by: Rosalind W. Sutch, Chris Catarino, Jane Scaccetti
The “Big Six” unveiled its Tax Reform plan on Wednesday September 27, 2017 with the tag lines, “MORE jobs,” “FAIRER taxes,” and “BIGGER paychecks.” That same day, President Trump took the stage in Indiana to outline what he called “historical tax relief to the American people” and charged American taxpayers to demand tax reform from their politicians. Both the Framework of the tax reform plan and the President’s speech lacked significant and vital details on how this “once in a generation opportunity” for tax reform will become reality. Our post summarizes the Framework touted as the “middle class miracle” and grades it against the four principles it was built upon.
The Unified Framework for Fixing Our Broken Tax Code is nine pages long, however there is enough whitespace and large font headers that it can be summarized onto one page. Many items and themes are familiar and similar to the House Republicans' A Better Way blueprint issued last summer and various proposals made by the President.
A tax reform bill will likely go through a legislative process called “reconciliation” since no democratic votes are needed with the republican Senate majority.
What is reconciliation?
According to the Tax Policy Center: “Congressional budget committees use the reconciliation process to ensure tax laws and mandatory spending programs are revised according to the budget resolution’s revenue and spending targets. The reconciliation process is a way to fast-track revenue and spending legislation into becoming law.” You can read more about this process here.
The quick take away is, for a tax reform bill to pass through reconciliation it must meet two parameters: It cannot exceed tax cuts allotted for in the agreed upon budget during the ten-year budget window; and it cannot add to the budgeted deficit after the end of the ten-year budget window. The draft budget would allow for $1.5 trillion in tax cuts, so using that as a guide, $1.5 trillion is the maximum tax cuts that can be passed if, and only if, those tax cuts do not add to the deficit after that ten-year budget window.
Individual Tax Provisions
- Standard Deductions Increased and Personal Exemptions Eliminated
- The new Standard Deduction is $12,000 for single taxpayers and $24,000 for married taxpayers. The Head of Household category is eliminated. Taxpayers without children would see an increase in the “zero tax bracket” created by the Standard Deduction, while most middle-income taxpayers with children would see decrease in the “zero tax bracket” by eliminating personal exemptions.
- Consolidation of Tax Rates
- The seven brackets are reduced to three – 12%, 25% and 35%. Under current law, the lowest tax bracket is 10%, and the highest is 39.6%.
- An additional fourth “top” rate or surtax could be added to ‘ensure that the reformed tax code is at least as progressive as the exiting tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers.’
- Spoiler alert- if this plan has any chance of making it through the reconciliation process, count on an additional top rate added!
- The Framework does not specify the income levels associated with the rates. This is a “massive” omission.
- Child and Dependent Tax Credit Changes
- Refundable Child Tax Credit remains at $1,000 but the marriage penalty is eliminated
- The framework states it "significantly increases" the child tax credit, but doesn't specify the increased amount nor the increased phase out limits
- Added is new non-refundable credit of $500 for non-child dependents. The president said this should assist adults caring for their elderly parents.
- Refundable Child Tax Credit remains at $1,000 but the marriage penalty is eliminated
- Certain Itemized Deductions Eliminated
- Most itemized deductions, including state and local tax deductions (income and real estate) are eliminated
- Mortgage interest and charitable contribution deductions remain.
- Alternative Minimum Tax (AMT) Eliminated
- High state and local taxes cause many to fall into the AMT. By eliminating those deductions, the proposed tax regime is more like AMT for all.
- Estate and Generation Skipping Transfer Taxes Eliminated
- A provision most important to our clients is the promised repeal of the Estate and Generation-Skipping Transfer taxes. Yes, that is all that is stated in the framework. No guidance was provided on how that impacts gifts already made or the basis in assets inherited.
Business Tax Provisions
- Maximum Small Business Tax Rate at 25%
- A maximum tax rate of 25% for business income of small and family owned businesses (not defined) not conducted through C-Corporations.
- Certain “measures” would be adopted to prevent recharacterization of personal income into business income to prevent wealthy individuals (not defined) from avoiding the top 35% personal tax rate.
- It’s curious how these measures will be accomplished under the veil of tax code “simplification” and reduction in regulations.
- Reduction in Corporate Tax Rate to 20%
- Corporate AMT ‘aimed’ to be Eliminated
- Businesses permitted to immediately write off (expense) the cost of new investments in depreciable assets, other than structures, made after Sept. 27, 2017, for at least five years
- Interest expense partially (not defined) limited
- Domestic Production Activities Deduction (DPAD or Section 199 Deduction) eliminated
- Numerous special exclusions and deductions (not defined) repealed or restricted
- Business credits, other than research and development (R&D) and low-income housing credit, repealed
Global Tax Provisions
- To transition from a worldwide tax system to new territorial system, accumulated offshore earnings are deemed repatriated and taxed over a period of time (not defined). Accumulated foreign earnings "held in illiquid assets" would be subject to a lower tax rate than foreign earnings held in "cash or cash equivalents." Neither rate is stated.
- Creation of new rules to protect US tax base by “taxing at a reduced rate and on global basis the foreign profits of US multinational corporations.” Your guess on this is as good as ours.
Tax Warriors Take - Report Card of Four Principles for Tax Reform
The Framework was built upon four principles of Tax Reform. We graded the Framework on those principles. Here’s how they scored:
- Make the tax code simple, fair and easy to understand
Many taxpayers who will qualify to file on a new “one page” tax return President Trump promised, currently file a 2-page Form 1040EZ. There isn’t a lot of simplification going on there. It’s misleading to say otherwise. However, there will be significantly less taxpayers itemizing their deductions under the proposed plan.
However, to implement many provisions noted above, especially the 25% rate cap on small business income, significant statutes and regulations must be drafted to meet the desired outcomes described in the Framework. The Framework employs many new terms that will need defining (“family owned businesses”, “wealthy individuals”). As we’ve seen before with “ordinary and necessary” business expenses, it can take years of caselaw to interpret these terms of art. This creates uncertainty and confusion - the opposite of simplification.
- Give American workers a pay raise by allowing them to keep more of their hard-earned paychecks
Some middle-income taxpayers will benefit from the proposed changes while others will not. It will depend on each person’s specific facts to determine who are the winners and losers. Without knowing the income levels at which the new individual rates will apply, it’s anybody’s guess who will fall into which group. But we’ll give them credit for trying.
- Make America the jobs magnet of the world by leveling the playing field for American businesses and workers
There is absolutely nothing in the Framework that addresses this. But we acknowledge lowering the corporate rate helps.
- Bring back trillions of dollars currently kept offshore to reinvest in the American economy.
Are we rewarding corporations who kept their profits off shore with a one-time discounted rate on repatriation? Yes, but isn’t it time to bring those dollars back?
It’s hard to believe the changes in the Framework could make it through the reconciliation process, but then again, there aren’t enough details to determine if it should. If you’re interested in a tax reform plan that could actually make it through the reconciliation process, check out our favorite tax blogger Tony Nitti’s attempt to craft revenue neutral tax reform posted a few weeks ago on Forbes.
The next steps are for Kevin Brady, chairman of the tax-writing House of Representatives Ways and Means Committee, to turn the Framework into legislation to be passed “by the end of this year.” Our crystal ball no longer works – but we will keep you informed as the information and details evolve.
Topics: Budget, tax provisions, president, Middle class, AMT, Estate Taxes, Trump, GOP, tax code, tax reform plan, framework, Indiana, reconciliation, consolidation, child tax credit, business tax provisions, global tax provisions, Sutch, tax rate, DPAD, Scaccetti