November 15, 2016
by Dean Zerbe, former Senior Counsel to the U.S. Senate Finance Committee and alliantgroup National Managing Director
The future is a foreign country, they will do things differently there. (apologies to Hartley)
The assumptions of the path forward for our country were shattered with the election results – and certainly no more so than in the area of tax policy. Instead of a long grind primarily focused about taxes and the wealthy, the nation will now focus on potentially sweeping tax reform and a lowering of tax burdens. Look for the administration/Congress to be very “go go” on tax reform with an eye toward having the changes in law in place basically by late Spring/early Summer – similar to the big George W. Bush tax cut that was signed into law in June of 2001.
The question is – between the rhetoric of the campaign and the reality of governing – what will become law? A good place to start is with President-elect Trump’s own proposals – bearing in mind that while it is important to take the big picture of cutting taxes seriously – caution is best before taking policies from the campaign literally.
In addition, it is well worth reading closely the ideas for tax reform from the House Ways and Means Committee led by Chairman Brady (R – TX) as well as the working group reports put forward on a bipartisan basis by the Senate Finance Committee led by Chairman Hatch (R-UT) and Ranking Member Wyden (D-OR). I anticipate that to a significant extent, the new administration will look to the tax-writing committees to fill in the details of the big picture on taxes.
There will be broad support among Republicans for pro-growth tax reform (and some support from some Democrats for at least some proposals – can I caveat that more?). However, keep in mind that there is an overall dollar cap (as yet undetermined) for many Republicans on how much they will be willing to see as to a greater hit on the deficit and debt. Translation – it isn’t how-high-the-moon in terms of tax cuts. The overall budget reconciliation number for taxes will impact tax reform overall – and also how much tax reform/reductions are offset by other revenue increases.
Finally, as an overall note, while I expect it may be Spring/early Summer for all this to be on the President’s desk for signature, the tax reductions should almost certainly be effective starting January 1, 2017.
So a thumbnail sketch of the major proposals and my best guess as to where they end up on the President’s desk for signature:
Ordinary income. The campaign called for top rates reduced to 33% (higher income) and going from 7 to 3 brackets and relief for middle class families. That should be doable. Also eliminate the 0.9% tax from the Affordable Care Act (ACA).
Capital Gains – 20% and eliminate 3.8 percent surtax from ACA. Yes, that will happen.
Dividends – 20%. Yes, that will happen.
Alternative Minimum Tax (AMT). Eliminate. Hmmm. Probably. But see cap on deductions below – will that effectively address what AMT ineffectively addressed? (i.e. some wealthy people paying very little to nothing in federal income tax . . . we will see).
Deductions – increasing the standard deductions for filers – but at the same time having a cap on overall deductions – example – capping itemized deductions at $200,000 for Married Joint filers and $100,000 for single filers. So Washington giveth and Washington taketh. The capping on deductions is a major factor in controlling the costs of reducing the rates, getting rid of AMT, etc. The thresholds for capping deductions; what is covered in the cap; etc. are fairly fluid at this point – and will be driven by the overall dollars allocated for tax reform. However, what is clear is that Republicans are comfortable with a tradeoff of fewer deductions/credits in exchange for lower rates.
Estate tax/death tax. The campaign proposed repealing the death tax but with capital gains over $10 million subject to tax. Also, the campaign put forward an intriguing anti-abuse proposal that barred contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives will be disallowed. I find that the elimination of estate/death tax is a rock that has broken many ships in the past. We will see – I’m skeptical and look for a more doable result – bringing the rate down to where it was previously (35%) or even matching what will be the new top rate for ordinary income (33%).
Family Limited Partnership – proposed Treasury regulations on discounting. Goodbye.
Carried interest – eliminate (ie tax as ordinary income). Everyone’s favorite loophole to talk about. Expect it will finally be on the chopping block – but anticipate only for deals going forward.
Child care/dependent care/child credit – the campaign put forward proposals in this area and Members of Congress on both sides of the aisle (see, example, Senator Rubio (R-FL)) have ideas for expansion in this area. I expect some pro-family changes in these areas of tax law.
Corporate Tax. Rate lowered from 35 to 15 percent. Wow. I think there is too much blood in the water to try to get the corporate rate that low (either from extensive loss of revenue and/or from hairpulling from elimination or reduction of Corporate tax deductions/credits). I see something more in the 25 – 28 percent range as a likely end result – certainly a strong improvement.
International Tax – When three major players in tax agree (Speaker Ryan (R-WI), Democratic Leader Schumer (D-NY) and Senator Portman (R-OH) on a major reform regime (in this case –international tax)– I say it’s beginning to look a lot like Christmas.
Business Tax. One of the most interesting ideas put forward by the campaign (as well as Ways and Means) is the concept of taxing business owners of pass-through entities (think S Corp., LLC, Partnerships, etc.) at a lower rate than the ordinary income tax rate. Hats off for tax reform that will not just benefit the big companies organized as C Corporations but also the vast majority of businesses in this country – businesses that are organized as pass-throughs. As with the proposal on Corporate tax – I blink at the idea of a 15 percent rate as being a bridge too far – but certainly possible to have the rate be equal to where I think the Corporate tax rate will end up – 25-28 percent.
Research and Development (R&D) Tax Credit. A tax credit for business that is widely embraced on a bipartisan basis – and should be expanded as proposed by Chairmen Hatch and Brady. The reality is for the new administration, with a focus on bringing back manufacturing, the R&D tax credit is the tax proposal that is vital in helping American manufacturing and international competitiveness. One idea being considered, expand the R&D tax credit for those businesses that do both their research and a significant amount of their manufacturing here in the U.S.
AFFORDABLE CARE ACT
Some non-tax provisions will be retained – especially the vitally important provision benefitting low income families that requires charitable hospitals to act charitably to the poor (a bipartisan section sponsored by then-Chairman Baucus (D-MT) and Senator Grassley (R-IA)).
However, the provisions of the ACA raising taxes – scythe.
So that’s the best guesses as of now. Things will get clearer fairly quickly – with the new President’s budget coming forward in February and more importantly, the Congressional budget resolution and the framework (and dollars for taxes) for reconciliation. The tax writing committees will have their pencils sharpened and we should have a good idea of the future of taxes by Spring. Interesting times.
Dean Zerbe is alliantgroup’s National Managing Director based in the firm’s Washington, D.C. office. Prior to joining alliantgroup, Zerbe was Senior Counsel and Tax Counsel to the U.S. Senate Committee on Finance. He worked closely with then-Chairman of the Finance Committee, Senator Charles Grassley, on tax legislation. During his tenure on the Finance Committee, Zerbe was intimately involved with nearly every major piece of tax legislation that was signed into law, including the 2001 and 2003 tax reconciliation bills, the JOBS bill in 2004 (corporate tax reform) and the Pension Protection Act. Zerbe is a frequent speaker and author on the outlook for short-term and long-term changes in tax policy, as well as ways accounting firms can help their clients lower their tax bill.
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