The election of a new president creates the anticipation of major changes in the currently existing tax laws. The proposed tax law changes, as identified during the campaign, by now President-Elect Donald Trump, if enacted into law will have far-reaching implications. The following highlight of some of the more significant proposed tax law changes:
Individual Income Tax
The Trump Plan will collapse the current seven tax brackets down to three tax brackets. The tax rates and breakpoints for each bracket are as shown below. These tax brackets are similar to those in the House GOP tax blueprint.
Brackets & Rates for Married-Joint filers:
Less than $75,000: 12%
More than $75,000 but less than $225,000: 25%
More than $225,000: 33%
*Brackets for single filers are ½ of these amounts
In addition, the Trump Plan proposes to retain the existing capital gains rate structure (maximum rate of 20 percent.) However, carried interest will be taxed as ordinary income.
In addition, the Plan proposes the repeal of the 3.8 percent tax on net investment income and the repeal of alternative minimum tax.
While proposed, it seems unlikely that there will be a total repeal of both the 3.8% NIIT and AMT due to the substantial loss of tax revenue that would result above and beyond the tax bracket changes. A more likely course of action would be for Congress to retain, but make changes to alternative minimum tax. Revisions may further increase the AMT exemption amount or may eliminate certain add-backs to taxable income or allow credits.
The Trump Plan will increase the standard deduction for joint filers to $30,000, from $12,600, and the standard deduction for single filers will be $15,000. The personal exemptions will be eliminated as will the head-of-household filing status.
Consequently, what is most noteworthy is that this change means that low-income Americans will have an effective income tax rate of 0. On the other hand, unmarried persons, supporting another person, but having higher income, may experience greater overall taxes.
In addition, the Trump Plan will cap itemized deductions at $200,000 for Married-Joint filers or $100,000 for Single filers.
The Trump Plan will repeal estate taxes on death, but replace it with a capital gains tax on estates over $10 million. Certain current benefits allowed for small businesses and family farms will likely continue or be expanded.
As a partial revenue offset, there will likely be imposed limitations on charitable contributions. Under the plan, individuals who at death make bequests to a private foundation will not be allowed a deduction from capital gains taxes.
Because this proposal will not take effect unless and until enacted, for individuals with large estates who are charitably minded, but wish to have a private foundation, they may plan to do so, but avoid any risk of capital gains taxes thereon at death, by creating and funding a foundation before death and prior to year-end. Alternatively, they may take a wait-and-see approach. For example, even if these changes are enacted, the new laws may possibly still permit lifetime gifts into a private foundation, and thereby avoid recognition of gain on the lifetime contribution.
The actual effect of this change will not actually eliminate death taxes. Given that the maximum capital gains rate is 20 percent, it will simply cut the effective tax rate of death taxes by one-half.
Interestingly, there is already a model for this exact system of taxes. In particular, Canada already has a capital gains tax in lieu of estate taxes. In Canada, a death is treated as a deemed disposition. Canada has a low lifetime exclusion amount, $800,000 ($1 million for qualified farm/fishing property), both which are inflation indexed) However, because Canada does not have a reduced capital gains tax rate, but follows a 50% exclusion, that also reduces the benefit of the exclusion amount, As a result, Canada’s tax, unlike the Trump proposal , presently generates significant tax revenue.
One of the open questions is whether the revised proposal will grant a step-up in tax basis for all assets. In particular, will this new law change the taxation of IRD items, such as installment sale notes, defined contribution plans and IRAs, when payments are received by heirs after the death of the note/account holder. Presently these assets considered to be “income with respect to the decedent”, i.e., IRD items, and are subject to the potential of both estate taxes at death and income taxes upon receipt of distributions/income. While currently, there is no “step-up” as to those items, recognizing gain on appreciation at death would seem to support eliminating the potential double taxation by allowing step-up in tax basis.
Americans will be able to take an above-the-line deduction for the cost of childcare on behalf of children under age 13. The deduction will be capped at state average for age of child, and for eldercare for a dependent. This deduction will not be available to taxpayers with total income over $500,000 Married-Joint /$250,000 Single.
This program is intended to focus on working, middle class families to provide a substantial reduction in their taxable income. The program is also intended to provide a broad benefit plan, and would include families who use other family members (e.g., stay-at-home parents or grandparents) as well as paid caregivers. The deduction would be limited to 4 children per taxpayer. There would also be allowed an eldercare exclusion, capped at $5,000 per year. The cap would increase each year at the rate of inflation.
