In-Depth: Republican Election Sweep Sets the Stage for Major Tax Changes in 2017

(Parker Tax Publishing November 2016)

By winning the White House and holding on to their majorities in the House and Senate, Republicans are in a position to fulfill campaign promises to reduce individual and corporate tax rates, repeal healthcare taxes, repeal the estate tax, and possibly implement broad, substantive tax reform.

With a Republican government seated for the first time in a decade, 2017 will bring numerous tax changes. Among the most likely to pass and the most important are these four:

(1) Across the board reductions in individual income tax rates.

(2) Reduction in the top corporate income tax rate.

(3) Repeal of healthcare taxes and credits enacted under the Affordable Care Act (Obamacare).

(4) Repeal of the estate tax.

All of the above changes were centerpieces of the Trump campaign and were also featured in a tax reform plan put forward last summer by House Speaker Paul Ryan and Ways and Means Chairman Kevin Brady ("Ryan-Brady plan"). All are likely to garner enough support to pass the Senate.

It's fairly likely that Congress will also eliminate several itemized deductions to help pay for the reduction in individual tax rates and repeal the alternative minimum tax. Both proposals are common to the Trump plan and the Ryan/Brady plan.

Less clear are the prospects for various other proposals appearing in one plan but not the other, such as President-elect Trump's proposal to allow families to deduct childcare expenses for children under age 13, or the Ryan/Brady proposal to exclude from tax 50 percent of investment income.

It's also unclear whether the tax changes will be retroactive to January 1.

Observation: Many practitioners are wondering about the implications of the election results for year-end tax planning. Our opinion is that while the Republican sweep may tip the scales on some year-end decisions about accelerating/deferring income or deductions, it's not really a game changer for a couple of reasons. First, we don't know whether next year's changes will be retroactive to January 1 or even apply in 2017. Second, it's possible that any rate reductions will be phased in, as they were back in 2001, when the top rate only went from 39.6 percent to 39.1 percent (on its way to 35 percent, five years later). So while factoring likely 2017 changes into year-end decisions makes sense, it's important not to weight them excessively.

Another open question is whether changes will come in the form of targeted legislation along the lines of the Economic Growth and Tax Relief Reconciliation Act of 2001, or a comprehensive tax reform package more akin to the Tax Reform Act of 1986. When Ryan and Brady unveiled their blueprint for tax reform last June, it seemed unlikely the proposals outlined would receive serious consideration. However, with the election of Donald Trump (who adopted key aspects of the Ryan/Brady blueprint in September), and Republicans holding onto their majority in both houses, there is now a good chance that Congress will pursue broad tax reform.

Before the election, there had been some discussion about the possibility of tax extender legislation. However, with real tax reform on the table, it's more likely that any extender legislation may be rolled into next year's tax package rather than worked on as a separate piece of legislation before year end.

A discussion of the specific changes included in the Trump plan and the Ryan/Brady plan follows.

Observation: There's no discussion of a Senate plan below, because, to date, there isn't one. Nonetheless, the Senate and its unique procedural rules will play a key role in shaping 2017 tax legislation. Senate Republicans will need to either win over at least eight Democrats to avoid a filibuster, or they'll have to use a budget process known as reconciliation to move any tax bill, which would constrain the contents of the bill. While this is unlikely to have much effect on the repeal of Obamacare, it will have a considerable impact on whether comprehensive tax reform gets done and, if so, on the makeup of the reforms.

I. Individual Tax Reform

On the individual tax front, it seems clear that the centerpiece of any tax reform package will be a reduction in individual tax rates, the elimination of the marriage tax penalty, the elimination of some itemized deductions, and the repeal of the alternative minimum tax. Both the Trump plan and the Ryan/Brady plan tinker with the standard deduction and personal exemption, as well as the taxation of investment income.

Trump Plan

During the presidential campaign, Donald Trump promised to reduce individual taxes across-the-board. Single individuals earning less than $25,000, or married individuals filing jointly and earning less than $50,000 would not owe any income tax, according to Trump.

As far as wealthy individuals, Trump promised that the rich would pay their fair share. Specifically, under the tax plan proposed by Trump, the current seven tax brackets would be collapsed into three brackets, with low-income taxpayers having an effective income tax rate of 0 percent. The Trump plan proposed that the brackets and rates for married taxpayers filing a joint return would be (1) income of $75,000 or less: 12 percent; (2) income of more than $75,000 but less than $225,000: 25 percent; (3) income of more than $225,000: 33 percent. The tax brackets and rates for single filers would be one-half of these amounts. The marriage penalty would be eliminated. Trump's tax plan would retain the existing capital gains rate structure (maximum rate of 20 percent) with the revised tax brackets. Carried interest, which is generally treated as capital gains, would instead be taxed as ordinary income. The 3.8 percent net investment income tax and the alternative minimum tax (AMT) would both be repealed.

