President Trump and the Big 6 Tax Plan: What Can We Expect?
Earlier this week, President Trump and the “Big 6” Republican leaders announced their long-awaited tax plan, setting the following goals for the proposal:
- Tax relief for middle-class families
- Added simplicity, resulting in a “postcard size” filing for most Americans
- Tax relief for business, particularly small businesses
- The closing of special interest tax breaks and loopholes
The proposed changes fall neatly into three categories.
Individual Tax Changes
The seven tax rates currently applied to ordinary income – ranging from 10% to 39.6% — would be consolidated into three brackets: 12%, 25%, and 35%. No detail was provided regarding the income levels at which each bracket would begin and end, however. In addition, the framework reserved the possibility that a fourth bracket — a top rate in excess of 35% — could later be added.
The standard deduction – currently at $6,350/$12,700 (single/married filing jointly), would be nearly doubled, to $12,000/$24,000. All itemized deductions other than the deductions for mortgage interest and charitable contributions would be eliminated. The combination of a higher standard deduction and eliminated itemized deductions would cause approximately 27 million more taxpayers to claim the standard deduction when compared to current law.
Personal exemptions – the $4,050 deduction each taxpayer is entitled to for oneself, a spouse, and any dependents – would be eliminated. The framework provided that these lost deductions would be rolled, at least in part, into an additional child tax credit, though only $1,000 of the credit would remain refundable, as is the case under current law. In addition, a new nonrefundable $500 credit would be enacted for non-child dependents, such as an elderly parent.
Lastly, the alternative minimum tax, estate tax, and generation-skipping tax would be eliminated.
What to do now?
Should the framework become law in 2018, taxpayers will receive no tax benefit for medical expenses, unreimbursed employee expenses, and real estate, personal property, and state and local income taxes. As a result, to the extent possible, taxpayers should strongly consider accelerating those expenses into 2017.
In addition, while the new brackets have not been provided, it is likely that ordinary income will be taxed at a lower rate in 2018 than 2017. As a result, taxpayers should defer the recognition of income – such as the receipt of a bonus – into 2018 whenever possible.
Business Tax Changes
The framework would reduce the corporate tax rate from 35% to 20%. The income of S corporations, partnerships, and sole proprietorships, which are not taxed at the business level but rather at the individual owner level, where current rates rise as high as 39.6%, would be taxed at a unified rate of 25%.
Treasury Secretary Steven Mnuchin has suggested that the 25% business rate will not apply to the income of service businesses; i.e., accountants, lawyers, and consultants. In addition, any wages paid to a business owner will continue to be subject to ordinary income rates as high as 35%, meaning there will be tremendous motivation for taxpayers to forego compensation in favor of an increased share of business profits. This will likely present enforcement challenges for the IRS.
For at least the next five years, businesses would be permitted to deduct the full cost of any capital improvements. As a trade-off, however, the framework would limit – in a manner not yet described – the deductibility of net business interest.
Finally, because the corporate and business rates would drop substantially, the Section 199 manufacturing deduction would be eliminated.
What to do now?
National Economic Council Director Gary Cohn stated his desire to implement full expensing retroactive to September 27, 2017. While there is no certainty this will come to fruition, taxpayers may want to consider accelerating large capital expenditures into the final months of this year with the promise of an unlimited immediate deduction and the ability to offset income that, in all likelihood, will be taxed at a higher rate in 2017 than 2018.
International Tax Changes
The framework would impose a one-time tax – at an as-yet-undescribed rate – on the reported $2.5 trillion of overseas profits earned by foreign affiliates of U.S. corporation. The international tax regime would then undergo a fundamental shift, moving from the current “deferral system,” in which a U.S. corporation pays U.S. tax when earnings of a foreign affiliate are repatriated to the U.S., to a “territorial system,” where the income of a foreign affiliate will only be taxed in the foreign jurisdiction; when the income is subsequently repatriated to the U.S., it will not be subject to U.S. tax.
What to do now?
Multi-national businesses should review their corporate structure to determine if any changes should be made in order to maximize the benefits arising from a shift to a territorial system.
As this week’s release was just a framework, more details should be forthcoming as more formal legislation takes hold. Tax advisers should follow these changes closely in order to most effectively implement 2017 year-end planning.
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