Over the few months, I've covered tax legislation updates thoroughly - so thoroughly that you may be thinking "Oh no, here we go again." It's understandable to feel disappointment with the way tax reform has been handled. After all, Donald Trump promised a laundry list of tax reforms on the campaign trail, House Republicans have introduced a list of proposed changes, and House Democrats have created an "action plan" detailing their idea of a fair tax system. But as of late, nothing has happened in the way of meaningful steps toward introducing, and much less voting on, a tax reform bill.
Fortunately, that may change quickly in the coming month or two.
On the 27th of September, the White House, House Republicans, and Senate Republicans released the "Unified Framework on Tax Reform", wherein they laid out their plans and talking points for the upcoming tax reform debate. Though the House of Representatives is out of session until October 23rd, the Senate is working toward finalizing their 2018 budget resolution. Once this budget resolution is released, they say, far more details will be released regarding tax reform.
The Unified Framework on Tax Reform is important because it shows that the Republicans are now working together toward putting their ideas on the floor for a vote. They plan to use budget reconciliation to pass the bill, a process whereby certain bills are fast-tracked and require a simple majority to become law. This means we'll likely know by the end of the year whether tax reform has worked. Unfortunately if a bill is passed by the end of the year, it appears as though it would be impossible to implement the changes retroactively to tax year 2017. Fortunately, this would allow us to plan ahead by accelerating deductions at higher rates for businesses and pre-paying to take advantage of itemized deductions like real estate taxes, state and local taxes, and investment interest before they're eliminated.
The Republicans have their work cut out for them. Already, the plan has been slammed as "the Trump tax scam," a "political time bomb," and perhaps my favorite, a plan that would "create a nation of cheaters." Whew. That's a lot of conjecture for a plan that's not yet fully formed.
The truth is, we don't know what is in store for tax reform. The Republicans are coming off of a hard double loss on healthcare that they're certainly not excited to repeat. This tax reform framework is heavy on big ideas and light on specifics, which has been the Republicans' modus operandi for tax reform since it first came to the forefront in the most recent election. Without rate and income brackets, tax credit and tax credit limitation amounts, and a specific list of proposed changes, it's probably best to take these opinion pieces with a dump truck load's worth of grains of salt. Remember, these pieces are often self serving.
What we do know is that the tax reforms proposed in the unified framework would be largely beneficial to small business owners. A 25% maximum federal tax rate on owners of passthrough businesses including partnerships, S-Corporations, and sole proprietorships would go a long way toward reducing our clients' tax liabilities. Immediate expensing of capital improvements would encourage continued business expansion. Retaining the research and development credit would encourage businesses to continue their efforts toward creating new, groundbreaking products. But we have discussed the potential for abuses, which could force these reforms to be repealed quickly. After all, it would be appealing for high income executives to become "subcontractors" taxed as a sole proprietorship to reduce their marginal tax rate from a proposed 35% to a proposed 25%.
Whether the tax reforms proposed in the unified framework will be beneficial for high net worth investors deriving the majority of their income from interest, dividends, and capital gains is up for debate. The unified framework repeats earlier calls for the repeal of the Alternative Minimum Tax (AMT), which disallows deductions for personal exemptions, real estate taxes, state and local taxes, and miscellaneous itemized deductions, among others. It also calls for the elimination of most itemized deductions, except for mortgage interest and charitable contributions. This could be seen as a wash for clients currently subject to AMT, because those deductions that would be eliminated with the proposed changes are already disallowed. But clients subject to AMT pay a maximum marginal tax rate of 28% on ordinary income, and if the proposed changes include narrower tax brackets, those clients could find themselves paying 35% under the new system. As I've discussed in the past, they could lose their carryover credit for prior year AMT, too. That could be a bitter pill to swallow.
The unified framework also calls for repealing the estate and generation skipping transfer tax. As I've discussed at length in prior blog posts, this would be a good reform because it creates a tremendous amount of complexity for high net worth individuals and accounts for significantly less than 1% of the government's revenues each year. But these two taxes are a political hot potato; i.e. it will likely be reinstated at some point, so we'd generally recommend continuing your estate planning endeavors regardless as long as you minimize the amount of gift tax you pay.
What the unified framework fails to mention is perhaps the most important aspect. Capital gains and dividends tax rates. In July, I said the following when analyzing the House Republican tax plan:
"it proposes taxing interest, dividends, and capital gains at new ordinary tax rates, but only after allowing a deduction for 50% of the net interest, dividends, and capital gains. If you have significant intangible income or are considering selling a business, this proposal should make your ears perk up. Rather than being taxed at 23.8% or 43.4%, all of your intangible income will be taxed at a maximum rate of 16.5%. That's a big deal."
The elimination of this key point in the unified framework, and the inclusion of the following sentence, "An additional top [tax] rate may apply to the highest-income taxpayers to ensure that the reformed tax code is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers," should tell us something - the Republicans are amenable to compromise. Let's hope the politicians from both side
s can come together and pass something great. It's time.
If you found this post helpful, pass it along! If you have questions regarding tax legislation and how best to structure your affairs, or if you're feeling underserved by your current tax advisor, drop me a line at firstname.lastname@example.org.