The 2016 elections are over, and the results have surprised many pundits, pollsters, financial markets, etc. Donald Trump was elected as President, and the Republicans maintained control of Congress with slight losses in each chamber. Setting aside the politics of the campaign and the elections, what are the prospects for possible tax legislation next year?
Outlook for 2017 Tax Changes
The prospects for some tax reform packages for next year were already in the mix in Congress regardless of what the results of the election would have been. House Republicans have been working somewhat quietly over the past several years on a tax reform package that it planned to introduce next year, although its fate depended upon the outcome of the election. With Mr. Trump’s surprising win, however, and with Republicans retaining control over Congress, the chances have significantly increased for enacting overall tax reform next year.
Trump released a tax proposal last year and House Republicans also unveiled a tax reform package earlier this year (labeled “A Better Way” – please click here for a link to this proposal), while the Senate is working on its own plan. There are some similarities in the Trump and the House plans, and this could serve as a blueprint for tax reform for 2017. Thus, based on these proposals, there are some initial observations on several selected changes in the tax reform proposal which are likely to be unveiled early next year.
Possible Tax Changes
Corporate Tax (C Corporations)
- Look for a reduction in corporate tax rate from the current 35% down to the 15-20% range. Congress and Trump realize that U.S. tax rates are not competitive with the rest of the world, and this tax rate reduction would remove some of the incentive now for companies to invert and move overseas. This drop in corporate tax rates, however, may result in the elimination of the 9% manufacturing deduction (DPAD).
- Another possible change would be the immediate full expensing of fixed asset additions (CapEx) and intangible assets, rather than depreciate or amortize these assets over a number of years. This provision may also include real estate additions, but not the cost of land.
- On the flip side, the deductibility of net interest expense for a business may be eliminated or significantly reduced.
- Many tax credits and special incentives may be eliminated or cut back as part of simplifying the tax law and bringing about these lower tax rates. Congress, however, would like to retain the Research Credit and LIFO Inventory method.
- Finally, the U.S. would move toward a territorial system for companies with foreign operations. Further, the pending Base Erosion Profit Shifting (BEPS) rules may not be implemented by the U.S.
Flow-Through Entities
- Mr. Trump and Congress realize that many closely held businesses are set up as pass-through entities (S Corporations and Partnerships/LLC’s), and they need to address the tax impact to them. The income from these entities is currently taxed at the top individual rate of up to ~ 40%. Congress and Trump do not intend on imposing these higher tax rates on these businesses, but instead may move toward a lower tax rate for owners of pass-through entities of around 25%. While not down to the 15-20% corporate tax rate, it would still be less that than the proposed (and current) top individual tax rate.
Individual Tax Items
- Trump and Congress would like to simplify the individual tax system, and also reduce the individual tax rates. Look perhaps for three tax brackets of 10-15%; 20-25%; and 30-33%. These tax rates and the income levels that apply to them will need to be ironed out.
- Capital Gains, Dividends, and Interest. Congress is considering a 50% deduction for income received from capital gains, qualified dividends, and interest. This deduction would drop the top effective tax rate for this investment income to ~ 15%-17%.
- Deductions. The deductions for charitable contributions and mortgage interest will likely be retained, however, the deduction for state taxes and property taxes could be eliminated.
- AMT. Mr. Trump and Congress have also proposed getting rid of the individual Alternative Minimum Tax (AMT)
Estate Tax
- Congress and Trump have suggested eliminating the estate tax, although it is uncertain at this point about any basis step-up provisions.
Affordable Care Act (ACA)
- Look for Congress to take up a proposal to repeal ACA and replace it with a different health insurance program (details of this replacement plan are still unclear). It is uncertain if the 3.8% surtax on investment income, which was added as part of the ACA bill, will also be repealed.
Regulatory Projects
- Two major tax regulatory projects unveiled by the IRS this year might perhaps be up in the air as a result of the election.
- The proposed Section 2704 regulations with transfer taxes (to cut back on valuation discounts) are scheduled to be finalized in the coming months. These regulations have been controversial, and Mr. Trump and the new Congress may try to derail these once they take control in January.
- The recently finalized Section 385 regulations for certain debt/equity arrangements with related parties have also been criticized. These might be re-evaluated by Mr. Trump and a new Congress.
This is a brief overview at this point of what to expect. Of course, nothing is cast in stone and changes to any of the above are possible, as well as other proposed tax changes. House and Senate leaders will need to get on the same page soon with their tax reform plans. Further, any tax reform will probably be part of a “budget reconciliation” process, and thus avoid a 60 vote hurdle in the Senate. Navigating the complex budget reconciliation provisions can be a challenge, so nothing is guaranteed. The effective dates and transition rules for any tax reform measures will also need to be evaluated.
Again, this is not final law, but is intended to provide some insight on likely tax changes expected in 2017, as tax reform will be a high priority for both Congress and the new Administration next year. Once the tax reform process gets started in 2017, things could move quickly.
As things develop further over the next several weeks, we will keep you posted. Please contact your Sikich tax professional if you have any questions.
