Presented by Scott Bartolf, CPA, MBA, CGMA The Current State of Tax Reform: Comparing President Trump s Plan to Others in the GOP
Agenda Discussion of President Trump s current plan for tax reform and how it would impact the taxation of individuals, corporations, and estates Examine similarities and differences between Trump s plan and the plans of other prominent GOP leaders Brady and Ryan Explore the GOP proposal for a border adjustment tax Consider planning ideas regarding the anticipated timing of tax reform 2
How Many Dollars are We Talking About? President Trump Tax Plan: Would reduce revenue over a 10 year period by $6+Trillion on a static scoring basis and $4+Trillion on a dynamic scoring basis GOP s A Better Way a blueprint for tax reform, authored by Kevin Brady, Chairman of the House Ways and Means Committee: would reduce revenue over a 10 year period by $2.5Trillion on a static scoring basis and $200+Billion on a dynamic scoring basis 3
Individual Income Tax: Tax Cuts vs. Tax Base Broadeners Primary Individual Cuts: marginal tax rate structure Current law has 7 rates: 10%, 15%, 25%, 28%, 33%, 35%, 39.6% Trump plan and Brady plan: 12%, 25%, 33% Primary Individual Base Broadeners: changes to itemized deductions and personal exemptions Current law: many itemized deductions allowed, subject to Pease limitation where taxpayers start losing 3% of itemized deductions as AGI exceeds $250k (S) and $300k (MFJ), $4,050 personal exemption Trump plan: itemized deductions capped at $100k S / $200k MFJ no personal exemptions Brady plan: No itemized deductions allowed except charitable contributions and mortgage interest no personal exemptions 4
Single Taxpayers Ordinary Rates Ordinary Income Tax Brackets Current Law Trump Brady $0-$10,350 0% 0% 0% $10,350-$15,000 10% 0% 0% $15,000-$19,625 10% 12% 12% $19,625-$48,000 15% 12% 12% $48,000-$52,500 25% 12% 12% $52,500-$101,500 25% 25% 25% $101,500-$127,500 28% 25% 25% $127,500-$200,500 28% 33% 25% $200,500-$423,700 33% 33% 33% $423,700-$425,400 35% 33% 33% Over $425,400 39.6% 33% 33% 5
Married Filing Jointly Ordinary Rates Ordinary Income Tax Rates Current Law Trump Brady $0-$20,700 0% 0% 0% $20,700-$30,000 10% 0% 12% $30,000-$39,250 10% 12% 12% $39,250-$96,000 15% 12% 12% $96,105-$105,000 25% 12% 25% $105,000-$172,600 25% 25% 25% $172,600-$252,150 28% 25% 25% $252,150-$255,000 33% 25% 25% $255,000-$433,750 33% 33% 33% $433,750-$487,650 35% 33% 33% Over $487,650 39.6% 33% 33% 6
Single Taxpayers Capital Gain Rates Capital Gains Tax Rates Current Law Trump Brady $0-$10,350 0% 0% 0% $10,350-$15,000 0% 0% 0% $15,000-$19,625 0% 0% 6% $19,625-$48,000 0% 0% 6% $48,000-$52,500 15% 0% 6% $52,500-$101,500 15% 15% 12.5% $101,500-$127,500 15% 15% 12.5% $127,500-$200,500 15% 20% 12.5% $200,500-$423,700 15% 20% 16.5% $423,700-$425,400 15% 20% 16.5% Over $487,650 20% 20% 16.5% 7
Married Filing Jointly Capital Gain Rates Capital Gains Tax Rates Current Law Trump Brady $0-$20,700 0% 0% 0% $20,700-$30,000 0% 0% 6% $30,000-$39,250 0% 0% 6% $39,250-$96,000 0% 0% 6% $96,105-$105,000 15% 0% 12.5% $105,000-$172,600 15% 15% 12.5% $172,600-$252,150 15% 15% 12.5% $252,150-$255,000 15% 15% 12.5% $255,000-$433,750 15% 20% 16.5% $433,750-$487,650 15% 20% 16.5% Over $487,650 20% 20% 16.5% 8
Comparing the Plans Issue Current Law Trump Brady Standard Deductions/ Personal Exemption $12,600 MFJ; $6,300 Single; Personal exemption: $4,050 Standard: $30,000 MFJ, $15,000 Single; eliminate personal exemptions Standard: $24,000 MFJ, $12,000 Single, $18,000 Single w/ child, eliminate personal exemptions increase CTC $1,500 Once a family exceeds four members, they are better off under current law. 27 million more taxpayers will take the standard deduction rather than itemize; simplifying return filings. According to a recent NYU study, the combination of the 12% bottom rate (in place of 10%), the loss of the head of household filing rates, and lost personal exemptions will raise taxes on 8M low-income taxpayers under Trump Plan. 9
Comparing the Plans Issue Current Law Trump Brady Child Benefits $1,000 child tax credit; EITC Keeps the child tax credit, keeps the child care credit, allows a deduction from AGI for child care expenses not counted in the child care credit ( if income < $500,000 Married, $250,000 Single). Child tax credit raised to $1,500, $1,000 refundable, raise phase-out from $110,000 to $150,000 10
Comparing the Plans Issue Current Law Trump Brady Alternative Minimum Tax Parallel tax calculation Repeals AMT Repeals AMT 11
