On April 26, 2017, President Trump unveiled his tax proposal to the public. The proposal offers substantial tax reductions for corporations, individuals, and pass through entities and has been heralded by the Administration as a means to simplify the tax code, relieve the burden on middle class families, lower the domestic tax burden for U.S. corporations to make them more competitive in the international theater, and most importantly, grow the economy by creating millions of jobs. The proposal was short on details, specifically avoiding how these cuts will be paid for, particularly with a swelling budget deficit. However, it does give greater clarity to the intended direction the Administration will take on this important topic.
Provided below is a brief summary of the proposal as well as other important points for consideration.
Summary of the President's Tax Proposal
The Administration stated that the focus is specifically on the middle class taxpayer with particular regard to both simplifying as well as lowering the tax burden.
- Reduce the current income tax brackets from seven to just three tax brackets of 10%, 25%, and 35%. It is important to note that we would be seeing only a modest reduction of the maximum tax bracket for high income individuals. Most of the savings will be available to taxpayers in the lower tax brackets.
- Eliminate the 3.8% Medicare tax on net investment income. This coincides with the Administration's goal of eliminating the Affordable Care Act and replacing it with a program that does not require this tax. Although it is not referenced in the proposal, it is assumed that this would also eliminate the 0.9% Medicare tax withholding as well.
- Double the standard deduction. This would dramatically reduce the number of taxpayers who itemize their deductions. Again, it is an attempt to simplify the tax process for many middle income taxpayers.
- Provide tax relief for families with child and dependent care expenses. The Administration would offer a credit of up to $2,100 to offset child and dependent care expenses.
- Eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers. Although not specifically stated, this likely addresses his goal of eliminating two key planning strategies.
- Carried Interest. This issue has a great deal of resonance for many taxpayers. President Trump has been resolute regarding his intent to repeal the tax advantaged carried interest strategy.
- Life Insurance. President Trump has also stated his intent to limit the tax advantages associated with life insurance policies. Specifically, he would require income tax recognition of earnings on the cash surrender value of life insurance policies held by high income taxpayers.
- Protect the home ownership and charitable gift tax deductions. There have been concerns raised, specifically in the charitable community, that the Administration's proposal would look to cap these deductions currently available to individuals. This provision nullifies these concerns. As for deductions related to home ownership, this specifically relates to his intent to protect the home mortgage interest deduction.
- Possible repeal of the state tax deductions. However, this proposal appears to eliminate the state income tax and real estate tax deductions. This would certainly adversely impact taxpayers incurring substantial state income tax and real estate tax liabilities.
- Repeal the Alternative Minimum Tax (AMT). This provision is very high on the Administration's wish list. The current AMT impacts an increasing number of taxpayers and affects many middle income taxpayers. This proposal would eliminate the burden for all.
- Repeal the estate tax. This provision has received a great deal of press. With the current availability of the $5.49 million lifetime exclusion, this provision would certainly benefit only the high-net-worth taxpayer. This proposal would also offer a step-up in tax basis on select assets held in the estate. Thus, with this repeal, there could be a capital gains tax liability incurred by taxpayers upon their subsequent sale of estate assets. In essence, taxpayers (or their estates or heirs) who would not have paid any estate taxes under the current law, could, under the Administration's proposal, pay income taxes as a result of their deaths.
The Administration has expressed a concern that U.S. businesses, by virtue of the current U.S. tax environment, are at a disadvantage on an international basis. The Administration is trying to "even the playing field" for U.S. businesses to make them more competitive on a global basis.
- 15% business tax rate. This would serve as a dramatic reduction of tax to corporations. Although it was not specifically stated in the proposal, this tax rate will likely be available for both C Corporation and S corporation taxpayers. It is hoped that the Administration's definition of "small business" will also include both partnerships and limited liability companies; however, this has not yet been specifically stated in the proposal.
