On September 27, 2017, the White House and Republican congressional leadership released a nine-page outline (the Framework) to guide the coming legislative effort on comprehensive tax reform. While the Framework offers few surprises and leaves critical details open, it does represent incremental progress toward achieving comprehensive tax reform and signals a major intensification of tax reform activity in the coming weeks and months.
Key Elements of the Framework
Individuals and Estates
- Three tax brackets (12 percent, 25 percent and 35 percent), with bracket income levels unstated
- Potential surtax or fourth bracket higher than 35 percent for highest-income taxpayers
- Increased standard deduction amount and expansion of child tax credit
- Modified approach to indexation throughout the tax code
- Repeal of the individual alternative minimum tax (AMT)
- General direction to eliminate itemized deductions, presumably including the deduction for state and local taxes, but not including mortgage interest and charitable gift deductions
- No suggestion of any (previously rumored) “Rothification” of retirement plans
- Elimination of estate and generation-skipping transfer taxes
General Business Taxation
- Corporate income tax rate reduced to 20 percent
- Pass-through tax rate (for sole proprietorships, subchapter S corporations and businesses taxed as partnerships) reduced to 25 percent, with unspecified restrictions to limit use of the pass-through rate to avoid the top individual rate
- Repeal of the corporate AMT
- Potential consideration of measures to reduce the double taxation of corporate earnings (an area of particular interest to Senate Finance Committee Chairman Orrin Hatch, who has been developing a corporate integration proposal)
- Accelerated recovery of certain capital expenses, including full expensing for at least a five-year period
- Partial and unspecified limits on deductions for net interest expense
- General direction to eliminate special deductions and credits, including the section 199 deduction for domestic production activities, but not including the R&D credit and the low-income housing credit
- Unspecified modernization of special tax regimes for specific industries
- Territorial dividend exemption for 100 percent of dividends received from foreign subsidiaries (in which a US parent owns at least 10 percent of the stock)
- Transition tax on currently accumulated foreign earnings under a deemed-repatriation model, employing a bifurcated rate (higher rate for earnings considered as held in the form of cash or cash equivalents), with rates and other details unspecified
- Imposition of a minimum tax on foreign earnings on a current basis, at a reduced rate, with rate and other details unspecified
- General direction to adopt measures to “level the playing field” between US-headquartered and foreign-headquartered parent companies
Observations and Likely Next Steps
Although the Framework remains a very high-level outline and provides little indication of whether and how its various desired tax-cutting measures might be achieved in view of budget and political limitations, the Framework is a useful first step in structuring what is sure to be an active and contentious phase of tax reform activity as the congressional tax writing committees get down to work.
The next hurdle will be congressional agreement on a budget resolution, which is needed in order for tax reform to proceed under a budget reconciliation process (requiring only a simple majority, rather than 60 votes, to clear the Senate). This resolution could accommodate a large, temporary overall tax cut, or it could require revenue neutrality. A key part of this discussion will be what revenue estimating approaches will apply for purposes of fitting the substantive legislation within whatever budget reconciliation instructions are ultimately adopted.
Meanwhile, the tax writing committees will be hard at work in developing detailed legislative language to implement the high-level concepts set forth in the Framework. As these details are filled in, hard choices will need to be made in order to fit a tax reform package within any realistic budget parameters, and countless important technical, timing and transition issues will inevitably arise.
The process is sure to be contentious, and the outcome uncertain, but it is safe to say that it is time for taxpayers to pay close attention to what is a rapidly intensifying tax reform effort. The McDermott Tax team is closely monitoring activity in this area, and is advising clients on potential impacts and planning responses. We will continue to provide general tax reform updates as circumstances warrant, as well as more detailed examinations of specific aspects of tax reform.