Polling Question #1 What items must be added to a tax reform package to offset lost revenue from the proposed tax cuts? 12
Comparing the Plans Issue Current Law Trump Brady Net Investment Income Tacks an additional 3.8% surtax on interest, dividends, rents, royalties, passive business income Eliminates NII and the rest of the Affordable Care Act Repeal and Replace in a stable and deliberate transition 13
What Will Happen to The Affordable Care Act? There was a proposal to immediately repeal the tax aspects of the plan, but deal with the insurance issue in 2018/2019 3.8% Net investment income tax 0.9% Additional Medicare tax Individual mandate Employer mandate Repealing the tax aspects would result in a $350B tax cut to the nation s richest 1% Issue: Obamacare would implode without the tax aspects because with no denial for pre-existing conditions, young healthy people must be forced into the insurance market. Many in the GOP have acknowledged that the ACA cannot be repealed until a replacement is ready. About a month ago President Trump said he has a replacement ready last week at the Nat l Governor s Association he said Now, I have to tell you, it s an unbelievably complex subject. Nobody knew that health care could be so complicated. 14
Comparing the Plans Issue Current Law Trump Brady Estate Tax Rate 40% 0% 0% Estate Tax Exemption $5.45M N/A N/A Appreciation Step up in Basis Tax appreciation subject to $10M exemption Step up in Basis Note: Trump would tax all appreciation in a decedent s assets at capital gains rates, subject to a $10M exemption. It appears this would take effect as a carryover basis to heirs, rather than an immediate tax at death. 15
Corporate Income Tax: Tax Cuts vs. Tax Base Broadeners Primary Corporate Cuts: tax rates and full expensing Current top corporate rate: 35% Trump plan proposed corporate rate:15% Brady plan proposed corporate rate: 20% Current law regarding major asset purchases: capitalize and depreciate Trump plan can elect 100% expensing Brady plan Expense asset, production, and wage costs Primary Corporate Base Broadeners: Trump cannot deduct interest if elect immediate expensing, many other corporate deductions eliminated Brady Destination Based Cash Flow Tax (DBCFT), eliminate interest and other corporate deductions and credits 16
Comparing the Plans Issue Current Law Trump Brady Corporate Tax Rate 35% 15% Tariffs on imports 20% Destination based cash flow tax Corporate deductions Plentiful Can elect to immediately expense all asset acquisition costs; if elect to do so, cannot deduct interest expense Expense asset costs, production costs, and wages no other deductions allowed Rate on Flowthrough business Income Presumably ordinary rates Can elect max of 15%; Distributions from large pass-throughs would be taxed as dividends. Max rate of 25% 17
Comparing the Plans Issue Current Law Trump Brady International Tax: repatriation International Tax: new system $2.5T held overseas that has yet to be taxed in U.S. Deferral system; no US tax on foreign income of foreign affiliates until repatriated. Deemed repatriation of $2.5T of overseas profits at onetime 10% tax, payable over 10 years. Worldwide: tax foreign affiliates on income immediately Deemed repatriation of $2.5T of overseas profits at onetime 8.75% tax, payable over 8 years. Territorial tax system 18
Tallying the Costs Issue 10 year cost - Trump 10 year cost - Brady Individual Tax Rates $1.5T $2.6T Reduced Flow Through Rate $900B $515B Corporate Tax Rate $2.3T $1.8T 100% Expensing, No Interest, DBCFT Other (AMT, NIIT, Estate, Itemized, changes to corporate deductions) $700B $130B $600B ($2.545T) Total Cost $6T $2.5T 19
Polling Question #2 A surprising aspect of President Trump s proposal on estate tax which differs from the GOP proposal is his plan to: 20
The Border Adjustment Tax Destination-Based Cash-Flow Tax Completely change the way U.S corporations are taxed by shifting from a net income based tax to a production based tax Would treat exports favorably and imports unfavorably Designed to: raise revenue (over $1T over next decade) to make up for cuts to corporate rate Increase American jobs Dependent on: Many economic factors to perfectly align WTO approval and actions of other nations 21
Border Adjustment Tax Current U.S. Corporate Tax System: Taxes based on where goods are produced rather than where they are consumed 35% tax rate on the net income of U.S. corporations Regardless of whether products are sold domestically or internationally, all net income from production is taxed in the U.S. 22