- Introduction of a territorial tax system. This is the Administration's attempt again to level the playing field for American companies. In essence, business would pay tax only on income earned in the U.S. For example, a manufacturer selling inventory to an international purchaser would not pay U.S. tax on this revenue.
- One-time repatriation tax. This provision would levy a 10% tax on the repatriation of amounts that U.S. companies have earned overseas. There is an estimated $2.6 trillion of offshore earnings and this would provide the opportunity for companies to repatriate these earnings without being taxed at a level that some view as punitive. It is intended to help offset some of the underlying cost related to the tax reductions under other parts of the Administration's proposal.
- Elimination of tax breaks for special interests. Although not stated, this is an opening salvo to the favorable tax advantages enjoyed by the insurance industry. The administration will focus on specific provisions favorable to certain lobbies to determine whether they should remain in force. It is important to note that many of these special interests are heavily moneyed and can provide contributions to legislators seeking election. Thus, the jury is out on whether the Administration can successfully see this one through.
- Items missing in the Administration's proposal
- Repeal of IRC Sec. 1031. Many taxpayers involved in commercial and investment real estate have relied on this provision to defer tax recognition on properly planned like-kind exchanges. Clearly, the omission of this provision is good news for real estate investors. However, it may be that the Administration has included this issue as part of the elimination of tax breaks for special interest groups mentioned above. President Trump has historically proposed to repeal this provision, and it may find its way into the comprehensive edition once this is published. We will have to wait and see.
- Acceleration of deduction for capital expenditures. President Trump has expressed his intent to promote capital expenditures by business interests. We have enjoyed the tax benefits associated with both bonus depreciation and IRC Sec. 179. It is hoped that a more detailed proposal will make permanent these deductions; however, we will need to wait and see on this as well.
- The Legislative math. Currently the Administration enjoys a majority in both the House and Senate. However, the Senate majority is slim (52 Republicans versus 46 Democrats and 2 Independents leaning Democrat). There is also an additional concern for the Administration that two and maybe even three Republicans will not support the Administration's proposal. Thus, the prospects are uncertain. Add to this the opportunity for the Democrats to filibuster the proposal that would in effect require the Administration to come up with 60 votes in the Senate to ensure its passage. Therefore, much like the tax proposals introduced by the Obama Administration in the past, it may be unlikely that this will pass in its entirety.
- Circumvent the filibuster. The Administration may be able to circumvent the filibuster by introducing the tax proposal as part of a budget reconciliation. However, this brings to bear some important issues.
- Requirement of a comprehensive cost/benefit analysis. Any proposal introduced under a budget proposal would need to be tax neutral; that is, it would need to demonstrate that any tax reduction provided under the tax proposal would be offset by a corresponding tax revenue from another source. The Administration may be hard pressed to demonstrate this revenue by assuming business growth as a means to increase the tax base which in turn increases the tax revenue.
- Ten-year expiration date. Any tax proposals introduced as part of a budget reconciliation is limited to a ten-year term until formally passed through traditional legislative means. Thus, any tax proposal passed through a budget reconciliation is not "permanent."
- Bipartisan support. The easiest path would be to seek bipartisan support from enough Democrats to avoid risk of filibuster. Although it is unlikely that the Democrats would support the Administration's tax proposal in its entirety, there are certain provisions, such as the corporate tax provisions, that do have bipartisan support and therefore have a better chance of passage. There has always been a bipartisan concern over the complexity and fairness of the corporate tax, and some Democrats have expressed a desire to work with Republicans to correct this.
Thus, a provision by provision review of the proposal may be in order to assess which if any of the provisions have a chance of passage and what if any planning should be done today to address them.
FGMK will be presenting our thoughts and insights on the Trump proposal via a web broadcast scheduled for May 18 at 10 a.m. Central Time. It is our hope to provide additional clarity regarding this issue and provide guidance on planning steps that clients and advisors should consider today in the event of this proposal's passage. This web broadcast will qualify for CPE credit and an invitation to the event will be sent to you via e-mail next week.
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