Republican Tax Reform Proposal Would Significantly Change Tax Rules for Businesses and Individuals

On September 27, 2017, President Donald Trump and Republican congressional leaders released an outline of their long-awaited tax reform plan.

The nine-page document, titled Unified Framework for Fixing Our Broken Tax Code, is intended to serve as a template for congressional committees as they draft legislation to cut tax rates, simplify the tax code, and provide a more competitive environment for businesses. The plan addresses tax issues that affect both businesses and individuals.

Business Taxes

Under the proposed framework, businesses are likely to experience large tax cuts in the following areas:

Corporate Tax Rate

The framework establishes a top corporate tax rate of 20%. According to the outline, this rate is less than the 22.5% average of the industrialized world. The current rate is 35%, although the effective tax rate after deductions and expenses is 23%. The corporate AMT tax would also be repealed. Additionally, the framework notes the committees may consider “methods to reduce the double taxation of corporate earnings.”

Pass-Through Tax Rate

Small and family-owned businesses conducted as pass-throughs benefit under the framework. Instead of paying tax at their personal income tax rate, which can currently be up to 39.6%, owners of sole proprietorships, partnerships, and S corporations will pay taxes at a maximum 25% rate.

The framework doesn’t define small businesses and anticipates that Congress will design anti-abuse measures to keep personal income from being recharacterized as business income to avoid the top personal tax rate.

Capital Investments

Under existing tax law, capital investments generally are depreciated over several years, although bonus depreciation provisions may permit a substantial acceleration of the depreciation deductions for certain property. The framework allows companies to immediately expense such new investments in tangible property—excluding structures—made after September 27, 2017, for at least the next five years.

Tax Credits and Deductions

The framework keeps the R&D credit and low-income housing credit but limits the net-interest expense deduction claimed by C corporations. It leaves the treatment of interest paid by noncorporate taxpayers to the committees to further analyze. It also discards the Section 199 domestic production activities deduction, deeming it unnecessary due to the substantial rate reduction. Numerous other unspecified deductions, business credits, and special exclusions will likely be repealed or limited.

Foreign Income

The framework envisions a territorial taxation system for multinational companies to remove incentives for keeping foreign profits and jobs offshore. It would grant a 100% exemption for dividends from foreign subsidiaries in which the US parent company has at least a 10% stake.

To transition to the new system, all accumulated untaxed offshore earnings would be immediately subject to a one-time tax at a fixed rate. Different rates will apply to money held in cash or cash equivalents—bonds or stocks, for example—and money invested in less-liquid assets, such as factories, with the latter taxed at a lower rate. The tax liability would be spread over several years.

The framework also aims to prevent the offshoring of profits to tax havens—and the resulting erosion of the US tax base—by taxing the foreign profits of US multinational corporations at a reduced rate and on a global basis. It instructs congressional committees to incorporate rules that level the playing field between US-headquartered and foreign-headquartered parent companies.

Individual Taxes

The framework proposes several changes to the existing tax laws for individual taxpayers:

Tax Rates

The framework reduces the number of tax rates from the current seven to three: 12%, 25%, and 35%. However, the framework provides that Congress can add a fourth bracket above 35% to ensure the new tax code is “at least as progressive as the current system and doesn’t shift the tax burden from high-income to lower- and middle-income taxpayers.” The highest rate now is 39.6%.

The framework doesn’t specify the income levels that will trigger each of the three rates, but it contemplates using a more accurate measure of inflation to index the tax brackets and other tax parameters.

Estate Tax and Generation-Skipping Transfer (GST) Tax

For 2017, the 40% top estate tax rate applies to estates that exceed the $5.49 million gift and estate tax exemption. The 40% top GST tax rate applies to bequests or gifts exceeding the $5.49 million GST tax exemption that are made to beneficiaries who are more than one generation below the giver. The framework repeals both of these taxes.

Alternative Minimum Tax (AMT)

The framework eliminates the AMT. This tax was intended to ensure high-income taxpayers pay at least a minimum amount of tax, but over the years, it’s affected more middle-income taxpayers.

Personal Exemptions and Standard Deductions

Perhaps the most significant change for many individual taxpayers is in this area. For 2017, the standard deduction is $6,350 for single taxpayers and married couples filing separately and $12,700 for married couples filing jointly. In addition, taxpayers may claim a personal exemption for each taxpayer and dependent, such as a dependent child, included on the tax return. For 2017, the personal exemption is $4,050 per person.

Under the proposed framework, the personal exemption is eliminated, and the standard deduction becomes $12,000 for singles and married couples filing separately and $24,000 for married couples filing jointly. In other words, it consolidates the personal exemption and the standard deduction into possibly a larger deduction for some taxpayers, although it would likely be a smaller combined deduction for taxpayers with one or more dependents.

Itemized Deductions

The deductions available to individual taxpayers will undergo numerous changes. The framework eliminates most itemized deductions but retains the mortgage interest and charitable contribution deductions. It also retains tax incentives for work, higher education, and retirement savings, but encourages Congress to simplify such benefits. No explicit reference is made to state and local tax deductions.

Child Tax Credit

The framework promises a significant increase in the child tax credit, which is currently $1,000 per child, but doesn’t specify an amount. It also increases the income levels at which the credit begins to phase out—currently $75,000 for single parents and $110,000 for married couples filing jointly—making the credit available to more families and eliminating the marriage penalty. Additionally, the framework provides a nonrefundable $500 credit for non-child dependents to help offset associated expenses.

What’s Next

The framework covers many tax issues but paints them with a broad brush. It will be up to the House Ways and Means Committee and the Senate Finance Committee to hash out the details, and lawmakers are certain to encounter a range of budgetary and political hurdles that might delay this process. The result could be legislation that differs substantially from the proposed framework.

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For more information about how the Republican tax reform plan could potentially affect your tax liability, contact your Moss Adams professional.