Under Trump's plan, the standard deduction for joint filers would increase to $30,000, from $12,600, and the standard deduction for single filers would be $15,000. Personal exemptions would be eliminated as would the head-of-household filing status. In addition, the Trump plan recommends capping itemized deductions at $200,000 for married-joint filers or $100,000 for single filers.

Trump's plan would also allow certain families to fully deduct the average cost of childcare from their taxes. The deduction would be available for children under age 13 and would be capped at an average cost for the age of the child. The deduction would also apply to eldercare for a dependent. The deduction would not be available to taxpayers with total income over $500,000 (married filing jointly) or $250,000 (single).

The Trump plan would also offer spending rebates for childcare expenses to certain low-income taxpayers through the earned income tax credit (EITC). In addition, all taxpayers would be able to establish Dependent Care Savings Accounts (DCSAs) for the benefit of specific individuals, including unborn children, with annual contributions being limited to $2,000 per year. When established for children, the funds remaining in the account when the child reaches 18 could be used for education expenses.

To encourage lower-income families to establish DCSAs for their children, Trump's plan proposes that the government would provide a 50 percent match on parental contributions of up to $1,000 per year for these households.

Finally, because of the reduction in rates and the increase in the standard deduction, Trump's plan proposes to do away with personal exemptions and most itemized deductions. However, charitable deductions and mortgage interest deductions would continue to be available.

Ryan/Brady Plan

The Ryan/Brady vision for individual tax reform also has three tax brackets: 12 percent, 25 percent, and 33 percent, with a zero percent bracket for low-income individuals. Like the Trump tax plan, the Ryan/Brady plan would repeal the AMT. With respect to the taxation of investment income, the Ryan/Brady plan would allow for families and individuals to deduct 50 percent of their net capital gains, dividends, and interest income, leading to basic rates of 6 percent, 12.5 percent, and 16.5 percent on such investment income depending on the individual's tax bracket.

In an effort to simplify the Tax Code, the Ryan/Brady plan calls for consolidating the basic standard deduction, the additional standard deduction, the personal exemption, the personal exemption for dependents, and the child tax credit into two simpler benefits - a larger standard deduction ($24,000 for married individuals filing jointly, $18,000 for single individuals with a child in the household, and $12,000 for other individuals, adjusted annually for inflation) and an enhanced child and dependent tax credit. Under the Ryan/Brady plan, the child tax credit and personal exemptions for dependents would be consolidated into an increased child tax credit of $1,500, with the first $1,000 being refundable, as under current law. A non-refundable credit of $500 would also be allowed for non-child dependents. The marriage penalty that exists in the current-law phase-out of the child credit would be eliminated, so that married couples would be able to earn up to $150,000 before their child tax credits start phasing out.

The Ryan/Brady plan does not include a proposal similar to Trump's plan in which individuals can deduct the average cost of childcare. Nor does it include spending rebates for childcare expenses for low-income taxpayers.

Like the Trump plan, the Ryan/Brady plan proposes to eliminate personal exemptions and most itemized deductions, but leaves in place charitable deductions and mortgage interest deductions. Despite this being an area of agreement between the two plans, the proposal is likely to be controversial.

II. Business Tax Reform

As with the individual income tax proposals, the centerpiece of both Trump's and the Ryan/Brady business tax reform proposals is a reduction in corporate tax rates. Both plans would also eliminate most deductions and credits, except for the research and development credit.

Trump Plan

While Trump's plan did not originally differentiate between corporate and small business tax rates, and there was some talk of reduced tax rates applying to unincorporated businesses like partnerships, that talk has been walked back. Under the Trump plan, the corporate tax rate would be reduced from 35 percent to 15 percent. In addition, the corporate AMT would be eliminated. Key to the Trump plan is a proposal for a 10 percent tax on a deemed repatriation of corporate profits held offshore.

The Trump plan would also allow U.S.-based manufacturers to elect full expensing of plant and equipment. However, if this election is made, a manufacturer would not be entitled to interest expense deductions. Trump's plan would also eliminate most corporate deductions and credits except for the research and development credit.

The Trump plan also proposes that businesses that pay a portion of an employee's childcare expenses would be able to exclude those payments from income.

