May 10, 2017
by Tim Hanford, ADC Strategies, LLC
Trump Tax Reform Plan
In late April, President Trump released his “2017 Tax Reform for Economic Growth and American Jobs” tax plan, described as “The Biggest Individual and Business Tax Cut in American History.” The single-page plan lacks significant detail and is very similar to Trump’s campaign tax reform ideas and too much of the House Republican tax reform blueprint. The Trump plan is intended to be a starting point for discussions with Congress on eventual tax reform “that provides massive tax relief, creates jobs, and makes America more competitive – and can pass both chambers.” Nothing in the plan represents a final decision, and the absence of any particular proposal apparently does not create an inference that the Administration has rejected that proposal.
For individuals, the Trump plan would reduce the current seven tax brackets to three brackets of 10%, 25% and 35% (compared to 12%, 25% and 33% in the House GOP blueprint). The plan gives no indication where those brackets would start, so it is impossible to determine the plan’s impact on most taxpayers. The plan would double the standard deduction and preserve mortgage interest and charitable deductions. The plan would “eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers” without indicating what those might be. One tax benefit that would be eliminated is the tax deduction for state and local income and property taxes, a change that is troubling to states with relatively high taxes. However, since the Trump plan also eliminates the alternative minimum tax that effectively denies the benefit of state tax deductions to many taxpayers, the elimination of the state and local tax deduction may be felt mainly by upper-income taxpayers. The Trump plan would also eliminate the death (estate) tax. Trump would repeal the Obamacare 3.8% surtax on investment income, thus apparently leaving the top capital gains and dividend tax rate at 20% (contrasted with the House GOP’s proposed top rate of 16.5% on capital gains, dividends, and interest).
For businesses, the Trump plan would impose a 15% tax rate. This rate would apply to corporations and to pass-through businesses (partnerships, LLCs, and sole proprietorships). But to avoid a massive shifting of compensation income to pass-through business income characterization, the eventual plan will likely need to include complex safeguards (e.g., making what is essentially personal service income ineligible for the business income rate). Trump would impose a territorial tax system leaving income earned overseas exempt from U.S. tax. And he would impose a one-time tax (at an unspecified rate) on income currently deferred overseas. Finally Trump would eliminate unspecified “tax breaks for special interests.”
There are numerous issues on which the Trump plan is silent. First, the Trump plan (like the House GOP Blueprint) does not specifically talk about the tax treatment of life insurance in either the business or individual context. Nor does the Trump plan mention the border-adjustable tax (“BAT”) proposed by House Republicans. Trump and his team have significant problems with the BAT but are continuing to discuss possible modifications with the House. And the Trump plan does not mention the House GOP’s proposal to eliminate the deduction for business interest expense. However, Budget Director Mick Mulvaney recently suggested that both the BAT and the interest disallowance remain under discussion. And the Trump plan says nothing about whether there would be expensing of business assets. As noted above, the Trump plan (like the House GOP blueprint) does not identify the tax breaks for “special interests” that would be eliminated.
There has been significant concern in the retirement plan community that tax reform might involve eliminating or limiting pre-tax contributions for retirement plans (e.g., 401(k) plans) and instead directing taxpayers to Roth accounts. The 2014 tax reform plan released by former Ways and Means Committee Chairman Dave Camp (R-MI) included such a proposal. The Trump plan is silent on the treatment of retirement savings, but National Economic Council Director Gary Cohn said during a press briefing, “Home-ownership, charitable giving, and
retirement savings will be protected….” The White House confirmed that 401(k) retirement plan deductions would be protected after press secretary Sean Spicer first said the opposite. House tax-writers are also hearing from stakeholders concerned about the potential loss of pre-tax retirement savings options and are understood to be reviewing proposals to preserve current pre-tax options while enhancing the attractiveness of Roth-type options.
Congressional Tax Reform Efforts
House Speaker Paul Ryan (R-WI) and House Ways and Means Committee Chairman Kevin Brady (R-TX) would like to enact the House GOP tax blueprint to provide permanent tax reform. But they understand that Congressional Democrats will likely oppose all efforts. This means that to get a tax reform bill through Congress, Republicans will need to use budget reconciliation procedures that require only 51 affirmative votes in the Senate (rather than the normal 60 votes required to overcome a filibuster). However, a consequence of using budget reconciliation procedures is that the bill cannot cause any revenue loss after the ten-year budget period. Controversy over the major House blueprint provisions intended to keep the legislation from losing money in the out years (BAT and the denial of the business interest expense deduction) has led many Republicans and the White House to consider an alternative reconciliation path that would satisfy the out year rule by making the tax reductions temporary. This is the approach used to enact the 2001 and 2003 tax cuts under President George W. Bush. However, the temporary tax cut alternative may not be as workable as it was in 2001 and 2003. Speaker Ryan in late April released a letter from the Joint Committee on Taxation (JCT) saying that even a three-year corporate tax rate cut would produce non-negligible revenue losses in years beyond the revenue-estimating period because of increased tax credit carryforwards and a reduced base of offshore income that would eventually be repatriated. The JCT letter will complicate any efforts to use reconciliation procedures to advance a temporary tax cut. More recently there have been reports that tax-writers are considering a budget period of as long as 30 years to permit temporary tax cuts for a significant period (e.g., 10-15 years) that do not create out year revenue losses.
Speaker Ryan continues to support his proposed border-adjustable tax (BAT) but, in the face of massive opposition from retailers and other importers, he has acknowledged that it would need to be changed. It is unclear whether the types of transition rules and changes likely envisioned by Ryan would be sufficient to overcome opposition to the BAT. Moreover, other changes to the BAT may increase opposition. As advanced in the GOP blueprint, the BAT would affect only businesses by denying them any deduction for imported items. However, a Joint Committee on Taxation staff member recently said it would be necessary to find a way to monitor direct sales from foreign companies to U.S. consumers, ensuring they are properly taxed, for the domestic retail industry to survive under the BAT.
Another controversial proposal in the House blueprint is the loss of the business interest deduction. Capital-intensive industries that now rely heavily on borrowing do not believe that immediate expensing of capital asset purchases (essentially a timing difference) is an adequate tradeoff for the loss of the interest deduction. Ways and Means Committee Chairman Brady has recently suggested that there might be grandfathering of existing debt and other modifications to avoid disrupting current capital structures of businesses.
If tax writers decide to stick with a permanent tax reform approach (rather than a temporary tax cut) and are forced to drop or significantly alter the BAT and/or the interest deduction disallowance, there may not be sufficient long-term revenue to offset the cost of the GOP blueprint’s (or President Trump’s) proposed business rate reductions. As a result, many observers continue to believe that the final business tax rate reduction will not go lower than 25%. And even that level of rate reduction may be phased in over several years.
As a result of the uncertainty about major components of tax reform, the timing of tax reform has slowed significantly. Treasury Secretary Mnuchin recently said tax reform would be completed by August, but soon acknowledged that was highly unlikely. The Ways and Means Committee held two tax reform hearings in May and is planning more in the coming months. Chairman Brady when asked whether his Committee would hold a summer markup said, “I’m less focused on the month than on the year for tax reform, which will be this year, 2017.” Senate tax writers are continuing to monitor House tax reform efforts but have not yet advanced their own proposals; so far they have said only that they will do their own bill rather than just adopting what the House may pass. In a recent survey of about 1,000 business executives, only 16 percent thought tax reform would get done this year; most thought it would happen next year.
Tim Hanford is the owner of ADC Strategies, LLC in Washington, DC and advises Newport Group’s non-qualified and insurance service teams on governmental affairs.
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