Border Adjustment Tax Current U.S. Corporate Tax System: Taxed Domestic Production (Produced in U.S. and consumed in the U.S.) Not Taxed Imports (Produced in other countries and consumed in the U.S.) Exports (Produced in the U.S. and consumed in other countries) Foreign Production (Produced in other countries and consumed in other countries) 23
Border Adjustment Tax Current U.S. Corporate Tax System: A B C All sales made in the U.S. All sales made outside the U.S. Revenue $1,000 $1000 $1000 COGS ($600) ($600) ($600) Net Profit $400 $400 $400 Tax $140 $140 $140 All sales made in the U.S., product imported from subsidiary in China 24
Border Adjustment Tax Problems with the current U.S. Corporate Tax System: Imports not taxed: Since U.S. corporations get a deduction for any product they import, production that is done outside of the U.S. and then sold to the U.S. is not taxed Foreign companies not taxed: The income earned by foreign companies from selling products to the U.S. is not taxed by the U.S. Tax based incentive to leave U.S: Why not move production facilities to a foreign country where labor is cheaper and taxes are lower - and then sell the product back to the U.S.? (AKA what many U.S. companies have been doing for years). It is easy to take advantage of the system as follows: 25
Border Adjustment Tax C and Chinese Subsidiary raise price from $600 to $1,000 Revenue $1,000 COGS ($1,000) C Net Profit $0 Tax $0 All sales made in the U.S., product imported from subsidiary in China By raising the price to $1,000, C eliminates its U.S. tax and shifts an extra $400 of income to a lower-tax jurisdiction (China) 26
Border Adjustment Tax Problems with the current U.S. Corporate Tax System: Requires complicated transfer pricing rules to prevent C doing what we saw in the previous example (which if left uncontrolled would lead to significant tax-base erosion). Encourages imports - by providing the deduction for COGS for imported products, but Discourages exports - by taxing U.S. corporations on sales outside the U.S. You can see how a system which encourages imports and discourages exports coupled with a very high 35% corporate rate; provides tremendous motivation for U.S. corporations to move production overseas and then sell back to the U.S as we saw in C s example. 27
Border Adjustment Tax Solution proposed by GOP: Shift from a production based tax to a Destination-Based Tax Reduce corporate tax rate from 35% to 20% Tax would now be imposed on U.S. consumption rather than U.S. production Specifically, this new system would tax: Domestic made in the U.S. and sold within the U.S. Imports made in other countries and sold within the U.S. The system would not tax: Exports made in U.S. and sold to other countries Foreign made in other countries and sold to other countries 28
Border Adjustment Tax Solution proposed by GOP: Border adjustment part - the sale of goods out of and into the U.S. will be adjusted at the border. When goods produced in the U.S. are sold outside the U.S. (exports), the revenue generated from the sale will NOT be included in taxable revenue. When goods produced outside the U.S. are sold into the U.S. (imports), the U.S. corporation that purchases the import will not be entitled to deduct the cost of the import as COGS. The theory is that all of these changes will entice companies to stay in the U.S. as we will see shortly, the proposal is based on a tremendous amount of Theory which has opponents of the proposal worried. 29
Border Adjustment Tax Destination-Based Cash-Flow Tax Since a destination-based tax focuses on where the product is sold, rather than where it is produced, it taxes consumption, rather than production, and is more reminiscent of a Value Added Tax (VAT) than a true corporate income tax. This format is going to be required if the U.S. is going to adopt a border adjustment tax as we will discuss a bit later. Most corporate deductions that we know today will disappear and businesses will generally only be able to deduct costs of production Move to 100% deduction for asset acquisition costs (no depreciation) Interest expense in excess of interest income would not be able to be deducted (dependency on debt would be reduced and earnings would no longer be able to be stripped from the U.S. through a U.S. corporation borrowing from a tax-indifferent foreign corporation and deducting the interest payments in the U.S.) 30
Polling Question #3 The current U.S. Corporate Tax System imposes a tax on 31
