On Wednesday President Trump and congressional Republicans unveiled their long-awaited framework for overhauling the United States tax code. Although much of the content was expected, the proposal is notable because it unifies the Trump administration and congressional Republicans prior tax reform plans and it frames the debate for the coming months. It also marks the starting point of a potentially difficult battle to enact significant tax reform.
The proposal calls for lower tax rates for individuals and corporations, eliminating the federal estate tax and a simplification of the increasingly cumbersome tax and reporting obligations. We have briefly summarized the main points of the framework below.
Individual Tax Reform:
Lower personal tax rates
The proposal would cut the number of income tax brackets from seven (ranging from 10% to 39.6%) down to three, consisting of 12%, 25%, and 35% brackets. A congressional committee would be given the authority to include a higher fourth rate for the highest-earning individuals if they determine that the three bracket approach shifts the tax burden from higher-income to lower-income taxpayers.
While the proposal increases the bottom tax bracket from 10% to 12%, it claims that lower-income taxpayers will pay less tax because of the large increase to the standard deduction which would nearly double from $6,300 to $12,000 for individuals and $12,600 to $24,000 for married taxpayers filing jointly.
Elimination of itemized deductions
Most itemized deductions would be eliminated except for the mortgage interest deduction and the charitable giving deduction. The deduction that historically has had the largest fiscal impact, the deduction for state and local taxes paid, would be eliminated. The non-partisan think tank Tax Policy Center estimates this would increase federal revenue by about $1.3 trillion over 10 years but it would be a significant burden for high-tax states such as New York and California.
Elimination of federal estate tax
In a fulfillment of one of Trump’s campaign promises, the federal estate and generation-skipping transfer taxes would be repealed. Under current law, the federal estate tax applies to individual estates over $5.49 million or to married individuals with combined estates over $10.98 million. The generation-skipping transfer tax applies to transfers during life or upon death that skip a generation. Both taxes would be eliminated.
The proposal is silent on the federal gift tax, which applies to transfers made during an individual’s life. It is also silent on whether a step-up in basis still will apply to assets passing at death or if heirs would take assets at a “carry-over” basis. Alternative Minimum Tax
The Alternative Minimum Tax would be repealed. Broadly speaking, the “AMT” is a separate tax system that was meant to prevent wealthy taxpayers from significantly reducing their income tax through the use of deductions. AMT income is calculated by taking total taxable income and “adding back” in certain itemized deductions. However, many of those deductions that would have been added back under the AMT would be eliminated under the Trump tax proposal.
Corporate Tax Reform:
Reduced corporate tax rate
The proposal would cut the corporate tax rate from 35% to 20%, eliminating most deductions and credits (other than the research and development credit and the low income housing credit), and eliminating the corporate alternative minimum tax. Businesses will also be allowed to immediately write off the cost of new investments over the next five years.
Reduced tax rate for pass-through entities
Under current law, most pass-through entities (partnerships, S corporations, and disregarded entities such as single member LLCs) do not pay tax at the entity level. Instead, the income flows through, and is taxed, to the underlying owners. The proposal would set the tax rate on business profits for pass-through income at 25%, and it would direct the congressional committees to classify wages versus business profits in the legislation to prevent individuals from avoiding the top personal income tax rate.
International Tax Regime:
The proposal would shift to a “territorial” dividend exemption system for businesses. There would be a new 100% exemption for dividends received by U.S. parents from foreign subsidiaries. In order to transition to the new system, all foreign earnings that have accumulated overseas would be treated as repatriated under the old system. The framework does not specify the rates, but it contemplates a two-tier tax rate, with a higher rate for cash profits and a lower rate for earnings that have been invested in illiquid business assets such as equipment.
Although the proposal would move to a territorial system for businesses, it does not discuss moving to a territorial system for individuals. Currently American citizens and green holders face U.S. tax and reporting obligations whether they reside in the U.S. or in a foreign country.
Congressional Republicans are confident they can complete tax reform by the end of the year. However, the framework is light on details and leaves several major policy decisions to the House Committee on Ways and Means and the Senate Committee on Finance, meaning that many contentious debates over the legislation are yet to come. The Butler Snow Tax team is closely monitoring the situation and has been considering the consequences of various potential tax reform proposals and helping taxpayers to develop planning responses. Please contact us if we can be of assistance.