As lawmakers in Congress mull the real possibility of comprehensive tax reform during the Trump administration, various proposals are being debated before legislation is introduced.
Last month, as Donald Trump was getting set to take the oath of office, his transition team unveiled a “Contract with the American Voter,” outlining his 100-day plan to “make America Great Again,” including vague plans for a Middle Class Tax Relief and Simplification Act (see Trump plans to introduce tax reform legislation in first 100 days). House Republicans issued their own set of tax reform proposals last June as part of their “A Better Way” plans, but that was more of a framework.
The tax reform proposals that emerge this year may borrow from ideas promoted last year on the campaign trail, and others like the border adjustment tax on imports that Republicans have described in recent weeks (see House tax chief pitches border-adjusted plan that Trump snubbed).
To sort out some of the possibilities, Grant Thornton released a Frequently Asked Questions page on the tax reform outlook in late January. Mel Schwarz, a partner and director of tax legislative affairs in Grant Thornton’s Washington National Tax Office, co-wrote the FAQ. He expects to see Congress moving tax reform forward in the next few months.
“I think that the leadership is still sticking to the idea that they’re going to be moving this through the first part of this year,” he said. “We still expect to see that happen, at least on the House side.”
However, he cautioned that GOP leaders in Congress and the Trump administration still need to get on the same page. “A lot depends upon whether or not and to what extent there can be a meeting of the minds between the House Republican leadership and the Trump administration,” said Schwarz. “That is probably going to be the most important item in determining exactly what is included in the legislation that the House tries to move forward.”
Border Adjustment Tax
The border adjustment tax is sure to be one of the more controversial items on the agenda, as some observers warn it could lead to a trade war with some of the U.S.’s biggest trading partners, challenges from the World Trade Organization, and increases in consumer prices for items like food and clothing. However, Schwarz thinks it will be an essential part of tax reform.
“Our understanding is that the border adjustment tax is a significant revenue component of the House Republicans, and it’s going to be difficult for them to drop it entirely,” he said. “I think there’s also a desire to include something that will be directed towards accelerating manufacturing capacity in the United States, which this should do.”
He foresees complications arising during a transition to the new rules. “There are always questions of how do you get from point A to point B,” said Schwarz. “Clearly how transition rules are written is going to be very important. I think some consideration will also be given possibly to situations where there really is not a domestic alternative to products that are imported. We have certainly heard that raised in a number of different industries.”
He sees the border adjustment tax as less controversial than an old-fashioned direct tariff would be. In combination with a reduction in the corporate tax rate, he believes it could even lead to lower consumer prices.
Another priority for Republican lawmakers and Trump is allowing multinational companies to repatriate the profits they have kept offshore in low-tax countries and bring them back to the U.S. at more favorable tax rates.
“That would be a reasonable item to be included in an overall shift, whether or not we go to border adjustability, the shift that’s been long discussed of going from our current worldwide tax system to a more territorial-based tax system, where if you earn the money overseas, you don’t pay U.S. tax on it, as opposed to right now where you pay the foreign tax, and then when you bring it back you get a credit. If our tax would have been higher, you have to pay the difference,” said Schwarz. “The idea of a mandatory repatriation at a significantly reduced tax rate, I think we are likely to see included in any tax reform package.”
On the personal income tax side, Trump’s plan and the House Republican plan have some differences on tax deductions. During the campaign, Trump proposed a cap of $100,000 on itemized deductions for single taxpayers and $200,000 for joint filers. In contrast, the House Republican plan doesn’t include a dollar limit but instead would eliminate most itemized deductions altogether. The House GOP plan does retain the deductions for mortgage interest and charitable giving, although those incentives could become less attractive for taxpayers who might prefer the higher standard deduction also envisioned by House Republicans.
“I would suspect there will be changes with regard to what happens with the itemized deduction,” said Schwarz. “We’ll have to wait and see, but I think the idea of some form of a limit on the deductions—both what is available as a deduction as well as a limit on the overall benefit of the deduction—we’re likely to see both of those in play. The big issue is going to be the deduction of state taxes. Lots of people who take significant deductions for state taxes as itemized deductions probably lose those deductions because they’re subject to the alternative minimum tax.”
House Republicans have long called for the elimination of the AMT, and that might finally happen with the Trump administration and a Republican-controlled Congress, although the ability to deduct state taxes might be a casualty.
“I think the disappearance of the individual alternative minimum tax is a strong likelihood for inclusion in this legislation,” said Schwarz. “Also keep in mind there is discussion about increasing the standard deduction. The more you increase the standard deductions, the fewer people who itemize, and the fewer people itemized deductions matter to.”
Another perennial proposal from Republican lawmakers is eliminating the estate tax, but that too has its complications.
“There are a couple of concerns,” said Schwarz. “One is do you just make the estate tax and gift tax go away, which I think is the way a lot of people view the proposal. Trump’s proposal was once you got above a certain amount of estate, then you’d have to mark to market and pay tax then at capital gains rates. I think he proposes a change there that gets us down to 16.5 percent. Arguably what you’re doing is raising the trigger amount and you’re cutting the estate tax in half because that’s going to be taxed as capital gains now, as opposed to paying estate taxes.”
But accountants might still need to deal with basis calculations, as they did when the estate tax rate went down to zero in 2010 as a result of the Bush tax cuts. “The estate tax is not just going to go away,” said Schwarz. “In a lot of ways, the idea of a tax at a significantly reduced rate, at the capital gains rate, may well be preferable to carryover basis. That was the rule we had in the Bush repeal of the estate tax. You didn’t have to pay any estate tax anymore, but you don’t get to increase the basis in what you inherit—the date of death value—and that of course raises problems like what did grandma pay for this back in the 1940s?”
Whatever happens in Washington, don’t expect to see the legislation right away.
“There is still a desire to move sooner rather than later, but this stuff is very hard,” Schwarz noted. “A lot of people want to go back to the ’86 Tax Reform Act when the committees—both the Ways and Means and the Finance Committees—did not have to settle on legislative language. They had what they called a ‘conceptual markup.’ It’s very different now. They can still do a conceptual markup in the Senate where they’ll describe what they want and then send staff off to write it. But in the House you’ve got to have legislative language. For a project of this size, that’s a huge additional undertaking. It requires a lot of staff time and it’s going to require a lot of member time because it’s not just what staff writes. The members need to review it, and their staffs need to help them understand what the legislative language says. Everyone would like for this to move as fast as possible, but it’s a big project and it may just need to take some additional time.”