January 6, 2017
If the past year demonstrated anything, it was that future events can never be predicted with certainty. Nevertheless, with the U.S. government legislative and executive branches now in the hands of the same political party, and with tax reform being a policy priority of Republicans in Congress, substantial changes to U.S. income tax laws will likely be made this year. Accordingly, with all the appropriate caveats and disclaimers regarding not knowing with certainty what the coming year might bring, and based on conversations with insiders in Washington and consultation with other informed sources, below is a brief summary of the items that we believe are likely to be included, or at least discussed, in connection with any 2017 tax legislation.
- Reduced Individual Income Tax Brackets and Rates. Individual tax rate brackets will likely be compressed to consist of only a few brackets — with three being most frequently mentioned. The highest marginal rate, currently 39.6%, will almost certainly be reduced, and 33% appears to be the odds-on favorite for the new highest marginal rate.
- Higher Individual Standard Deduction. The standard deduction for individuals will likely be increased substantially. The tradeoff, however, is that it appears most other individual deductions are potential candidates for elimination, with the exception of the mortgage interest and charitable deductions.
- Repeal of the Net Investment Income Tax. This excise tax was adopted to help finance the Affordable Care Act and appears likely to be on the chopping block for repeal. The tax imposes an additional 3.8% tax on certain passive investment income of individuals who have adjusted gross incomes above $250,000 in the case of married joint filers, $125,000 in the case of married individuals filing separately and $200,000 in the case of unmarried individuals.
- AMT Repeal. The individual and corporate alternative minimum taxes might be repealed (at long last).
- Reduced Corporate Tax Rate. The top corporate tax rate, currently 35%, will also likely be reduced. Although some sources have mentioned a rate as low as 20%, given budget constraints it appears more likely that the new maximum corporate rate will be reduced to around 25%.
- Treatment of Carried Interests. President-elect Trump specifically mentioned during the campaign that he supports treating income from carried interests (primarily referring to equity interests in equity funds and real estate joint ventures that are received for providing services and not for paid-in capital) as ordinary compensation income in all cases, thereby not allowing for any income from such carried interests to produce capital gain income. The prospects for such a change in the tax treatment of carried interests is uncertain.
- Elimination of Business Interest Deduction. Based on the belief that current tax laws granting such a deduction favor leveraged financing over equity financing, many of the tax reform proposals that Congress is considering include eliminating any deduction for interest expense related to debt used to finance business and real estate activities. As an offset, however, these proposals have also mentioned permitting immediate write-off of capital expenditures, as opposed to current law that provides for depreciation deductions over the useful life of the acquired property.
- International Tax Reform. A substantial overhaul of international taxation seems likely. These changes will probably move the U.S. international tax regime to one similar to the territorial income tax system followed by most other developed countries. Unlike the current U.S. tax regime in which U.S. businesses are subject to U.S. income tax on their world-wide operations, adoption of a territorial system will impose U.S. income taxes only on revenues from U.S. operations, thereby eliminating much of the disparity between the U.S. international tax system and that followed by its major trading partners. In connection with international tax reform, a reduced tax rate or other incentive might be temporarily granted for repatriating back to the U.S. untaxed profits from international businesses that remain parked overseas.
- Higher Taxes on Imports. Retailers and other businesses that rely on imports for a significant part of their inventory or production of goods may not fare as well under the tax law changes. This is because some of the proposals include some form of disincentive for acquiring products overseas, primarily by disallowing or providing a reduced expense deduction on imported goods.
- Elimination of Estate and Gift Tax. While the current unified lifetime exemption amount for gift and estate taxes is approximately $5.5 million ($11 million per married couple), which eliminates most taxpayers from ever having to pay estate and gift taxes, some members of Congress believe that any estate tax can have a harmful effect on certain family-owned small businesses by requiring the sale or refinancing of a business upon the death of the principal owner. Accordingly, estate and gift taxes might be entirely eliminated. Note that a tradeoff might be that the popular basis step-up on death is eliminated.
The above is merely a brief summary of some of the changes we anticipate will at least be discussed and possibly enacted in the coming months. We believe a tax reform bill will likely be adopted no later than the end of August 2017. As for the effective date, given budget constraints and new infrastructure spending initiatives that the incoming Trump administration has discussed, the changes likely will not be retroactive but will instead be effective as of 2018. Of course, as mentioned above, we have based this assessment on the best information we currently have, which might change based on unforeseen events or other circumstances.
Any member of Taft's Tax group will be happy to discuss these proposals in further detail and how they could impact your particular tax planning.