Trump Announces Tax Reform Proposal
By Mitchell Kopelman, partner-in-charge of Tax and Technology and Biosciences, and Steven Gluck, tax associate
President Trump announced a tax overhaul proposal Wednesday, Sept. 27. Many parts of the plan are concepts President Trump previously stated he wants implemented, and a few parts of the proposal have not been mentioned before. In the analysis below, we reference sections by their title in the framework and discuss what that section means to Aprio clients.
Aprio commentary: President Trump has long wanted to remove every deduction except for home mortgage interest and charitable contributions. But with doubling the standard deduction from $12,000 to $24,000, many taxpayers may no longer get a benefit from having interest from a home mortgage or giving to charities. Many more taxpayers may not even qualify or need to itemize, making their tax returns much simpler.
The mortgage and charitable deductions could become overrated. If a married couple bought a house with a $500,000 mortgage and have an interest rate of 4 percent, they would pay $20,000 in interest. If they then donated $4,000 to charitable organizations, then their total itemized deductions would equal the amount allowed under the proposal of $24,000.
Essentially, there would be no tax benefit for the mortgage and donations. Thus, the tax plan could discourage taxpayers from buying homes or giving to charity. This might impact the housing industry and non-profits.
Taxpayers with other significant itemized deductions should explore if certain expense deductions would be totally lost, or if they could be used in other ways. Those might include medical expenses, state taxes, real estate taxes, investment interest expense and miscellaneous itemized deductions, currently limited to 2 percent of adjusted gross income (AGI). In some cases, having a lower income tax rate on taxable income would make up for these lost deductions.
While the deduction for state taxes would be eliminated, many taxpayers with high state taxes today are subject to alternative minimum tax because of the state tax addback, and thus are not receiving much of a benefit for their state tax expenses.
Individual Tax Rates:
Aprio commentary: President Trump had already stated his wish to reduce the number of tax brackets to simplify the tax system. However, this proposal also states that instead of just the three 12 percent, 25 percent and 35 percent brackets previously disclosed, an additional bracket may be added for the highest income-earning taxpayers.
What will be the definition of “an additional top rate,” what might this percentage end up being, and how will “highest income taxpayers” be defined?
Uncertainty remains about tax rates for qualified dividends and long-term capital gains.
Enhanced Child Tax Credit:
Aprio commentary: President Trump proposes to increase the child tax credit, as well as the income levels individuals can earn before the child tax credit begins to phase out. The current child tax credit is $1,000 maximum for each qualifying child. The phase-out currently begins after $110,000. Two relevant questions remain: How much will the credit increase? How much income could you earn before the credit begins to phase out? President Trump also stated his intention to replace the $4,050 exemption for each dependent with a non-refundable credit of $500 for dependents who are not children. This would cause a higher tax liability for individuals who have dependents who are not children, such as parents.
Individual Alternative Minimum Tax (AMT):
Aprio commentary: Getting rid of the individual Alternative Minimum Tax (AMT) would, indeed, simplify the tax code and tax filing for clients affected by the AMT. In addition, many taxpayers have carry-over credits, which are limited due to AMT today. If AMT is repealed, our clients may be able to claim some or all of their carry-over credits faster than if AMT remains in place. We are wondering if the final plan will include references to how some or all carryover unused tax credits can be utilized.
Death and Generation-Skipping Transfer Taxes:
Aprio commentary: President Trump has mentioned wanting to get rid of the death tax before, but has not mentioned the removal of the generation-skipping transfer tax (GST) until this proposal. But he still did not say if the gift tax itself would be removed. Gift tax is payable on gifts of more than $14,000 annually. Since the gift and death tax are connected, it is surprising President Trump only mentioned putting the death tax up for repeal and not the gift tax.
Tax Rate Structure for Small Businesses
Aprio commentary: President Trump does not state the definition of small and family-owned businesses. This means it is unclear if all entities operating as sole proprietorships, partnerships, or S corporations would have 25 percent as the maximum tax rate, or if certain limitations would be put in place on entities that are not “small” or “family-owned.”
Small business may mean only certain companies that have revenue amounts under a certain threshold to qualify for the maximum tax rate of 25 percent.
Family-owned may also mean that only companies that are owned or run by the owner and immediate family may qualify for the tax rate of 25 percent, vs. companies that are owned or run by hundreds of family members. Until more details are given, it is uncertain which sole proprietorships, partnerships, and S corporations would have 25 percent as the maximum tax rate or if all of them would.
Several legislators have suggested, prior to this most recent tax policy release, that businesses which provide professional services, such as healthcare, legal and accounting, would not be eligible for these lower rates. Many of these types of companies are formed as flow-through entities, and they may not be eligible for these lower rates.
