The inability of Congressional Republicans to pass legislation which would repeal, replace, modify, alter or any other verb you may like, the Affordable Care Act has raised the stakes on the GOP to pass something substantive on the tax front.
You may hear the term “tax reform” regularly, but doing comprehensive tax reform is one of the heavier lifts that can be undertaken by the Legislative Branch (it was last done in 1986). Unlike the strategy (I’m using that term very loosely) that Republicans used in addressing Healthcare, the party has publicly debated and brought forth a variety of tax plans over the past few years.
The fact there has been discourse about taxes, doesn’t mean there is uniform agreement on what to do. Further, it is highly unlikely that Democrats will eagerly engage in this process, meaning that even if the House, Senate and President Trump agree on something, that there will be an expiration date on the policies (Using the budget reconciliation process allows the Senate to move legislation along on a simple majority vote. It also means that the legislation is only valid for the budget window period or roughly 10-years).
We do know that there are very few people who like the tax code as is currently written. The United States lags other countries in corporate tax rates, putting U.S.-based companies at a disadvantage and incentivizing companies to keep revenues offshore. For the majority of U.S. businesses who operate as pass-thru entities and pay taxes at the individual rate, there are the challenges of add-on taxes, like those from the ACA, and a code that picks winners and losers. For instance, distributors and retailers pay a significantly higher effective tax rate than other lines of trade.
Recent news that the leadership from the White House, Senate and House of Representatives have agreed to a tentative outline of tax principles are, they are not disclosing a lot publicly. Here’s a list of things we think they are thinking about and are worth considering how they may impact your business.
1. Lower Corporate Tax Rate & Lower Business Income for Pass-Thru’s. The lower corporate rate is easy to understand. What is interesting is how a pass-thru would implement the dual tax rates, one for the profitability of the business and the second for income drawn from that business.
2. Broad Capital Expensing. The House of Representatives had flirted with the idea of 100% business expensing but discussions have indicated they are backing off that tactic and will settle on a robust plan which will allow for broader expensing of capital improvements.
3. Repeal of the Estate Tax. This has been a pledge from Republicans for decades and is still in the game. One thing to watch. A repeal of the estate tax which does not maintain the step-up in basis will draw opposition from some who would normally be allies on this issue. The upside here is House Ways & Means Committee Chair Kevin Brady (R-TX) has included step-up in basis in his legislation to repeal the estate tax.
4. Significant Increases in the Standard Deduction. This is aimed as a middle class tax cut and will allow for the elimination of some tax credits. Some in the real estate and home building industries do not like this provision as they believe it will have a negative impact on the housing industry.
5. Elimination of the State/Local Tax Deduction. If you live in a high tax state/community this is one that many Republicans are targeting for repeal. It will put GOP members of Congress from those states in the spotlight.
6. Limits on Interest & Mortgage Deductibility. House Republicans had discussed eliminating interest deductibility in their initial proposal. Capping the amount that could be deducted (both business interest and mortgage interest) could be used as a “pay-for” for lower rates.
7. Loss of Deductibility of Health Insurance & Retirement Plans. This is a provision that could impact both employer and employee. The questions is simple as it relates to employees, these are clearly financial benefits and should they be taxed as income? For employers, what would limits or the elimination on the loss of deductibility of health insurance plans do to the bottom line? Would some employers pull out of the insurance game? I view this as a longshot but it’s on the table.
8. Elimination of LIFO (Last In, First Out) Accounting? There are a few ways Congress could go here. The first would be to force LIFO companies to move away from LIFO and tax their LIFO reserves, some of which have been built up over 50+ years and/ or elimination of LIFO on a prospective basis. Over the year’s there have been a handful of attacks upon LIFO and from my perspective, this is absolutely the most serious. Simply put, Congress needs to get the money from somewhere to pay for tax reductions and LIFO is a fat target.
Earlier in this piece I talked about how challenging tax reform would be. That’s why I am still advising members that if these efforts fail, simple across the board rate reductions and some tax code modification (far from reform) is still possible and might be more likely to occur than broad reform.
Here’s what we know. Nobody likes our tax code, except maybe CPA’s who make their living helping people navigate it. The GOP’s failure on healthcare has raised the stakes on taxes in that it is vital they show their supporters, and voters, that they are accomplishing something. The clock is ticking.