Chances of tax reform: Better than even
Despite the seeming waning talk about tax reform, it is still a strong possibility, according to some experts.
Rick Lazio, former Congressman and U.S. Senate candidate, currently senior vice president of alliantgroup, and Dustin Stamper, director in Grant Thornton LLP’s Washington National Tax Office, agree that there’s a better than even chance that tax reform is in the near future.
“In my conversations with key people, 75 percent of them say that a bill will be signed by the end of the first quarter in 2018,” said Lazio. “The timetable has been set back. It’s [Sen. Majority Leader Mitch] McConnell’s view that they will try to find agreement on ‘Repeal and Replace’ by the August break, and focus on tax reform in the fall.”
“Tax reform has run into some headwinds,” agreed Stamper, “but it’s still a historic opportunity. The early timelines were overly optimistic. We always thought that it would take most of this year and into next year, and I still think that we’re on track for that. There’s no guarantee of success, but there is a better chance than there has been for decades.”
It’s helpful to remember how many times the 1986 reform was declared dead and had to be resurrected, according to Stamper. “There’s a good chance of this happening in the next year and a half,” he said. “There’s still some uncertainty, which can make it easy to sit back and wait and see, but there are some things that need decisions before the effective date of tax reform. It needs to be studied now so that decisions can be made quickly.”
Lazio believes the proposed bill can be conferenced and on President Trump’s desk by the end of the year. “If not, by the end of the first quarter in 2018,” he predicted.
“McConnell had said this bill will be revenue-neutral. That’s very constraining, given that there’s probably a 90 percent chance that border adjustment is out,” Lazio said. “That’s $1.2 trillion in additional revenue that will no longer be available.”
An additional constraint to the breadth of the bill is the inability to get repeal of the Affordable Care Act, he suggested. “It would have given more room to make adjustments on the tax side. The ACA repeal would have a material impact on how bold they can go on taxes.”
“Because of these constraints, the bill will be much more of a traditional tax bill, rather than a $4 or $5 trillion tax bill,” said Lazio. “There will be a reduction of rates to 22-25 percent, with a reduction of brackets from seven to three, for individuals.” The corporate rate will come down somewhat to between 22-25 percent also. It’s going to be politically challenging if the corporate rate ends up any higher than 25 percent because the largest corporations pay an effective rate of less that. If they lose some of their tax preferences and deductions, it will be hard to generate enthusiasm on the part of corporations.”
There are some issues regarding rates on pass-throughs, Lazio noted. “There is the opportunity to get significantly lower rates, but there will be complications in terms of compliance. They have to ensure that taxpayers do not improperly shift from the personal side to the business side for the lower rate that they would be paying for individuals. That’s something for pass-through entities to watch to see how complicated this will be in terms of building safeguards against income shifting.”
Both the House plan and the Trump administration’s plan assume that the R&D credit will stay, he said. “There’s no risk to the R&D credit – actually there is the opportunity to potentially enhance it in a limited way. Offshore income is another area that will be in the final draft. It will be going to a territorial system with a one-time relief to repatriate money parked overseas. Those are areas where businesses ought to be keenly focused.”
One way of softening the constraints of revenue neutrality will be to have the effective date kick in a bit later, and make the bill less than permanent. “I think it will be a 10-year bill,” Lazio said. They won’t be able to pull it off without it.”
It is important that businesses realize that they don’t have time to wait and see, according to Stamper. “Many planning opportunities will only be relevant if they are implemented before tax reform is effective,” he said.
The potential for lower rates in the future increases the value of deductions now, when rates are higher, “Deferring income related to advance payments, and accelerating deductions for things like prepaid expenses, are just a few examples of some of the opportunities that are available. And many building assets can be broken out and reclassified to depreciate them using shorter lives.”
While the one-time lower tax rate on repatriated earnings parked overseas is attractive, businesses should assess whether it is more favorable to repatriate before tax reform becomes effective to take advantage of any foreign tax credits.
Although border adjustment may not make it into the final bill, the possibility of it accentuates the need to consider its ramifications before entering into any long-term agreements with foreign suppliers, Stamper noted.
“Your business should carefully consider its entire tax and financial situation before making major decisions,” he said. “It’s possible that rate cuts are made effective early, or don’t happen at all. The good news is that deferring tax is typically a good move, if only for the cash flow benefits and the time value of money “
The value of other planning strategies, such as repatriating earnings early, will be heavily dependent on the outcome of tax reform, Stamper indicated: “Either way, your business may need to take action before the effective date of tax reform.”