A Breakdown of the Proposed Framework on Tax Reform
Tax reform has been in the works behind the scenes for months (and some parts of it for years), but it has now been released to the public and nearly every business and individual taxpayer will be impacted. However, the framework released by Congress was short on details.
This may be the first time in a generation (since 1986) that we will have comprehensive tax changes taking place, yet there are still many uncertainties with tax reform this year, including the specific details of the proposed changes; the effective dates of any changes; the prospects on whether tax reform will be enacted at all, etc.
Highlights of the Proposed Changes
The framework offers the following main themes that will encompass tax reform this year:
- Tax relief for middle-class families
- The simplicity of “postcard” tax filing for the vast majority of Americans
- Tax relief for businesses, especially small businesses
- Ending incentives to ship jobs, capital, and tax revenue overseas
- Broadening the tax base and providing greater fairness for all Americans by closing special interest tax breaks and loophole.
The Administration leaves it to the congressional tax-writing committees to draft the actual tax legislation that adheres to the above themes, but also spells out the details of these changes:
Some of the individual tax changes included in the framework are as follows:
- Tax Brackets. The individual tax rates will be condensed from the current seven brackets down to three at 12%, 25%, and 35%.
- Standard Deduction. This deduction will be doubled to $24,000 for married filers and $12,000 for single filers.
- Child Tax Credit and Dependency Exemption. The proposal indicates it will provide tax relief to families by repealing the personal exemption for dependents, but significantly increasing the Child Tax Credit (and the income levels where this credit is phased-out).
- Marriage Tax Penalty. This “penalty” that is part of the current tax code is proposed to be eliminated under tax reform.
- Alternative Minimum Tax (AMT). AMT has snared numerous unsuspecting taxpayers in recent years, including many middle income taxpayers, but it is targeted to be repealed by tax reform.
- Itemized Deductions. The framework calls on the elimination of the deduction for taxes (state income taxes, property taxes, and sales taxes), but retains the deduction of mortgage interest and charitable contributions. Again, the doubling of the standard deduction in many cases may be worth more than a taxpayer’s total itemized deductions (especially after removing any taxes).
- Estate Tax and GST Tax. The proposal calls on the repeal of the estate tax (referred to as the “death tax” in the framework) and the generation-skipping tax (GST). No mention, however, is made of the current gift tax, and thus this presumably will still apply.
Some of the proposed tax changes for businesses included in the framework are as follows:
- Corporate Tax Rate. The framework calls on a reduction in the corporate tax rate to 20% which is less than the average of the industrialized world (of 22.5%), but higher than the 15% the Administration had hoped for. Further, the proposal plans to eliminate the corporate AMT.
- Small Businesses and Pass-Throughs. The framework limits the maximum tax rate to 25% that is applied to the “business income” of small and family owned businesses conducted as sole proprietorships, partnerships (LLCs), and S Corporations. The framework contemplates that provisions will be added to prevent the re-characterization of other personal income into this lower-taxed business income category.
- Expensing of CapEx. The framework allows businesses to immediately expense for tax purposes “the cost of new investments in depreciable assets other than structures made after September 27, 2017, for at least five years.” This is the only item in which the framework offers a specific date. Thus, apparently any qualifying capital expenditures made after September 27, 2017 will be allowed to take the full expensing provision, even if the legislation is not enacted until, say late in 2017.
- Deduction for Interest Expense. The deduction for net interest expense incurred by C Corporations will be partially limited, and similar treatment will also apply for interest paid by non-corporate taxpayers. Again, details of these limitations will be worked out.
- DPAD (Section 199 Deduction). The 9% DPAD deduction for domestic production activities will be eliminated under tax reform. The lower tax rates indicated above should help offset the repeal of this deduction.
- Tax Credits. The framework proposes to retain business tax credits for research and development (R&D) and low-income housing, however, other credit may be scrapped.
Some of the proposed tax changes to international businesses included in the framework are as follows:
- Territorial Tax System. The framework indicates that as part of tax reform, the existing foreign tax regime will be replaced with a 100% exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake).
- Transition Period. Further, to transition to this new territorial system, the framework treats foreign earnings that have accumulated overseas under the old system as repatriated. Thus, these earnings will be subject to tax in the US. The framework further provides that accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents. Also, payment of the tax liability on these repatriated amounts will be spread out over several years. The details of these provisions will be ironed out by the tax writing committees.
Prospects for Passage
The main question besides the specifics of the above tax changes is whether tax reform will be enacted at all this year. The fact that congressional efforts failed at repealing and replacing the Affordable Care Act (ACA) this year should not necessarily mean that tax reform will fail as well.
There are different issues involved in each piece of legislation, and the politics of each also differs. It will still, however, be a major political drama in Washington this fall, and it is a toss-up whether it will pass. This tax reform train will have many ups, downs, twists, and turns as it navigates its way through Congress.
Timeline: What Happens Next?
The tax reform process has now begun. Even though it seems that not much has happened over the past several months, much will begin to happen very quickly. The pace of activity on tax reform will greatly accelerate.
The projected timetable is to have the House Ways & Means Committee and then the full House work on the bill in October, and then on to the Senate in November. A conference committee may likely then be needed to reconcile differences between a House version of tax reform and the Senate’s version. The leaders hope to have a final tax reform plan enacted this year, and at this point, it seems like it will be late November, or December.
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Jim Brandenburg is a tax partner with Sikich LLP, a Top 100 CPA firm. Jim has extensive experience and knowledge in corporate and partnership tax law, mergers and acquisitions, and tax legislation. His expertise includes working with owners of closely held businesses to identify tax planning opportunities and assist them in implementing these...