By R. Donavon Munford, Jr.
President-Elect Donald Trump promised a sweeping overhaul of the US Tax Code during this past year, and his selection for Treasury Secretary, Steven Mnuchin, says that tax reform will be his top priority. Of course, it is the Republican controlled Congress that will have the final say on tax changes. All of these parties do agree, however, that the US should have lower tax rates and a broader taxable income base. Significant changes are being proposed for both income taxes and transfer taxes. Historically, the President and Congress seldom are able to agree on any major tax legislation before Memorial Day, so the specifics of any sweeping overhaul will not be clear until next summer.
CORPORATE INCOME TAX CHANGES
Lower Rates: Trump has proposed reducing the corporate income tax from its current maximum rate of 35% to a maximum rate of 15%. House Republicans support reducing the rate to 20%. Trump wishes to eliminate the corporate Alternative Minimum Tax (“AMT”) and most corporate deductions and credits (such as financing arrangements and interest costs).
Foreign Profits: Trump proposes a 10% tax on repatriated earnings and profits of foreign subsidiaries that were not previously taxed. With more than an estimated $2.5 trillion in foreign profits subject to being repatriated, this would be a one-time revenue windfall. House Republicans favor a repatriation of earnings at tax rates even lower than 10%. Further, the Republican House leadership proposes changing the US approach to global corporate tax allocations to make the US policy consistent with the rest of the world.
Import Tax: Trump campaigned in favor of an import tax equal to 25% to 35% on goods that we import to the US. Congress has not proposed such import tariffs. This type of tax could have far reaching consequences affecting international trade and perhaps spark trade wars with our partners.
INDIVIDUAL INCOME TAX CHANGES
Lower Rates: Trump proposes decreasing the number of tax brackets from seven (7) to three (3) and lowering the maximum rate from 39.6% to 33%. The House Republican leadership proposes the same maximum rate of 33%, but it would apply the maximum rate at higher income levels.
Long-Term Capital Gains: Trump proposes keeping the maximum long-term capital gains rate at 20%, but have it effective only at higher income levels. The House Republicans favor eliminating the lower long-term capital gains rates, but instead to tax only 50% of long-term capital gains, interest income and dividends at ordinary income rates. As a result, the maximum effective tax rate for long-term capital gains, interest income and dividends would be 16.5%.
3.8% Medicare Surtax: Both Trump and House Republicans propose eliminating the Medicare surtax of 3.8%.
Alternative Minimum Tax: Both Trump and House Republicans propose eliminating the AMT. It is important to note, however, that the proposed limits on deductions advocated by Trump and the House Republicans would make the AMT unnecessary.
Carried Interests: Trump has proposed taxing carried interests as ordinary income instead of long-term capital gain. If the ordinary income tax rates are also decreased, however, this change may not increase revenue significantly. House Democrats have supported taxing carried interests as ordinary income for a number of years, but House Republicans have not made such a proposal.
Itemized Deductions: Trump wants to cap all itemized expenses at $100,000 for single filers and $200,000 for married couples filing jointly. The House Republicans propose allowing itemized deductions only for charitable donations and mortgage interest paid, but not with a cap.
ESTATE AND GIFT TAXES
Eliminate Estate Tax: Trump and House Republicans both propose eliminating the estate tax and generation-skipping transfer taxes.
No Step-up: On the other hand, their proposals would eliminate the step-up in basis of assets for large estates and would perhaps have a deemed realization of capital gains in an estate in excess of $10 million. Because the elimination of the step-up in basis for assets would presumably increase capital gains taxes for most beneficiaries, the revenue loss from this change could be limited.
Gift Tax Stays: Neither Trump nor the House Republicans propose any changes to the gift tax.
PASS THROUGH ENTITIES
Both the Trump campaign and House Republicans appear to support an entity level tax on reinvested earnings of partnerships, disregarded entities and S corporations. It is unclear at this time how an entity level tax would affect the taxation of partners, members and shareholders.
SUMMARY
It appears that (i) income tax rates may be lower in 2017, (ii) some itemized expenses may not be deductible in 2017, and (iii) making gifts to your children and grandchildren may become more expensive tax-wise than leaving the assets to them through your estate. Nonetheless, the proposals from Trump and the Congress are still so vague, and the potential tax consequences are so unclear, that we will need to wait until we know more about this possible overhaul of the tax system before we can understand what’s ahead!
For more information about these potential tax changes, please contact Heyward Armstrong or Carl Patterson of Smith Anderson.