On April 26, the Trump Administration made its much-anticipated release of several “core principles” of its tax plan. In doing so, the administration affirmed its desire to enact comprehensive corporate and individual tax reform. However, while tax reform has been a stated focus of the Trump administration and Congress, details remain elusive. The single-page, bullet-point plan provides few concrete details, instead reaffirming previously announced principles that will drive negotiations with Congress. Notably, the proposal does not include a border adjustment tax.
The key parts of the proposal are:
- Tax rate reduced to 15 percent
- Convert to a territorial system pursuant to which earnings of foreign subsidiaries are not subject to future tax upon repatriation
- One-time deemed repatriation of existing earnings of foreign subsidiaries at an undetermined tax rate after which such earnings could be repatriated without future tax
- Highest marginal tax rate reduced to 35 percent with two other tax brackets: 10 percent and 25 percent
- No deduction for state and local taxes while the standard deduction would be doubled
- Partnerships/S corporations/LLCs/Sole proprietorships: 15 percent rate for business income, with expected measures to prevent conversion of owner compensation to business income
- Repeal AMT
- Repeal estate tax
Summary of Tax Reform Proposals
While the administration has not provided significant details on its tax reform plan, the broad contours of the plan have developed over the past several months and are summarized below.
The administration’s business tax plan (the “Trump Plan”) proposes a 15 percent rate on the net income of corporations, small businesses, and partnerships. The Trump Plan also would reduce individual taxes by cutting the number of tax brackets from seven to three, with rates of 10 percent, 25 percent, and 35 percent, doubling the standard deduction, and increasing certain childcare tax benefits. The plan would partially offset such increases by eliminating most itemized deductions including the deduction for state and local taxes. Only the home mortgage interest expense and charitable contribution deductions would be preserved. The Trump Plan also would eliminate the alternative minimum tax and the 3.8 percent net investment income tax that applies to individual taxpayers earning more than $200,000 a year, which was enacted as part of the funding for the Affordable Care Act. In addition, it would eliminate the estate tax, which applies to estates worth more than $5.49 million for individuals and $10.98 million for couples.
The Trump Plan would move to a territorial system, in which foreign profits earned by US companies are not subject to US tax. The current system generally taxes foreign profits when they are repatriated, subject to a foreign tax credit. It also effectively permits indefinite deferral of most foreign profits. The Trump Plan would also impose a one-time tax on about $2.6 trillion of these foreign profits held offshore.
The House Republicans’ business tax plan, as set forth in their “Blueprint” released last summer, would reduce tax rates on the net income of corporations to 20 percent and on partnerships to 25 percent. The Blueprint also would provide immediate and automatic full expensing of all business investments other than land. The Blueprint also would disallow deductions for net interest expense, in order to equalize the tax treatment of debt and equity financing. In addition, the Blueprint would introduce border adjustments to the taxation of products, services and intangibles that are imported into or exported from the United States. Border adjustments would rebate the tax on items exported from the United States and impose a 20 percent tax on items imported into the United States and eliminate the deduction for the costs of imported goods. The border adjustment tax is not included in the Trump Plan, and the administration has indicated that it does not support it in its current form.
As to individuals, the Blueprint is similar to the Trump Plan in that it would reduce the number of income tax brackets (with a maximum individual income tax rate of 33 percent) and would increase the standard deduction, but it would go farther in reducing taxes on investment income (i.e., capital gains, dividends and interest) through a 50 percent exclusion of such income.
Both the Trump Plan and the Blueprint have as a stated goal the elimination of so-called special interest tax breaks, but few details have been provided as to which specific provisions would be eliminated.
Prospects for Comprehensive Tax Reform
Even though it is still in the preliminary proposal stage, the Trump Plan faces significant obstacles. While both the Trump Administration and the House Republicans are generally in favor of lower corporate and individual tax rates, accelerated expensing and the elimination of certain special tax incentives, the prospects of passage of these proposals, particularly in the Senate, is not clear. Democrats have promised opposition to any tax plan that gives tax breaks to the highest income earners. Furthermore, many so-called deficit hawks may hesitate to support any plan that is not revenue neutral. Treasury Secretary Steven Mnuchin predicted that the Trump Plan would be deficit neutral after factoring in economic growth that would result from the tax cuts and elimination of deductions. Others have strongly contested that claim. Although the administration only purported to release principles of a plan, many of the proposals mirror parts of the tax plan Trump had proposed during the campaign, which the nonpartisan Tax Policy Center has estimated would cost approximately $6.2 trillion in the first decade.
Given the slim Republican majority in the Senate, any bill may require passage by simple majority through the reconciliation process. Reconciliation allows the bill to pass with only a majority, rather than 60 votes, but is only permitted for bills that do not add to the deficit beyond a ten-year window after passage. Accordingly, the tax rate reductions, if enacted, may be temporary unless accompanied by substantial revenue offsets.
Furthermore, given the differences between the administration and Congress, the expectation of significant opposition to any comprehensive tax reform proposals, and the complexity of comprehensive proposals, even if tax reform is ultimately passed the process could take a significant period of time. As with many significant changes in law, the effective date of such changes is expected to be prospective and, as was the case with the Bush tax cuts, may be phased in over time. Accordingly, comprehensive tax reform, if passed, may not have its full effect for several years.
Special thanks to Shearman & Sterling associate Azeka Lobo for her contributions to this client publication.