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Monday, January 16, 2017

Trump Tax Reform Update # 1

Early in 2017, President-Elect Trump will be taking office with a large majority of Republicans in the House (235 to 191) and a majority of Republicans in the Senate (51 to 47).  One major focus of the new administration will be tax reform.

What exactly will the new tax legislation look like? At this point, there are more questions than answers: Will the Republicans be able to pass what they want in the way of tax reform or will the Democrats block or modify the changes.  Exactly what specific terms and policies do the Republicans want to accomplish in their tax reform? Are there differences between the designs of the Congressional Republicans and the new president on what new tax reforms should look like? Will the Republicans modify their goals in tax reform in order to get at least some support from the Democrats in Congress? How will the tax reforms coordinate with efforts to balance the budget and hopefully not add to the already staggering federal deficit? How will potential tax reform be impacted by other administration priorities like repeal of the healthcare law, illegal immigration, major infrastructure projects, etc.?

Of course, most if not all of us are highly focused on potential changes to the tax code as any change in taxes will likely have a significant impact on our assets and our families.  As of today, we don’t know for certain what the new legislation will include.  But, we do have knowledge and experience from prior administrations that we can draw on.

Let’s consider a few facts and see what we might expect from a Trump Administration with regard to tax reforms.

First, one central theme of Mr. Trump’s campaign was the reform of the corporate tax structure.  That was a theme early on in Mr. Trump’s campaign, and it was often repeated even up to election day.  It is also true, that towards the end of the campaign, Mr. Trump voiced his intention to provide personal income tax simplification and tax relief for the middle-class, and even an end to the estate tax!  That all sounds good, but will it in fact turn out to be all beneficial or might there be some little devils in the details?

What Tax Reform May Entail

The current expectation is that tax reform under President Trump will include the following: reduction of marginal income tax rates for all individuals and businesses, repeal personal exemptions, capping of itemized deductions (as of this writing in early January 2017, the current expectation is that Trump may eliminate some or many current deductions but likely would retain interest deductions on home mortgages, and most current charitable deductions).

New Income Tax Rules

Trump’s plan calls for three ordinary income tax brackets of 12%, 25% and 33%, maintaining current capital gains tax rates of 15% and 20%. Increase of the standard deduction from $6,300 to $15,000 for single filers and $12,600 to $30,000 for couples filing jointly.  The plan caps itemized deductions at $100,000 for single filers and $200,000 for married joint filers.  The Alternative Minimum Tax and the Net Income Tax would be repealed.  The rule on carried interest would be changed so that it would be taxed as ordinary income.

New Estate Tax and Transfer Tax Rules

Not quite as clear as the expected new law on income tax, but it appears the new administration will propose legislation that will repeal the estate tax.  It is also expected that the Generation Skipping Transfer Tax (GSTT) rules will be repealed as well.  Currently the expectation is that the Gift Tax rules will remain in place.  As yet to be determined, there is widespread speculation that the “Carry-Over Basis” rules may be repealed entirely or modified.  Remember, under the current law, property that is inherited from a decedent obtains a stepped-up basis to the value of the asset on the death of the decedent.  Thus, if a taxpayer received an asset from a decedent with a value of $100,000, even if the decedent had a basis in the asset of say $10,000, the recipient of the asset would get a stepped-up basis on the death of the decedent to $100,000 and could sell the asset without incurring any capital gains.  If there was no stepped-up basis, the recipient would receive the asset with the same basis as the decedent ($10,000) and on the sale of the asset, the recipient would have a capital gain on the difference between the decedent’s basis and the value on sale (presumably a long-term capital gain on $90,000).  There is some discussion of the new tax law include some amount of basis adjustment, such as much as perhaps $10,000,000 per decedent.

Business and International Taxes

The Trump tax proposals look to reduce the corporate taxes from 35% down to 15%.  There is a good bit of ambiguity in the current draft plans as to exactly which corporate taxpayers may be included in this reduced tax rate structure.  Keep in mind, millions of small business are taxed at the business owners’ individual tax rate, while C corporations are taxed at the applicable corporate tax rate.  Some commentators have pointed out that preliminary Trump tax reform calls for reduction to 15% for “all businesses, both big and small that want to retain the profits within the business.”  We’ll see what this means in the next few months or so.  On the international front, Mr. Trump proposes an offer to businesses to repatriate monies currently offshore, with a one-time 10% deemed repatriation on corporate profits held offshore (currently not taxed in the US until they are repatriated).  It has been suggested in public statements by Mr. Trump that this could bring in trillions of dollars and billions of tax dollars that would be utilized by the administration to fund a massive investment in US infrastructure.

