Press Room: Tax Release
Republicans Release Unified Framework for Tax Reform, Open Door to Tax Increase on Wealthy
On September 27, 2017, The Trump Administration, House Committee on Ways and Means, and Senate Finance Committee released a nine-page Unified Framework for Fixing Our Broken Tax Code (Unified Framework) that specifies a proposed tax rate of 20% for C corporations and 25% for small and family-owned passthrough businesses. In order to ensure that tax reform does not shift the tax burden from high-income to middle- and lower-income taxpayers, the proposed individual tax rate brackets of 12%, 25%, and 35% may be supplemented with an unspecified additional top rate. A potential new top bracket is a significant shift in stance for Congressional Republicans and opens the possibility that the top tax rate will remain at 39.6% or could even increase as a part of tax reform. The Republican pitch is clear - tax reform for businesses will create economic growth and more jobs, and the proposed tax changes at the lower and middle-income levels will put money in the pockets of Americans prior to the 2018 mid-term elections.
Where Do We Go From Here?
The Unified Framework is the result of a series of meetings and negotiations of the Big Six—a working group of Republican leaders that includes Secretary of Treasury Steven Mnuchin, National Economic Council Director Gary Cohn, Speaker of the House Paul Ryan, Senate Majority Leader Mitch McConnell, House Ways and Means Committee Chair Kevin Brady and Senate Finance Committee Chair Orrin Hatch. The Unified Framework was intended to provide just enough detail to entice House Freedom Caucus conservatives to vote for a budget that contains instructions for passing tax reform legislation. In order to move tax legislation through the special budget reconciliation process that requires only a simple majority vote in the Senate (i.e., not subject to the 60 votes needed to overcome a filibuster), Congress must next pass a fiscal year 2018 budget that provides instructions for tax reform. These rules preclude legislation that increases the federal deficit in years beyond the current 10-year budget window. The budget is expected to provide parameters around how much of the tax reform would be deficit financed over the 10-year budget window, while the remaining tax rate reductions would be offset by changes to tax preferences, elimination of deductions, or other revenue raising measures. After the budget is passed, the House Ways and Means Committee and Senate Finance Committee will begin a Committee mark-up process on the legislation. Details regarding tax reform legislation and base broadening measures are reserved for the Committees to resolve during the mark-up process, which is likely to occur in late October or early November.
What’s In and What’s Out of the Unified Framework?
Although details remain scarce, the Unified Framework illuminates the contours of the debate and the emerging consensus among Republicans. The table below provides insight with respect to the direction Republicans appear to be heading on key tax reform proposals.
|Overview||Tax reform that creates economic growth (jobs in the United States) and provides tax relief to middle- and lower-income taxpayers.||Bipartisan tax reform similar to 1986 tax reform is out, Republicans continue to plan for a process using budget reconciliation procedures||President Trump is actively reaching out to Senate Democrats in the hopes of securing at least a few votes for this tax plan in the event that more than two of the 52 Senate Republicans do not support the plan|
|Individual Income Tax Rates||Three tax brackets: 12%, 25%, and 35%; potential additional top tax rate for the highest-income taxpayers; repeal of alternative minimum tax (AMT)||At a top rate of 35%, many higher-income taxpayers may see a net tax increase due to repeal of some itemized deductions; if an additional top rate is imposed at 39.6% (or higher), high-income taxpayers could face a significant tax increase|
|Individual Deductions and Credits||Retain deductions for charitable giving and mortgage interest; repeal the personal exemption and all other itemized deductions; double the standard deduction (creating a larger zero tax bracket) and provide additional child tax credits||Trump’s proposal for a $200,000 (married) / $100,000 (single) overall cap on itemized deductions||Although not specifically mentioned, the state and local tax deduction still seems to be on the chopping block despite political pressures on high-tax-state Republicans; the proposed changes to the personal exemption and standard deduction would greatly simplify tax filings for many middle and lower-income taxpayers|
|Investment Income||Maintain or raise retirement plan participation; no change from present top capital gain rate of 20% is mentioned; anti-carried interest legislation is not mentioned but is likely to be included; a mark-to-market and ordinary regime for derivatives is not mentioned but is likely to be included||Blueprint proposal to tax capital gains, dividends, and interest as ordinary income with a 50% exclusion seems unlikely given the silence of the Unified Framework on taxation of capital gains||A potential reduction in rates applicable to long-term capital gains seems unlikely given the political climate and concerns of moderate Republicans in the Senate; whether an additional top bracket would be applied to capital gain income, similar to a Buffet Rule is unclear at this time; a haircut on retirement incentives for wealthier taxpayers is possible, similar to a Romney Rule|
