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Apr 27, 2017

McGuireWoods Tax Policy Special Update: White House Unveils Tax Reform Plan

The Trump Administration today released its tax reform plan after having kept the public in suspense since February when President Trump first made the announcement that the White House is formulating its own blueprint to overhaul the U.S. tax code.

As expected, President Trump’s tax plan is sparse on details, laying down high-level principles to guide Congress in its tax reform efforts on both the business side and the individual side. If the plan looks familiar, that’s because it is quite similar to the tax reform proposal Trump touted on the campaign trail.  Notably missing from the announcement today was any mention of the border adjustment tax (“BAT”) or any other border tax, 100 percent immediate expensing, and interest expense deductibility.

Below is a detailed look at President Trump’s business tax reform proposals.

15% Business Tax Rate. Based on comments at the White House tax reform briefing, the 15 percent tax rate for businesses would be applicable to both corporations and pass-through entities. For corporations, this rate cut represents a significant reduction from the maximum rate of 35 percent.  It has been estimated (unofficially) that the cost of the corporate tax rate cut is nearly $2 trillion. No significant revenue offsets have been provided to pay for the 20 percent cut. For pass-throughs, this rate raises a question about how owner-operated businesses, often organized as pass-through entities, would be taxed at both the business rate and individual rate.

Territorial Tax System (with Deemed Repatriation). The tax plan proposes shifting to a territorial tax system and away from the current worldwide tax system.  In addition, there would be a one-time deemed repatriation tax on offshore earnings. During the briefing, Treasury Secretary Steven Mnuchin did not identify a specific rate applicable to the offshore earnings, noting that the administration is still working out these details.

Elimination of Tax Breaks for Special Interests. Though Mnuchin did not explicitly state that special interest tax breaks would be eliminated, the official White House press release provided that it would do so.  No specific tax incentives were identified, however.

Now that Trump’s tax core principles have been released, this raises a number of questions…

How does the Trump tax plan compare to the Blueprint?

The Trump plan moves toward the House GOP tax report (“Blueprint”), a process that began on the campaign trail, in several key areas:

Individual Rates/AMT. Trump proposes to reduce the current 7 tax brackets to 3 brackets: 10%, 25%, and 35%. This is very similar to the 3 proposed brackets in the House GOP tax blueprint (12%, 25%, and 33%).  Key differences are a slightly lower rate on lower income earners (which, when combined with the proposed higher standard deduction, creates a 0% bracket) and a slightly higher rate on upper income earners. In addition, both the Trump plan and the Blueprint repeal the Alternative Minimum Tax.

Standard Deduction. Trump proposes to double the standard deduction.  This is identical to the House GOP tax blueprint.  For a family this would mean an increase in the standard deduction from $12,000 to $24,000.

Death Tax Repeal. Trump proposes to eliminate the estate tax, which is identical to the House GOP tax blueprint. Both provide additional tax relief for small businesses.

Business Rate Reduction. Trump proposes a 15 percent rate on business income earned by both corporations and pass-through entities. This is a more aggressive rate reduction than under the House GOP tax blueprint which proposed a corporate rate of 20 percent and a pass-through business rate of 25 percent.  But both share the idea that the corporate rate must be reduced dramatically from the current 35 percent and that pass-through businesses should have rate on business income separate from individual rates.  At the press conference, Mnuchin explained that the administration will propose special rules that would apply to wealthy business owners to prevent abuse of the system.

Territorial System/Repatriation. Trump proposes moving to a territorial tax system, with a one-time tax on foreign earnings that have not been repatriated to the United States.  This is identical to the House GOP Tax Reform Blueprint.  A move to a territorial tax system is a significant step toward strengthening U.S. global competitiveness.

Home Ownership/Charitable Deduction. Trump proposes to protect the home ownership and charitable gift tax deductions.  This is very similar to the House GOP tax blueprint, which provides for a mortgage interest deduction for homeowners and an incentive for charitable giving.  Both proposals recognize the importance of home ownership and charitable giving to communities across the United States.

What does it mean for the BAT?

