The tax reform plan released Wednesday by Republican leaders and the Trump administration is more focused on corporate taxes than individual taxes, experts say — and while it may not be the beginning of the end of tax reform, it might be the end of the beginning, as Congress now faces the difficult task of turning it into actual legislation.
The Unified Tax Reform Framework is a significant step toward tax reform, according to Dustin Stamper, director in Grant Thornton’s Washington National Tax Office. “It’s missing some details, but these are deliberate to give tax writers some breathing room to adjust to hit revenue and distribution goals,” he said.
The provisions in the framework for individual taxpayers held some surprises for him (see Republicans release tax plan framework). “The biggest surprise to me was just how far the Republicans appear to have retreated over individual tax cuts,” Stamper added. “Not that long ago they were pushing hard for sweeping tax cuts for individuals in which individual and corporate rates would be reduced in lock step. What we have now is a top rate of 35 percent, but with the possibility of a fourth rate that would be close to what we have now, even in conjunction with the loss of itemized deductions. It appears they’re afraid of getting beat up over the perception that they’re providing tax cuts for the wealthy.”
The business tax reforms could come with a few gotchas.
“One of the dangers is that almost half of all business income runs through pass-throughs,” said Stamper. “They’re also providing reduced rates for pass-throughs, but they haven’t offered any details on how that would apply. One of the threats to pass-throughs would be if they imposed an arbitrary solution, like considering 70 percent of revenue as compensation regardless of the situation. Since pass-throughs would have to give up all the same incentives that corporations do, they’re entitled to a rate cut as well.”
Congressional tax legislation writers will need to be careful in how they draft the bill.
“There are established principles to distinguish compensation from business income,” said Stamper. “They don’t want to be so afraid of getting demagogued on that issue that they hurt pass-thoughs that have legitimate business income that is entitled to the lower rate.”
Howard Wagner, managing director at Crowe Horwath LLP, is concerned about the limitations on interest expenses. “A lot of businesses have a significant amount of interest expense on their books and losing this interest expense deduction will be a stealth tax increase,” he said. “That’s the big thing that’s out there for domestic businesses, as I see it. The question is how much will it be limited and how much of your interest expense are you going to lose?”
Accountants will want to keep an eye on the tax rates for pass-through businesses like partnerships.
“It’s a little bit more detail around what they’ve been talking about for the past six months,” said Wagner. “One of the big topics for discussion was what pass-through entities will pay, and they settled on 25 percent for that as their starting point. The thing that’s not clear is if all pass-through entities will get that, or just certain pass-through entities. For example, Treasury Secretary [Steven] Mnuchin made some comments that professional services businesses that weren’t manufacturers, and he singled out accounting firms, might not get the lower rate. So if I were an accountant, an attorney, a physician, an engineer, a consultant, I would be paying attention to who is going to be able to get that rate. Professional service businesses should pay close attention based on Mnuchin’s comments a few weeks ago.”
Others see few surprises in the bill. “It doesn’t look a lot different from what we’ve been hearing,” said Todd Simmens, former staff member of Congress’s Joint Committee on Taxation and a partner at BDO USA. “It includes the concept of reducing the rate brackets to three, but it leaves open the possibility of a fourth rate, which could be close to what we have now. This may be a vehicle to get support from some Democrats because some members of Congress feel that reducing rates across the board is too much of a cut. By leaving open the possibility of a fourth rate, they may get support from some on-the-fence members.”
The alternative minimum tax and the state and local tax deduction could prove to be sticking points.
“AMT repeal would be an expensive cut, but they’re proposing the elimination of deductions like the deduction for state and local tax,” Simmens added. “That might raise some eyebrows, but it is a factor in the AMT so a lot of taxpayers subject to the AMT may not get the benefit of the deduction anyway.”
“On the corporate side, the 20 percent rate is in line with what we’ve been hearing,” he said. “The two big changes in the framework are a move to a territorial system, and the elimination of the estate tax.”
Bill Smith, managing director of CBIZ MHM’s National Tax Office, sees little that is new in the framework and he pointed to some resemblances to an earlier House Republican tax reform blueprint.
