The inauguration of President Donald J. Trump and seating of the Republican controlled 115th Congress brought with it a significant opportunity for an overhaul of the federal income tax system. Following the failure of Republican attempts to repeal portions of the Affordable Care Act (the ACA, and often referred to as Obamacare by its critics), the timing of such tax reform is now very much in doubt. The Trump administration had previously set a target date of August 2017 – before the next Congressional recess – for tax reform to be enacted. The administration has now largely conceded that tax reform will be finalized in that timeframe.
It is nevertheless instructive to consider the potential changes that may be forthcoming in order to reduce reaction time and, if necessary, to discuss the proposed changes that might be damaging (or most helpful) to your personal or business tax situation with elected officials and other legislative influencers. While proposed lower marginal income tax rates receive most of the attention in the popular press, other aspects of the Republican tax proposals may have a much larger impact on the final tax bills of many business and individuals. As currently constituted, these proposed changes are sure to produce clear winners and losers going forward. Pinpointing who might be in each of those categories at this point is mostly a guessing game however.
Great uncertainty about the proposed income tax changes remains. Notwithstanding the expansive list of policy priorities laid out during the Trump campaign, income tax reform does appear to have both Presidential and Congressional support early in the new administration despite differences between their proposals. It is still too early to tell which provisions are most likely to be implemented as is, and which will be subject to change or elimination as various constituencies weigh in. Generally speaking, there is also still a glaring sparsity of detail regarding many of the current income tax proposals. It is also worth noting that the Republicans do not have a filibuster proof majority in the U.S. Senate, so any tax reform may have to be enacted through the budget reconciliation process which will impose certain further limitations on the implementing legislation.
The proposed changes suggested by Congressional Republicans last summer, and President Trump during his campaign and in his White House release on April 26th, to personal income taxes are fairly consistent in calling for a substantial reduction in tax rates and in the number of tax brackets. Both proposals also call for increases in the standard deduction and elimination of personal exemptions, as well as elimination of the alternative minimum tax. The House proposal would eliminate all itemized deductions except for the home mortgage interest and charitable contribution deductions. President Trump’s campaign proposal would instead place a cap on all itemized deductions ($100,000 for single filers and $200,000 for married filing jointly) without necessarily eliminating any of the current deductions, though there was no mention of these caps in the latest press release. The two proposals also differ in the treatment of capital gains tax rates with the House proposal seemingly more favorable to individual taxpayers.
The current proposals for corporate tax reform also have some measures in common. Both proposals would significantly cut the corporate tax rate and would change the way in which most capital expenditures are deducted, and make corresponding changes to deny the deductibility of interest expense. Both proposals also seek to tap into offshore earnings of multinational corporations by currently taxing unrepatriated earning of foreign subsidiaries, although the details of the two proposals differ in how to do so. The biggest differentiators in the corporate tax proposals center around foreign trade. The House proposal would seek to impose a “border adjustment” tax that would disallow deductions in costs of goods sold for imported goods and products. President Trump, on the other hand, seems more comfortable with a “reciprocal tax” or tariffs as a way to promote U.S. manufacturing. Both these proposals will likely prove problematic for certain industries, and even with respect to compliance with world trade agreements to which the U.S. is a party.
As these proposals get debated in Congress in the coming months (and possibly years), there will necessarily be compromises and changes that are made. As previously noted, President Trump is very uncomfortable with the border adjustability provisions of the House GOP blueprint. That provision, in and of itself, has the potential to substantially increase the taxes on retail businesses, automobile manufacturers, oil refiners and other industries that rely on imported goods and products notwithstanding the dramatic drop proposed in the corporate income tax rate going forward. Of course, exporters of U.S. made products and services could benefit substantially from such a provision. It should also be noted that Senate Republicans have expressed doubts about border adjustability. Consequently, Senate Finance Committee Chair, Orrin Hatch (R-Utah) had proclaimed that Republican Senators might also be preparing a separate tax bill for consideration but the details of which have not yet been released.
The proposed changes to the depreciation and immediate expensing of capital expenditures, together with the new limitations on the deductibility of interest expenses could also profoundly affect many businesses. Capital intensive industries would seem poised to benefit from the immediate expensing of those costs. On the other hand, those businesses that rely heavily on leverage, including private equity and venture capital firms, could see great disruption in their business models due to the limitations proposed on the deductibility of interest expense.
As with any personal income tax rate cuts, it is anticipated that those at the top of the income spectrum will see the greatest percentage cuts in their net taxes while even those in more modest tax brackets will see some benefit. If President Trump’s initial proposal with respect to itemized deductions is enacted, it could severely impact large charitable gifts due to the partial loss of a charitable contribution deduction. The GOP proposal would appear to protect those charities since the full charitable contribution deduction would be retained along with the home mortgage interest deduction. Similar winners and losers will emerge with respect to many of the other proposed changes as well if enacted.
Nevertheless, it may still be too early to plan in earnest for any of these proposed changes until further developments come out of Washington. We are still waiting for President Trump to fully present the details of his tax reform proposals as the public has received only broad strokes of that plan to date. The following months will then see all of the proposals make their way through the Congressional legislative process. As seemingly happens with all federal legislation, there will likely be contentious debate and horse trading with respect to all of the proposed tax changes during that process. Implementation will be further delayed if the potential tax legislation is reliant on any budgetary savings that would presumably arise out of repeal (and replacement) of the ACA, as that legislation will have to be enacted first.
Thus, while we can anticipate tax cuts to benefit many taxpayers at some point under a Republican regime, placing a bet on any particular tax reform proposal surviving the legislative process intact is foolhardy at this juncture. Given all of the moving parts, it seems unlikely that any tax legislation would be finalized until late 2017, and probably even more likely in 2018.
William C. Hussey, II is a partner at White and Williams, LLP where he is the Chair of the Tax and Estates Practice.