With the last major tax overhaul taking place more than thirty years ago, it’s time to modernize the tax code so it works for businesses and individuals in the 21st Century. However, the tax code is complex and reform is a tricky subject for Congress — the slightest change is like pushing on a balloon. Read on as we explore how tax reform could impact multiple areas — like corporate and individual tax rates, accounting methods, and estate planning — if Congress is able to develop a proposal that garners enough support to pass.
Reflecting back on the Tax Reform Act of 1986, efforts to develop a plan took place even before the 1984 Presidential election. Large substantive tax reform like this takes much study, hearings and extensive negotiations. It must also overcome the Senate filibuster rules, which require sixty votes to end debate and vote on a bill.
One of the significant impediments faced by Congress today in simply cutting rates is the so-called Byrd Rule. This rule allows the Senate to use “Reconciliation” once per year to pass certain types of legislation with a simple majority. In order to use reconciliation, the bill must not significantly increase the federal deficit beyond a ten-year period or is otherwise an "extraneous matter" – i.e., a policy, not a fiscal matter. However, Congress can change the rule at any time — an idea that has been proposed.
SO, WHAT’S ON THE TABLE NOW?
International Taxation: Speaker Ryan’s Border Adjusted Tax appears to have been eliminated. Instead, lawmakers are discussing a hybrid approach that would combine permanent changes to prevent foreign profit shifting by corporations with lower tax rates for a number of years. Other tax proposals, including deduction limitations and rate reductions for individuals and businesses, might similarly include some permanent and some temporary changes.
Business Income: There is still talk of business integration. Having one tax rate for business income, regardless of whether the business is conducted in a taxable or a “flow –through” entity (partnership, LLC, or S Corporation) or by a sole proprietor. Tax writers are faced with how to distinguish business income of these entities from the personal services income of their owners in order to avoid creating an inadvertent tax shelter.
Corporate and Individual Tax Rates: It is possible that the business tax rate will be “permanent” at whatever it is set at, or as permanent as tax rates are, to allow business owners to plan long-term. Individual rates could be reduced temporarily, keeping in mind that such reductions often get extended or become a bargaining chip between a future president and Congress.
Accounting Methods: Repealing the cash method of accounting for all large and medium sized service businesses is one potential source of revenue to offset the cuts. This has been part of a tax reform proposal in 2014 which never got out of committee, but still underpins the thinking of some Congressional members.
Estate Tax: Repeal of the estate tax is similarly still front and center; however, it’s estimated that only about 11,000 estate tax returns will be filed. Of these, less than half will owe a tax and the total tax collected will be less than $20 billion. That’s not much to give up for Congress and the President to fulfill at least that promise.
OTHER PROPOSALS UNDER CONSIDERATION
For individuals, proposed changes that may impact them include:
• Eliminating the deduction for state and local taxes
• Repealing the Alternative Minimum Tax (“AMT”)
o If the state and local tax deduction is eliminated, the AMT is repealed AND tax rates are lowered, many taxpayers in high-tax states will have no meaningful tax reduction. They may even find themselves with a tax increase.
• Increasing the standard deduction
• Eliminating all other deductions except those related to mortgage interest and charitable contributions
• Expanding support for child care and expenses
It is still unclear if the Net Investment Income Tax and the Medicare surtax, which would have been eliminated with the Affordable Care Act repeal, will be repealed in tax reform. It appears that the revenue cost may be too high and, since primarily wealthier individuals pay these taxes, the political cost may be too high as well.
On the business side, eliminating the interest expense deduction and allowing full expensing of capital expenditures continues to be discussed. Many small businesses (among them family farms) may not have equal access to the equity and debt markets and expect this proposal to contain certain exceptions if it moves forward. This means the objective of simplifying the tax code will take a hit.
As Congress continues its efforts to rewrite the tax code and agree on a tax reform plan —a feat that has not been accomplished in thirty-one years — we will continue to closely monitor the situation. For further insights into the tax reform landscape, or for personal tax guidance contact Mike Greenwald, MMP, CPA, Partner at Friedman LLP: 212.842.7513 or firstname.lastname@example.org.
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