The Trump Plan would further offer spending rebates for childcare expenses to certain low-income taxpayers through the Earned Income Tax Credit (EITC). The rebate would be equal to 7.65 percent of remaining eligible childcare expenses, subject to a cap of half of the payroll taxes paid by the taxpayer (based on the lower-earning parent in a two-earner household).
This rebate would be available to married joint filers earning $62,400 ($31,200 for single taxpayers) or less. Limitations on costs eligible for exclusion and the number of beneficiaries would be the same as for the basic exclusion. The ceiling would increase with inflation each year.
The Plan also proposes that all taxpayers would be able to establish Dependent Care Savings Accounts (DCSAs) for the benefit of specific individuals, including unborn children. This proposal is modifies the existing Coverdell Education Savings Accounts under Section 530 which already allows total annual contributions limited to $2,000 per year from all sources, but does not provide for unborn children as of yet. As with the existing plan, there is an account owner (parent in the case of a minor or the person establishing elder care account.) When established for children, the funds remaining in the account when the child reaches 18 can be used for education expenses, but additional contributions could not be made.
To encourage lower-income families to establish DCSAs for their children, as a change to the existing law, the federal government will provide a 50 percent match on parental contributions of up to $1,000 per year for these households. In addition, when parents fill out their taxes they can check a box to directly deposit any portion of their EITC into their Dependent Care Savings Account. As with existing Coverdell accounts, deposits and accumulated earnings will be free from taxation prior to distribution; unused balances can rollover from year to year.
The Trump Plan offers to lower the business tax rate on corporations from 35 percent to 15 percent, and eliminate the corporate alternative minimum tax. This rate is available to all businesses, both small and large, that want to retain the profits within the business. This proposal will offer a deemed repatriation of corporate profits held offshore at a one-time tax rate of 10 percent.
In addition, the Plan eliminates most corporate tax expenditures credits except for the Research and Development credit. Firms engaged in manufacturing in the US may elect to expense capital investment and lose the deductibility of corporate interest expense. An election once made can only be revoked within the first 3 years of election; if revoked, returns for prior years would need to be amended to show revised status. After 3 years, election is irrevocable.
The annual cap for the business tax credit for on-site childcare authorized by Sec. 205 of the Economic Growth and Tax Relief Reconciliation Act of 2001 would be increased to $500,000 per year (up from $150,000) and recapture period would be reduced to 5 years (down from 10 years).
Businesses that pay a portion of an employee’s childcare expenses can exclude those contributions from income. Employees who are recipients of direct employer subsidies would not be able to exclude those costs from the individual income tax and the costs of direct subsidies to employees could not be used as a cost eligible for the credit.
The foregoing changes would have significant tax consequences. A number of benefits, such as Section 199 providing a benefit for domestic production would be eliminated, in exchange for lower tax rates overall. While US businesses would enjoy lower taxes, it is unclear that this would result in any repatriation of offshore earnings into the United States. While taxes are certainly a motivation for not repatriating funds, corporations doing business overseas may have non-tax reasons for retaining money offshore, including the costs of currency conversion back into US dollars. In addition, corporations with funds offshore will tend to continue to hold moneys outside of the US for purposes of foreign investment.
From the US standpoint, one issue would be the significant reduction to funds available for federal programs. Republicans tend to disagree when it comes to drastic reductions to federal programs, particularly those that affect their constituency, including roads, farm subsidies and public projects. While the United States could substantially increase deficit spending initially to maintain programs, from past experience during the Reagan years, drastic tax cuts were immediately counterbalanced by increasing tax rates and decreases in tax benefits in the following years.
Expectations for Enactment.
Not every proposal by an elected candidate becomes law. The realities of the budgetary process, particularly given the substantial deficit that would result from this proposal, would indicate some call for compromise. However, given a Republican House and Senate, and that the tenants proposed reflect the general sentiments of the Republican party, many of proposed provisions, or some lesser variation thereof, are likely to be enacted into law, effective possibly as early as the 2017-year.
While a wait-and-see approach may be prudent, Wagner Kirkman Blaine Klomparens and Youmans LLP is actively advising as to year-end tax planning in light of these proposals.