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Tuesday, October 17, 2017

Summary and Observations on Tax Reform Framework

On 9/27/17, the Big 6 released their tax reform framework to guide the drafting of tax reform legislation (see my 9/30 post for links).

UPDATE: On 11/2/17, the House Ways and Means Committee Chairman Kevin Brady released H.R. 1, the Tax Cuts and Jobs Act. I'll have a new post on key points of this soon.  I'll also mention some of its key points in my Federal Tax Update at the start of CalCPA's Federal, State, Local & International Taxation Conference on 11/15/17 (the conference runs 11/15 to 11/17) in Universal City.

Here is my summary and observations on the Big 6's framework released 9/27 upon which H.R. 1 and the Senate Finance Committee's bill expected to be released early November, are based.

9-page framework
Lots of details are missing such as where rate brackets start and end, rate on investment income, and what “loopholes” will be closed.
Standard deduction of $24K for MFJ and $12K for single
Will the head-of-household filing status continue?
Personal and dependency exemptions are removed. 
The stated deductions are almost double the current amounts.
Individual rates: 12%, 25% and 35% and perhaps a rate above that for high income individuals for progressivity.
Today, lowest bracket is 10% and highest is 39.6%.
Will there be a special rate for investment income, including today’s 0% rate that applies to some capital gains?
Where will these brackets start and end?
Child Tax Credit – phase-out limits increased; first $1K is refundable.
Non-refundable credit of $500 for non-child dependents.
Today, CTC only applies to children under age 17 while dependency might go up to age 23 (full-time student).
If all workers are to get a higher paycheck and today about 45% of individuals pay no income tax due to low income, even if they get a higher refundable child credit, it won’t affect their paycheck.
 With this change and repeal of the dependency exemption, employers likely will need to get new W-4 forms from employees (and IRS needs to create the new W-4 form).
Only itemized deduction for home ownership and charitable contributions remain.
Repeal of state tax deduction can result in tax increase for many taxpayers.
Repeal of medical expense and casualty loss might adversely taxpayer’s ability to pay.
Preferences “that encourage work, higher education and retirement security” are retained.
No details provided. Is the preference that encourages work the EITC? Will education provisions and retirement plan options be streamlined and simplified?
Individual and corporate AMT repealed.
What happens to any minimum tax credit a taxpayer is carrying forward at date of enactment?
Repeal of other provisions.
What might this include?
Repeals estate and GST taxes.
What happens to basis of assets at date of death?
Will the gift tax remain?
Corporate rate is 20%.
Per the framework, the average corporate rate among industrialized countries is 22.5%.
The rate for “business income of small and family-owned businesses is 25%. There will be measures to “prevent recharacterization of personal income into business income.
Assuming there are rate cuts, less than 5% of owners would possibly even be in a rate above 25% (although many in this group have significant income). There are still payroll tax considerations and make it important that all non-C corporation owners distinguish services income from return on capital invested in the business.
Double taxation of corporate income might be addressed.
Senator Hatch has discussed corporate integration via a dividends paid deduction approach with withholding.
Expensing of new investments in depreciable assets other than structures, made after 9/27/17 will be expensed, at least for the first five years.
This is the only mention of a date in the framework. Will it include expensing of intangibles as well? New or also used property? Why five years only? What happens after that? The five years is likely due to the need to keep the bill revenue neutral by year 11 due to the budget reconciliation. Will temporary rather than permanent expensing adversely affect the economic growth projections? The Tax Foundation says yes (Pomerleau, “Economic and Budgetary Impact of Temporary Expensing,” 10/4/17).
Net interest expense of C corporations is “partially limited” and a similar treatment for other entities will be considered.
There are likely two rationales for limiting the interest expense deductions: (1) a revenue raiser, and (2) if assets are expensed and debt-financed, the effective tax rate is very low, perhaps even zero or negative; thus warranting a limitation on the interest expense.
§199 manufacturing deduction will be repealed.
No surprise here as this measure (199) is really just a rate cut for many taxpayers, but added complexity. However, it is only available for domestic manufacturers.
Various unnamed tax preferences will be repealed or cut back. Only the research and low-income housing credits will remain.
The rationale for keeping the research credit is likely because other countries with a lower tax rate also have research incentives. Also, this credit exists not only for its incentive effect, but also to address the spillover effects when a company engages in R&D but others benefit from it as well.
Changes will be made to tax rules for specific industries to “better reflect economic reality” and reduce tax avoidance.
No examples are provided.
For businesses, worldwide taxation will be replaced with territorial with a 100% exemption for dividends from foreign subs (if the U.S. parent owns at least 10%). Transition rules will include deemed repatriation with a rate lower for illiquid assets than for cash and cash equivalents. Payment will be spread over several years. To prevent shifting certain income to tax havens, there will be a reduced tax rate on the foreign profits of U.S. multi-national companies
Many details are missing here including the deemed repatriation tax rate, the period for paying the tax, and what other rules will need to change due to the shift from a worldwide tax system.

The plan also states President Trump’s President Trump’s Four Principles of Tax Reform:
1.      Simple, fair, easy to understand
2.      Give American works a pay raise.
3.      Make America a jobs market of the world
4.      Bring back trillions of dollars of unrepatriated earnings.

What do you think?

1 comment:

Jeff said...

I have to admit overall I'm not a fan of the currently proposed tax reform. I appreciate your analysis.