SBLC Takes A Deep Dive Into House Republican Tax Proposal

At the end of June, the Republicans on the House Ways and Means Committee released their tax reform proposal. This blueprint for tax reform is among a handful of issue-based proposals that House Republicans released to help frame the party platform in advance of the convention and the November elections. Now that it has had the opportunity to closely review the proposal and monitor various responses to it, the Small Business Legislative Council (SLBC) has followed up to provide more detail.

The proposal, which is presented in a report-style format and has not yet been reduced to legislative language, asserts that it will do three things—fuel job creation, make the tax code simpler and fairer and transform the IRS.

The proponents of the plan have stated that it is intended to be revenue neutral. However, the Joint Committee on Taxation has not yet performed an analysis of the proposal. The conservative leaning Tax Foundation has, using dynamic scoring, estimated that the proposal would reduce revenue by $191 billion over ten years. On the other hand, the more liberal Citizen Tax Justice Group has estimated that the proposal would increase the national debt by $4 trillion over 10 years. Needless to say, with many elements of the proposal still in generalities and with no legislative language—it is essentially impossible to predict its impact with much certainty.

The proposal targets three general areas for reform: corporate taxation, individual taxation and the Internal Revenue Service (IRS) as an entity.

Breaking down each of these focus areas, the key elements of the proposal are as follows:

Corporate Tax Reform

  • The proposal would reduce the top corporate tax rate to 20 percent (from the current 35 percent). This would represent the biggest tax cut in history.
  • S corporations and pass-through entities would not be subject to the individual tax rate but would rather be subject to their own tax brackets with a top rate of 25 percent. [This is a change in the right direction, but we don’t see why the rates between pass-through entities and C corps shouldn’t be the same.]
  • The proposal would repeal the Alternative Minimum Tax (AMT) for both individuals and corporations.
  • The proposal would eliminate the current depreciation rules and instead provide for full immediate write-off of investments.
  • The proposal would allow interest expenses to be deducted against interest income. Any net interest expense could be carried forward indefinitely and allowed as a deduction against interest income in future years. The proposal indicates that the Ways and Means Committee would work to prepare special rules for financial services companies.
  • The proposal would preserve the last in first out (LIFO) accounting method and the Research and Development Credit.
  • The proposal would eliminate “special interest deductions and credits.” The proposal is not totally clear as to what is captured by this definition but it does indicate that this would include the domestic production deduction (Section 199) which the proposal indicates will no longer be necessary.
  • To address corporate inversions, the proposal would move the country to a destination and territorial-based tax system under which the location of the consumption rather than the production would be the relevant factor.
  • The proposal would include a one-time repatriation rate of 8.75 percent for cash or liquid items abroad and a 3.5 percent rate for other assets. Companies repatriating assets would have eight years to pay these taxes.
  • The proposal would provide a 100-percent exemption for dividends from foreign subsidiaries.

Individuals

  • The proposal would consolidate the current seven tax brackets into three at 0/12 percent (not sure what 0/12 percent means), 25 percent and a top rate of 33 percent (currently top rate is 39.6 percent).
  • The proposal would allow individuals to deduct 50 percent of net capital gains, dividends and interest income. Any remaining investment income would be taxed at six percent, 12.5 percent or 16.5 percent depending on the individual’s tax bracket.
  • The proposal would establish simplified “postcard filing” for individuals in which the entire tax filing would be reduced to a postcard. A big stated goal of the proposal is to reduce the number of tax payers itemizing.
  • The proposal would consolidate the standard deduction, the additional standard deduction and the personal exemptions (including for children and dependents) and instead provide for an inflation adjusted deduction of $24,000 for married filing jointly, $18,000 for single with a child and $12,000 for individuals.
  • The proposal would convert the dependent exemption and child tax credits into a $1,500 child tax credit with the first $1,000 being refundable and a $500 credit for non-child dependents. The proposal would also adjust the phase-out for married joint filers, allowing married couples to earn up to $150k before the phase out.
  • The proposal retains the Earned Income Tax Credit (EITC) but directs the Ways and Means Committee to look into ways to reduce fraud.
  • The proposal states that the Ways and Means Committee will work to develop a proposal to consolidate the higher education benefits to make them more effective.
  • Under the proposal, health insurance will continue to be excluded from income. [We have heard, however, from a very reliable source, that they expect the legislation to have a 75-percent cap on the tax exclusion for health care on the individual side but retain the 100 percent deduction for health insurance on the employer side.]
  • Under the proposal, retirement savings incentives will be retained and the Ways and Means Committee states that it will be examining options to make retirement savings more efficient. [We’ll need to monitor this carefully since often making retirement savings more efficient is a euphemism for cutting back on available options and contribution levels.]
  • The proposal would eliminate all itemized deductions except for the mortgage interest deduction and the charitable deduction. [The loss of the deduction for state income taxes could hit some taxpayers very hard.]
  • Finally, the proposal would repeal the estate and gift tax. [Note that there is no mention of retaining the step-up in basis in the proposal. Thus, the repeal of the estate tax without a retention of the step-up in basis would be, for the vast majority of small business owners, a tax increase.]

Internal Revenue Service (IRS)

  • The proposal states that it would streamline the IRS by moving it towards a “service first” mission and creating separate individual and business units.
  • The proposal would create an independent small claims court independent of the IRS, to resolve routine tax disputes.
  • The proposal would create an IRS Administrator appointed by the president with the advice and consent of the Senate.

Overall the proposal retains most of the big ticket items, like the home mortgage deduction and the earned income tax credit, the repeal of which would make the proposal more controversial.  The proposal would provide more favorable treatment to S corporations and pass-through entities but still does not place them on a level playing field with C corporations. We are also concerned by the fact that, in repealing the estate tax and GST tax, the proposal does not mention the step-up in basis (which, as we have discussed in prior alerts, could prove problematic for small businesses and their owners).

The bottom line is that, because it is not in legislative form, the proposal lacks the level of specificity that will be necessary to identify how many of these proposals will impact small businesses and their owners.  Moreover, it is unclear how this proposal would be revenue neutral and, if it is, what the revenue raisers would be.

Responses to the Plan

As can be expected, the response to the proposal has been divided largely along party lines.

Congressman Sander Levin (D-MI), the ranking member on Ways and Means, criticized the proposal as being overly broad and lacking details. Others on the left have criticized the proposal as helping the rich by shifting the tax burden more towards compensation and away from investment income.

Reports have been that Republican Presidential Nominee Donald Trump has reacted positively to the proposal after staff level talks. Trump’s own tax proposal would reduce tax revenue (10.1 trillion over 10 years as estimated by the Tax Foundation) far more severely than the House proposal. However, this proposal and budget number have raised concerns from both sides of the aisle. Obviously, the outcome of the election, including which party wins the White House and which party controls each chamber will largely determine the future of the proposal and whether it will get consideration next year.

Produced by the SBLC, of which PPAI is a member and PPAI president and CEO Paul Bellantone, CAE, serves as a board director, the SBLC Report offers a quick and candid review of what’s going on in Washington. The mission of the SBLC is twofold: to make improvements in public policy for small business and to help member associations in their communications with business members. Please note that this weekly is for the sole personal, informational use of PPAI members and should not be posted to any website.    

filed under industry-news | july-2016
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