26 Sep 2017 The “Big Six” Washington Lawmakers Release Their Unified Tax Plan
On the campaign trail and throughout 2017, lawmakers in Washington D.C. have promised to pass a bill to reform the U.S. tax code this year. Much of the anticipation has been based on a blend of President Donald Trump’s tax plan outline which was released in April 2017 and the House Republicans’ blueprint which was released in June 2016.
The Big Six
The Big Six released a framework for tax reform on September 27, 2017 that is intended to act as a unified tax plan for hashing out the details of actual tax reform legislation. The plan’s principles for tax reform include fairness, simplicity, lowering tax rates to increase Americans’ take-home pay, making the U.S. tax system internationally competitive, and incentivizing corporations to return their profits to the U.S. from overseas.
The “Big Six” is shorthand for the big six tax-writers in D.C., namely Paul Ryan (Speaker of the House), Kevin Brady (House Ways and Means Committee Chairman), Mitch McConnell (Senate Majority Leader), Orrin Hatch (Senate Finance Committee Chairman), Steven Mnuchin (Treasury Secretary), and Gary Cohn (National Economic Council Director). Their unified tax plan represents an agreement between the House, the Senate, and the White House.
The plan articulates a proposal that includes tax cuts for businesses and individuals, which House Republicans view as a stimulus to the economy. While President Trump proposed to lower the top tax rate for all businesses to 15% throughout his campaign, including the top tax rate for pass-through entities, budgetary constraints have made this promise a difficult one to come to fruition.
Lower Corporate Tax Rate
Under the plan, the top corporate tax rate would be 20%. This is a significant drop from the top rate in 2016 which was 35%. In addition, the plan proposes to eliminate the corporate alternative minimum tax (AMT).
Lower Pass-through Rates
The top pass-through rate would be 25%. This is a significant drop from the top rate in 2016 which was 39.6%. The plan proposes, however, to prevent abuse of the preferential rate. For example, while small business profits would receive the 25% preferential rate, any taxable compensation to partners in a business may be taxed at their individual tax rates.
A lower tax rate for pass-through entities, such as partnerships, limited liability companies (LLCs), and S corporations, means a lower tax rate for the owners, who are currently taxed at their individual tax rates. Thus, a lower tax rate for pass-throughs can fundamentally change how you should structure your businesses and investments to obtain preferential tax treatment.
Lower Individual Rates
The unified tax plan provides three brackets, with tax rates of 12%, 25%, and 35%, but there is no indication yet as to what income thresholds may separate these three brackets. This is a reduction from the seven brackets in 2016, which consisted of the following tax rates: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The plan also proposes to repeal the individual AMT. Notably, however, the plan leaves the door open for an additional top individual tax rate to be determined at a later date.
Larger Standard Deduction
The plan would also roughly double the standard deduction, which was $6,300 for individuals in 2016, or $12,600 for married couples filing jointly. This means that itemizers may soon be in the minority. The Tax Policy Center estimates that people who itemize their deductions may fall as low as 5% due to the doubling of their standard deductions.
Individual Tax Incentives
The plan specifies that tax reform shall retain benefits for individuals that work, pursue higher education, and save for retirement. It intends, however, to modify these benefits to improve their efficiency and effectiveness. The plan does not go into further detail regarding such modifications.
In particular, the plan does not discuss “Rothification,” a topic that is likely to come up again to achieve revenue neutrality. The Rothification of retirement savings would tax retirement savings upfront instead of when they are withdrawn. Some Republican lawmakers have been discussing the idea as a revenue raiser, while others believe this would actually reduce your incentive to save for retirement.
Child Tax Credits
While the plan would repeal the personal exemptions for dependents, it would significantly increase the Child Tax Credit. The first $1,000 of the credit would be refundable, which is the same as before, but the plan would increase the income levels at which the Child Tax Credit begins to phase out. This change would help middle-income taxpayers take advantage of the credit.
The plan also provides a non-refundable credit of $500 for non-child dependents to help defray the cost of caring for other dependents.
Elimination of the Personal Exemption
The additional standard deduction and personal exemptions for married couples would be consolidated into the larger standard deduction, discussed above. The plan states that this would effectively create a larger “zero tax bracket” by eliminating taxes on the first $12,000 of income earned by a individuals, or the first $24,000 for married couples filing jointly.
State and Local Tax Deductions
The plan does not expressly eliminate nor keep the state and local tax (SALT) deduction. In order to simplify the tax code, however, the plan proposes to eliminate “most” itemized deductions, while expressly retaining the tax incentives for home mortgage interest and charitable contributions. Accordingly, the SALT deduction is firmly situated on the chopping block.
While the SALT deduction for state income taxes generally favors those with annual incomes of more than $200,000, which disproportionately affects high-income taxpayers, the SALT deduction for real property taxes is a popular tax benefit for middle-income taxpayers. As a result, a full repeal of this deduction would raise over $1 trillion over the next decade, but would also result in higher taxes for many middle-income taxpayers. Thus, its possible repeal is a sensitive subject and will be subject to ongoing scrutiny.
