Trump's Tax Simplification Plan

Trump's Tax Simplification Plan
April 28th, 2017

Wednesday, Treasury Secretary Steven Mnuchin and White House National Economic Director Gary Cohn announced a broad outline of President Trump’s new tax plan. The highlights include a consolidation of the tax brackets, doubling the standard deduction, and the elimination of three highly divisive taxes: the alternative minimum tax, the 3.8% Medicare surcharge on investment income, and the estate tax. The administration is also proposing a one-time tax, to repatriate American corporations’ overseas funds that have not previously been taxed in the U.S. They coupled that directive with a huge reduction in the corporate tax to 15%. The outline was concise, but hardly clear and has left the media scrambling with headlines of “huge tax cut for the rich”, “Trump eases his burden” and “middle class not saving taxes”. We wanted to send you a breakdown of what was included, what wasn’t mentioned and Meridian’s take on the plan.

Simplification of the tax code: Simplification is certainly achieved by the reduction of 7 tax brackets to 3; 10%, 25%, and 35%. Doubling the standard deduction will also reduce the number of taxpayers that file a Schedule A for Itemized Deductions, reducing paperwork for the IRS. The home ownership and charitable deductions are specifically protected. While not specified in the memo, Mnuchin disclosed that state and local tax deductions were eliminated in their plan. The administration also proposed an elimination of the 3.8% Medicare surcharge on net investment income for taxpayers with $200K+ adjusted gross income (AGI). Not as publicized, there is a note on providing tax relief for escalating child care costs. We suspect that may translate to an increase in the Dependent FSA deferral limits.

  • What we don’t know: The tax bracket percentage reduction is only theoretical. Without clarifications on the bracket divisions (i.e. at what income level are taxpayers exposed to each new bracket), it is unclear how the new rates impact tax payers. Doubling the standard deduction will help offset this problem for low income earners without homes. Elimination of the state and local income tax deductions will put pressure on state governments to lower costs in the long-term, so we expect pushback from the high income tax states’ representatives. In the short-term, it’s a net negative for the taxpayers in those states, as this is perhaps the most utilized itemized deduction in the current tax code.

Bottom line: No clarity on impact of low and middle class taxpayers, certain benefit for high income earners, investors and business owners, certainly in the states with no income tax, like Texas.

A dramatic shift in business taxation: The reduction in the corporate tax rate from 35% to 15% (including pass through entities such as LLCs) would be a clear message that Trump wants offshore divisions of domestic companies back to the US. In fact, if they had not included the note “Territorial tax system to level the playing field for American companies”, we would have expected incentives for other countries to come here as well. The lack of clarity parallels the bracket division issue on the individual code: rate decreases but a wide range of changes on the expense deduction side could marginalize the benefit. “Eliminate tax breaks for special interests” and “Eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers” are pretty specific phrases. I expect that, as more details emerge, the proposed business code will be dramatically overhauled, changing the depreciation schedule and disallowing business deductions, possibly going so far as changing the nature of pass-through entities.

  • Debt and Revenue Neutral concerns: Mnuchin did not assert that this proposal is revenue neutral. The corporate tax rate reduction is so dramatic, it is unlikely that the loss of certain itemized deductions and targeted tax breaks can offset it. The final product will be negotiated and amended several times as it passes the House and Senate. The repatriation of cash, estimated to conservatively be more than $2 trillion, taxed at a conservative rate, could help moderately offset the business tax drop for one year, but the tax has been publicly discussed as being allocated to infrastructure spending. The Trump White House is hoping that the reduction in the corporate tax rate will bring businesses back state-side, increasing GDP and taxable revenue.

Bottom line: A reduction in corporate taxes to this scale is unlikely, but so was a Trump presidency. If enacted, a 15% corporate tax would provide huge tax savings to companies and could spur some capital investments, increased dividends, and hiring. The question is: can economic growth alone offset trillions in tax cuts?

Estate Tax Repeal

Estate taxes are currently only leveraged for deceased individuals with taxable assets of more than $5.49 million, or couples with more than $10.98 million. With portability in place, this effects a small percentage of Americans and is expected to generate approximately $20 billion in tax revenue this year1. As the beginning of the baby boomers start to turn 70, even without any estate tax changes, the Federal Budget shows those numbers are expected to double over the next 10 years.

Alternative Minimum Tax Repeal

The Alternative Minimum tax is a completely parallel tax system, often affecting retirees, managers and mid-level executives. Again, this is a tax system that is more likely to capture additional taxes from those in high-tax states, but not those in the top tax bracket. According to the Tax Policy center, about 30% of households of expanded cash income between $200,000 and $500,000 will be captured by the AMT. That rises to 62% for those with incomes between $500,000 and a million2. For 2014, that was $4.2 million taxpayers paying a combined $28.6 billion in alternative minimum taxes3.

For now, the priority will be to overhaul health care and pass a budget for the rest of the year. Our opinion is the oversimplified release just does not have enough meat to allow one to form a meaningful opinion. The Committee for a Responsible Federal Budget tried to model it and could only come up with a range cost of $3 to $7 trillion, which averaged would in turn impact the deficit to be anywhere from 89% to 111% of GDP4. It is likely that the administration is well aware that many of the proposed changes will be difficult to get through Congress and is positioning for negotiations with House and Senate leaders.

Included below is a link to the actual Press Release titled “2017 Tax Reform for Economic Growth and American Jobs” and video of the White House commentary.

As always, we are not tax advisors. Please check with your tax advisor before making any changes.

We certainly expect to have much more to discuss on this topic in the coming months. In the meantime, should you have any specific questions or points you would like to discuss, please don’t hesitate to reach out to us.