|Net Investment Income Tax (NIIT)||No change||Eliminate 3.8% net investment income tax (NIIT) as part of tax reform legislation||Any elimination of the NIIT would be a part of separate healthcare legislation which is currently stalled in the Senate|
|Estate Tax and Generation Skipping Transfer Tax||Repeal||Estate tax repeal would likely be accompanied by disallowance of stepped-up basis for estates over $10 million by providing carry over basis to the inheritor; the gift tax is likely to remain in place|
|Small and Family Owned Passthrough Business||25% top rate with measures to prevent recharacterization of personal income into business income||The Blueprint called for a special rate for active passthrough business income, the substitution of small and family-owned for active may indicate an intent to further limit the applicability of this special rate||Personal income (reasonable compensation) is subject to individual rates; it is still unclear what type of income is business versus personal – Mnuchin recently commented that all income from service businesses would be exempted from the special rate|
|Corporate||20% top rate; elimination of the AMT; may consider methods to reduce double taxation of corporate earnings; modernize tax rules for special industries and sectors||The Unified Framework keeps the door open for Hatch’s proposal for corporate integration to be included in tax reform, although inclusion of corporate integration seems unlikely|
|Capital Expensing||Expensing of new investments in depreciable assets other than structures for at least five years beginning September 27, 2017||Blueprint proposal for 100% expensing for all capital investment, including intangibles seems to be off the table in favor of a temporary measure that is limited to the types of property normally eligible for bonus depreciation||The proposal appears to be akin to 100% bonus depreciation for a 5-year period and expansion of small business expensing; the effective date of September 27, 2017 is intended to prevent businesses from holding off on making investments while the tax reform process continues|
|Repeal of Net Interest Expense Deduction||Partial limitation on the deduction for net interest expense of C corporations; treatment of interest by non-corporate taxpayers is under consideration||The Blueprint proposal to completely eliminate the tax deduction for net interest expense for all businesses appears to have been tossed out||A thin-capitalization rule for multi-nationals is a possibility, for example, the Camp draft included a limitation on the deductibility of interest expense based on how leveraged the U.S. company is relative to the worldwide group; an overall limitation on interest to a percentage of taxable income is another possibility|
|Other Business Tax Base Broadeners||Eliminate most tax preferences except research credit and low-income housing credit; the domestic production deduction (Sec. 199) would be eliminated along with numerous other special exclusions and deductions||The Blueprint stated that the LIFO inventory method would be retained; the Unified Framework is silent with respect to LIFO, opening the possibility of LIFO repeal||The Unified Framework singles out the research credit and the low-income housing credit for retention and leaves the door open for retention of other credits to the extent budgetary limits allow|
|International||Territorial (100% dividend exemption system) for multinational corporations; one-time deemed repatriation at a two-tiered reduced tax rate for cash and illiquid assets, payable over several years; global minimum tax at a reduced rate on certain types of income; new rules to level the playing field between U.S. headquartered parent companies and inbound companies||Border adjustment was officially abandoned in a July 27th statement by the Big Six||A current minimum tax on certain types of foreign earnings similar to that proposed by Camp is likely; limitations on the deductibility of interest expense (discussed above) are aimed at multinationals; some additional curtailment of other intercompany deductions such as royalties is also possible|
For a discussion of the Big Six’s Joint Statement on tax reform, see August Has Arrived, But Tax Reform Details Remain Scarce (August 1, 2017). For a discussion of the White House’s prior statement on tax reform, see our prior Tax Release. For an analysis of the House’s tax reform Blueprint and comparison to President-Elect Trump’s pre-election goals for tax reform, see our November 2016 Tax Release.
Release of the Unified Framework represents a significant positive step towards tax reform legislation. The next step is for Congress to enact a budget for fiscal 2018, hopefully by mid-October. The House Freedom Caucus announced support for the Unified Framework, which should speed the budget process in the House. Taxpayers must continue to wait for the House Ways and Means and Senate Finance Committees to resolve the key details, which will emerge after the budget is in place, in late October or early November. It remains to be seen whether the tax plan can garner enough Republican support to pass on a party line (with at least 50 Republican Senators and Vice-President Pence to break a tie), or whether President Trump’s outreach to Democrats can provide a few extra votes. Given the crowded legislative agenda, it will be difficult to pass tax reform by the end of 2017 and the timeline could easily slide to the first quarter of 2018. In the meantime, taxpayers should continue to prepare for potentially significant tax changes, including a reduction in tax rates on business income and a deemed repatriation tax on multinational corporations.