Recent Developments' Effects on Possible Tax Reform
Author: Damien Martin
There have been three recent actions in Washington that inform the outlook on possible tax reform:
- On April 26, the White House announced President Trump's guidelines on tax reform.
- Legislation to repeal and replace the Patient Protection and Affordable Care Act (ACA) passed the House on May 4.
- Tax reform legislation was introduced in the Senate on May 17.
These developments have made headlines in Washington. But what do they mean for you, and how do they affect the overall possibility of comprehensive tax reform?
Before exploring the answers, here’s a quick recap of reform-related activity in Washington to date:
- The House Ways and Means Committee’s blueprint for tax reform, “A Better Way: Our Vision for a Confident America” (House Blueprint), was released June 22, 2016, and provides the tax reform vision of House Republicans. A key and controversial aspect of the proposal is a move to a destination-based, cash flow system with border adjustability—learn more in our article, “Border Adjustment Tax Debate Heats Up.”
- President Trump campaigned on a platform that similarly calls for comprehensive tax change through lower individual and business tax rates.
- Republicans gained control of the White House and Congress with the November 8, 2016, election. As a result, the tax proposals of President Trump and House Republicans became likely starting points for tax change—see our article, “Election Results May Lead to Tax Changes in the New Year.”
- On the road to tax reform, the White House and House Republicans first set out to repeal and replace the ACA. A fiscal year (FY) 2017 budget resolution was passed on January 13, 2017, and the American Health Care Act (AHCA) was introduced to the House by the House Ways and Means and House Energy and Commerce committees on March 6, 2017—read our March 2017 alert.
- Efforts to repeal and replace the ACA were put on hold March 24, 2017, when the scheduled AHCA vote in the House was canceled due to lack of support. Following this announcement, the White House and Republican leadership in the House indicated they were shifting efforts to tax reform.
President Trump’s Tax Reform Guidelines
Tax reform discussions heated up April 26 when Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn announced President Trump’s tax reform vision. The announcement was accompanied by a one-page list containing 12 bullet points titled, “2017 Tax Reform for Economic Growth and American Jobs,” providing the president’s goals, process and guidelines for tax reform. The guidelines retain many of the president’s campaign proposals and report to purposefully lack details to foster negotiation and support with Congress. See highlights of President Trump’s guidelines and a comparison of current tax law to the House Blueprint on our Tax Reform Resource Center.
While there are many similarities between the president’s tax reform guidelines and campaign tax proposals, some key differences include:
- Individual tax brackets of 10 percent, 25 percent and 35 percent versus those of 12 percent, 25 percent and 33 percent discussed on the campaign trail and in the House Blueprint
- A switch to a territorial system for taxing foreign earnings that applies only to income earned within our borders
- The guidelines didn’t address immediate capital recovery or the loss of the interest deduction included in the campaign proposals
- The guidelines didn’t provide how the 15 percent rate on business income would apply to pass-through entities
- The guidelines didn’t take a position on carried interests
The destination based cash flow tax with border adjustability, a key aspect of the House Blueprint, also was noticeably absent from the announced guidelines.
AHCA Passes the House
Despite the March announcement that efforts to repeal and replace the ACA were on hold, House Republican leadership announced May 3 that votes had been secured to ensure AHCA passage. Changes were made to attract additional support, including allowing states to apply for a waiver if they establish a high-risk pool to cover individuals with high-cost health conditions and adding $8 billion in funding to subsidize coverage costs for people who could be affected as a result of the provision. After passing in the House with a narrow 217-213 margin on May 4, the next step for the bill is for House Speaker Paul Ryan to pass it to the Senate Finance Committee, which is expected once the Congressional Budget Office estimates its effects. Legislation is typically not held at this step; however, it appears Republican leadership in the House wants to ensure the bill conforms with budget reconciliation rules before sending.
The FY17 budget resolution means only a simple majority of 51 votes is necessary in the Senate for the legislation to advance and avoid filibuster. However, an important limitation to the budget reconciliation rules is that a 60-vote supermajority is necessary to approve provisions that lose revenue beyond the budget window, typically 10 years. Senate Finance Committee Chair Orrin Hatch has voiced concerns surrounding the ability to use these rules to eliminate all ACA taxes, which is a key aspect of the AHCA.
