Trump administration and a Republican controlled Congress - Possible tax changes on the horizon
11 November 16
The 2016 US Presidential election proved to be anything but predictable, though the election of Donald J. Trump as 45th President of the United States is likely to mean that high net worth earners and investors will benefit significantly from proposed income tax reform.
Hilary Clinton was believed to be the heavy favorite going into election night, meaning that most tax policy analysts and tax practitioners focused on Clinton's tax proposals, which included significant changes to the scope of the estate and gift tax, along with income tax changes aimed at increasing taxes on the wealthy.
In addition to taking the White House, Republicans will now control both the House of Representatives and the Senate. Consequently, many of the proposals included in the Republican House and Ways Committee Report, issued on June 24, 2016, have a reasonable, if not likely, possibility of becoming the law of the land. These proposals in many respects overlap Trump's proposals.
In light of the Republicans' control of the House, Senate, and White House, here are some possible legislative changes we could expect to see in the coming year under a Trump administration:
- Consolidate the current seven income tax brackets into three, with rates on ordinary income of 12%, 25% and 33%.
- Tax carried interest income at ordinary income rates.
- Capital gains and qualified dividends taxed at a maximum rate of 20% and eliminate the 3.8% Affordable Care Act surtax (Net Investment Income Tax); note, however, that the House Report drops the maximum rate to 16.5%, while also reducing tax rates on interest income.
- Eliminate all itemized deductions except for home mortgage interest and charitable contributions; however, Trump's proposal includes a $200,000 cap on such deductions.
- Eliminate the individual alternative minimum tax.
- Eliminate federal estate and possibly generation-skipping taxes, while still allowing step-up in basis for estates under $10 million (Trump's proposal refers only to "death taxes" and has capital gain recognition at death for assets valued above $10 million, whereas the House proposal would repeal estate and generation-skipping taxes and has no basis step-up at death).
Neither proposal makes mention of a repeal of the gift tax, though this would provide an opportunity to clients to transfer significant wealth into multigenerational structures and possibly restructure family vehicles in a way that could provide for more flexible management and control than may be permitted under the current regime.
- Reduce the federal corporate tax rate to 15%.
This reduction could potentially stimulate international in-bound investment into the United States because the US would be viewed as a quasi-tax haven when compared to other taxing jurisdictions.
- Reduce the tax rate on business income earned by pass-through entities, such as partnerships and S corporations, to 15% (however, the House Report rate would be 25%).
Although the details of this proposal are unclear, Trump's plan specifically states that “this rate is available to all businesses, both big and small, that want to retain the profits within the business.”
- Enact a deemed repatriation of currently deferred foreign corporate profits, at a tax rate of 10%, and end tax deferral on corporate income earned abroad.
- Allow businesses engaged in manufacturing in the US to choose between the full expensing of capital investments or the deductibility of interest paid.
- Eliminate the domestic production activities deductions and all other business credits, except for the research and development credit.
Conclusion and Observations:
A Trump administration combined with Republican control of the Senate and the House will likely lead to significant tax legislation in 2017. The possible content of that legislative reform can be anticipated based on the President elect's tax reform proposals and the Republican blueprint for tax reform released by House Republicans this past summer. It appears likely that estate and gift tax repeal with some form of carryover income tax basis may happen as it has been a principal tax proposal for most Republicans since 2002. However, Senate procedural rules may force some sort of compromise, unless the legislation is enacted through the budget reconciliation process.
If efforts to repeal the Federal estate (and possibly the gift tax) are successful, there may be less need to utilize certain wealth planning techniques designed solely to minimize Federal estate and gift taxes and virtually all estate plans would need to be modified. However, income tax planning will take on increased importance and the use of wealth planning techniques to minimize state estate taxes will remain. Similarly, the benefits of thoughtful tax and wealth planning, including the use of trusts, for family governance, family and business succession, asset protection and preservation, income tax planning (including state income tax planning), and distribution flexibility will continue to be very important.
Income tax reform proposals include reduction of maximum rates for 39.6% to 33%, elimination of the 3.8% net investment income tax, elimination of the alternative minimum tax, continuation and expansion of lower tax rates on passive investment income and long term gains and a new lower tax rate on business income. The impact of these income tax reform proposals will save high net worth earners and investors billions of dollars.
Corporate and business income tax reform will likely include lowering of rates, elimination of popular business deductions and foreign earnings repatriation incentives. These may provide powerful incentives for enhanced investing in the US by US and non-US investors. A 15% corporate tax rate may also change the form in which business is conducted, and reverse the bias for flow-through entity structures that has existed since 1986.