Trump Wins Presidential Election: Potential Federal Tax Impacts

By: Jerald David August

The presidential election is history and Donald J. Trump is President-elect. We all know that Mr. Trump has promised substantial reductions in the federal income tax rates applicable to both individuals and businesses in a major effort to stimulate our economy and provide for GDP growth in excess of 3.5% each year.  His vision is to create 25 million new jobs over the next ten years.

The outline of his proposals on federal taxation (the “Trump Tax Plan”) would further increase the standard deduction allowed individuals to close to four times its current level. Tax rates would be substantially reduced particularly for business profits. As an offset, the Trump Tax Plan would limit or remove certain tax deductions or credits that have long been part of our Internal Revenue Code.  

The Trump Tax Plan is estimated to reduce federal gross revenues by close to $10 trillion over its so-called “scoring period” of ten years. It is expected, however, that the expected increase in capital investment in the United States, growth in jobs in various domestic financial markets, and the tax on the repatriation of trillions of dollars of offshore profits warehoused for years by large public and private concerns will more than exceed the cost of the tax reduction and thereby reduce the overall federal deficit.  

The marginal tax rates cuts are expected to increase incentives to work, save and invest. It is also anticipated that other tax proposals currently circulating among House and Senate Republicans, and well as new proposals, may find their way into the Trump Tax Plan. The Trump Tax Plan should be expected to be introduced in the next session of Congress perhaps as a comprehensive tax reform legislation package or alternative as part of a budget reconciliation bill under fast-track type rules.  

While the Trump Tax Plan has been announced for some time our clients and friends of the Firm should take a new look at the major proposals that may be part of the legislative package introduced in early 2017.

Proposed Changes in the Individual Income Tax

  1. Replace the current seven income tax brackets ranging from 10% to 39.6% into three brackets of 10%, 20% and 25%.

  2. Increase the standard deduction to $50,000 for joint returns and $25,000 for individuals.

  3. Capital gains and dividend income would be taxed at a maximum rate of 20%. Carried interest income may be taxed as ordinary business income at the maximum rate of 15%, as discussed below. So at first glance it looks as if the carried interest holders are not being penalized at all. In fact there will be an overall rate reduction from the current tax impact on economic benefits realized on carried interest from 23.8%, i.e.,  long term capital gain and passive investment income tax, to 15%.

  4. Reduction in amount of allowable itemized deductions (other than mortgage interest and charitable contributions) and elimination of income tax exclusions for employer provided health insurance and tax-exempt interest.

  5. Repeal of the individual alternative minimum tax.

  6. Imposed income tax on the annual inside build-up on investment income on certain life insurance contracts issued after this year.

  7. As part of the repeal of the Affordable Care Act, eliminate the 3.8% net investment income tax on high income taxpayers, i.e. joint filers with annual income over $250,000 (not indexed for inflation) and single filers with annual income over $200,000.

Repeal of the Federal Transfer Tax

  1. The Trump Tax Plan includes the repeal of the federal estate and gift taxes, which presumably includes the generation skipping transfer tax. Note that the gift tax repeal may have some unintended side effects such as the ability to shift tax rates and tax burdens among affiliates or family members on an as desired basis. The repeal of the gift tax proposal might need a second look in the interests of proper tax administration.  

  2. With a repeal in the wealth tax there presumably will be consideration given by Congress to denying estates of decedents to obtain a step-up in basis under Code Section 1014. Otherwise, unrealized gains on assets held at death will not ever be subject to income tax (or estate tax).

Proposed Changes in the Income Taxation of Businesses

  1. Reduce the corporate income tax rate from its current maximum of 35% to 15%. Now that would place the United States towards the most favorable business tax rates among our treaty partners and is hoped will stimulate growth in our economy by domestic as well as foreign business concerns and investors.

  2. Limit the highest maximum individual income tax rate on partnerships, S corporations and other owners of other pass thru entities engaged in business operations to no more than 15%. This means that the maximum corporate and individual income tax rates on business income would be the same. Presumably dividends paid by C corporations to shareholders would still be nondeductible for federal income tax purposes.

