Tax Reform and Tax Planning for 2017
Today is the start of a new year, and one that comes with many questions. What will the new diet fads be for New Year’s resolutions? What will be the new popular trends for 2017? What will happen to interest rates? And what will happen with tax reform?
While we entered 2016 knowing the tax law we had ahead of us with the passing of the Protecting Americans from Tax Hikes Act (PATH Act), we begin 2017 with many things unknown. With President-elect Donald Trump set to swear in on January 20, one thing appears to be certain: things are about to change.
The Trump tax proposals and those of the Republican House of Representatives (the “Blueprint”) share many key aspects. Because they are similar in many ways, it can be expected that some mix of the two will become law. While nothing is set in stone, it is very likely that 2017 could provide the largest tax reform overhaul since 1986. So what changes are expected, and what can be done now that 2016 has passed?
Potential Tax Reform
Individual Income Tax
Both Trump’s plan and the Blueprint propose a reduction in personal income taxes. Trump proposes three tax brackets (compared to the seven we now have) at 12%, 25%, and 33%. He also proposes eliminating the alternative minimum tax for individuals, increasing standard deductions, and imposing a cap on itemized deductions.
The Blueprint has similar provisions and also proposes reducing the tax rates on interest, dividends, and capital gains to half of the ordinary rate, or 6%, 12.5%, and 16.5%. Both plans would repeal the 3.8% Medicare surtax and part of the Affordable Care Act. Other proposals include changes to family-based education and other similar tax credits.
Corporate and Business Tax Reform
Corporate and business tax reform is the area most likely to see major changes. Trump’s plan includes the intent to reduce the corporate tax rate to 15%, while the Blueprint suggests 20%. Along with a proposed 10% rate on the repatriation of foreign earnings, the intent is that these reductions could make the United States more competitive in the global business market.
Both parties also propose eliminating depreciation deductions. Under the proposed changes, businesses would be allowed to expense costs incurred for fixed assets immediately for tax purposes. While this is to the advantage of the taxpayer, it could come at the cost of losing the deduction for net interest expense.
Other proposed corporate changes include eliminating the alternative minimum tax and the Domestic Production Activities Deduction (DPAD). LIFO inventory and the R&D credit would be retained. Both proposals share the goal of creating a simpler system and lowering overall tax rates, with the trade-off of eliminating a variety of corporate tax deductions and credits.
Both the Trump plan and the Blueprint have issued proposals that would help to “level the playing field” for small businesses. Under these plans, sole proprietors and flow-through entities could see a major change in the way active business income would be taxed. Trump’s plan calls for a 15% tax rate, and the Blueprint calls for a 25% tax rate on active business income. This would provide a substantial reduction from the current marginal tax rates that individuals currently pay related to their business income.
Tax Planning
While nothing is certain for tax reform, it does appear likely that at a minimum, we will be looking at lower tax rates in 2017. What does this mean for your bank? Whether an S or C corporation, any deductions that you can accelerate into 2016, and any income you can defer to 2017, could result in a permanent tax savings. You may have considered all of this in December, but now that year-end has passed, there is still opportunity to do some tax planning with your tax advisor.
For calendar year taxpayers, there are several accounting method opportunities to consider when preparing your 2016 tax return. Some accrual basis taxpayers may want to consider converting to cash basis. This accounting method change may still be made and filed with your 2016 return. Also, if you have not elected the 12-month rule related to prepaid expenses in the past, doing so on your 2016 return will help to accelerate deductions.
For cash basis taxpayers, you may have accelerated some of your expenses by paying some additional bills in December. If these include fees for services (tax preparation, legal fees, etc.), be sure that these services are performed by April 15 in order to get the benefit for prepayment. Accrual basis taxpayers, remember that you have until March 15, 2017, to pay out bonuses and profit sharing in order to benefit from a deduction on your 2016 tax return.
While these proposals call for a potential elimination of depreciation deductions, there is still time to use depreciation as a planning tool for 2016. While any assets for 2016 are already placed in service, how they are depreciated for tax purposes is still up to you. To accelerate deductions to 2016, you should consider bonus depreciation or Section 179 expensing for qualified assets, assuming your bank and/or shareholder group is eligible. A cost segregation study is another way to determine whether there are depreciation deductions that you can accelerate into 2016. Your tax advisor can help to determine your options, and remember that these can be performed retroactively.
With the current environment and potential for major changes, discussions of tax structures may be in our future. If tax rates drop significantly for corporations, there may be a shift in the current dynamic of S corporations vs. C corporations. While these decisions would rely on many factors, none of which will be finalized any time soon, it could be a topic of conversation by the time we ring in the next New Year.
These proposals have given us a lot to speculate on and could bring the most changes to tax reform in many years. That being said, there is a significant legislative process before anything would become final. Consult with your tax advisors at Wipfli to address any questions regarding how these proposals may affect your bank.
