Breaking Down Trump's Tax Framework and Its Potential Impact on Small Businesses
President Donald Trump, working with the "Big Six" group of administration officials and Republican leaders, revealed a brief framework for tax cuts on Sept. 27, 2017, marking the most significant development in tax reform since the administration's unveiling of its tax outline in April 2017.
The framework adopts many ideas previously proposed in the President's tax outline and in the House Blueprint, but still requires Congressional tax writing committees to get to work on fleshing out the concepts. Nevertheless, it gives us the latest thinking on where tax reform may be heading. Below are the key changes outlined in the plan.
Individual taxation under the framework would be modified as follows:
- The seven tax brackets under current law would be replaced with three brackets set at 12, 25 and 35 percent. The framework also left open the possibility of a fourth bracket with a higher rate.
- The child tax credit would be increased, although no specifics were provided. The House Blueprint called for a $500 increase to $1,500. The framework also adds a $500 non-refundable credit for non-child dependents.
- The standard deduction would be nearly doubled to $24,000 for married couples filing jointly and $12,000 for single filers. Congressman Jim Renacci (R-Ohio), addressing the University of Akron's National Tax Conference on Sept. 28, stressed that with this provision, approximately 95 percent of U.S. taxpayers would not itemize deductions.
- Personal exemptions would be eliminated. For some larger families, this proposal could lead to a tax increase, notwithstanding the tax rate changes.
- Neither capital gains rates nor the Net Investment Income Tax (NIIT) were addressed.
- The individual alternative minimum tax (AMT) would be repealed.
- The only remaining deductions will be for charitable contributions and home mortgage interest, meaning the state and local tax deduction and other itemized deductions would be eliminated.
- The framework calls for retaining tax benefits that encourage work, retirement savings and education. However, no specifics were given.
- The estate and generation-skipping transfer tax would be repealed.
The framework also calls for the following changes to business taxation:
- The corporate tax rate would be reduced from 35 to 20 percent.
- A special 25 percent tax rate would be created for income from small and family-owned pass-through businesses, with a promise to include anti-abuse provisions to prevent the shifting of wage income to lower-taxed business income. The framework also implies that larger pass-through businesses may not qualify for this special rate.
- Full expensing of depreciable assets (other than structures) placed in service after Sept. 27, 2017 would be provided for five years.
- Interest expense deductions for C Corporations would be capped, although no specific amount or percentage was provided. Repealing interest deductions for other business entities is to be considered.
- The Domestic Production Activities Deduction (DPAD) would be eliminated.
- The R&D credit and the low-income housing credit would be preserved, although the framework states, "The committees may decide to retain some other business credits to the extent budgetary limitations allow."
Companies with international operations would see the following changes under the framework:
- The controversial Border Adjusted Tax (BAT) is replaced with a territorial tax system designed to tax income where it is earned geographically. This proposal includes a "100 percent exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10 percent stake)."
- Paired with the above provision is a one-time tax, to be paid over time, on deemed profits held overseas. A similar provision in the House Blueprint called for two rates: one for cash (and cash equivalents) and a lower rate for non-cash assets. The rates to be applied to the deemed repatriation were not specified in the framework.
Impact on small businesses
If passed in its current form, the framework provides tremendous benefits to small businesses. First and foremost, the tax rate on pass-through entity income is slashed by almost 15 percent -- from the maximum individual rate of 39.6 percent to 25 percent. Next, the incentive to invest in tangible assets such as equipment over the next five years by permitting full expensing is unprecedented. Finally, the elimination of the estate tax will permit small businesses valued over $11 million to pass the business on to heirs without having to worry about selling or refinancing to pay the estate taxes due.
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Overall, the framework is a minor pivot from prior tax proposals, but we still lack any drafted legislation that now must be quickly cobbled together by the House and Senate tax writing committees. As it stands, the framework provided enough detail for a preliminary revenue estimate from the Committee for a Responsible Federal Budget, which estimated the framework would result in roughly $5.8 trillion of tax cuts and $3.6 trillion of base broadening, creating a net tax cut of $2.2 trillion.
Many obstacles lie in the way of turning the framework into law. One hurdle is how to pay for the tax cuts. Chief White House economic adviser Gary Cohn predicted tax cuts will pay for themselves through increased economic growth. Treasury Secretary Steven Mnuchin claimed economic growth resulting from proposed tax cuts will actually create a surplus that will reduce the deficit, but didn't challenge the premise that no studies exist to back that up. And University of Michigan economics professor Joel Slemrod has said, "Can tax cuts pay for themselves? The evidence overwhelmingly suggests that this is not true."
With little time left on the legislative calendar, far right Republicans upset about any increase to the deficit and Democrats decrying the framework as a government handout to the wealthy, tax reform legislation in 2017 is far from a certainty.
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