By: William Hussey
Since the release of Republican tax reform principles on September 27th by the so-called “Big Six,” both the U.S. House of Representatives and Senate have passed budget resolutions which clear a path forward for federal tax reform. As was widely anticipated, the House adopted the Senate budget resolution on October 26, 2017, and thus avoids the need to go to conference to work out the differences between the two chambers’ versions. The now joint resolution allows Congress as a whole to pass tax reform measures along party lines with a simple majority vote. The resolution also allows for tax cut measures to add up to $1.5 trillion to the federal deficit over a decade. However, the details of specific tax reform measures remain shrouded in a fog of ambiguity.
A brief review of the more salient provisions under consideration highlight the amount of work that still needs to be done in both chambers before tax reform becomes a reality:
Personal Income Taxes
The proposals aim to reduce the number of tax brackets to three, with rates of 12%, 25% and 35%. It has also been proposed that the current 39.6% rate might be retained for those at the highest income levels. It is not yet known where each tax rate will kick in as the income levels for the respective brackets have not been finalized.
Standard and Itemized Deductions
Current proposals would essentially double the current standard deduction to $12,000 for individuals and $24,000 for married couples, but would also eliminate personal exemptions. The state and local income tax itemized deduction may yet be eliminated or reduced substantially and is a matter of much contention within the Republican party ranks in Congress. The charitable contribution and home mortgage interest itemized deductions, however, now appear to be safe from elimination.
Retirement Plans
Although President Trump has vowed to keep the 401(k) plan benefit in its current form, the amount that can be set aside annually may yet be reduced in order to raise additional tax revenue to offset the rate cuts envisioned in the reform effort.
Corporate Income Tax Rate
The stated goal is to reduce the marginal tax rate from 35% to 20%. However, as numerous revenue raising offsets have been taken out of consideration, such as the Border Adjustability Tax, the corporate tax rate will likely be somewhat higher in order to stay within the stated budget parameters.
Special Pass-Through Business Income Tax Rate
The special 25% tax rate envisioned for income generated by pass-through business entities, such as S Corporations and partnerships, is fraught with concern over preventing the owners of service partnerships and other pass-throughs (who presumably provide services for compensation which would otherwise be taxed at ordinary income tax rates) from gaming the system. A number of proposals have been floated to prevent such a result, but none of those proposals appear to have gained substantial traction at this point.
“Death Taxes”
The federal estate and GST taxes are still on the chopping block for repeal. However, it is still not clear whether the federal gift tax will also meet its demise, and whether there will still be a tax bases adjustment at death. Of course, repeal of the federal “Death” taxes may not materialize in the search to reduce the budgetary impact of their repeal (which would likely be several hundred billion dollars over a 10-year budget window).
We anticipate that more of these details will be finalized in the coming weeks and months as the Republicans aim to finalize a tax reform package along with the federal budget by year-end under increasing pressure from their constituents to do so. As Senator Graham (R-SC) recently said “That (failing to pass tax reform) will be the end of us as a party, because if you’re a Republican and you don’t want to simplify the tax code and cut taxes, what good are you to anybody?” Stay tuned for further details as this plays out in the nation’s capital.