Federal Tax Update – Republicans Release a “Unified Framework”

On Wednesday, September 27, the Trump administration and Congressional Republican leaders released their “Unified Framework for Fixing Our Broken Tax Code.”  This nine-page document is the general framework they currently intend to follow as they embark upon tax reform.  The likelihood of its passage in this or a modified form is difficult to predict.  We believe the items in bold below are most likely to have the biggest impact on you and your business. 

Observation:  The framework appears to be a carefully crafted document.  Although it is short on specific details, it is believed that this was done intentionally to leave the details to the discretion of the legislators.  In addition, it was thought that by omitting many of the details, special-interest opposition could be avoided until the legislative process was underway. 

Business Taxes

• Limits the maximum rate applicable to pass-through business income (sole proprietorships, partnerships, and S corporations) to 25%.  As-yet-unspecified measures will be adopted to prevent recharacterization of earned income from personal services to business profits.
• Reduces the top C-corporation tax rate to 20%. 
• Repeals the corporate Alternative Minimum Tax.
• Recommends consideration of methods to reduce the “double taxation” of corporation earnings (no further detail provided).
• Permits immediate unlimited write-off of the cost of new investments in depreciable assets other than structures (presumably buildings) made after September 27, 2017 (to be effective for at least five years).
• Limits (to an unknown degree) the deduction for interest expense incurred by C corporations.
• Eliminates the current Domestic Production Activities Deduction (DPAD).
• Preserves the Research and Development Credit and low-income housing credit.
• Replaces the worldwide taxation system with a territorial system that includes anti-base erosion measures.
• Provides an exemption for 100% of dividends from foreign subsidiaries of which a U.S. parent owns at least 10%.
• Imposes a one-time tax on accumulated oversees earnings, with a lower tax rate for illiquid assets.  This tax liability will be spread out over “several years.”
• Imposes a reduced tax rate and, on a global basis, the foreign profits of U.S. multinational corporations.

  Observation:  With the exception of fixed asset expensing, the framework does not provide any effective dates. 

  Observation:  Limiting interest deductions for C corporations will increase the effective tax rate for leveraged C corporations and could dramatically increase the tax burdens on companies that have been acquired on a highly leveraged basis. 

  Observation:  Bonus depreciation has effectively permitted the immediate write-off of 60% of most new equipment since 2008.  Based on past experience, it seems that 100% expensing (which was allowed for the last quarter of 2010 and all of 2011) will have a limited impact on most businesses and is rarely an incentive to acquire eligible assets that aren’t then needed in the business.   

  Observation:  Previous comments by the Treasury Secretary indicate that professional services firms may not be eligible for the 25% maximum rate applicable to pass-through businesses.  The framework does not mention this type of limitation specifically. 

  Individual Taxes

• Consolidates the current seven rate brackets into three brackets:  12%, 25%, and 35%. 
• Gives Congress the option of creating an additional unspecified top rate that would apply to the highest-income taxpayers to avoid shifting the tax burden from high-income to lower- and middle-income taxpayers.
• Roughly doubles standard deductions to $24,000 for married filing jointly and $12,000 for single filers.
• Eliminates personal exemptions.
• Increases and enhances the Child Tax Credit, making the first $1,000 refundable.
• Repeals the Alternative Minimum Tax. 
• Eliminates most itemized deductions other than home mortgage interest and charitable contributions.
• Repeals the estate (death) tax and generation-skipping transfer tax.

Observation:  It appears that the deduction for state and local income taxes as well as real estate taxes will be eliminated.  This will increase the overall effective tax rate of taxpayers residing in high-tax states.  Many affected taxpayers, however, will benefit from the repeal of the alternative minimum tax, under which the deduction for such taxes has never been allowed.

Observation:  The loss of the federal deductions for income and real estate taxes may increase your state income tax cost if you file in a state that allows you to itemize. 

Observation:  The rough doubling of the standard deduction, combined with the elimination of personal exemptions, on a combined basis and without consideration of any other changes, will increase taxable income for non-itemizing singles or couples with more than one dependent.

Observation:  The framework does not mention the preferential rates currently applicable to dividends and long-term capital gains.  Preferential rates on long-term capital gains were eliminated when the last overhaul of the Tax Code was conducted in 1986.  You can expect vigorous debate surrounding this issue. 

Observation:  The framework does not mention the current federal gift tax and does not discuss what (if anything) would replace the death tax.

Observation:  Although the framework aspires to have taxpayers file their tax returns on postcards, this sort of radical rewrite of the Tax Code is not contemplated by the current proposals.

Observation:  Despite all the press, the reduced number of tax brackets primarily simplifies the math only for taxpayers who prepare their returns manually.

Observation:  In 2004 a tax proposal that would have merely replaced an “extraterritorial income exclusion” with a reduced top federal income tax rate morphed into a tax bill that changed hundreds of provisions of the Internal Revenue Code.  There is no telling what this framework may lead to.

Please note again that this framework is just a template that outlines general principles; it is not proposed legislation.  Many of the concepts discussed in the framework are identical or similar to proposals discussed by President Trump, both prior to and after his election victory last November, and by Republican Congressional leaders over recent years.  The Trump administration and Republican leaders have been clear that tax reform is a top priority; however, to date there has been no proposed legislation. 

We will continue to monitor any developments coming from Washington and will update you on any developments as soon as they occur.  Please contact your Wipfli relationship executive if you have any questions regarding tax reform or if you would like to know how specific proposals could apply to you.