Ryan/Brady Plan

Under the Ryan/Brady plan, the top tax rate for corporations would be cut to 20 percent and the top tax rate applicable to small businesses and pass-through entities would be 25 percent. Under this approach, sole proprietorships and pass-through businesses would pay or be treated as having paid reasonable compensation to their owner-operators. Such compensation would be deductible by the business and would be subject to tax at the graduated rates for families and individuals. The compensation that is taxed at the lowest individual tax bracket rate of 12 percent effectively would further reduce the total income tax burden on these small businesses and pass-through entities.

The Ryan/Brady plan would also provide that a business could fully and immediately write off the cost of investments. The write-off would apply to tangible and intangible property, but not land. In addition, a business would be allowed to deduct interest expense against any interest income, but no current deduction would be allowed for net interest expense. Any net interest expense would instead be carried forward indefinitely and allowed as a deduction against net interest income in future years.

With respect to net operating losses (NOLs), the Ryan/Brady plan would allow such losses to be carried forward indefinitely and increased by an interest factor that compensates for inflation and a real return on capital. Carrybacks of net operating losses would not be permitted and the deduction allowed with respect to an NOL carryforward in any year would be limited to 90 percent of the net taxable amount for such year determined without regard to the carryforward.

The Ryan/Brady plan would generally eliminate special-interest deductions and credits in favor of providing lower tax rates for all businesses and eliminating taxes on business investment. The aim is to allow business decisions to be made based on the economic potential rather than the availability of targeted tax benefits. The Code Sec. 199 domestic production activities deduction would be among the popular tax breaks eliminated by this proposal.

Similar to the Trump plan, however, the Ryan/Brady plan would keep the research and development credit.

With respect to international taxation, the Ryan/Brady plan moves toward a cash-flow tax approach for businesses, which reflects a consumption-based tax. According to the plan, this approach will allow the United States to counter the border adjustments that U.S. trading partners apply in their value added taxes. The cash-flow based approach that will replace the United States' current income-based approach for taxing both corporate and non-corporate businesses would be applied on a destination basis. This means that products, services and intangibles that are exported outside the United States will not be subject to U.S. tax regardless of where they are produced. It also means that products, services and intangibles that are imported into the United States will be subject to U.S. tax regardless of where they are produced. According to the Ryan/Brady plan, this will eliminate the incentives created by the current tax system to move or locate operations outside the United States and will allow U.S. products, services, and intangibles to compete on a more equal footing in both the U.S. market and the global market.

III. Repeal of Obamacare

President-elect Trump and the Republicans in Congress have promised to repeal and replace Obamacare. A key aspect of this will be the repeal of a collection of taxes that are integral to the healthcare law. These taxes include:

(1) the 3.8 percent Net Investment Income Tax (NIIT);

(2) the .9 percent additional Medicare tax,

(3) the penalties associated with the individual and employer mandates;

(4) the tax on "Cadillac" healthcare plans; and

(5) the excise tax on medical devices.

The Ryan/Brady plan does not address what would replace Obamacare, other than to say that the issues surrounding a repeal are being addressed by a Health Care Task Force. The Trump campaign's position has been that replacing Obamacare will entail a combination of health savings accounts, allowing the sale of health insurance across state lines, a federally subsidized high-risk pool, and the creation of a patient-centered health care system that promotes choice, quality, and affordability.

Various experts have pointed out that dismantling Obamacare may prove more difficult than originally thought, mainly because the health care law has grown to provide more than 20 million Americans with health coverage (12 million through the health insurance exchanges, and 8 million through Medicaid expansion), and that keeping just the popular parts (such as requiring insurance companies to cover preexisting conditions) is impractical.

Given the challenges of the "replace" part of "repeal and replace", there seems to be an emerging consensus that there will have to be a transitional period, perhaps running through 2017, during which premium subsidies, federal funded Medicaid expansion, healthcare market reforms, and other aspects of Obamacare will continue. If so, it raises the question of whether Congress would repeal the taxes that pay for the program while the federal government continues to incur its cost. As a result, practitioners shouldn't be surprised to see delayed effective dates for both the repeal of Obamacare's healthcare provisions and the taxes that fund them.

IV. Repeal of the Estate Tax

Both Trump and Ryan/Brady agree on eliminating the estate tax, although Trump's plan includes an exception.

Trump Plan

The Trump plan would repeal the estate tax, but capital gains held until death and valued over $10 million would be subject to tax, with an exemption from such tax for small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent's relatives would be disallowed.

Ryan/Brady Plan

The Ryan/Brady plan would eliminate the estate tax, as well as the generation-skipping transfer tax.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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