Tax law changes

February 1st, 2017 / By: / Business, Management

How the Trump Administration may affect businesses.

Any change in Washington, D.C., brings the possibility—and the likelihood—of tax law changes. The election of Donald Trump as the 45th president of the United States is no exception. In his campaign, President Trump highlighted several goals of tax reform that included reducing the official corporate tax rate from its current 35 percent to 15 percent.

In addition, Trump stated during his campaign that he favors capping the individual tax rate at 33 percent, down from 39.6 percent. And it is not just Trump who would like to see the Affordable Care Act (ACA) repealed or substantially amended. As an essential part of any congressional repeal effort, the 3.8 percent Medicare tax on investment income would also be repealed.

THE PROPOSALS

President Trump’s campaign promised to work with Congress to introduce broader legislative measures within the first 100 days of his administration, including the following:

Middle Class Tax Relief and Simplification Act. This economic plan is designed to expand the economy 4 percent annually and create at least 25 million new jobs through massive tax reduction and simplification. The plan includes a combination with trade reform, regulatory relief and lifting the restrictions on American energy. The largest tax reductions would be for the middle class; a middle-class family with two children would get a 35 percent tax cut under the proposal. The current number of brackets would be reduced from seven to three, and tax forms would likewise be greatly simplified. The business rate would be lowered from 35 percent to 15 percent, and the trillions of dollars of American corporate money overseas could be brought back at a 10 percent rate.

End the Offshoring Act. This act is intended to establish tariffs to discourage companies from laying off their workers in order to relocate in other countries and ship their products back to the U.S. tax-free.

American Energy and Infrastructure Act. This act proposes to leverage public-private partnerships and private investments, using tax incentives to spur $1 trillion in infrastructure investment over 10 years. It is revenue neutral.

CORPORATE TAX RATE REDUCTION

Trump and House Republicans have stated they want to see the corporate tax rate cut from its current top rate of 35 percent (the highest worldwide). Trump favors a tax rate of 15 percent while House Republicans want a tax rate of 20 percent. 

Trump specifically proposed a reduction in the top corporate tax rate to 15 percent while extending the same 15 percent top rate to the income of pass-through entities and sole proprietorships. The current top corporate tax rate is 35 percent, and the current top rate on business income from pass-through entities and sole proprietorships is 39.6 percent.

The plan from House Republicans is more moderate. The House GOP plan also includes “base broadeners” to counter the revenue lost from the rate drop, which Trump’s plan does not include. As a result, under Trump’s proposal, the corporate income tax raises less revenue than does the House GOP’s plan.

Trump has proposed that some sort of tax, like the tax on corporate dividends, would be applied to distributions of business income from these other entities. The Trump campaign had stated that it hopes to include provisions to prevent the conversion of ordinary income into business income, although there are no details at this point.

With congressional concerns about increased deficit projections from the Trump proposals, these proposed rates may have to come up somewhat. Congress may also be concerned about extending the corporate tax rate to other business income due in part to the deficit.

PASS-THROUGH BUSINESSES

Most incorporated businesses, so-called C corporations, are taxed twice—once at the entity level and again when shareholders pay taxes on dividends and capital gains. In other words, pass-through businesses such as LLCs, partnerships and S corporations don’t pay taxes at the entity level since their profits are passed to the owners and taxed at the individual income tax rate.

That’s long been a stumbling block for would-be tax reformers. There is general agreement that the marginal tax rate on C corporations is too high, but if that is cut, pass-throughs wouldn’t get a reduction and may even face a tax increase. Some proposals consider cutting the ordinary income tax rate, but many experts say that could be expensive.

One alternative is to give pass-throughs a reduced rate compared to wage income, which has been proposed by Trump (a 15 percent rate cap) and House Republicans (a 25 percent rate cap). Both plans have a top ordinary rate of 33 percent, according to published reports.

However, creating a special rate for pass-throughs might encourage gaming, according to the Tax Foundation, a Washington, D.C.-based think tank, giving business owners an incentive to recategorize their wage income as business income. Trump’s campaign materials seemed to include rules to prevent pass-through owners from converting their compensation income, which is now highly taxed, into profits taxed at the proposed 15 percent rate.

The most likely scenario appears to tax pass-through entities at 15 percent but tax them again on distributions. That is good news for those in businesses that retain a substantial share of their income. It would also increase the tax differential between corporate investment and pass-through investments.

CORPORATE TAX EXPENDITURES

Corporate tax expenditures, except for the research and development (R&D) tax credit, could be eliminated in exchange for a lower corporate tax rate. In order to pay for lower business tax rates, Trump proposes the elimination of certain unspecified “corporate tax expenditures.” He has, as mentioned, indicated the R&D credit would be spared.

Congressional Republicans have run into trouble with lobbyists whenever they get too specific about what tax breaks they would eliminate in return for lower corporate rates. In all likelihood, this will continue to be a difficult hurdle.

FIRST-YEAR WRITE-OFFS

Of interest to many small businesses, Trump has proposed a doubling of the Section 179 small business expensing election from $500,000 to $1 million. That would mean that up to $1 million for new equipment and other business property could be written off as an expense in the first year. Presumably, the ceiling for all capital expenditures would also be raised after the first-year expensing is lowered, dollar for dollar.

In lieu of a deduction for interest expenses, manufacturers would be allowed to deduct all new investments. As proposed, businesses engaged in manufacturing in the U.S. could elect to expense capital investment and lose the deductibility of corporate interest expense. An election once made could only be revoked within the first three years of election.

CONGRESS PROPOSES

As the new Congress is seated, Trump’s proposals will likely be incorporated into a host of other changes. Where this will end up is hard to predict, since on the congressional drawing board there are a number of tax proposals that might emerge in the lame-duck session. More likely, when Congress undertakes the 2018 budget this spring, the process will include:

• creating a new business rate for small businesses that are organized as sole proprietorships or pass-through entities instead of taxing them at individual rates

• reducing the corporate tax rate to 20 percent

• providing for immediate expensing of the cost of business investments

• allowing interest expense to be deducted only against interest income, with any net interest expense carried forward and allowed as a deduction against net interest income in future years (with special rules that will apply for financial services companies)

• allowing net operating losses (NOLs) to be carried forward indefinitely and increased by an interest factor, and eliminating NOL carrybacks

• retaining the research credit (but evaluating options to make it more effective)

• generally eliminating certain
(but unspecified) special-interest deductions and credits

• moving “toward a consumption-based tax approach.”

PAYING FOR THE CUTS

Any tax cuts, real or proposed, must be paid for in some way. Some estimates put the 10-year deficit increase at $9 trillion for the proposals of President Trump. Obviously, there is some sleight of hand that can be used to ignore at least part of the problem currently, but it’ll show up quickly. 

In the long run, the overall tax bills of most taxpayers—including those of many businesses—will be lower. However, there could be cutbacks in certain tax credits and other deductions for particular industries. In other words, some taxpayers may benefit less than others, making it more important than ever to keep an eye on our lawmakers’ decisions.

Mark E. Battersby writes extensively on business, financial and tax-related topics.

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