Republicans hit the microphones this week to reveal their “framework” for tax reform. The 35 page Better Way plan that originated on Paul Ryan’s desk back in June of 2016 has been watered down into the 9 page Unified Framework for Fixing Our Broken Tax Code released on Wednesday. For those uninterested in reading the source material, here are the highlights:
Lower Rates, Fewer Brackets - Brackets fall from 7 to 3+1 (12%, 25%, 35% and ??%). The plus one is a yet defined high income bracket meant to placate Democrats. Income levels where the brackets transition haven’t been determined.
Double Standard Deduction – This doubling takes the 0% tax bracket up to $24,000 for those married filing jointly. Since 75% of Americans don’t itemize, this doubling should provide additional relief. For the wealthy who itemize, it’s of no benefit. Most likely fewer will itemize in the future, further simplifying the code.
Increased Child Care Credit - Nice gesture, but undefined. Currently $1,000 per child. A new non-child dependent credit of $500 also appears for the first time.
Reduced Itemizations – For the 25% of Americans who itemize, reductions here take a toll. Mortgage, charitable, educational, and retirement itemizations stay, while state and local tax deductions go. Itemized deductibility will receive contentious debate, funded primarily by PACs located in Connecticut, New York, New Jersey and California. However, often the state tax deduction gets negated by the AMT so it may be a wash. Overall, fewer itemizations means fewer loopholes, loosely defined as deductions your neighbor qualifies for that you do not.
Repeal of Estate Tax and AMT - While the moral argument for the estate tax includes redistributing outsized family fortunes (see the Rockefeller’s), in reality, this tax generates more pain than revenue. For 2017, only 5,460 estates paid taxes totaling $20 billion. 98% of all estates in 2017 owed no tax at all as they totaled less that the current $5.5 million taxable threshold. Republicans argue that illiquid small businesses and farms get victimized by the tax, but, per the IRS, only 80 of the 5,400 returns filed impacted small businesses and farms. This may be a negotiable give up for the Republicans.
The AMT was adopted in the 1970’s to limit tax reduction strategies for the wealthy. However, income levels were not indexed for inflation and around 5 million filers now pay the AMT. This is just bad design and needs to go.
Big Business Tax Cut – The 35% corporate tax rate falls to 20%. Additionally, companies can write off business investments immediately rather than over time. Undoubtedly, adopting these provisions will support higher levels of employment, incomes and investment.
Small Business Tax Cut – Most small businesses simply pass their business income on to their owners. This results in a 39.6% business tax rate. Under the plan this rate falls to 25%. Clearly, this will result in entity gamesmanship as people attempt to convert compensation into distributions. The loophole seamstress has work to do here.
Eliminate Offshore Profits Tax - The United States taxes US corporations on repatriated profits generated in other territories. This provides incentive for large multinationals to stockpile cash overseas. No other developed country does this and we need to eliminate it to encourage even more investment within the US.
Notable absences to the framework include cuts to capital gains taxes and removal of the Obamacare tax array. Sad. In essence, this bill targets corporate tax relief with simplifications elsewhere. Luckily, this framework did harmonize the White House, Senate and House Republicans. This should reduce party infighting and direct negotiations across the aisle where they belong.
In sum, to quote Perry Green, our resident tax savant, “I have three criteria for the perfect tax system: low rates, easy preparation, and applicable to everyone except me. In the immortal words of Meatloaf, two outta three ain’t bad.”
Where to Invest Now
The reform provisions presented on Wednesday held little surprise. Trump broadcast his ambitions on the campaign trail and the Ryan led Republicans published their plans over a year ago. Nonetheless, the “odds” of passage have risen over the past month as talk became ink. To identify the investment winners, one only needs to look at the biggest legislative beneficiaries: