With the recent release of a tax reform framework by Republican leaders and the Trump Administration (Unified Framework), enactment of tax reform is still at the top of the Republican agenda. The timeline for 2017 is tight and a slide into the first quarter of 2018 seems likely. In light of the recently released details, we recommend that individuals take proactive measures to plan for changes that are likely to occur, including the elimination of targeted tax breaks that benefit the wealthiest taxpayers. The impact of the proposals are dependent on each particular taxpayer’s situation with respect to the mix of capital gain and ordinary income, types of deductions, and whether the taxpayer is currently subject to the alternative minimum tax. It is likely necessary to prepare detailed calculations to gather an understanding of how the proposals would affect an individual.
So what should individuals be doing now? Here are the highlights of some key points and tax planning opportunities:
- The Unified Framework calls for a 20% tax rate for C corporations and a 25% tax rate for small and family-owned businesses and a reduction from the seven current tax brackets to three brackets at 10%, 25%, and 35%. The framework provides discretion to create a higher fourth rate for the wealthiest individuals. A potential new top bracket is a significant shift in stance for Congressional Republicans and opens the possibility that the top rate will remain at 39.6% or could even increase as a part of tax reform. The present law 20% top capital gain rate is not mentioned and for now we presume it would otherwise be retained. The possibility of higher marginal tax rates for high-income taxpayers complicates planning and decisions about whether to defer discretionary income beyond 2017. The limitation of the 25% rate to small and family-owned businesses suggests that the tax base to which this special rate applies could be significantly narrowed compared with President Trump’s campaign promises.
- The 3.8% net investment income tax will not be considered as part of tax reform legislation. Instead, this tax is being considered as a part of health-care legislation which is currently stalled in the Senate. While healthcare reform was unsuccessful through the fiscal year 2017 budget reconciliation process, it is likely to be a Republican priority in fiscal 2018. Retroactive repeal of the net investment income tax for 2017 now seems very unlikely. The possibility of higher marginal tax rates for high-income taxpayers complicates planning and decisions about whether to defer discretionary income to which the 3.8% net investment income tax applies.
- The Unified Framework eliminates all itemized deductions other than for home mortgage interest and charitable giving, including the elimination of the deduction for state and local income and real property taxes. The elimination of deductions for state and local taxes and other deductions means that higher income taxpayers, particularly residents of high-tax states may experience a tax increase rather than a tax cut under the proposal, regardless of whether a fourth top tax bracket of 39.6% (or higher) is included.
- The Unified Framework renews calls to repeal the individual alternative minimum tax (AMT). However, as noted above, under the proposal the regular tax would become similar to the present law AMT with an increase in rate from 28% to 35%, or even 39.6% (or higher).
- The Unified Framework also calls for the repeal of the estate tax and generation skipping transfer tax but does not call for repeal of the gift tax. Until there is greater detail regarding the repeal of the estate tax, we recommend that individuals not make gifts that result in gift tax. Moreover, there is some belief that if the estate tax is repealed, the carry-over basis rules will replace the stepped-up basis rule. You should evaluate the impact that the potential repeal of the stepped-up basis rules would have on your individual estate plan.