As the Senate struggled with the repeal and replacement of the Affordable Care Act (ACA), Congress has been working behind the scenes on tax reform. Leadership from both the House and the Senate has been holding discussions with their committees of relevant jurisdiction as well as the White House (this group has informally become known as the “Big Six”). The Big Six is comprised of Congressmen Paul Ryan and Kevin Brady, Senators Orrin Hatch and Mitch McConnell, Treasury Secretary Steven Mnuchin, and National Economic Council Director Gary Cohn.
A first draft of actual legislation as a product of these discussions is now expected in September. Consequently, we anticipate little activity in August due to the congressional recess, but anticipate movement in the fall once members negotiate the budget and the debt ceiling limit. At this time, it appears the final product will be some form of corporate tax reform or merely a corporate rate reduction, instead of a tax overhaul. The following is a brief overview of items we expect to be included in the initial proposal.
Corporate tax rate. While the White House originally proposed a 15 percent corporate rate, Speaker of the House Paul Ryan has indicated a 20 percent corporate tax rate may be more realistic. In order to achieve that kind of rate reduction (15-20 percent from 35 percent), the elimination of most business tax deductions would be required. The general rule of thumb is that each percentage point rate reduction costs approximately $100 billion over 10 years, so financing a rate reduction purely on disallowing tax deductions may prove difficult, if not impossible. The House-passed bill that repealed the ACA’s tax provisions provided a leg up on revenue-neutral tax reform. Now that those taxes remain in place, Republicans no longer have the associated savings and will have less room to overhaul the code without adding to the deficit.
Another barrier to achieving revenue neutrality is that the border adjustment tax, initially proposed by House Republican leadership and projected to raise over $1 trillion in tax revenues, is no longer being discussed as an option to help pay for a rate reduction.
Questions also remain on how a lower rate will apply to pass-through entities. Senators are reviewing whether pass-through entity owners who are actively involved in business operations should have portions of their pass-through income taxed at different rates (e.g. compensation or return of capital).
Repatriation. Some type of repatriation is expected in the upcoming proposal in order to encourage businesses with international operations to bring profits back into the United States. Proposed tax rates on accumulated foreign earnings have ranged between 8 and 15 percent. Almost certainly, if this provision survives in any proposed legislation, the rate will be driven by the revenue needed to make tax reform revenue neutral. The originally stated intent of lower rates on repatriation proceeds was to fund infrastructure improvements, but that is seemingly less and less likely. Repatriation is expected to be coupled with movement from a worldwide system of international tax to a territorial system.
Direct write-off of capital investment and limits on interest deductibility. Full expensing of capital investment, other than land, is expected to be included in the proposal. In exchange for full expensing, businesses would forgo any interest deduction on related debt. Businesses dependent upon substantial debt financing may be adversely impacted by this policy.
Individual taxation. The administration would like to replace the current seven-bracket system with three rates of 10, 25 and 35 percent. To offset those reductions, most itemized deductions would be disallowed except for the mortgage interest and charitable contribution deductions. The biggest impact here is the elimination of the deduction for state income and real estate taxes, which would impact residents of the highest tax states the most. The alternative minimum tax (AMT) would also be discontinued. However, if the deduction for state taxes is eliminated, this proposal would in substance, replace the current regular tax system with the AMT as most individuals are subject to the AMT due to high state tax deductions. The standard deduction would also be doubled in the proposal.
For related insights and in-depth analysis, see our tax reform resource center.
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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.