Corporate tax rates:
Aprio commentary: President Trump hopes that reducing the corporate tax rate to 20 percent would give corporations incentive to come to the United States for its low tax rate. This lower rate could actually entice U.S. companies to be less interested in moving profits offshore for tax purposes. But if a company can still produce higher profits due to labor or raw material costs outside the United States, we expect companies to still operate globally in an efficient manner.
Many of our clients who are U.S. manufacturers of goods and technologies benefit from the use of a Domestic International Sales Corporation (DISC) today. This vehicle might not provide future benefits. This will be dependent on many factors, including what the future qualified dividend tax rate will be for individuals.
Expensing of Capital Investments and Interest Expense:
Aprio commentary: This proposal would incentivize companies to invest in new assets, since they would be able to depreciate eligible assets and lower their taxable income immediately. However, the framework does not state which assets would be considered eligible to immediately be expensed other than structures, which we believe translates to mean buildings. Until more detailed information comes out, it is unclear which assets companies would be able to immediately expense.
Once again, the proposal refers to bringing this relief to “small businesses,” which are again not defined. What is a small business?
The newest proposal suggests that if a company borrows funds to purchase new assets and then depreciates those assets immediately, the company would not be able to deduct the interest expense related to the asset purchased.
Perhaps only interest expense related to “eligible” assets, which are referred to as “structures,” would be able to be written off. What is the result if we perform a cost-segregation study on a “structure” which results in the assignment of values to non-building assets? This reduces the depreciable life of certain assets to shorter life than “structures” — would the related interest be deductible?
Additionally, the proposal refers to C corporations vs. non-corporate taxpayers being subject to different rules on interest deductions. It is difficult to see why the government would want to have different rules for writing off interest expense based on the form of entity. This seems to be the opposite of simplification.
Section 199 and Tax Credits:
Aprio commentary: Today, domestic manufacturers with the marginal tax rate of 35 percent can effectively reduce their effective tax rate by 3 percent with “Section 199.” Under the new proposal, this deduction would no longer be allowed. However, given that the new marginal tax rate would be 20 percent, this repeal of the current-law domestic production deduction would not negatively affect domestic manufacturers; under the proposal, taxpayers would have their tax rate lowered 15 percent, which seems worth the trade of giving up the maximum 3 percent benefit they have today.
We are thrilled the Trump administration has decided to preserve R&D and low-income housing credits. These credits encourage companies to innovate and help those who need affordable housing.
The R&D credit continuance should provide adequate incentive for the technology and manufacturing sectors to continue to expand in the United States.
The low-income housing credit continuance should provide continued incentive for housing developers to build affordable housing.
Territorial Taxation of Global American Companies:
Aprio commentary: The administration states that American companies will not have to pay taxes on dividends from foreign subsidiaries in which the American companies have at least a 10 percent stake. While this sounds positive, it is contrary to the last statement in the proposal, discussed below.
All offshore accumulated earnings are expected to be taxed. However, earnings that are held as illiquid assets would be taxed at a lower rate versus those assets held in cash or cash equivalents. The tax due would be paid over an unspecified number of years.
The administration does not give a definition for illiquid assets, though it does identify cash and cash equivalents as being subject to a higher tax rate. This means it is uncertain which assets would be considered illiquid and subject to a lower tax rate. If for cash equivalents the government intends to use the standard accounting definition (if assets can be turned into cash within 90 days), the government can choose any definition for this purpose.
Also, for illiquid assets, it is not known if they mean assets that cannot be turned into cash after a year or one operating cycle, whichever is longer. In addition, it is unknown as of what date this would be effective. Is it too late to put foreign accumulated earnings that are in cash or cash equivalents today into illiquid assets to reduce the tax rate on these earnings? If it is not too late, companies may consider using some or all of their accumulated earnings held as cash or cash equivalents to buy useful illiquid assets for their businesses and lower their tax rate. Since the amount of years is not given for the payment of the tax due on foreign earnings, it makes it more difficult for companies to plan.
Corporations shipping jobs and capital overseas:
Aprio commentary: This section states companies will have to pay taxes on the foreign profits of U.S. multinational corporations, which seems to contradict the previous section stating future foreign dividends would not be taxed. In addition, it does not state what the lowered rate would be.
Aprio will continue to monitor proposed changes in tax legislation. We expect that if any legislation is signed into law, it will be late in 2017.
If you have any questions or would like to discuss how you, your family or your business will be impacted, please contact either your Aprio tax advisor; Mitchell Kopelman, partner-in-charge of Tax and Technology and Biosciences, at firstname.lastname@example.org; or Steven Gluck, tax associate, at email@example.com.