Possible tax impacts & considerations with the new Trump administration
The inauguration of Donald Trump as the nation’s 45th President and the beginning of the 115th Congress bring much uncertainty to the political and economic landscape. One near certainty, however, is a focus on tax reform during 2017, as reform was a large piece of the economic component of Trump’s campaign. In addition to his various campaign positions, House Republicans released a tax reform plan in June 2016 (the Blueprint) that many expect to be the starting point for any legislation drafted in the House in 2017.
Highlights of each are discussed below.
Income tax considerations
From an individual standpoint, Trump’s tax plan proposes compressing the current seven tax brackets into three, as well as removing the individual alternative minimum tax (AMT). This would reduce rate brackets on ordinary income to 12 percent, 25 percent and 33 percent.
Trump similarly proposed lowering the corporate income tax rate from 35 percent to 15 percent, while also removing the corporate AMT. Trump has indicated that pass-through entities whose owners wish to retain the profits within the business may also be taxed at this flat 15 percent tax rate, rather than flowing that income through to the owners and potentially taxing it at the higher tax rates on ordinary income.
The full impact of making such an election under the Trump plan is not defined; therefore, it is possible that a second layer of tax would apply if the earnings were later distributed to the owners. In comparison, the Blueprint lowers the business income tax rate from 35 percent to 20 percent. Pass-through entities would retain a single level of taxation and be subject to a tax rate capped at 25 percent on business taxable income with a reasonable compensation deduction required in calculating business taxable income.
Depending on the effective date of any proposed legislation, businesses should consider accelerating deductions into the 2016 or 2017 tax years and deferring income to future periods in order to maximize the impact of the tax rate differential. Doing so could create a permanent, rather than timing, tax difference.
Capital gains considerations
Trump’s plan does not seem to specifically address the current tax rate for capital gains, although it does call for a repeal of the net investment income (NII) tax related to passive income, including capital gains. As such, it may be that Trump modifies the capital gains tax rate structure to align with his proposed three-pronged tax brackets. Under the Blueprint, rates on capital gains would effectively be reduced via a deduction equal to 50 percent of net investment income, which would include not only capital gains and dividends, but also any interest income. For example, taxpayers in the highest bracket (33 percent) would effectively pay a 16.5 percent tax on capital gains.
Potential ACA Repeal
Much has been made recently about the possible “repeal and replace” approaches the new administration may take concerning the Affordable Care Act (ACA). While repealing the ACA has many implications, the one most pertinent and obvious tax provision is removing the 3.8 percent NII tax.
Business deductions and credits
As part of Trump’s efforts to streamline the tax code, he has proposed eliminating many business tax deductions and credits, including the domestic production activities deduction (U.S. Internal Revenue Service (IRS) Section 199). Under current law, the domestic production activities deduction is a permanent benefit from deducting 9 percent of qualified production activities income generated in the United States. However, also of significant importance, the research and development credit made permanent in 2015 would remain in effect.
Trump also proposed a new method of cost recovery whereby manufacturers and distributors could elect to currently expense 100 percent of capital investments, but lose the benefits of deducting corporate interest expense. The House Blueprint provides for a similar deduction, but does not appear to limit it to manufacturers. This proposed expensing methodology may provide more immediate benefits; however, the election would need to be analyzed to examine any revocation provisions, and to determine whether the immediate expensing of such investments outweighs the depreciation and interest deductions available without the election, as well as the potential impact on other tax preferences such as Section 199.
With President Trump’s occupancy of the White House and the Republicans’ continued majorities in both the House and Senate, the likelihood for tax reform is at an apex not seen in quite some time. While we cover some of the areas more likely to have a significant short-term impact, we recommend businesses and individuals begin familiarizing themselves with the nuances of these potential changes to better grasp how they may affect businesses and personal tax posture.
Nick Harrison, CPA, and Stephen Kimberlin, CPA, work for Dixon Hughes Goodman in Richmond and are members of the Virginia Society of Certified Public Accountants. You can reach them at:
Nick Harrison, CPA
Partner, DHG Tax
Stephen Kimberlin, CPA
Manager, DHG Tax