Tax Reform Overview – September 27, 2017

On September 27, 2017, the Trump Administration, the House Committee on Ways and Means, and the Senate Finance Committee released “Unified Framework for Fixing Our Broken Tax Code.” This nine-page proposal put out by the “big-six” represents the first significant overview of tax reform as it will be proposed by the President and the Congressional tax writing committees. The framework is clearly tilted to favor the wealthy and corporations.

 

The goals outlined in the publication include:

• Tax relief for middle-class families;
• Simplified tax-filing for most Americans;
• Tax relief for businesses, especially small businesses;
• Ending tax incentives that send jobs, capital, and tax revenue overseas; and
• Broaden the tax base and increase fairness by closing special interest tax breaks and loopholes.

 

The process of developing specific legislation by the Ways and Means and Finance committees will now begin, and will include a series of hearings and (hopefully) bipartisan participation.

 

Following is an outline of goals for the legislation (and some of my own observations):

 

Tax Relief & Simplification for American Families

 

• Simplify the tax code and provide tax relief by roughly doubling the standard deduction to:
  • $24,000 for married taxpayers filing jointly, and
  • $12,000 for single filers.
• This change is designed to eliminate taxes on the first $24,000 of income earned by a married couple and $12,000 earned by a single individual.
• Under current law, taxable income is subject to seven tax brackets. This proposal reduces the number to three brackets of 12%, 25%, and 35%.
  • The concept is that families in the current 10% bracket will benefit from the larger standard deduction, a larger child tax credit and additional relief to be developed during the committee process.
  • An additional top rate may be added to avoid shifting the tax-burden from high-income to lower- and middle-income taxpayers. The current top rate is 39.6%.
• Enhanced Child Tax Credit and Middle Class Tax Relief:
  • Personal exemptions for dependents would be repealed but the Child Tax Credit would be increased. The current law allows the first $1,000 of the credit to be refundable and that provision would be retained.
  • Increase the income levels at which the Child Tax Credit begins to phase out.
  • Non-refundable credit of $500 for non-child dependents to help offset the cost of caring for other dependents.
• Individual Alternative Minimum Tax [AMT]:
  • No details were provided on this, but the stated goal is to simplify the tax code by repealing the existing individual AMT, which requires taxpayers to do their taxes twice.

• Itemized Deductions:
  • Most itemized deductions will be eliminated, but the home mortgage interest and charitable deductions will be retained.
  • Among the deductions that may be eliminated are the deductions for state and local taxes (most of which are present in “blue” states.
• Work, Education, and Retirement:
  • No details are provided, but the stated goal is to retain tax benefits that encourage work, higher education, and retirement security.
• Other Provisions Affecting Individuals:
  • Again, no details – just a statement of intent to simplify the tax code by repealing many exemptions, deductions, and credits for individuals.
• Death and Generation-Skipping Transfer Taxes:
  • These taxes would be repealed.

 

 

Competitiveness & Growth for All Job Creators

 

• Tax Rate Structure for Small Businesses
  • Limits the maximum tax rate applied to the business income of small and family-owned businesses conducted as sole proprietorships, partnerships and S Corporations to 25%.
    • About 95% of businesses in the US are structured as pass-throughs (e.g., S Corporations) and they generate a majority of the government’s corporate tax revenue.
  • Adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.
• Tax Rate for Corporations
  • Reduce the corporate tax rate to 20%.
• Expensing of Capital Investments
  • Permit businesses to immediately write off (“expense”) the cost of new investments in depreciable assets other than structures made after September 27, 2017, for at least five years.
• Interest Expense
  • The deduction for net interest expense incurred by C Corporations will be partially limited.
• Other Business Deductions & Credits
  • Many business credits will be repealed, but business credits in two areas where tax incentives have proven to be effective will remain:
    • Research & Development; and
    • The Low-Income Housing Tax Credit.
  • Tax Rules Affecting Specific Industries
    • No specifics given – just a desire to improve the current tax code.

 

The American Model for Global Competitiveness

 

• Territorial Taxation of Global American Companies
  • End incentives to keep foreign profits offshore by exempting them when they are brought back to the United States.
• Stop Corporations from Shipping Jobs and Capital Overseas
  • Wills set rules to protect the U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations.

 

The cost of this framework is unknown, but estimates range from $2 trillion to more than $5 trillion over the next ten years. The devil is in the details and how this plan will be paid for will determine how quickly it moves through Congress (or if it moves through Congress). The key issue as it stands right now is that the government simply does not have enough money to pay for the plan. Ironically, in order for the Senate to avoid a filibuster (and reliance on the democrats to pass a plan), taxes may actually have to be raised – by as much as $3 trillion over the next decade in order to ensure that the bill is revenue neutral.

 

The term “revenue neutral” means that the overall legislation will not change the total revenues collected by the Federal government. For example, if tax rates are reduced, as proposed, that reduction has to be paid for by raising revenue in other ways, such as scaling back tax preferences. As noted above, the initial framework scales back a number of preferences, but – what are the chances that these preferences will actually be passed? This is only part of what will make a final tax reform bill so difficult. Here are a few minefields the tax-writing committees will have to navigate:

 

• Scrapping the deduction for what businesses spend on interest is going to be a tough sell – this is a treasured benefit for industries that rely on debt financing – i.e., big banks, private equity firms, electric utilities, real estate developers, farms, and small businesses.
• Doing away with deductions for state and local taxes will be resisted by House Republicans from high-tax states such as New York and New Jersey.
• Major objections are already being heard from the real estate industry. While the plan specifically calls for preserving the mortgage interest deduction, a proposal to double the standard deduction will make taxpayers less likely to itemize their tax returns and claim the mortgage deduction. Therefore, one of the main financial advantages to homeownership will be diminished.

 

While all of us in the affordable housing industry applaud the fact that the Low-Income Housing Tax Credit is included in this initial plan, there is no guarantee it will be there at the end of the process. We will are going to have to be diligent and continue to make the case for the program, or face the possibility that it will be sacrificed to retain the other, less socially beneficial, tax benefits.