“My reaction is there’s not much that’s new,” said Smith. “The limitation on full expensing to five years is new. Obviously the business rates switched, but going to the 20 percent corporate rate was in the blueprint. The pass-through rate of 25 percent was in the blueprint. The limitation on interest rate expense has been around. The repeal of AMT and the estate tax, the elimination of itemized deductions, except for charitable and mortgage interest. It’s all the same things we’ve heard all along. They’re just very minor tweaks to everything that we’ve heard.”
“A lot of people are going to be happy that the alternative minimum tax on both businesses and individuals is proposed to go away,” said Wagner.
The provisions of the framework on repatriating foreign profits back to the U.S. may not have their intended effect on multinational corporations, he noted. “They’re not going to have a choice,” said Wagner. “Businesses are going to pay U.S. tax on the deferred foreign profits with or without repatriation. Whether they bring it back or not is another story.”
The bill will need to move forward as part of the reconciliation process, Simmens noted. “If it were a stand-alone bill, it could get filibustered,” he said. “But as part of the reconciliation process, even though they only need 51 votes, there’s a 10-year window after which it reverts back.”
Congress will be kept busy hashing out the details of the tax overhaul.
“There’s a great deal of work to be done in the next several months,” observed Tom Reynolds, former senior member of the Ways and Means Committee, and current senior policy advisor at Holland & Knight. ”The next order of business is a budget resolution for the reconciliation process. Members of the Freedom Caucus, a strong conservative element in the Republican Party, wanted to see more details. The question is if there are enough details in this framework for them to support a reconciliation resolution, which includes a budget resolution.”
The congressional leaders and Trump administration officials who drafted the framework behind closed doors were collectively known as the Big Six, but now a wider group of players will have a hand in honing the actual legislation.
“So far we’ve seen tax reform in a test tube — the lab of the Big Six,” said Reynolds. “Now we’ll see the reactions of people on K Street, in Congress, and around the country.”
“There will be a lot of push and pull,” Reynolds added. “The big question is how the tax writers will pay for it, and how much will be permanent versus how much will be in the 10-year window of reconciliation.”
Smith pointed to how Trump has moved steadily to embracing the tax rates proposed by House Speaker Paul Ryan, R-Wis., and his fellow House Republicans in their tax blueprint.
“It was just another attempt to sell the plan they’ve been very close on, and Trump has generally pivoted towards the House blueprint as he’s made changes,” said Smith. “He started out with individual rates of 12, 25, and 33 [percent], and then he went to 10, 25 and 35 and now he’s gone back to 12, 25, 35. To me those aren’t huge changes in anything, so I’m left with the thought that not very much has changed.”
Trump may have trouble picking up support from lawmakers in states with state income taxes, Smith suggested, and they aren’t only Blue States. “He says he has the support of leadership in the House and Senate, but they still have all of the hurdles we were thinking they would have as it gets written up, and getting the votes,” said Smith. “And one of the big ones, which isn’t news, is the loss of the state and local tax deduction. I think not only in California, New York and New Jersey, but it’s going to have a very big impact on a lot of people in this country who don’t consider themselves to be extremely wealthy. They still rely on the state and local income tax deduction.”
“The reality of the state and local tax deduction is the benefit primarily goes to the middle class and the upper middle class,” said Wagner. “The lower-income taxpayers have the standard deduction. Higher-income taxpayers in high-tax states are typically in the alternative minimum tax and don’t benefit from the state tax deduction. The burden of losing the deduction falls on middle-class and upper middle-class taxpayers.”
Smith pointed out that the budget resolution making its way through Congress could allow for up to $1.5 trillion in tax cuts over 10 years. “Are they going to have to propose a classic Bush tax cut concept where all the savings disappear after 10 years, and then we’re right back into re-upping tax cuts every year under special provisions,” said Smith. “Not only that, but that’s a $1.5 trillion tax cut, and Republicans have projected a cost of between $3 trillion and $7 trillion over a decade, so they’re going to have stumbling blocks on the deficit and neutrality and how to pay for it. I just don’t think we’re close to tax reform, in my opinion. Could it happen? Absolutely, but I think we’ve just seen the broad strokes and the devil is in the details.”
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