Border Adjustment Tax What would the border-adjustment tax look like? A B C All sales made in the U.S. All sales made outside the U.S. Revenue $1,000 $0 $1,000 COGS ($600) ($600) $0 Net Profit $400 ($600) $1,000 Tax $80 ($120) $200 All sales made in the U.S., product imported from subsidiary in China 32
Border Adjustment Tax Results for companies A, B, and C: Company A profit is computed in the same manner, but a tax benefit is realized due to the reduced 20% rate Company B now has a large tax LOSS and will either be left with an NOL or potentially receive a rebate of $120 Company C now has a $1,000 profit and pays $200 in taxes. 33
Border Adjustment Tax Proposed U.S. Corporate Tax System with destinationbased cash-flow tax: Taxed Domestic Production (Produced in U.S. and consumed in the U.S.) Not Taxed Exports (Produced in the U.S. and consumed in other countries) Imports (Produced in other countries and consumed in the U.S.) Foreign Production (Produced in other countries and consumed in other countries) 34
Border Adjustment Tax A quick look at the results above illustrates Corporation C being harshly punished. It has lost a $600 deduction, and at a 20% rate, it has cost the company $120 in additional tax (would have been $400 * 20% = $80). Therefore, opponents of the tax believe that Corporation C will pass this tax on to consumers in the form of increased prices. On the other hand, supporters of the tax believe that the value of the U.S. dollar will rise under a border adjustment tax which would offset the tax implications to Corporation C. 35
Border Adjustment Tax - Economics The success of the new system would be highly dependent on several economic factors falling into place: Proponents argue that the value of the U.S. Dollar would rise due to supply and demand If the price of imported goods rises at all (at first), there will be a smaller demand in the U.S. for imports. As a result, we will buy fewer imported products, leaving less dollars in the hands of foreign sellers, meaning LESS SUPPLY of U.S. $. At the same time, because U.S. exporters will have a smaller tax bill, they will lower prices. This will increase demand for the product, which will result in GREATER DEMAND for the U.S. $. Greater demand + less supply = increase in value of the U.S. $. 36
Border Adjustment Tax - Economics Some economists believe the value of the dollar will rise by 25% and foreign currencies will depreciate by 20% If that happens, the $1,000 of revenue Company B gets from selling overseas (in foreign currency) would no be worth only $800. At the same time, the $600 of product Company C purchases from China would now only cost them only $480 in U.S. $. 37
Border Adjustment Tax - Economics What would the border-adjustment tax look like AFTER a currency adjustment? A B C All sales made in the U.S. All sales made outside the U.S. Real Profits $1,000 $800 $1,000 Real COGS ($600) ($600) ($480) Net Profits $400 $200 $520 Less: Tax ($80) $120 ($200) After-tax cash $320 $320 $320 All sales made in the U.S., product imported from subsidiary in China 38
Border Adjustment Tax - Economics What purpose would the border adjustment tax serve if everyone ends up in the same place? It would create incentive for U.S. corporations to stay home which would: Create U.S. jobs Simplify tax system (corporate deductions and transfer pricing) Raise $1T plus to offset drop in corporate tax rate: Since the U.S. currently operates at a trade deficit ($500B more imports than exports each year). 39
Border Adjustment Tax - Economics Would the border adjustment tax really influence trade (i.e., cause the U.S. to increase exports and decrease imports)? Most likely not over the long run because exports and imports are two sides of the same coin. Under current law, because the U.S. taxes exports and not imports, imports are reduced in the long run because fewer exports, means we have less cash to purchase imports. If we switch to the border adjustment tax, the U.S. will tax imports but not exports. This will reduce exports in the long run, because if demand for imports falls, foreign countries will not have enough U.S. $ to purchase U.S. products. 40
Border Adjustment Tax - Economics Therefore, the theory is that trade will not be influenced for one of two reasons: The value of the $ will increase, or The price of imports will increase If the value of the $ does not increase and instead the price of imports increases, it will drive U.S. consumers away from imports. This will drive up domestic prices, which would equalize prices with imports. As a result, imports and domestic goods should remain on equal footing as under current law per the example we looked at above. 41
