The much-anticipated tax framework is out. The Trump Administration, House Ways and Means, and Senate Finance committee have released their framework for tax reform. The reform proposal is sweeping yet scant on details, but is very important to all of us. It changes our tax bill, our investments and our economy. I’ll try to put a couple of issues to light and recognize that this will be a long road of analysis and we are now in the beginning phases.
First, the mission of the reform is to:
- Provide tax relief for middle-class families.
- Create simplicity of “postcard” tax filing for the vast majority of Americans.
- Provide tax relief for businesses, especially small businesses.
- End incentives to ship jobs, capital, and tax revenue overseas.
- Broadening the tax base and providing greater fairness for all Americans by closing special interest tax breaks and loopholes.
Does this proposal do that? In a short answer, yes, but the devil is in the details. For example, we know the standard deduction is doubled, which makes filing easier for millions of Americans, but we don’t know the actual income brackets. We know there are now 3 individual tax brackets instead of 7. We know the corporate rate will decrease on the marginal end, but that affects every company differently. Here are some points to think about as this process unfolds.
It ain’t over until the fat lady sings. All of this is only a framework and we currently have no bill. The process of tax change is complex. Tax bills have to start in the House, then go to the Senate for consideration and debate, and then are crafted by a Joint Committee before they get to the President. If there is an entire rewrite of the Tax Code, it’s my opinion that would require a 60 vote majority in the Senate. If this is a budget reconciliation bill, it will only require a simple majority in the Senate and could pass on party lines. However, reconciliation has an expiration date, like a carton of milk. A reconciliation bill will expire in 10 years (think about the ‘Bush tax cuts’). We will have to watch the process.
It can make tax filing way simpler. One issue is whether this simplifies tax filings and if the framework stays in the current form, it clearly does. Using 2014 data from the Tax Policy Center, the vast majority of taxpayers (about 92 million) take the standard deduction, which would be doubled under this framework. I was talking to a friend in the media and if you couple a very simple return with a simpler tax system, we could file on an app, which is not much different than the online e-file we do now. However, for security reasons, I don’t think we’ll actually have ‘postcard’ filing, unless we want to make our private information really open to the public.
Contrary to rhetoric, everyone does not pay less. I was watching an Administration official claim that “everyone will pay less taxes”. My wife Anne asked me what I thought. I think I used the phrase ‘poppycock’ (maybe it was spicier). I’ve spent 40 years trying to understand the tax law, and the only way everyone pays less taxes is to eliminate them. Even then, people currently entitled to an Earned Income Credit would have less money (since the Earned Income Credit is refundable). Here’s an example: If a single mom with three kids who owns a house makes $100,000 and pays Michigan income taxes and property taxes, she likely will pay more under this plan. If she makes $450,000, she’ll pay less. An adult daughter who has her mom living with her and is covering her non-Medicare medical expenses will probably pay more, since medical deductions are eliminated. Using the original Trump Tax Plan in late 2016, we ran a bunch of our client’s returns under the ‘old’ way and the ‘new’ way. Folks in lower income brackets who did not itemize and who did not have a lot of dependents, paid less. Folks in high brackets paid less. People with lots of itemized deductions in middle income ranges with dependents tended to pay more. As they say in the ads: your mileage may vary.
There is no ‘death tax’. Sorry, this one makes my tax professor hackles go up. The President alleged that “To protect millions of small businesses and the American farmer, we are finally ending the crushing, the horrible, the unfair estate tax, or as it is often referred to, the death tax.” First, recognize the estate tax is generally only imposed on estates larger than $11 million ($5.5 million if you’re single). We hope you are there. Second, according to the Tax policy Institute, in 2015, only 5,500 estates were subject to the estate tax.. Out of those 5,500, only 700 were small businesses or farms, and even then there are special provisions in the current tax code for small businesses and farms. I’m just a poor old wealth manager, but I think $11 million is pretty big. But here’s what’s stuck in my craw: Warren Buffet has a pretty good sized estate, like $39 billion. He’s leaving almost all of his estate to the Bill and Melinda Gates Foundation on his death (as are the Gates). If he leaves his kids $11 million (which is what he said he would do) and the rest to charity, there is no tax on his death. The phrase ‘estate tax’ is a tax on the amount heirs get, not the tax on your death. When I give my seminars, I’ll ask ‘who opposes the death tax?’ I get a unanimous response of yes. When I ask ‘how many of you have more than $11 million?’, no hands show (or if they do, they get drinks on me). So, if you are fortunate and your dad has $4.5 billion, you save $1.8 billion when he dies. You get a 100% tax cut. But it’s an estate tax repeal, not a death tax repeal.
Business tax reforms. A part that a lot of people agree on (me too), is that our business tax system needs to be overhauled. The current maximum rate for corporations in the US is 35%, way over other developed countries. The framework lowers it to 20% and that should help grow corporate profits, but more importantly, keep business here. Under the 35% rate, corporations hire people that are really smart to figure out how to cut taxes, usually by shifting the profits abroad. I remember when Tim Horton’s bought Burger King and I said ‘When I use the phrase “Canada” and “tax haven” in the same sentence, we need reform.’ The cut in the corporate rate should encourage staying in the US. The framework also allows full-expensing for depreciable assets other than structures. Again, good. Ford or GM is encouraged to buy equipment here and have jobs here. But, as we say in law school, “the big print giveth, and the fine print taketh away”. There are a wide array of exclusions and credits being eliminated, from lower taxes on the first $10 million of corporate profits (which would actually be the small and mid-sized businesses) to tax exclusion for credit unions to orphan drug credits. Another big change is on pass-through entities (like LLCs and Subchapter S corporations) where the tax rate would be 25%. Business owners and their CPAs will find that one to be very important. There’s also a territorial tax system for multinational companies (I say halleluiah). This plan proposes all overseas profits will be considered repatriated and taxed currently. But, details are scant.
Stay tuned. I graduated from U of D in 1977, 40 years ago. I went into accounting because it was hard and had math (yes, I am a nerd). I’ve seen a wide array of tax situations, from the creation of 401(k)s to big tax reform in 1986 to various tax bills. Taxes need to change with the dynamics of our economies. The world of 1977 or 1986 or 2001 is not the world of 2017. We have the possibility of changing our tax system and making it better. However, you have to break eggs to make cake. Be assured we’ll keep watching and talking about it as the drama unfolds.