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Saturday, September 30, 2017

Tax Reform Framework Observations

Press conference on release of tax reform framework on 9/27/17
On September 27, the "Big 6"* released their tax reform framework. It doesn't add much more than we have known for the past 16 months other than:
  • Top corporate rate is 20% rather than President Trump's 15%. The 20% rate should help us be more competitive internationally, particularly along with a shift from a worldwide system to a territorial one (15% would be better, other than for the budget effect).
  • The individual brackets will be 12%, 25% and 35% and perhaps something higher than 35%. In April, President Trump suggested 10%, 25% and 35% while last June the House Republicans suggested 12%, 25% and 33%. Today's lowest bracket (other than zero) is 10%. Seems odd to try to sell tax cuts with a higher lowest rate, but the effect also depends on where the brackets start and end and a few other provisions.
There are lots of cautions to exercise in dealing with this brief framework:
  • There is a lot missing such as where individual tax brackets start and end, whether the head-of-household filing status will be repealed (it is not mentioned in the framework), what "additional tax relief" will be provided "during the committee process," the rate that applies to capital gains and other investment income, and whether interest expense of businesses operating as other than C corporations will be limited.
  • While the standard deduction will be doubled, the personal exemptions and additional standard deduction (for age and blind) are removed. So, for example, today, a single person has a personal exemption of $4,050 and standard deduction of $6,300 for a total of $10,350. Doubling the standard deduction to $12,000 and removing the exemption means an increased deduction of $1,650 rather than $6,300.
  • The dependency exemption is removed and replaced with a "significantly" larger child tax credit but it doesn't say how much higher.  Also, the child tax credit is for children under age 17 while the dependency exemption covers up to age 23 and perhaps even higher in some instances.
  • A more accurate measure of inflation will be used to adjust brackets, the standard deduction and phase-outs. This makes sense but does mean that future adjustments will be less than we have today (this is a revenue raising provision).
  • Will repeal of the estate tax also include repeal of the step-up (or down) in basis at date of death or similar measure to ensure that gains at death don't escape both the estate tax and the income tax which would be a tremendous benefit to wealthy individuals?
Another big caution - don't believe everything you hear. For example, when President Trump announced the framework while in Indiana, he noted that it would not help him, implying that it helps the middle class (see Washington Post article of 9/27/17).  Not true at all.  The rate cut helps him. Also, he likely holds his vast business operations in many different types of entities including partnerships and S corporations and will benefit from the top rate of 25% on such income even after paying himself reasonable compensation. Also, if he is still carrying forward a net operating loss, repeal of the AMT helps him. And repeal of the estate tax is a tremendous tax cut for him. The Tax Policy Center's analysis of the framework indicates that about 75% of the tax benefits of the framework go to the top 25% of income earners in 2018 and 87% by 2027, with the top 1% benefiting the most. Of course, due to missing details, they had to make some assumptions, such as where the individual brackets start and end.

Speaker Ryan says many individuals will have a postcard size tax return - unlikely but perhaps shorter. But why are we talking about fitting a 21st century tax system on a postcard return rather than having a just-in-time filing system?

And, we don't have a cost estimate - will the plan raise or lower revenue. Most likely it will lose revenue (the framework is almost all tax cuts rather than noting many revenue raisers). The Senate budget plan includes $1.5 trillion over the next ten years for tax reform - meaning that it is okay to lose $1.5 trillion. The Committee for a Responsible Federal Budget estimates that that framework might lose $2.2 trillion over ten years ($2.7 trillion when interest on the new borrowing is included). Also, how will any tax reductions for low and middle-income individuals compare to increased health insurance and health care costs due to weaknesses in the Affordable Care Act and the costly income exclusion for employer-provided health insurance that are not addressed?

And, when will we see details? Speaker Ryan has suggested we'll have a new tax system before 2018. Let's see. There is still a lot of work to figure out the details, draft the legislative language, hold hearings, and gain support of both parties (the framework indicates that bipartisan support and participation is encouraged). All possible, we'll see.

What do you think?

*Mnuchin, Cohn, Brady, Hatch, McConnell and Ryan


David Sacarelos said...

Many high net-worth taxpayers in California currently are subject to a top federal 28% AMT marginal tax rate. Since many of the tax preferences, adjustments and deductions would be eliminated under this Framework, the top marginal rate (and potentially top effective rate) might increase to 35%, or at a rate that is in excess of 28%. You are correct in saying that the details of the brackets are important. Many in California with personal real estate holdings might find that they are subject to an increase in their federal tax rate, since they are currently subject to the AMT.

With respect to the top 25% rate for certain flow-through entities, some are questioning if guaranteed payments made to partners would be taxed at a rate different/higher than the top 25% rate. One would hope that the drafters would also tax guaranteed payments at the top 25% rate. This of course would not remove the exposure of partnership income being subject to the self-employment tax.

Professor Nellen said...

David, thanks for the comments. I think guaranteed payments to partners for services will be taxed at usual individual rates rather than capped at 25% to be sure suchcompensatuon is taxed similar to that of an employee.

L Carpenter said...

This: But why are we talking about fitting a 21st century tax system on a postcard return rather than having a just-in-time filing system?

Also, why are we still stuck with April 15 as a filing date for individuals? Why not your birthday as your year end and 30 days later (or 60) for a filing due date? That would eliminate major time crunches and in the just-in-time system you're talking about could easily be managed.

Yeah, I know, pie in the sky. Government inefficiency means many jobs and lifetime paychecks for government employees.

James Kronenberg said...

Professor Annette Nellen,

Appreciate your "tracking" and analysis for "Tax Reform" (?? - really) proposal. I noticed you mentioned that Donald Trump (in spite of his claim of no personal tax benefits) would be a beneficiary of proposed "Tax Reform". After contemplating this for a while, I realized that he is actually correct given his massive ("grossly offensive") Net Operating Loss carry-forward even though he has refused to release his personal tax returns contrary to other US Presidents. Any individual marginal income tax rate changes proposed under "Tax Reform" won't really have any impact for him. Wondering if you think this makes sense given what we know about DT personal taxes ?

Professor Nellen said...

James, thanks for the comment. If he continues to have a net operating loss carryover, he is today at least paying AMT because he can't he can only use an AMT NOL to reduce is AMT income by no more than 90%. So he pays AMT unless he continues to generate losses every year.

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Anonymous said...

Thanks for the insightful "Tax Reform" Framework piece, Annette, Be looking for your critique of the Senate and Conference versions... Sausage is looking more delectable as this goes on...
As the The Donald's NOL it might be useful to remember that it's Section 172 and more broadly the entirety of Title 26 that is embarrassing to me... 45+ years in the academic & Tax consulting world... plying at a profession legislated into existence...Hummm?

As the NOL, as you know, the modifications required by section 172(d) are intended to reduce the loss to reflect a real, economic, hard-dollar loss...(i.e. real money) so, if calculated correctly, that would mean, in the Donald's case, he lost $900+ Million which congress said write it off... It also means that during the C/O period he earned real hard dollar income of the same amount in order to absorb it... among Forbes 400 richest in one year, negative net worth the who really knows...Hope to catch up with you and Gray for your update class..


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