  3. Repeal many tax-incentive tax credits, expenses and cost recovery and depletion allowances for businesses.

  4. Repeal the alternative minimum tax on corporations.

  5. Allow the repatriation of accumulated earnings and profits of foreign subsidiaries of U.S. companies at a tax cost of 10% payable over a deferred period of time.

  6. Tax the future earnings and profits of foreign subsidiaries of U.S. companies annually as the profits are realized. With the tremendous reduction in business income tax rates perhaps we won’t see the continuing trend over the past ten years or so for multinational corporations to engage in an inversion transaction and efforts to stop such exodus such as Code section 7874, which provision has been around for over a decade, as well as the new section 385 regulations and efforts by the Service to enforce other earnings stripping type provisions in the Code or regulations.

Possible Impacts of the Trump Tax Plan (Other Than Direct Incentives to Increase Capital Investment and Jobs in the United States)

  1. Reduction in net-tax cost of making charitable contributions since the 39.% maximum tax bracket is to be reduced 25% and with further due regard to the 15% maximum rate on business income realized by individuals who are owners in a business enterprise.

  2. With the highest tax rate on individuals having business income is 15%, as compared with wage earners at 25%, there is obviously incentive to realize business profits as owners or even perhaps as self-employed individuals although such outcome is presently unclear.

  3. With the reduction in many tax incentives in the Code allowing expensing and cost recovery allowances, and increasing the standard deduction, there may be less record keeping burdens on individual taxpayers. This is further evidenced by the proposed repeal of the individual alternative minimum tax as well as the Affordable Health Care Act 3.8% surcharge on net passive investment income.

  4. Specialized industries dependent on tax-advantaged investments such as oil and gas (depletion allowances); alternative energy production (tax credits); orphan drug research (credit for qualified research expenditures); private purpose exempt bonds (interest exclusion); specialized housing projects (historic tax credits; low income housing credits); life insurance (tax-free build up in cash surrender value); capital investment (15 year straight-line recovery for qualified leasehold improvements) and other incentives provided in the Code may greatly change capital improvement decisions.

  5. Wider look through for currently taxing earnings of a controlled foreign corporation.

  6. Foreign investors may directly benefit from the reduced rates of tax and applicable rate of withholding on investment as well as business income. That will in turn lead to reduced withholding rates on gains from interests in United States real property as well as ownership interests in pass through entities engaged in business in the U.S. While the Trump Tax Plan does not suggest that FACTA be repealed, don’t be surprise if this issue surfaces.

  7. Effective date. Uncertain at present of course but most likely Mr. Trump will want the tax legislation passed “immediately”, i.e., for taxable years beginning after the tax legislation is introduced into Congress perhaps with blended tax rates to be in effect for 2017.

Crystal Ball As to the Parts of the Trump Tax Plan That Gets Enacted Into Law?

There is no certainty at this time what parts of the Trump Tax Plan will be introduced into law and enacted by Congress next year but a major tax bill should be expected to be a key feature of the “first 100 days” plan of our new President. With a Republican controlled Senate and House it is likely something will pass early next year. But unless 60 votes in the Senate can be found to support the entire bill, it is possible that the shelf life of the Trump Tax Plan, as finally scripted, debated and polished, may sunset after ten years if enacted into law in 2017 as part of a reconciliation bill.

Now that the election is over, it definitely is time to start thinking about what the Trump Tax Plan will look like and how it will impact business and taxpayers, including foreign investors in U.S. businesses and investments. There will be much to digest and think about in the near future.

"Disclaimer of Use and Reliance: The information contained in this blog is intended solely for informational purposes and the benefit of the readers of this blog. Accordingly, the information  does  not constitute  the rendering of legal advice and may not be relied upon by the reader in addressing or otherwise taking a position on one or more specific tax issues or related legal matter for his or her own benefit or the for the benefit of a client or other person.” ©Jerald David August for Kostelanetz & Fink, LLP”