On Wednesday, April 26, 2017, the White House issued “2017 Tax Reform for Economic Growth and American Jobs” which outlined its goals and high-level components of proposed tax cuts. If passed, the Trump administration asserts that it would represent the largest individual and business tax cut in U.S. history.
Key elements of the proposed changes to our current tax system include:
Business Tax Measures:
- A reduction of the top tax rate on corporate profits from 35 percent to 15 percent.
- A comparable 15 percent top rate on business profits from non-corporate (pass-through) entities.
- A one-time tax on offshore business profits.
- Modifications aimed toward creating a territorial tax system going forward.
Individual Tax Measures:
- A reduction of the current seven tax brackets to three brackets of 10, 25, and 35 percent (the current top bracket is 39.6 percent).
- Doubling of the standard deduction.
- Simplification by eliminating many tax deductions, while keeping deductions for mortgage interest and charitable donations.
- Elimination of the Alternative Minimum Tax.
- Elimination of the complicated 3.8 percent tax on net investment income that was enacted to help finance Obamacare.
- Elimination of the estate tax.
Treasury Secretary Steven Mnuchin has indicated that the administration plans to “move as fast as we can and get this done this year.” How optimistic an individual feels about the prospects for achieving this goal likely vary depending on their political affiliation as well as their conservative/liberal orientation toward the budgetary implications of the proposed tax cuts.
The generally accepted usage of the term “Tax Reform” refers to a process of rebalancing the current tax system in a way that does not lead to a material budgetary deficit over a relatively long timeframe (generally 10 years). Politicians and commentators will have ample opportunities to pitch their respective arguments as to whether the White House’s proposed tax system modifications fit the definition of tax reform or simply constitute tax cuts. Ultimately, those who find themselves as winners or losers as a result of any tax changes that are enacted may care less about the textbook definition of reform and more about their personal impact.
What are examples of some of the implications of President Trump’s tax proposals, assuming they are enacted?
If all business profits are subject to the same top tax rate (whether that is 15 percent or perhaps some higher rate), a preference for the use of pass-through entities for qualifying businesses should continue. However, how much business profit is passed out to owners in the form of salary versus profit distributions could become a considerably more interesting topic. With a proposed top rate of 35 percent on income other than “business profit,” a high salary may not make good economic sense.
Plus, employees with high salaries may now have a much stronger desire to participate in formal ownership of the businesses for which they work because they will naturally want to qualify for the same lower income tax rate as the owner.
For individuals who reside in high tax states (such as New Jersey and New York), the elimination of the alternative minimum tax sounds like a great concept as state tax deductions may be the reason they’ve historically been subject to the AMT. However, the proposed elimination of deductions for state taxes may lead to an outcome wherein these individuals actually pay the equivalent of the AMT while simply eliminating the AMT forms from their tax return. In other words, the filing process may become simpler, but the tax paid may be the same.
The current AMT rate is capped at 28 percent while the proposed top regular rate applied to income without the state tax deduction would be 35 percent. Perhaps the deduction for real estate taxes will survive as part of the stated goal of protecting home ownership deductions. If that is the case, it may soften the impact.
The legislative process ahead should certainly prove to be interesting for those with an interest in tax matters. While things are currently in the early proposal stage, we will hopefully have more clarity over the next few months about what will actually be enacted in 2017. If we look to history as a guide, the Reagan administration’s tax reform process and the more recent health care reform initiatives would suggest that the betting line for the passage of significant tax reform this year should be attracting weaker odds than just a few months back.
However, we are still very much in a wait-and-see mode and we will continue to keep you informed of developments. In the meantime, if you would like to discuss your business or individual tax situation and what strategies may be prudent for you in the current environment, please don’t hesitate to contact us.
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