What does this mean for tax reform? Repeal of the ACA taxes through health care reform provides an easier path for tax reform efforts. Eliminating the ACA taxes is common ground in both the tax reform proposals of President Trump and House Republicans; however, it would likely require offsetting revenue raisers, an automatic sunset provision or a tax increase effective at the end of the budget window for tax reform legislation to advance using budget reconciliation procedures. Repealing these taxes outside of tax reform legislation would provide more flexibility to lower income tax rates within the current proposals without bipartisan support.
Senate Introduced Tax Reform Legislative Text
On May 17, Republican Senate Finance Committee member John Thune added to the tax reform discussion by introducing the Investment in New Ventures and Economic Success Today Act of 2017 (INVEST Act of 2017). Key aspects of the bill intended to be a significant component of an overall tax reform package for reducing individual and business tax rates include:
- Expansion of the deduction for startup and organizational expenses from $5,000 to $50,000 and an increase in the phaseout of the deduction from $50,000 to $100,000. Additional costs would be deducted through 10 years versus the current 15 years with the bill
- Simplification of accounting for small and midsize businesses with average annual gross receipts of $15 million or less by allowing these taxpayers to:
- Use the cash method of accounting
- Immediately deduct the cost of inventory, rather than employ an inventory method of accounting, e.g., specific identification, first-in-first-out or last-in-last-out
- Avoid the uniform capitalization rules, which generally require a business to capitalize direct and indirect costs of inventory. These costs are recovered as inventory is sold
- Avoid the completed contract method primarily used to account for small construction contracts
- Permanent increase of the Internal Revenue Code (IRC) Section 179 expensing limit to $2 million with a dollar-for-dollar phaseout beginning at $3 million as well as a broadening of the definition of property eligible for §179 expensing to include building costs such as roofs, heating, ventilation and air conditioning, fire protection and alarm and security systems
- Permanent extension of 50 percent bonus deprecation
- Reduction in the recovery period for farm machinery and equipment from seven to five years for farmers and ranchers, restoring a provision that expired in 2009
- Mandatory update of the schedule of property class lives by the end of 2020 and every five years thereafter starting in 2022. Property class lives are currently determined by Revenue Procedure 87-56
- Increase in the amount of the annual deduction for business cars, light trucks and vans up to $50,000 through six years as well as allowing 50 percent bonus deprecation up to $25,000 in the year the vehicle is placed in service
- Reduction in the recovery period for intangible property, e.g., goodwill, to 10 years from the current 15-year period
Much like with President Trump’s guidelines, there are key departures between the INVEST Act of 2017 and the House Blueprint. Fundamental differences include the House proposals of full expensing of all capital expenditures, elimination of the deduction for net interest expense and border adjustability.
Updated Outlook on Tax Reform
These three recent developments are steps in advancing tax reform, and the White House and Republican leadership in Congress are optimistic tax reform efforts will continue to move forward. This month, the Trump administration began actively working with Congress and other stakeholders to foster support and develop details of a plan that can pass the House and Senate. And as a step toward developing legislative text in the House, the House Ways and Means Committee held the first of a series of tax reform hearings May 18. Support to advance tax reform efforts also is coming from outside of the beltway with the May 18 announcement of a multimillion-dollar campaign to build momentum for tax reform by the Americans for Prosperity and Freedom Partners.
On the other hand, the developments also serve as a reminder that tax reform efforts are just getting underway. The journey ahead remains uncertain, as many key questions are unanswered and there are a limited number of working days left in Congress this year with many nontax-related items to be addressed. President Trump’s guidelines also raise questions about the administration’s position on aspects of tax reform by leaving out details necessary to understand how they would operate and excluding the president’s previous proposals. Further, differences between President Trump’s guidelines, the House Blueprint and INVEST Act of 2017 highlight the many difficult policy issues that have yet to be reconciled at this point despite Republican control in Washington.
At this point, the overall tax reform outlook remains uncertain following these developments, and it’s too early to accurately predict the timing or substance of tax reform. Even so, tax reform proposals advanced by the White House and Congressional Republicans call for lower individual and business tax rates. Taxpayers who expect to see lower tax rates in the future should evaluate tax planning strategies now that accelerate deductions and defer income. To learn more about how tax reform developments may affect your situation and discuss planning opportunities, contact your BKD advisor.