Mortgage Interest Deduction
The plan expressly keeps the mortgage interest deduction. The mortgage interest deduction’s purpose is to incentivize and increase homeownership. This tax preference, however, will only benefit those taxpayers who continue to itemize their deductions.
Charitable Contribution Deduction
The plan also expressly keeps the charitable contribution deduction. It emphasizes that this tax benefit strengthens civil society and reduces dependence on government by incentivizing charitable giving.
Estate Tax Repeal
The plan includes a repeal of the estate tax and the generation-skipping transfer (GST) tax but does not discuss the step-up in basis provided at death, nor propose that a capital gains tax should apply at death in lieu of the estate tax. During his election campaign, President Trump stated he would treat death as a recognition event and tax capital gains on death in the absence of an estate tax.
Democrats have criticized the possible repeal of the estate tax as giving a favorable tax break to only the wealthiest Americans. For example, in 2016 the estate tax only applied to an individual’s estate that was worth more than $5.45 million, or $10.9 million for a married couple’s estate. In fact, the previous administration supported proposals to increase the rate and applicability of estate tax.
It is unknown whether the gift tax would be repealed along with the estate and GST taxes. Under prior bills that have been introduced to eliminate the estate tax, however, such proposals have generally retained the gift tax.
Certain members of the House have proposed making this year’s tax reform retroactive to January 1, 2017. Unfortunately, retroactive changes are going to be difficult to pass this year because lawmakers are loathe to make the revenue raisers similarly retroactive. While President George W. Bush’s tax cuts in 2001 provided retroactive tax rate relief, they were not a part of revenue-neutral tax reform.
Research and Development (R&D) Credits
The plan expressly keeps the R&D credit. Other business tax credits are on the chopping block.
The plan expressly states that committees may consider methods to reduce the double taxation of corporate earnings. Chairman Hatch, in particular, has expressed a preference towards a dividends-paid corporate integration plan that would reduce the effective corporate tax rate.
The unified tax plan declares that the deduction for net interest expense incurred by C corporations will be partially limited. This limitation is important to achieve revenue neutrality. Businesses have urged that their existing debts and arrangements, however, would need to be grandfathered under such a proposal. Thus, policymakers are likely to consider exemptions for small businesses and agriculture.
The plan remains silent on the treatment of interest paid by non-corporate taxpayers, but says committees may consider such treatment in the near future. Policymakers may consider eliminating or partially limiting interest deductibility for non-corporate taxpayers as well in order to create additional revenue for the proposed rate reductions.
Full Expensing of Capital Investments
The plan would allow businesses to expense (i.e., deduct immediately) the cost of new investments that are made after September 27, 2017. All depreciable assets, other than structures, would be eligible for full expensing under this proposal for a period of five years.
House Republicans believe that the full expensing under this plan would lead to the greatest amount of economic growth, while a large number of companies believe this tax break should instead be used to lower the corporate tax rate even further.
Repatriation Tax Holiday
The plan proposes a one-time repatriation tax rate reduction on profits being held overseas. Under the plan, accumulated foreign earnings held in illiquid assets would be subject to a lower tax rate than foreign earnings held in cash or cash equivalents and payment of the tax liability will be spread out over several years. While the plan fails to provide exact details, we know that the House blueprint would set the repatriation tax at 8.75% for cash and 3.5% on other property, payable over 8 years.
Economists believe corporations may be deferring tax liability on nearly $2.5 trillion by holding corporate profits overseas. The idea behind a repatriation tax holiday is that by taxing those profits at a lower tax rate, we are incentivizing corporations to bring their earnings back into the United States which can increase wages, employment, and economic growth. When then-President George W. Bush tried this idea in 2004, however, most of the money was given directly to the owners of the corporations instead of boosting the economy.
Territorial Tax System
After repatriating corporate profits, the plan proposes a shift to a territorial tax system. Such a system would provide a 100% exemption for dividends from foreign subsidiaries in which the U.S. parent owns at least a 10% stake. The plan leaves the door open for anti-abuse rules to be incorporated by the committees.
Border Adjustment Tax (BAT)
Earlier this year, Chairman Brady backed off a border-adjustment proposal amid pressure from retailers and senators. The proposal would have taxed imports and exempted exports as a core piece of the House blueprint on tax reform.
Affordable Care Act (ACA) Tax Repeal Unlikely
Republicans face the September 30, 2017 deadline to vote on a new healthcare bill through budget reconciliation, a procedural maneuver that allows the Senate to avoid a filibuster by Democrats and advance a bill with only a simple majority. Notably, Senator John McCain announced this month that he will not be supporting the Graham-Cassidy bill. This healthcare bill would scrap the Obamacare taxes, credits, Medicaid expansion, and cost-sharing reductions. Instead, Senator McCain issued a statement that supports a bipartisan effort to pass healthcare reform at a later date.
Prospects for Bipartisanship
The Chairmen of the House Ways and Means and Senate Finance committees have also stated that they welcome and encourage bipartisan support and participation in the tax reform process.
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