United States: Republicans Release New Tax Reform Framework

On September 27, 2017, the Trump administration and Republican leaders in Congress released their "Unified Framework for Fixing our Broken Tax Code." This nine-page document is the result of months of meetings on tax reform by the so-called Big Six: Treasury Secretary Steve Mnuchin, National Economic Council Director Gary Cohn, House Speaker Paul Ryan, Senate Majority Leader Mitch McConnell, House Ways and Means Committee Chairman Kevin Brady and Senate Finance Committee Chairman Orrin Hatch.

The goal of the framework is to move the tax reform process forward, in particular to build support for a budget resolution that will permit the House and Senate to pass tax reform legislation by a simple majority vote. With that goal in mind, the framework answers several important questions regarding tax reform, but it leaves far more either unanswered or with too brief or too vague of a description to evaluate.

Because it is an advocacy piece, the framework is light on details. And, when it has details, they generally focus on the good news (e.g., taxpayer-favorable provisions that are being added or expanded) rather than the bad news (e.g., provisions being eliminated or reduced). Further, in many cases, the framework uses guarded language or caveats when discussing politically sensitive areas. For example, the framework "aims" to consolidate the tax rates for individuals, "envisions" changing inflation adjustments and repealing provisions to make the tax code simpler and "contemplates" preventing wealthy individuals from avoiding the top personal tax rate. Areas that are still unsettled or where further work is required are left to the Ways and Means Committee and the Finance Committee to work through and resolve.

What the framework says

A. Rates

Individuals

The framework "aims" to consolidate the current seven tax brackets into three brackets of 12 percent, 25 percent and 35 percent, although it warns ominously that "an additional top rate may apply to the highest-income taxpayers to ensure that the reformed tax code is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers." The framework also calls for use of a more accurate (i.e., less taxpayer-favorable) measure of inflation for purposes of indexing the tax brackets and other tax parameters.

Businesses

For corporations, the framework would reduce the top tax rate to 20 percent. It notes that "the committees also may consider methods to reduce the double taxation of corporate earnings," leaving open the possibility of a corporate integration proposal.

For pass-through entities, the framework would "limit the maximum tax rate applied to the business income of small and family-owned businesses conducted as sole proprietorships, partnerships and S corporations to 25%." Nonetheless, the framework "contemplates that the committees will adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate."

B. Deductions, exclusions and exemptions

Individuals

The framework would:

  • Combine the existing standard deduction and the personal exemptions for taxpayer and spouse and increase it to US$24,000 for married taxpayers filing jointly and US$12,000 for single filers
  • Convert existing personal exemptions for dependents into an enhanced child tax credit or a non-refundable US$500 credit for non-child dependents
  • Eliminate "most" itemized deductions, but "retain tax incentives for home mortgage interest and charitable contributions"
  • Retain "tax benefits that encourage work, higher education and retirement security," although the committees are encouraged to simplify them "to improve their efficiency and effectiveness"

Punted to the committees:

  • "Work on additional measures to meaningfully reduce the tax burden on the middle-class"
  • Repeal of many of the "numerous" exemptions, deductions and credits for individuals that "riddle the tax code" in order to "make the system simpler and fairer"
  • The appropriate treatment of interest paid by non-corporate taxpayers

Businesses

The framework:

  • Would provide immediate expensing, for at least a five-year period, for all depreciable assets—other than structures—acquired after September 27, 2017
  • States that the deduction for net interest expense incurred by C corporations will be partially limited
  • Specifically calls for the repeal of the section 199 manufacturing deduction, and states that "numerous other special exclusions and deductions will be repealed or restricted," with two explicit exceptions: the R&D tax credit and the low-income housing tax credit; however, "the committees may decide to retain some other business credits to the extent budgetary limitations allow"
  • Would "modernize" the tax rules affecting specific industries "to ensure that the tax code better reflects economic reality and that such rules provide little opportunity for tax avoidance"

C. Repealed

The framework would repeal:

  • The individual alternative minimum tax (AMT)
  • The corporate AMT (or at least would "aim to")
  • The estate tax and generation-skipping transfer tax

D. International tax reform

The framework:

  • Calls for adoption of a new "territorial" tax system with a 100 percent exemption for dividends from foreign companies in which the US parent owns 10 percent or more of the shares. However, this dividend exemption comes at price: "to prevent companies from shifting profits to tax havens, the framework includes rules to protect the US tax base by taxing at a reduced rate and on a global basis the foreign profits of US multinational corporations."
  • Would impose a "deemed repatriation" tax on US multinationals with offshore earnings. Different rates would apply to earnings held in liquid and illiquid form, although neither the rates nor the period over which the payments must be made is specified.
  • States that the committees will incorporate rules to level the playing field between US-headquartered parent companies and foreign-headquartered parent companies.

What the framework doesn't address

  • Effective dates (other than for expensing)
  • Phase-ins and transition rules
  • How the international tax rules would apply to individuals
  • How it plans to comply with the budget rules
  • Whether there are changes to the gift tax and basis step up at death provisions.

Next steps

The House and Senate have to agree on a budget resolution that provides for a tax reform package in line with the framework. Once that is agreed to, the Ways and Means Committee and Finance Committee can proceed to marking up tax reform legislation and filling in the blanks.

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