Political Realities

Many seasoned observers of US politics predict a few of the following points regarding the context of the current political reality: (1) it is very likely that President Trump will try to move a majority of his ambitious legislation priorities within the first 100 days of his administration (this is a common practice among newly elected presidents as they hope to take advantage of their political capital as their new administration is established); (2) politically it would seem wise to offer legislation with at the very least some bipartisan support. Why? Because hopefully the Republicans learned from the Democrats’ passage of healthcare in 2010.  Whether you support the ACA (Obama Care) or not, it is clear that due to the fact that the Democrats passed the legislation without any bipartisan support, it became a major target of repeal or reform by the loyal opposition almost on the day of passage.  Many Republican leaders in Congress have already voiced their preference to working out some form of compromise legislation on tax reform that would result or at the least encourage some bipartisan support. (3) Both Republicans and Democrats have voiced concern of the continually growing Federal Deficit.  This would seem to foretell a need to offset any revenue reduction (tax reduction) with offsets of Federal spending; (4) Both Republicans and Democrats have expressed support for reform of corporate taxes, especially the issue of the currently very high US corporate tax rate of 35% (where many other developed countries impose as low a corporate rate as 15%).

The complexities of Congressional rules on budgets, resolutions and reconciliations are beyond the scope of this article but of critical consideration are the rules which allow passage of legislation related to taxes and budgets by either a simple majority (which the Republicans currently have in the Senate) versus a rule requiring 60 votes (making bipartisanship at least in the Senate a necessity) and the invocation of the so-called “Byrd Rule.”  Note that the “reconciliation process” is not subject to filibuster (a technique utilized by the minority party in the senate to prevent legislation from being voted on).  Under the Byrd Rule, any single Senator may call a point of order against any provision or amendment that is “extraneous” to the reconciliation, one of which is that the provision costs money (net loss of revenue dollars) beyond the budget window (typically 10 years).  The Byrd Rule is the reason President Bush’s “repeal of the estate tax” was sunset after 10 years (thereby avoiding the ability of any Democrat Senator from raising the Byrd Rule in opposition to the Bush estate tax repeal.

Will Estate Tax Repeal Mean the Death of Stepped-up Basis?

From sources widely published and discussed among the tax commentators and political reporters, there appears to be a counter balance to the proposed estate tax repeal.  That is the abolishment or perhaps modification of the “Stepped Up Basis Rule.” 

As mentioned earlier, the stepped-up basis rule under current law allows any property that passes due to the death of the taxpayer to receive a tax basis that is equal to the assets fair market value at the date of death.  If stepped up basis is modified or eliminated, it could generate tax revenues that could allow a compromise acceptable to some Democrats (especially in the Senate) and even some deficit hawk republicans (in both the Senate and the House).

Planning Considerations Under New Trump Tax Reform

Clearly there are some things we know and much we will need to await in order to see what is passed by Congress and signed into law by the new president.  Nonetheless, there are some general thoughts which should be considered by all tax payers and estate planning clients.

  1. Consider large charitable gifts and review the implications under what we know now is at the very least likely under the new tax reform.  This will mean different things to different taxpayers, but if the estate tax was a significant factor in the taxpayer’s calculation on the charitable gift, it might make sense to delay or reduce the amount of the gift until there is clarity on the estate tax and charitable rules under the new tax reform.
  2. Transfers to Irrevocable Trusts should be analyzed with an eye on increased flexibility.  Under Florida law it is possible to create an irrevocable trust that may be “decanted.” Decanting means that an irrevocable trust may be “poured-over” into a new irrevocable trusts with new or different terms or even beneficiaries.  Like the decanting of wine from a bottle to a decanting vessel. 
  3. Transfers of Closely-Held Businesses interests should also be analyzed with the focus on current rules and the proposed new regulations under the IRS newly proposed 2704.  This newly proposed regulation was initiated under the Obama Administration, and as of this point in time, there appears to be little to no certainty as to whether or not it will proceed or be dropped by the IRS under the new administration. If you are contemplating the transfer of interests in a close-held entity, stay tuned.
  4. Review of current estate plans will be critical as many trusts and in the case where the taxpayer doesn’t utilize a trust but only a Last Will & Testament, under the will, there are “formula clauses” that determine the funding of sub-trusts (like marital trusts, family trusts, bypass trusts, etc.).  As soon as we know what the new tax rules are, everyone with existing estate planning documents should at the very least have their documents reviewed by their estate planning attorney and perhaps discussed with their CPA as to how the new income tax and transfer tax rules may impact their estate plan.

Stay tuned for a very interesting and challenging 2017!

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