Wednesday, August 2, 2017
We are now into August and we don’t really have a good fix on where tax legislation might be headed, if anywhere. A little over a year ago, a House committee set forth a “Blueprint” for tax reform, and there have been some comments from legislators here and there that have discussed various aspects of what might end up as a part of an overall bill. But, it still remains to be seen where the Congress might be headed with tax reform.
Today’s post takes a look at what some of this tax talk has been, where it might be headed, how the process might unfold and the expiring/expired provisions that might be on the immediate “to do” list.
The Political Process and Realities
Of course, any tax legislation must work its way through the political process. While the Republicans control both the House and Senate, the margin of their Senate majority is razor-thin in that they only hold 52 seats. That’s problematic in the Senate because of a Senate rule that requires a 60-vote supermajority. However, if tax legislation happens as part of the budget reconciliation process only a simple majority is necessary. That would make any tax legislation “filibuster proof.” But, it would come at a price – it would have to “sunset” in 10 years unless it is deemed to be revenue neutral.
So, what is the reality of getting 60 votes to pass a straight-up tax bill? My view is that it’s next to none – at least for any type of comprehensive reform. 60 votes might be obtained for provisions that “nibble on the corners,” but I just don’t see any type of significant reform garnering 60 votes at this time – or at any time in the near future.
Tax Reform in General
Individual taxes. In 2016, the Republicans in the House produced a tax plan that would decrease individual tax rates and also reduce the number of brackets. The top rate would be cut to 33 percent on the individual income tax, and the capital gain rate would also be reduced for all taxpayers regardless of their ordinary income tax bracket. The top capital gain rate would be 16.5 percent. The House proposal is slightly different from what the President has proposed, so there would have to be some sort of compromise reached. That’s true for both individual rates and capital gain rates. Both the House and the President would also repeal the 3.8 percent net investment income tax. But, that provision was recently proposed to remain in the Code as part of the on-going negotiations over what to do with Obamacare.
It also appears on the individual income tax side of things that the personal exemption would rise under the House GOP proposal and the President’s proposal. However, negotiations will need to occur concerning differences over whether the personal exemption should be eliminated, the level of the child tax credit, and what itemized deductions would be retained or eliminated. But, at this point in time, it looks as if the mortgage interest deduction and the deduction for gifts to charity will be retained under their existing rules. As for the alternative minimum tax (AMT), there appears to be general agreement on the Republican side that it should be eliminated. This is something that Senator Grassley has pushed for some time.
Transfer taxes. There seems to be a consensus that the federal estate tax should be eliminated. That’s not a big deal for most people given that the current level of the exclusion eliminates federal estate tax on a gross estate of up to $5.49 million. However, the big question for far more people is whether the rule allowing an heir to receive an income tax basis in inherited property equal to the fair market value of the property at the time of the decedent’s death will be retained. That’s a big deal. If the rule is eliminated, what will replace it? Will there be a capital gains tax when property is gifted or inherited, which would create a basis step-up” rule. Will there be an exemption up to a certain amount? Will the federal gift tax be retained? These are all important questions for which there really aren’t clear answers to right now.
Payroll tax. Under current rules, owners of their own businesses and those receiving flow-through income from an entity pay a 15.3 percent maximum tax (FICA and Medicare) on the first $127,200 of income. Above $127,200, the rate is either 2.9 percent or 3.8 percent. With adjustments, that $127,200 could easily exceed $200,000 in another 10 years or so. One proposal that’s been discussed is to have at least a portion of all flow-through income be subjected to these payroll taxes with no income threshold. In addition, it may no longer be limited to the taxpayer’s active business income.
Corporate and business-related tax. This is one area that I believe something will get done. The President would like to cut the corporate tax rate to 15 percent to make the U.S. rate more in-line with the major countries around the world. The GOP House plan is a bit different – a “destination-based cash flow tax” at a flat 20 percent. That’s basically a value-added tax (VAT) with a deduction allowance for wages that are paid. In addition, business interest would be deductible against business income, with any excess being allowed to be carried forward. Costs associated with imported goods wouldn’t be deductible under such a plan, but costs for exporting goods could be deducted. In addition, this type of a VAT tax would eliminate the corporate AMT, and would also allow a net operating loss to be carried forward indefinitely (but not back) with an inflation adjustment. The current domestic production activities deduction would be eliminated.
Also, being discussed is the immediate deduction of the cost of business assets. If that occurs, that would eliminate the need for like-kind exchanges (except for land exchanges). It would also eliminate the need for expense method depreciation. But, would the sale of these business assets generate ordinary income, or would it be capital gain? What about the sales of breeding stock? Will that generate ordinary income? Questions also remain over the handling of pre-productive costs, deferred payment contracts, pre-paid feed expense, business interest expense and the treatment of state income and personal real estate taxes.
An extender bill should address certain specific items, including:
- The definition of “specified plant” for purposes of the provision that allows bonus depreciation to be claimed for fruit/nut plants at the time of planting/grafting instead of waiting until the plant become productive.
- The provision that allows the exclusion from gross income discharge of debt associated with a principal residence. The current provision expired at the end of 2016. The same can be said the provision that allows mortgage insurance premiums to be treated as qualified residence interest, and the above-the-line deduction for qualified tuition and related expenses. Both of these provisions also expired at the end of 2016.
At the present time, it appears that tax reform is in line behind the repeal of Obamacare. It may finally be dawning on the Republicans in Congress that the President won’t accept their inability (so far) to take action on that front. That reality delays tax reform. So, it may be September or October until tax reform really begins to take serious shape. This process can be frustrating to watch, but it is the present reality.
Clients will begin (if they haven’t already) asking questions about tax policy and where things might be headed. Hopefully today’s post will provide some guidance that can assist in advising clients on what is being considered and what, if anything, they can do from a planning standpoint.