By Robert Duquette, CPA
This is the second of continuing updates from PICPA's Federal Tax Committee that are planned over the next few months to keep our members informed with only the facts and no political spin.
With Congress recently agreeing on a budget framework, the U.S. House of Representatives is poised to roll out its initial detailed tax plan. We have come a long way from President Donald Trump’s single-page plan in April, and the nine-page Unified Framework of a few weeks ago that outlined several provisions with substantial impact to taxpayers. Here are some of the provisions in that framework:
- Four individual rate brackets: 0 percent, 15 percent, 25 percent, and 35 percent
- A doubling of the standard deduction and the elimination of personal exemptions
- Elimination of most itemized deductions, except mortgage interest and charitable contributions
- An enhanced child tax credit
- Repeal of both individual and corporate Alternative Minimum Tax
- Repeal of the estate tax
- A lowering of the corporate rate from 35 percent to 20 percent
- A limit on corporate interest expense
- A special top rate of 25 percent on pass-through business income
- 100 percent immediate expensing on business equipment
- An immediate low-rate tax on unrepatriated foreign earnings
- A new low-minimum tax on foreign earnings
- No more Sec. 199 domestic manufacturing deduction, and probably no LIFO
- Preservation of the research and development credit and low-income housing credit
- Limitations on net operating loss carryovers
Congressional staff tax experts have been working on specific proposals for over a year now. With a final push the past few weeks, and a lot of massaging to address some concerns, the first “detailed” look at what tax reform may look like should arrive any day now.
It also appears that Republican Party leadership has planned an extraordinary path to expedited passage if they can secure at least 218 votes in the House, and 51 votes in the Senate. That is in part because the recently passed budget framework clears the way for needing only 51 votes in the Senate as compared to the normal 60 votes needed for this type of legislation. Additionally, the leaders know that the longer their legislative markup does not get to the full chamber for vote, the more likely it is that the plan can get derailed. The president and his party seem determined to push for passage by the end of this year, and perhaps as early as Christmas.
Besides the hundreds of lobbyists attempting to preserve and negotiate their particular constituency’s preferences into a final bill, what will continue to be the most significant drivers of the debate? Below is a summary of what I consider the most relevant drivers and the controversy surrounding the framework to date:
- The 10-year budget that just passed cuts tax revenue by about $5.5 trillion and raises about $4 trillion in revenue, for a net deficit increase over the next 10 years of about $1.5 trillion. This will be added to a projected $10 trillion in additional national debt of $20 trillion to $30 trillion.
- Under the budget reconciliation rule, tax reform cannot cost $1 more than the $1.5 trillion additional deficit allowed over the next 10 years, or any one Senator can block it. The same rule requires that tax reform cannot cause any more deficits after 10 years, or the legislation causing it must be reversed at that time. (This happened a few years ago when the “Bush tax cuts” had to be reset to higher levels.)
- The Tax Policy Center issued in September its estimate of the impact of the framework, and predicted a net cost of $2.4 trillion over the next 10 years, and an additional $3.2 trillion in the following decade after that. (They had to make several assumptions that they deem reasonable about missing details in the framework.)
- The president and congressional leaders continue to make the case that the intent of tax reform is to provide relief to the middle class, and not to provide tax cuts to the “wealthy.” The president’s Council of Economic Advisers recently released its findings that the framework would create $4,000 to $9,000 of annual wage growth for the average household through the benefits passed to employees in the form of wage increases and job growth through the cut in the corporate tax rate. This conclusion was apparently based on comparing worldwide corporate tax rates with wage growth rates over the past few years.
- The Tax Policy Center report concluded that 80 percent of the framework’s benefit would accrue to the top 1 percent within 10 years, and 90 percent to the top 5 percent over that same period. This is due to the top 5 percent of Americans paying over 60 percent of the individual tax receipts, and because certain framework provisions arguably do appear to directly benefit the wealthy, including retention of the mortgage interest and charitable contribution deduction for itemizers; the 25 percent tax rate cap on pass-through income; the lowering of the top individual rate from 39.6 percent to 35 percent; and the lowering of the corporate tax rate from 35 percent to 20 percent, among other corporate tax reform provisions.
- Regarding the relationship between a corporate income tax rate change and its impact on employees, shareholders, the customer, and overall GDP growth (the “supply side” theory), a Google search reveals that the empirical studies appear to be inconsistent. Some studies suggest roughly 60 percent to 80 percent of the benefit goes to employees for every $1 cut in taxes, while others suggest shareholders primarily benefit. As to the impact on GDP, the research is equally inconclusive: some suggest it would be significant, while others (including the Congressional Research Service) conclude it would be negligible, unless we were in a recession.
In addition to the lack of consensus on whether the administration’s major policy objectives can theoretically be met by this framework, there are a number of specific provisions being negotiated that could have a major effect on millions of taxpayers:
- Will the state and local tax deduction be allowed up to a cap?
- Will 401(k) plans maintain their current tax-favored status or be capped?
- Will the mortgage and charitable deduction be capped?
- Will there be a higher rate on the top 1 percent or on incomes over $1 million?
- Will the estate tax still apply above a certain amount? Will basis still get stepped up?
- How will business income be defined for purposes of the special 25 percent pass-through rate?
- How many years will the 100 percent immediate expensing of equipment be allowed, and will that provision allow for both used and new equipment, or just new?
- Will there be exceptions on the denial of corporate interest expense?
- What will be the new minimum tax rate on future foreign earnings?
- What rate will investment income such as dividends, interest, and capital be taxed at, and will the 3.8 percent investment income tax be repealed?
Insight into these questions will be forthcoming, and will be included in our next update. In the meantime, it appears that tax reform is gathering steam, including a substantial corporate rate reduction. Let the debates begin!
Robert Duquette, CPA, is a retired EY tax partner who is currently a Professor of Practice in the College of Business and Economics at Lehigh University and a member of the Griffin/Stevens & Lee Tax and Consulting Network. He has served on PICPA’s Federal Tax Committee for over 20 years focusing on federal tax reform and the national debt.
Other blogs in the Federal Taxation Committee Series:
For more information on 2017's landmark federal tax reform, check out the Federal Tax Reform Guide
presented by the Pennsylvania CPA Journal