As Donald Trump settles into his new presidency, it is an appropriate time to revisit tax proposals1 articulated by both President Trump and House Republicans, as well as their potential impact on comprehensive tax reform. Recently, President Trump indicated that a formal tax plan will be released by the administration in the forthcoming weeks. If enacted, the type of changes that are currently being considered would greatly transform the current tax system for both individual and business taxpayers.
This Stroock Special Bulletin provides a general overview of President Trump's preliminary tax proposal ("Preliminary Trump Plan"), and highlights differences from a similar proposal outlined by House Republicans.
Individual Income Tax
With respect to individual income tax rates, the Preliminary Trump Plan mirrors that of the House Republicans. Under both plans, taxpayers would fall into three brackets: 12, 25, and 33 percent. Maximum rates would be applicable to income over $225,000 ($112,500 for single filers). Additionally, both plans aim to place a limit on itemized deductions. The Preliminary Trump Plan would limit claims of itemized deductions to $200,000 ($100,000 for single filers), while House Republicans would eliminate all itemized deductions other than for mortgage interest or charitable contributions. Note that both plans look to increase the standard deduction. Thus, the increase in the standard deduction potentially may lead to a decrease in the number of taxpayers choosing to itemize.
Observation - The elimination of (or limitation on) an itemized deduction for state and local income taxes could have a significant effect on taxpayers residing or working in high-taxed state and local jurisdictions.
Alternative Minimum Tax
President Trump and House Republicans also aim to repeal the alternative minimum tax (AMT). The AMT originally was established to address concerns that the tax law permitted some high income taxpayers to pay minimal or no tax, while taxpayers with less income were paying a higher percentage of their income in tax.2 Although the AMT has evolved throughout the years, the general idea is for taxpayers to calculate their tax liability twice, and then pay the higher of the regular tax calculation or the AMT calculation (with a potential offsetting credit in later years for some or all of the amount paid as AMT). Eliminating the AMT would be in line with President Trump's goal to simplify the tax code.
Observation - Eliminating the AMT will benefit taxpayers in medium income brackets and significantly simplify their tax reporting.
Both plans call for a repeal of the 3.8 percent Affordable Care Act tax on net investment income (NIIT).3 Taxpayers earning an adjusted gross income of more than $250,000 for joint filers ($200,000 for single filers) are subject to NIIT on the lesser of net investment income for the taxable year or the excess of (i) taxpayer's modified AGI over (ii) the threshold amount.4 This additional tax is computed differently in some respects than the regular tax and the AMT, and necessitates three calculations of taxable income.
In addition to eliminating the NIIT, the Preliminary Trump Plan would retain the existing capital gains rate structure with the new individual income tax brackets.5 Thus, taxpayers falling into the highest tax rate bracket of 33 percent would be subject to a maximum rate of 20 percent on long-term capital gains. House Republicans concerned with the issue of double taxation on income from savings and investment believe that the existing capital gains rate structure only "partially mitigates" the problem.6 House Republicans noted that the addition of the NIIT, as well as the Pease limitations on itemized deductions, can push the tax rate on capital gains and dividends to nearly 25 percent.7 For that reason, their plan would reduce the tax imposed on investment income by allowing taxpayers to deduct 50 percent of their net capital gains, dividends, and interest income (note the Preliminary Trump Plan is silent in regards to dividends and interest income). The result of this deduction would be to reduce tax rates to 6, 12.5, and 16.5 percent on such income.
Observation – Maintenance or reduction of tax rates on investment income is likely to facilitate increased investment and trading activity. Additionally, uncertainty as to whether and when these changes may be implemented could significantly affect timing decisions by individuals as to holding or disposing of assets.
President Trump has called for the elimination of the carried interest tax regime that allows for profits stemming from long-term investments by sponsors of private funds to be taxed at a capital gains rate of 20 percent plus a 3.8 percent NIIT. This tax rate is markedly less than the highest ordinary income tax rate of 43.4 percent (inclusive of NIIT). President Trump has pushed for carried interest to be taxed as ordinary income, emphasizing that carried interest has been "so good for Wall Street investors, and people like [President Trump], but unfair to American workers."8
Although House Republicans have not addressed this subject in their plan, House Ways and Means Committee Chairman Kevin Brady has previously stated that House Republicans would consider whether a change to carried interest should be included in any tax reform package.9
Observation - Close attention will be paid by private fund sponsors and real estate entrepreneurs as to whether carried interest legislation will be adopted and, if so, possible strategies to restructure the investment form of their activities.
1 "Tax Reform That Will Make America Great Again," September 14, 2016. See "Fact Sheet: Donald J. Trump's Pro-Growth Economic Policy" available at https://www.donaldjtrump.com/press-releases/fact-sheet-donald-j.-trumps-pro-growth-economic-policy-will-create-25-milli . See also "A Better Way, Our Vision for a Confident America: Tax," June 24, 2016, available at http://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf .
2 Starczewski, 587-3rd T.M., Noncorporate Alternative Minimum Tax.
3 26 U.S.C § 1411(c)(1). The net investment income tax includes gross income from interest, dividends, annuities, royalties and rent, as well as gains on the disposition of property.
4 Id. at § 1411(a)(1).
5 "Tax Reform That Will Make America Great Again," September 14, 2016.
6 "A Better Way, Our Vision for a Confident America: Tax," June 24, 2016. http://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf .
7 Note the Pease limitation was aimed at limiting some itemized deductions for high income earners.
8 "An America First Economic Plan: Winning The Global Competition," Aug. 8, 2016, available at https://www.donaldjtrump.com/press-releases/an-america-first-economic-plan-winning-the-global-competition .
9 Bloomberg Politics, "Brady Says Carried Interest Tax Provision Under Study," Nov. 15, 2016, available at https://www.bloomberg.com/politics/trackers/2016-11-15/brady-expect-no-action-on-carried-interest-tax-until-fall-2017 .
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.