By Kenneth H. Bridges, CPA, PFS November 2016
With the Republicans in control of The White House and Congress, the stage could be set in 2017 for the most significant tax legislation we have seen since The Tax Reform Act of 1986. Predicting future tax legislation is risky business, but based on Donald Trump’s campaign proposals and legislative proposals from Republicans in Congress in the past, we can get a sense for what we might see in 2017.
Repeal of portions of the Affordable Care Act – Republicans have long vowed to repeal The Affordable Care Act. While it appears likely that we will keep the more popular portions of the law (e.g. health insurance for those who were previously uninsured, no pre-existing condition exclusion, and ability to keep young adult children on parents’ policy), we will most likely see the unpopular portions repealed (e.g. the 3.8% Medicare tax on investment income, the 0.9% Medicare tax on earned income, the penalty on individuals who fail to buy health insurance, and the employer mandate penalties on employers who do not provide the required health insurance to employees). The real question here is how do you pay for the popular portions of Obamacare, without the unpopular provisions.
Reduction in corporate tax rates – The Federal corporate income tax rate is 35% (with some lower rate brackets for lower amounts of income), and state rates go as high as 12%. In reality, most companies have a much lower effective rate because of various special deductions and credits. Nevertheless, the U.S. rate of 35% is generally considered to put U.S.-based companies at a disadvantage in global competition and encourage companies to relocate outside the U.S. Trump has proposed reducing the rate to 15%. House Republicans have proposed 20%. 25% seems more realistic as a first step.
Repatriation holiday – U.S. companies are subject to U.S. tax on their worldwide income, with a credit or partial credit for foreign tax paid. Income of foreign subsidiaries is generally not subject to U.S. tax until repatriated. Most other countries have a territorial system, whereby tax is paid only on income from sources within the country. Many U.S. companies with global operations have left substantial earnings parked offshore in foreign subsidiaries in order to avoid U.S. tax. What we might see now is a repatriation holiday, whereby these earnings can be brought home at a reduced rate (possibly combined with a move to a territorial system). It should be noted that a similar repatriation holiday was created as a temporary stimulus measure in 2004, but most economists concluded that it did very little to stimulate the U.S. economy.
Immediate expensing of business investment – With the Tax Reform Act of 1986, the lower tax rates were paid for in part by broadening the tax base via more lengthy depreciation periods. In more recent years, however, the tendency has been towards permitting immediate expensing of capital investments (e.g. various temporary “bonus depreciation” rules of up to 100%). There is some talk of making permanent such immediate expensing rules, but that would seem to run counter to the base broadening needed to offset lower rates.
Limiting business interest expense – House Republicans have proposed to largely eliminate the business interest expense deduction.
Expanded deductions and credits for childcare – During the campaign, Trump heavily promoted the idea of expanding deductions and credits for childcare. So look for something to be enacted in this regard.
Reduction in tax rate for flow-through business income – Most U.S. businesses (especially smaller businesses) are conducted through flow-through entities like S-corps and LLCs. The top Federal individual rate (39.6%) is a little bit higher than the top corporate rate, but not enough to offset the many advantages of flow-through treatment (e.g. no second level of tax at owner level on distributions and ability to pass losses through to owners). However, a significant reduction in the corporate rate without a comparable reduction in the individual rates would put flow-through entities at a disadvantage. Accordingly, we could potentially see a special rate apply to business income from flow-through entities. It is too early to know exactly how that might work, and the special rate might be limited to earnings left invested in the business (taking away one of the principal advantages flow-through entities have under current law).
Reduction in individual tax rates – Under current law, there are 7 tax rate brackets, with a top ordinary rate of 39.6%. Look for the number of rate brackets to be reduced to 3, with a top ordinary rate of around 33%. The current maximum rate of 20% on qualified dividends and long-term capital gains will likely remain the same.
Repeal of the alternative minimum tax – The highly unpopular alternative minimum tax (AMT) mostly serves to claw back the benefit of the deduction for state income tax, real estate taxes, and investment expenses, the lower rate brackets, and incentive stock options, while adding complexity to the tax system. Its repeal seems likely.
Limiting itemized deductions – Itemized deductions may be eliminated, except for mortgage interest and charitable; and with an overall cap placed on these. Given that most individuals who incur AMT do so because of the deduction of taxes and investment expenses, the elimination of these deductions might mean that the repeal of the AMT costs the government very little revenue, and that the benefit to taxpayers of repeal of the AMT is largely illusory.
Standard deduction and personal exemptions – The standard deduction could be increased as a means to exclude more people from the income tax system and as a perceived simplification of the system. The result, however, is to essentially devalue or eliminate for many taxpayers the tax benefits of home ownership and charitable giving. Personal exemptions, which are not deductible in computing AMT, may be eliminated (another way of offsetting the cost of repealing the AMT).
Taxation of carried interests – Under current law, the receipt of a “future profits interest” (a/k/a “carried interest”) is not subject to tax, and the character of future income from it is often long-term capital gain. The fact that hedge fund managers have been able to take advantage of these rules has brought them in the bulls eye for tax legislation. During the campaign, Trump said carried interests should be taxed as ordinary income. Look for some change here. The real question is whether legislation will be narrowly targeted at hedge fund managers, or broadly applied to include real estate developers and other businesses.
Repeal of the estate tax – In its current form, the estate tax applies to only a tiny fraction of the population (about 0.1%) and accounts for less than 1% of Federal revenue. The current exemption level (approximately $5.5 million per person), makes it relatively easy for a married couple to shield up to approximately $11 million of net worth with minimal planning (and much higher amounts with some basic planning). Nevertheless, the estate tax has long been unpopular, and with President-elect Trump and Congressional Republicans vowing to repeal it, its days could be numbered. Repealing the estate tax, however, may come at an income tax cost. Under current law, assets included in a decedent’s taxable estate (regardless of whether any estate tax is actually paid) get an income tax basis step up to fair market value. Trump has proposed that, in lieu of the estate tax, estates which are sufficiently large that the estate tax would have been incurred would instead pay an income tax on the unrealized capital gain in assets held.
Complete repeal of the Internal Revenue Code – Many Republicans have called for the complete repeal of the income tax, and replacement of such with a national sales tax (often referred to as the “Fair Tax”). We have not heard as much about this recently, and such does not seem likely, but who knows.
Hilary Clinton had proposed to increase the estate tax rate and the income tax rate on higher income individuals. With the election of Donald Trump and a Republican majority in both the House and Senate, it seems a virtual certainty that income tax and estate tax rates will not go up in the near future. It is impossible to predict with certainty what tax legislation we will see enacted in the future, but a Tax Reform Act of 1986 style rate reduction and base broadening seems likely.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.