White House Releases Tax Reform Principles, But No Details
On April 26, 2017 the White House released a fact sheet titled 2017 Tax Reform for Economic Growth and American Jobs: The Biggest Individual and Business Tax Cut in American History, which outlines President Donald Trump’s principles for tax reform. The principles largely echo Trump’s campaign proposals and provide no details, but do clarify his position vis-à-vis the House Republican Blueprint for Tax Reform (Blueprint) in certain areas.
Lower Rates and Fewer Deductions for Individuals
Trump calls for middle-income tax relief and simplification through reducing the seven tax brackets to three brackets at 10%, 25%, and 35%, doubling the standard deduction, and providing relief for families with child and dependent care expenses. He would eliminate targeted tax breaks that benefit the wealthiest taxpayers, but retain tax deductions for home ownership and charitable gifts. He renews calls to repeal the individual alternative minimum tax (AMT) and the estate tax. The 3.8% net investment income tax would be repealed, but the present law 20% top capital gain rate would otherwise be retained.
Although the fact sheet provides no details, Treasury Secretary Steven Mnuchin and National Economic Director Gary Cohn stated during the press briefing that Trump would eliminate all itemized deductions other than for home mortgage interest and charitable giving, including elimination of the deduction for state and local income and real property taxes. The elimination of deductions for state and local taxes and other deductions means that higher income taxpayers, particularly residents of high-tax states may experience a tax increase rather than a tax cut under the proposal. Significantly, Trump shifted away from his campaign proposal to cap itemized deductions at $200,000 for married couples/$100,000 for singles, which would have effectively limited the charitable deduction for philanthropically inclined wealthy individuals. His revised proposal to retain the charitable contribution deduction while eliminating all other deductions is in line with the Blueprint.
15% Rate for Business Income
Trump would lower the U.S. tax rate for business income from one of the highest in the world to one of the lowest at 15%. Trump reiterated his call to apply the 15% rate to all business income, whether earned in corporate or pass-through form. Compensation of individuals would be subject to the top 35% individual rate. Divergence of the top tax rates applicable to business income, individual income, and capital gains creates complexity and potential for abuse. Mnuchin promised that the administration would work with Congress to develop rules that would prevent the recharacterization of compensation as lightly taxed business income. It is unclear where the line would be drawn. Will passive income be taxed at individual or business rates? Is professional services income treated as business income or compensation? Many questions are being raised with respect to the feasibility of this type of policy. Moreover, Trump’s proposed rate is significantly lower than that proposed by the Blueprint at 20% and 25% for corporations and pass-through businesses, respectively.
Trump finally endorsed a territorial-style tax system, which he did not explicitly call for during the campaign. The territorial system, which exempts foreign earnings from residual U.S. tax, is in line with most other developed countries and is consistent with the Blueprint. Trump reiterated plans for a one-time deemed-repatriation tax on previously untaxed foreign earnings and elimination of tax breaks for special interests, but still has provided no details regarding offsetting revenue raising provisions. In addition, no stance was taken with respect key aspects of the Blueprint, including expensing for capital investment, the denial of the deduction for net interest expense, and the controversial border tax adjustment proposal.
What Happens Next?
Trump favors dramatically lower tax rates for business income in the expectation of growing the economic and creating jobs in the U.S. – that much is clear. As expected, the principles reiterate campaign pledges and provide limited insight with respect to tax reform proposals and the path forward. More details may emerge when the administration releases its more complete budget proposals in May (possibly June). The tax-writing committees in Congress are in discussions with the White House regarding the contours of tax reform legislation and further details or legislative language seem unlikely to be provided any time soon. The House Ways and Means Committee will begin holding hearings regarding the key aspects of the Blueprint, so border adjustments will continue to make headlines. In the meantime, Republicans may make another attempt at Obamacare repeal, including the 3.8% net investment income tax. Given the extended timeline, it appears unlikely that tax legislation would become law before the fourth quarter of 2017, with the possible exception of repeal of Obamacare taxes.
Despite many obstacles, enactment of tax reform that includes lower rates for business income is still at the top of the Republican agenda. It is never too soon to begin planning and preparing for tax reform, which will include lower tax rates for business income. Please contact us if you would like to discuss the impact of legislation and legislative proposals on your business as well as tax planning considerations in advance of tax reform legislation.