On April 26, 2017, Treasury Secretary Steven Mnuchin and U.S. National Economic Council Director Gary Cohn, presented the blue print for President Trump’s tax reform proposal (referred to as the “2017 Tax Reform for Economic Growth and American Jobs” and hereinafter referred to as the “Current Proposal”). The Current Proposal is a successor to a tax reform plan posted on the Trump campaign website during the presidential campaign (hereinafter referred to as the “Campaign Proposal”). This article will review and comment on a number of the items in the two proposals (the Campaign Proposal and the Current Proposal).
A general theme noted in comparisons of the two proposals is the considerably less detail in the Current Proposal. Presumably, the Current Proposal’s less detail provides more flexibility in Congressional negotiations on tax reform. Given the Current Proposal’s emphasis on economic growth and jobs, this article will start with the items impacting businesses.
In the corporate tax area, both proposals reduce the maximum corporate tax rate from 35% to 15%. However, the Current Proposal also extends this rate reduction to “pass-through entities” (presumably S-corporations, limited liability companies, and partnerships) resulting in a maximum tax rate reduction from 39.6% to 15% on the owners’ income from these type of entities. The rate reduction for “pass-through entities” was not in the Campaign Proposal.
The Current Proposal includes a conversion to a “territorial tax system” from the current worldwide system to “level the playing field for American companies”. Under the “territorial tax system”, the company’s income tax liability will be determined based on its income related to the United States rather than its world-wide income. In contrast, the Campaign Proposal provided limited relief by permitting certain manufacturing firms to elect to expense capital expenditures in exchange for the loss of the deductibility of corporate interest expense.
Both proposals eliminate the corporate alternative minimum tax and provide for a one-time tax on offshore earnings (i.e., repatriated earnings). While the Campaign Proposal contained a 10% tax rate on repatriated earnings, the Current Proposal is silent as to the tax rate. Both proposals refer to the elimination of special corporate tax breaks. However, the Campaign Proposal continued the research and development tax credit and increased the business tax credit for on-site childcare.
In the individual income tax area, both proposals reduce the number of tax brackets from seven to three. The Current Proposal contains the following tax rates: 10%, 25%, and 35%, but is silent as to the range of the tax brackets. In contrast, the Campaign Proposal contained the following tax brackets and rates for married joint filers: 12% (less than $75,000), 25% ($75,000 but less than $225,000) and 33% (more than $225,000); with the brackets for single filers being 1/2 of these amounts.
The Current Proposal doubles the standard deduction (from $12,700 to $25,400 in 2017 for married joint filers and from $6,350 to $12,700 in 2017 for all others), while the Campaign Proposal increased the standard deduction to $30,000 for joint filers and to $15,000 for others. The Current Proposal is silent as to head of household filing status and personal exemptions. The Campaign Proposal eliminated both. The Current Proposal refers to protecting the deductions for mortgage interest and charitable donations. In contrast, the Campaign Proposal capped itemized deductions at $200,000 for married joint filers ($100,000 for single filers).
In addition, both proposals (a) provide tax relief for families with child and dependent care expenses; (b) eliminate the individual alternative minimum tax; and (c) eliminate the 3.8% Medicare tax on net investment income. The 3.8% net investment tax was adopted as part of the Affordable Care Act (sometimes referred to as Obamacare) and generally impacts individuals with adjusted income above $200,000 ($250,000 for joint filers). The repeal of the 3.8% net investment tax is included in the House’s repeal of Obamacare which may result in it being dropped from the tax reform blueprint.
The Campaign Proposal called for retaining the existing capital gains rate structure (20% maximum rate) and provided that “carried interests” (e.g., a profits interest in an investment partnership) would be taxable as ordinary income rather than as capital gain. The Current Proposal is silent as to the taxation of capital gains and “carried interests.”
In the estate and gift tax area, both proposals eliminate the estate tax. However, the Campaign Proposal provided that “capital gains held until death and valued over $10 million will be subject to tax.” Presumably, the Campaign Proposal contained a variation of carry-over tax basis under which estate beneficiaries would pay capital gains upon the sale of assets received from the estate if the capital gain exceeded the $10 million amount. Both proposals are silent as to changes to the gift tax and the generation skipping tax.
Significantly, a number of changes in the Current Proposal are in the U.S. House of Representatives Republican’s “A Better Way – Our Vision for a Confident America” (released June 24, 2016; hereinafter referred to as the “Better Way”). For example, the Better Way includes (a) the adoption of a “territorial tax system”, (b) a lower tax rate for “pass through entities”; (c) the elimination of all itemized deductions except the mortgage interest deduction and the charitable contribution deduction; and (d) the elimination of the estate tax (without the offsetting capital gains tax on large estates). However, the Current Proposal differs from the Better Way in that the Current Proposal calls for the “biggest individual and business tax cut in American history”. In contrast, the Better Way is intended to be relatively revenue neutral (i.e., not significantly increase the size of the national debt).
The Current Proposal states that through May, “the Trump Administration will hold listening sessions with stakeholders to receive their input.” As such, we can expect the blueprint for tax reform to continue to evolve.