Overall Observations

With every change, there are winners and losers. People who are either helped by the change or people who are hurt by the change. I will point those out throughout the commentary below.

  • This “Framework” is put forth by the so-called “Big Six” of Administration and Republican legislative leaders.
  • House Ways and Means Committee Chair Brady recently stated that further details will be released after Congress adopts a final budget for 2018, hopefully by mid-October.  As the budget is currently stalled while seeking additional rank-and-file Republican support, it is believed that this is to encourage completion of the budget work. The House Freedom Caucus, for example, has been unwilling to support the budget until the tax reform details were released.
  • It is believed that Senate leadership will introduce the tax plan as a reconciliation measure, meaning that only 51 votes are needed for passage, but it must be either revenue-neutral or sunset within ten years.
  • Most of these provisions were mentioned by then-candidate Trump during the 2016 campaign. So few of these concepts are new, but some new details have emerged.
  • No effective dates are given other than the asset expensing provision for businesses, but a 2017 effective date seems unlikely.
  • Commentators give a preliminary net tax cost to the Treasury of $3 to $7 trillion. The Committee for Responsible Federal Budget tags it at $5.8 trillion. Note that Senate leaders recently agreed on a path forward that would cost up to $1.5 trillion over ten years, so this plan might lose the support of some deficit hawks like Bob Corker (R-TN) who could say that this is just too expensive. And as is the case with ACA repeal, when you formulate a plan without involving the Democrats, you have a very slim margin of error on Congressional support. Just a few “no’s” can sink the ship.
  • The fate of the 3.8% tax on net investment income is not mentioned in the proposal.

Individual Tax Changes

  • Personal exemptions are eliminated.
  • Increase the standard deduction to $12,000 for single filers and $24,000 for married filing jointly filers.
    • Commentary: The Administration calls this larger standard deduction the “zero tax bracket”.  There isn’t actually a zero tax bracket in the technical sense in this proposal, so the proponents of this plan us the term to mean that the first $24,000 of income for a married couple filing jointly is not taxed.  It’s just that the mechanism is a standard deduction, not a rate bracket.
    • Commentary:  Put these two changes together, and the winners are those with no or few dependents. Larger families lose.
    • This is roughly a doubling of the standard deduction, before considering the loss of the exemptions.
    • Commentary: Those who itemize will lose, as their exemptions are lost in exchange for a larger standard deduction that they will not use.
  • Itemized deductions
    • Most of these are repealed, but notably leaving the deduction for home mortgage interest and charitable contributions.
      • Commentary: Several press outlets have reported that this language means that the deduction for state and local taxes is repealed. The official material does not explicitly say this, but to mention that the deductions for home mortgage interest and charitable contribution would survive suggests that others are at risk.
      • Commentary: Some national commentators note that the primary beneficiaries of the state and local tax deduction are those from high-tax states like New York, New Jersey, and California – states that typically vote Democratic.
      • Commentary: With a significant expansion of the standard deduction and the loss of many itemized deductions, more and more taxpayers will find themselves with true simplification in being subject to the standard deduction.
  • Tax brackets
    • Current seven brackets (10%, 15%, 25%, 28%, 33%, 35%, 39.6%) are changed to three brackets (12%, 25%, 35%).
      • Commentary: It would seem that the those at the bottom rate would experience a tax increase (from 10% to 12%) but proponents will argue that these taxpayers will benefit from the larger standard deduction and have a net tax reduction.
      • Commentary: The proposal does not tell us at what levels of income these rates would apply.  Critics say that this is intentional to avoid a calculation of the actual cost to the Treasury.  Proponents say that this detail will be worked out through negotiation in the legislative process.
    • The description of this provision says that an additional top rate may apply to ensure that the wealthiest do not benefit disproportionately, but does not propose a rate.
      • Commentary: No discussion is given of the current preferential rates for long-term capital gains and qualifying dividends, which would presumably remain.
  • Dependent tax credit
    • The existing $1,000 per child tax credit is retained.  But the levels of income where this benefit phases out is increased (no amount was given) so that more taxpayers actually benefit from this rule.
    • A $500 non-refundable tax credit for non-child dependents is also offered.
  • Alternative minimum tax (“AMT”) is repealed.
    • Commentary: Note that many taxpayers are subject to the AMT because of the high amount of state and local tax they pay.  Removing that deduction would decrease the number of those subject to the AMT, and thus would reduce the revenue cost to the Treasury of an AMT repeal.
  • Transfer taxes
    • The estate tax is repealed.
      • Commentary: The estate tax is currently projected to affect 0.12% of Americans.
    • The generation-skipping transfer tax is repealed.
    • The gift tax remains.
  •  Other
    • Per the official release – “The framework retains tax benefits that encourage work, higher education, and retirement security.”  No specifics are given.  Perhaps this means that provisions like the Hope Education Tax Credit would remain.

Business Tax Changes

  • Tax rates
    • “C” corporations currently pay a graduated tax rate of 15% to 35%.  This is reduced to 20%.
      • Commentary: Remember that the 2016 House “Blueprint” plan reduced the revenue cost of this change with something called a “border adjustment” tax.  This proposed offset is not included in this final plan, thus the cost is greater than discussed in the past.
    • Flow-through businesses (proprietorships, partnerships, LLCs, LLPs, “S” corporations) are currently taxed at individual rates of up to 39.6%.  This is reduced to 25%.  But compensation income cannot be restructured to benefit from this rate.
  • Deductions
    • Depreciation.  Instead of using depreciation, businesses can immediately expense the cost of new investments in depreciable assets (other than structures).  Effective for investments after 9/27/2017 and for the following five years.
    • Interest.  The deduction for interest expense will be restricted.
    • The domestic production activities deduction (Section 199) is repealed.
    • Other deductions repealed or restricted (no details).
      • Commentary: For businesses that have a significant dependence on debt or the Section 199 deduction, the loss of these provisions could more than offset the benefit of tax rate decreases.
  • Alternative minimum tax is repealed.
  • Credits. The R&D and low-income housing credits are retained, suggesting that others are at risk.

International Tax Changes

  • The current system is largely scrapped.
  • The US would follow the model of most of the world by using a “territorial” income tax system.  In this system, a corporation would pay US tax on earnings in the US.  Contrast this with the current system, where US corporations are generally taxed on worldwide income when it is repatriated to the US, with credits allowed for taxes paid to foreign countries.
  • US corporations would not be taxed on repatriated earnings of foreign subsidiaries.  A transition move would tax the “deemed” repatriation of current offshore earnings.  This tax is paid over several years, and illiquid assets are taxed at a lower rate.
    • Commentary:  No rate(s) on this repatriation tax is given, and no period of payment is given.

This commentary is provided by DMJ’s Milton Howell and published September 28, 2017. Please contact us if you have any questions.

 

R. Milton Howell III, CPA, CSEP
R. Milton Howell III, CPA, CSEP

Milton is a tax partner experienced in taxation issues including, tax research for both open and closed transactions, structuring complex tax transactions, estate and income tax planning, and representing clients before tax authorities. Milton regularly writes and reviews articles in local, regional, and national publications on tax matters and spends significant time monitoring current tax issues and legislation.

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