The Trump presidency brings with it a lot of uncertainty for a number of reasons. Among them, President Trump has his own unique ideas and intends to create his own agenda apart from that of any political party.
BUT TRUMP HAS A TAX PLAN
The Trump Tax Plan. One part of Trump’s agenda that is pretty clear is his proposed tax reforms, which are aligned with traditional conservative Republican thinking: cut taxes and shrink government. It is therefore likely to receive significant support. On the Trump campaign’s website, the Trump Tax Plan is set forth in very simple terms and is summarized below.
Income Tax. Trump wants to simplify the U.S. tax structure by, among other things, imposing only three tax brackets on individuals (12%, 25% and 33%) and only one on businesses (15%). Currently, there are seven individual tax brackets (10%, 15%, 25%, 28%, 33%, 35% and 39.6%) and eight corporate tax brackets ranging from 15% to 39%.
Application of “Corporate” Tax to Pass-Through Entities. Trump has suggested cutting taxes on the owners of “pass-through” entities, such as S corporations, limited liability companies and partnerships, to 15%. Under current law, the taxable income of such entities is passed through to their owners and taxed at the owners’ tax rates, which in the case of an individual could be as high as 39.6%.
Repatriation of Corporate Cash. U.S. companies hold an estimated $2.5 TRILLION outside the United States (although Trump thinks it’s double that), which is currently escaping the U.S. tax system entirely. Trump intends to incentivize such companies to repatriate these funds by taxing amounts that come back to the United States at a rate of 10% in a one-time repatriation program.
Elimination of Corporate “Tax Breaks”, But . . . Trump proposes eliminating “most corporate tax expenditures.” However, one new corporate tax break is proposed. Currently, capital investments must be expensed through depreciation deductions over a period of years. The Trump Tax Plan would allow manufacturing companies to elect to immediately expense their capital investments in full in lieu of deducting interest expense. This could strategically lower reported income and therefore income taxes for businesses.
Capital Gains Tax. Long-term capital gains (on investments held for more than one year) will remain at the current rates of 0%, 15% and 20%. In addition, short-term capital gains (on investments held for one year or less) will continue to be taxed as ordinary income, but subject to the new tax brackets.
Obamacare Taxes. The Affordable Care Act imposes a number of taxes and penalties on both individuals and businesses. Most significantly, it imposes a 3.8% Medicare surtax on net investment income. This is one of the principal funding mechanisms for the program. Trump has promised to repeal Obamacare and replace it with a program that is not funded by increased taxes.
Other Initiatives Impacting Personal Income Taxes. Following are some of the additional initiatives Trump currently proposes that will impact personal income taxes.
- Carried Interests. In very simple terms, a carried interest is a kind of profit distribution that benefits partners and managers at investment firms, including those in private equity, real estate and venture capital. A carried interest is often the principal element of the compensation of these partners and managers, and is currently taxed as capital gains. The Trump Tax Plan would tax carried interests as ordinary income.
- Alternative Minimum Tax. This tax was initially intended to close “loopholes” that advantaged very wealthy taxpayers; however, the AMT has increased its reach, and now applies to many people whose income is higher than average but not extremely high. The AMT reduces or eliminates various tax benefits that are available under the regular income tax, such as personal exemptions and payments for real estate and state taxes. Taxpayers must figure their tax liability twice and pay whichever is higher: the AMT or the regular tax. Trump proposes to eliminate the AMT.
- Estate Tax. This is a tax imposed on the transfer of assets from the estate of a deceased person to his or her heirs. The tax is currently imposed only if those assets exceed $5.45 million per individual. Trump wants to abolish the estate tax completely. However, the Trump Tax Plan would subject the decedent’s unrealized capital gains that have accrued as of the date of death to capital gains tax, but there would be a $10 million exemption. Currently, the tax basis of each asset owned by a decedent is reset to its fair market value at the date of death, which means that unrealized capital gains in those assets are never taxed.
- Itemized and Standard Deductions and Personal Exemptions. The Trump Tax Plan would cap itemized deductions at $200,000 for married couples filing jointly and $100,000 for single filers. The standard deduction for joint filers would be increased to $30,000 (up from $12,700 for 2017 under current law) and to $15,000 (up from $6,350) for single filers. The personal and dependent exemptions deductions would be eliminated.
WHAT WILL HAPPEN?
Assuming all of the above reforms are enacted, the Internal Revenue Code will be in for its most significant overhaul since 1986.
U.S. Businesses Will Pay Lower Taxes, But . . . As noted above, the current corporate tax rate is as high as 39%. However, few businesses pay taxes at the highest rate because of the myriad ways the current law permits the rate to be reduced through deductions, credits, etc. The tax rate businesses actually pay is called the “effective” tax rate. Estimates of the current average effective tax rate that U.S. businesses pay range from 11% to over 30%.
Thus, while the implementation of a 15% business tax will reduce the income taxes paid by a significant number of business taxpayers, the overall reduction in taxes will in all likelihood be less than the proposed reduction from 39% to 15% would seem to indicate.
U.S. Businesses Will Have More Cash, But . . . With the significantly lower tax rate, coupled with the repatriation program, it is likely that U.S. businesses will have more disposable cash in the United States. It will be interesting to see how these funds are put to use. The hope is that those funds will be used for hiring more workers, business reinvestment, and expansion. However, many commentators believe that this “tax windfall” is more likely to benefit shareholders through stock buybacks and dividends, which is what happened when the U.S. initiated a repatriation tax holiday in 2005.
The Very Wealthy Will Benefit the Most. There are many studies which show that the more wealthy the individual, the more that individual will benefit from the Trump Tax Plan. For example:
- The elimination of the estate tax will benefit estates valued at more than $5.4 million. Under current law less than one percent of the people who die each year pay any estate tax.
- People who are currently in the 35% and 39.6% tax brackets will pay only 33% under the Trump Tax Plan. The top tax rate applies to only taxpayers in the top one percent.
WHAT SHOULD YOU CONSIDER DOING NOW?
It is practically impossible to provide any meaningful guidance at this point because, as we said in the beginning, uncertainty reigns. President Trump’s cabinet picks are apparently not in full agreement with his articulated agenda, and Trump himself vacillates on what he thinks should happen and how. We believe, however, that Trump and the Republican majorities will make significant changes to the U.S. tax system in a way they believe will benefit the U.S. economy.
Questions? Call us.