The tax plan outlined by the Trump Administration is silent on the BAT as proposed by the House GOP tax blueprint or a “reciprocal” tax that had been hinted at over the past two months. This does not mean that the White House has completely rejected the BAT, however. At an event this morning hosted by The Hill, Treasury Secretary Stephen Mnuchin simply said that the BAT “wouldn’t work in its current form,” adding that the administration will continue to have discussions on revisions to the BAT the White House would consider. 

What does this all mean for the tax reform process?

President Trump’s tax plan raises questions about process.  The GOP plans to pass tax reform through the budget reconciliation process. Under reconciliation, any provision increasing the deficit outside the ten-year budget window cannot be included in the reconciliation bill.  If the bill is revenue-neutral and does not increase the deficit in the out-years, then the tax provisions could be permanent. This is why House Speaker Paul Ryan has envisioned tax reform to be revenue-neutral and why the Blueprint is counting on the potential revenue raised from the BAT.

The significant tax rate cut proposed in Trump’s plan does not come with any apparent significant offsets. Without such offsets, these rate reductions would be temporary and expire at the end of ten years. Given its potential impact on the deficit, Trump’s plan may draw opposition from within the GOP party itself. George Callas, a tax specialist for Speaker Ryan, signaled that some GOP lawmakers will not support enacting tax cuts without offsets.

On the issue of offsets, Mnuchin has argued that the tax cuts could pay for themselves thanks to the projected economic growth. The use of dynamic scoring has been floated as a way to address the deficit constraints imposed by the budget reconciliation process.

Could Trump’s Plan be distributionally neutral (except for 15% pass-through rate)?

The tax plan outline released today by the White House has not yet been scored, but it does include several items that could help make it close to distributionally neutral compared to current law.

  1. Trump set the top individual rate at 35% instead of 33% as he campaigned for.  This means that the highest income earners receive only a 5% reduction in their tax rate (down from 39.6% to 35%).
  1. To offset that tax cut, all individual deductions and credits would be repealed with the exception of home mortgage interest, charitable gifts, and retirement savings.  The plan contemplates elimination of the deduction for state and local income taxes, which in high-tax states alone could mean a tax increase of 3 percentage points.
  1. The Trump plan does not address the Earned Income Tax Credit, but assuming it is not repealed, the doubling of the standard deduction and additional child care tax incentives could actually reduce the effective tax rate on low-income Americans.
  1. The elimination of the Alternative Minimum Tax will help upper income Americans, but few millionaires.  The repeal would benefit those earning between $150,000 and $500,000.  Depending on where the tax brackets are placed, many of these individuals could remain in the 35% bracket.

The one exception to distributional neutrality is the plan’s commitment to provide a 15 percent rate to pass-through businesses.  This would be a significant reduction from 39.6 percent to a broad swath of U.S. business income attributable to partnerships, S Corporations, and sole proprietorships.  The result: a dramatic reduction in taxes paid by millions of high-income Americans. 

The Administration did not answer the question as to whether this rate would apply to independent contractors. Independent contractors are businesses that are traditionally organized as sole proprietorships.  Unless this provision is changed or limited, the plan likely would be scored by the Joint Committee on Taxation as lowering taxes on high-income earners more than reductions to middle class and low-income taxpayers.

What’s the best path forward?

The tax principles laid out by the Trump Administration stayed fairly close to those pitched on the campaign trail and revealed some convergence with the House GOP tax blueprint. The principles provide enough wiggle room for the administration to determine the best path forward.  

One path is to further align with the House GOP Blueprint. Republicans in both the Senate and House are aiming to pass tax reform through the budget reconciliation process and make the tax changes permanent. To do so, significant revenue offsets would be needed to side step the reconciliation restrictions.  Otherwise something akin to the Bush tax cuts may be the result.

Then again, there is always the option of making tax reform a bipartisan endeavor. If Trump can get Democrats on board, the reconciliation process can be avoided altogether, which will help to ensure the durability of any tax reform legislation.

As the Trump Administration continues its dialogue with the House and Senate, the principles will begin to shape and guide the best path forward, both politically and aspirationally.


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