on business cash flow. The corporate tax rate would be reduced to a flat 20% and the maximum rate for income from pass-through businesses would be 25%. The key element of the consumption-based Blueprint plan is to allow the cost of capital investment to be immediately expensed, but to couple expensing with a complete disallowance of net interest expense. The proposal would eliminate most business credits and incentives except for the research credit and it also would retain the last-in, first-out (LIFO) inventory method. It includes a fully territorial tax system with a one-time deemed repatriation of previously untaxed foreign income at a tax rate of 8.75% for cash and 3.5% for other profits. It also modifies all business income taxes to be border-adjustable, similar to the operation of a value-added tax (VAT). Under the proposal, products, services and intangibles that are exported outside the United States would not be subject to U.S. tax regardless of where they are produced. Products, services, and intangibles that are imported into the United States would be subject to U.S. tax regardless of where they are produced. The Blueprint cites economic research concluding that consumption-based tax systems are widely regarded as more pro-growth than income-based tax systems.

Side-By-Side Comparison

The chart below provides a side-by-side comparison of the major aspects of the tax plans:

  Donald Trump House Republican Blueprint
Overview Trump's plan would reduce the number of brackets and top marginal tax rates. Trump recently revised his plan to include the same marginal rates for individuals as the Blueprint The Blueprint would reduce the number of brackets and top marginal tax rates. It shifts from an income tax to a consumption-based approach for taxing business income
Individual Income Tax Rates Three tax brackets: 12%, 25%, and 33%; cap at $200K; eliminate AMT; carried interest taxed as ordinary income Three tax brackets: 12%, 25%, and 33%; eliminate AMT; eliminate itemized deductions other than charitable and mortgage interest
Investment Income No change from present top capital gain rate of 20%; eliminate 3.8% net investment income tax (NII) Capital gains, dividends, and interest taxed as ordinary income, but allows a 50% deduction (equivalent to top rate of 16.5%); Eliminate NII
Estate and Gift Tax Repeal; disallow stepped-up basis for estates over $10 million by providing carry over basis to the inheritor Repeal
Passthrough Business 15% top rate 25% top rate
Corporate 15% top rate 20% top rate
Business Tax Base Broadeners Eliminate most tax preferences except research credit; election of either immediate expensing for capital investment or deduction for business interest expense Immediate expensing for capital investment and eliminate deduction for net interest expense; eliminate most tax preferences except research credit, but retain LIFO inventory method
International One-time deemed repatriation at 10% rate and end deferral regime One-time deemed repatriation at 8.75% (cash) / 3.5% (other) and territorial; business taxes are border adjustable

 

The Takeaway

Tax reform is at the top of the legislative agenda for 2017. The Republican-led House has proposed fundamental changes to the way business income is taxed in the United States. A consumption-based tax, if enacted, would disallow deductions for net interest expense while allowing immediate expensing of capital investments. This type of system would have a dramatic impact on the way most businesses are taxed, whether highly leveraged, capital-intensive, or both. While Congressional Democrats have expressed general support for tax reform for businesses, there are significant hurdles that must be addressed for tax reform legislation to progress.  Nevertheless, much of the groundwork has been laid for tax reform legislation in 2017. Individuals and businesses should not delay careful consideration of how these policies would impact their tax position as legislative action could come swiftly in 2017.

Please contact us if you’d like to discuss the impact of legislation and legislative proposals on your business and strategies to provide a voice on pending legislation being considered by Congress.