Border Adjustment Tax Advantages: Generates $1T of tax revenue on the trade deficit that can be used to fund the reduction in the tax rate (helps bring tax reform closer to revenue neutral which pleases members of both parties) Important note: this only raises revenue as long as the U.S. is operating at a trade deficit. If we should swing to a surplus it would stop generating net revenue. Keep companies in U.S. Creates U.S. jobs Eliminates loopholes Strip earnings from U.S. through loan from foreign company to U.S. because interest is no longer deductible Moving IP to a foreign country and licensing back to U.S. will not work either, because royalty payments would no longer be deductible. Simplifies corporate tax system (less deductions and no transfer pricing) 42
Border Adjustment Tax Challenges: Will the World Trade Organization (WTO) approve? A border adjustment tax is ONLY permitted on an indirect tax, like a VAT. Most VATs do not permit a wage deduction, i.e., labor costs are part of the tax base. Will other countries challenge the U.S. s use of a BAT when combined with a wage deduction? This essentially means that our exports are taxed less than imports, because products produced here and sold abroad are allowed a wage deduction, while the value of products produced outside the U.S. and sold here would be disallowed in full from a deduction perspective. 43
Border Adjustment Tax Challenges: What if the significant economic assumptions required to make it work are not realized? If the U.S. $ fails to rise as predicted: Importers will pass on additional tax burden to U.S. consumers. Therefore, the price of imported goods will rise. Low-income taxpayers will be hit hard 44
Border Adjustment Tax Challenges: How will large exporters be handled? Since export revenue is excluded from the tax base, very profitable exporters (Exxon, Apple, J&J) will likely have a negative tax liability. Will they have an NOL that can be carried forward?» What if the company never has taxable income under the new system? How do they benefit? Will they receive an instant rebate? This could be a political nightmare if the IRS is cutting checks to large exporters. Would companies be able to sell the NOLs? 45
Border Adjustment Tax Current Political Battle: Republicans want to use the reconciliation process for the 2018 FY budget to pass tax reform. This would require only 51 votes out of the Senate. There are currently 52 Republicans and 2 Independents, but more than three already have voiced opposition to the border adjustment tax. Brady and Ryan are adamant that the DBCFT needs to be part of any tax reform package. President Trump told the Wall Street Journal: I don t love it. A week later, he seemed to back off those comments. He then added that a border tax could be used to make Mexico pay for the wall. 46
Border Adjustment Tax Current Political Battle: Large exporters are in favor due to the obvious tax benefits The retail industry (Target, Best Buy, Gap) hates it, saying it will increase prices. Rich U.S investors in foreign assets hate it, because if the dollar does increase in value, they lose billions! Advocacy for Prosperity, an advocacy group supported by billionaire industrialists Charles and David Koch, is activating a grassroots army against the border adjustment tax. 47
Border Adjustment Tax Current Political Battle: What if the border adjustment tax does not become a reality? Does the GOP have a backup plan? Possibilities: Drop the corporate income tax rate to 28% and not add 100% asset expensing. Drop the corporate rate to 20% and ignore the increased deficit. 48
Tax Planning Ideas Defer income until 2018, but be careful; certain middle-class taxpayers could end up paying a HIGHER rate under Trump. Accelerate capital gains into 2017 for certain middle-class taxpayers to take advantage of potentially lower rates (only if not subject to NII). Defer the acquisition of business assets until 2018 to potentially take advantage of 100% expensing. 49
Tax Planning Ideas Consider switching from an employee to an independent contractor/consultant to save up to 18%. Make charitable contributions in 2017 before the cap on itemized deductions hits, and to offset income taxed at higher rates. What to do about estate planning? Wait-andsee? Continue on? 50
Polling Question #4 What was the most useful part of this presentation? 51
Questions??? Scott Bartolf, CPA, MBA, CGMA Senior Tax Manager sbartolf@withum.com 732-842-3113 52