Article written by FGMK Tax Partner Fuad Saba and Tax Manager Jill Boland
The Republican Party yesterday rolled out its proposed changes to the U.S. tax code, in what may become the most comprehensive overhaul of U.S. tax law since the 1986 Tax Act. The plan espouses four goals: (1) to simplify the tax code; (2) to lower taxes on American workers; (3) to entice companies to do business in the U.S.; and (4) to bring the offshore profits of U.S. companies back to the U.S. The proposed changes would impact the U.S. tax treatment of individuals, corporations, and certain cross-border transactions.
Individuals
The GOP plan has been crafted largely with a view toward the simplification of the tax code. As drafted, the plan would reduce the number of tax brackets (from seven to three), and would modify the tax rates applicable to those individuals in the lowest and highest income tax brackets:
The tax rate for those in the lowest tax bracket would be raised from 10% to 12%.
The tax rate for those in the highest bracket would be lowered from 39.6% to 35%.
The tax rate for those in an as-yet-undefined “middle” bracket would be 25%.
However, the plan holds out the possibility of a higher tax bracket for higher-income individuals.
The plan also proposes the elimination of most individual itemized deductions, including the state and local tax deduction. Any detriment to individuals who rely on these deductions is proposed to be offset by the benefit of an almost doubled standard deduction as well as lower tax rates.
The standard deductions for individuals and married couples would be increased to $12,000 and $24,000, respectively.
Surviving individual deductions would likely include those for charitable gifts and home mortgage interest.
The child tax credit would be expanded to include taxpayers with higher levels of income, and would be partially refundable.
The estate and generation-skipping transfer taxes, which have long been the target of tax reform for the GOP, would also be eliminated.
Corporations
The GOP plan proposes a corporate tax rate of 20%, which, while greater than the Trump administration’s target rate of 15%, would be a significant reduction from the current corporate income tax rate of 35%.
The plan proposes a separate tax on flow-through businesses. Currently, profits from such businesses pass through to the individual business owners, who are then taxed on those profits at their respective individual tax rates. The GOP plan would impose a special 25% tax rate on such pass-through profits, instead of taxes calculated at the business owners’ individual tax brackets. The plan instructs the tax-writing committees to add features that would prevent the abuse of this provision.
The plan also proposes to “streamline” business deductions, but does not list which deductions would be reduced or eliminated.
As written, the plan allows the immediate expensing of costs of new investments (made after September 27, 2017) in depreciable assets, for at least five years. However, investments in “structures” are specifically excepted from this provision. Investments in structures originally were not excluded in the GOP “blueprint” issued in June 2016, leaving open the question of the survival of the like-kind exchange provisions of code section 1031.
Importantly, while the plan discusses limiting deductions for business interest expense, it does not provide significant detail as to these limitations.
The plan is silent with regard to certain issues that are of particular interest to small business owners, such as modifications to the current capital gains tax rates as well as carried interest (profits interests provided to partnership sponsors).
International
Under the current U.S. tax regime, corporations and individuals are taxed on their worldwide income. The GOP plan proposes a partial shift to a territorial system of taxation for U.S. corporations, under which dividends received by U.S. corporations from 10% or greater foreign subsidiaries would be exempt from U.S. tax.
If the GOP tax plan is ultimately enacted, U.S. companies would be motivated to repatriate future offshore earnings in order to take advantage of the territorial dividend exemptions. It is unclear from the text of the proposed plan whether the exemption would cover deemed dividends under existing anti-deferral tax mechanisms as applicable to Controlled Foreign Corporations. Multinational corporations rely heavily on sometimes complex operational structures to ensure that their offshore income is not taxed currently under these mechanisms. The territorial exemption could render much of this planning moot.
The GOP plan additionally proposes that all offshore assets of US-owned companies would be considered repatriated and subjected to a one-time repatriation tax – perhaps as high as 10% according to some reports. The plan calls for a preferential rate on the deemed repatriation of illiquid assets, such as real estate.
In light of the GOP’s experiences with the Affordable Care Act, GOP leaders are under pressure to support and pass a bill that would deliver on one of the party’s foundational promises. The passage of tax reform will require strong bipartisan support, and the appointment of Dave Kautter as the new Assistant Secretary of the United States Treasury for Tax Policy was an important step in the path forward to tax reform. Kautter has broad bipartisan appeal and was unanimously approved by both the Senate Finance Committee and the Senate itself. Certain provisions in the GOP’s plan are more likely to withstand the legislative vetting process ahead –particularly those addressing corporate tax reform – if Kautter is able to garner bipartisan support.
Taxpayers would not be well-advised to attempt tax planning around the potential enactment and implementation of the GOP’s tax plan. It is uncertain which, if any, provisions of the plan will survive the legislative process. In addition, there is no indication as to the intended effective date of such legislation, or to what extent its provisions may be retroactive.
