With the election of Donald Trump as the nation’s 45th president, major tax reform suddenly becomes a very real possibility. Republicans have kept their majority in both the House and the Senate which will make the legislative process much easier for Trump’s tax proposals, though not without some resistance expected from Democrats on Capitol Hill. This election does create an opportunity for the biggest tax law changes since 1986.
Here we take a look at some of the Trump tax law changes proposed during his campaign, consider the impact of those changes and the likelihood of these proposals actually becoming law in 2017.
Individual Tax Law Changes
Trump proposed changing the individual tax rate structure to one of just three brackets on ordinary income of 12%, 25% and 33%. The reduced rates on capital gains of 15% and 20% would be retained, and it appears those lower rates would also apply to qualified dividends. The alternative minimum tax (AMT) would be repealed completely. The standard deduction would be raised to $30,000 for a joint return and $15,000 for single filers and there would be an overall cap on itemized deductions of $200,000 for joint returns and $100,000 for single filers. Personal exemptions would go away and head-of-household status would be eliminated. The proposed rates for the Trump plan closely follow the rates proposed in the GOP Tax Reform Blueprint released earlier this year.
Observation: Although the standard deduction increases for all taxpayers, because of the increase in the bottom tax rate from 10% to 12% and the elimination of personal exemptions, some lower income taxpayers could see a small increase in their tax bills under the Trump tax plan.
Income from carried interests would now be taxed as ordinary income instead of being taxed at the 20% capital gains rate that has typically applied. In conjunction with the planned repeal of the Affordable Care Act, the 3.8% income tax on net investment income (NII) would also be repealed.
The Trump plan would provide a new above-the-line deduction for childcare expenses of children under age 13 capped at the state specific average cost for children of that age, as well as for eldercare expenses for a parent (subject to a phase out for higher income taxpayers). The earned income tax credit would be expanded to include more working parents who would not otherwise qualify.
Business Tax Law Changes
The Trump plan would reduce the corporate tax rate from a maximum rate of 35% to a rate of 15% (the GOP Blueprint calls for a US corporate rate of 20%). US manufacturers would be able to fully expense new plant and equipment investments, though by doing so would forego any deduction for net interest expense. Most tax credits, other than the research credit would be eliminated. For US taxpayers with foreign subsidiaries, there would be a one-time deemed repatriation tax of 10% on foreign earnings of those subsidiaries.
There has been some lack of clarity about the applicability of the 15% tax rate on income from pass-through forms of businesses (such as partnerships, S corporations, LLCs taxed as partnerships and sole proprietorships). The Trump campaign had proposed a type of unified business rate whereby the owners of pass-through entities could elect to be taxed at the flat corporate rate of 15% instead of the individual rate that would otherwise apply if the income is retained in the business. From language used in the Trump campaign materials, it would appear that this income would later be taxed as a dividend similar to those from a regular (“C”) corporation when distributed out to the shareholders. The Trump plan mentions consideration of rules to prevent pass-through owners from converting what would otherwise be higher taxed compensation income to lower-taxed small business income.
Observation: The resolution of how to deal with pass-through entities will have potentially major tax consequences to many small business owners. The difference between a 33% rate (which would remain the top rate for employees) and the 15% rate for businesses is significant.
Estate & Gift Tax Changes
The Trump plan calls for a repeal of the federal estate tax. The plan makes no mention of the gift tax. However, there is a provision to impose income tax on the capital gains on assets held at death to the extent those gains are greater than $10 million; (it is unclear if the $10 million would apply individually or for a couple. It appears that such gains would not be taxed until the assets are sold later by the heirs. Essentially, this results in a partial disallowance of the step-up in basis that normally results from the creation of an estate. In addition, the ability to contribute appreciated assets to a charity established by either the decedent or the decedent’s family would be eliminated.
So What Will Happen in 2017?
Prospects for enactment of tax reform will be in some doubt due to significant differences between the plans of Republicans and Democrats, especially on the taxes paid by upper income individuals. Democrats will still have some ability to block bills because the Republicans will not have the 60 votes required for a super-majority. Republicans have suggested using the budget reconciliation process to push legislation through Congress, and one of the requirements of budget reconciliation is that a super-majority is required to approve provisions that lose revenue for the government beyond the budget window, which is normally 10 years. Another consideration (not directly tax related) is that budget reconciliation can be used only to pass provisions that have a fiscal effect on the Federal budget – in other words, impact revenues or spending. Because some sections of the Affordable Care Act do not have such a fiscal effect, it may be difficult to use budget reconciliation as a tool for repeal of those sections.
There will certainly be much debate and discussion on tax reform over the next year. If you have questions on how this could impact your tax picture, please contact your Elliott Davis Decosimo tax advisor for assistance. For more information and detail on the potential tax law changes under President Trump, please follow this link to a special report [Post-election proposed tax policy changes]