On September 27, 2017, congressional leadership and the Trump administration released a nine page tax reform framework document called the “Unified Framework for Fixing Our Broken Tax Code.” The framework serves as a guide to Congress in developing tax legislation aimed to simplify the tax code, provide tax relief for individuals and businesses, improve America’s business climate compared to other nations, and encourage the return of funds kept offshore to America. The framework’s guidance is summarized below in four categories: 1) individuals; 2) c-corporations; 3) s-corporations, partnerships, and sole proprietorships; and 4) other items.
Individual Tax Reform
The framework reduces the number of income tax brackets from seven to three. The three income tax brackets would be taxed at 12%, 25%, and 35%. No guidance was provided regarding income levels of the new brackets. Therefore, it cannot be determined if the reduction in the number of brackets will result in an increase or decrease to a particular individual’s income taxes.
The standard deduction would nearly double under the proposed framework. Currently, the standard deduction for a married couple filing jointly is $12,700 ($6,350 for individuals). This means that a married couple is currently not subject to federal income taxes until their taxable income exceeds $12,700. Under the proposed framework, the standard deduction would increase to $24,000 for married couples filing jointly ($12,000 for individuals), exempting the first $24,000 of taxable income from taxes for married couples. This would also reduce taxes for those currently not benefitting (or not significantly benefitting) from itemized deductions.
To offset the reduction in tax revenue from an increased standard deduction, the framework proposes eliminating all itemized deductions with the exception of the mortgage interest deduction and charitable contribution deduction. This would have negative impact on individuals currently benefitting significantly from itemized deductions through the use of deductions such as the medical expense deduction, state tax deductions, or investment interest deduction. Additional tax revenue offsets may include the elimination of personal and dependency exemptions. Other items in the framework include enhanced child tax credits and abolition of the alternative minimum tax.
C-Corporation Tax Reform
The framework indicates the tax rate for c-corporations would be decreased from 35% to 20%. In addition, certain deductions or credits may be eliminated or reduced to offset the tax revenue reduction. The framework specifically mentions the deduction for interest paid would be limited, and the deduction for the domestic production activity deduction would be eliminated.
S-Corporation, Partnership, and Sole Proprietorship Tax Reform
Owners of businesses taxed as S-Corporations, Partnerships, and Sole Proprietorships would be taxed at a flat rate of 25% of taxable business income received from that business, rather than having taxable business income from their business subject to the graduated tax brackets. This would be a tremendous tax reduction for many business owners. However, the framework indicates tax reform will include measures to prevent wealthy individuals from avoiding the top personal tax rate of 35%, but no additional specifics were provided as to what these measures may be. Similar to C-Corporations, the domestic production activity deduction would likely be eliminated to help offset reductions in tax revenue.
Other Tax Reform Items
The estate tax, currently a tax of 40% of an estate’s value (after the exemption of $5.49 million per deceased taxpayer), would be completely eliminated. Provisions to encourage the return of assets held overseas would likely be included, as well as modification of international income taxation in the United States from a worldwide tax regime to a territorial tax regime. This means American companies would only pay tax on income earned in the United States to help avoid double taxation.
Donovan CPAs will continue monitoring tax legislation developments over the coming weeks.