The drumbeats for tax reform are growing louder.
The Trump administration, in conjunction with the president’s hand-picked “Big Six”1 group of GOP leaders, has released a nine-page outline of tax reform proposals. Not only would the plan overhaul numerous individual provisions, it would have a major impact on corporations and pass-through business entities, including significant changes for the manufacturing sector.
Manufacturers are likely to look favorably on the tax plan’s provisions. The quarterly survey by the National Association of Manufacturers released at the end of September 2017 found that a strong majority of small and large manufacturers said the promise of tax reform will spur growth and create jobs. The survey found that 64% of manufacturers would expand, 57% would hire more workers and 52% would raise wages and benefits if the GOP proposals are passed.
Generally, the tax reform provisions don’t include any effective dates, nor is enactment assured, with or without modifications. Here is an overview of the key proposals and their expected impact.
Corporate Tax Proposals
These key changes for C corporations, including incorporated manufacturing firms, are designed to stimulate business growth:
- Reduce the top corporate tax rate from 35% to 25%. Trump’s initial proposal lowered the rate to 15%.
- Allow immediate “expensing” for at least five years of new investments in depreciable assets, other than buildings, purchased after September 27, 2017.
- Partially limit interest deductions for C corporations (details weren’t provided).
- Repeal the corporate alternative minimum tax (AMT).
- Preserve the research credit (Congress would review most other business credits).
- Repeal the Section 199 deduction for domestic production activities. This deduction is currently available to all business entities.
The list of corporations that might profit from these proposed changes is long. Larger corporations would benefit from a reduction in the top corporate tax rate and businesses of all sizes could use the expensing allowance.
However, partially limiting interest expense deductions will likely play a significant role in C corporations’ investing and financing decisions and affect corporations carrying significant debt. It’s unclear how Congress will handle carryforwards of any credits that are eliminated. Many manufacturing firms would miss the Section 199 deduction.
Pass-Through Tax Proposals
The tax outlook for pass-through business entities — including partnerships, S Corporations and Limited Liability Companies (LLCs) — will be very different if the new tax reform plan is approved. It proposes that:
- Business income received by pass-through entities be taxed at a maximum rate of 25%. Currently, this income is taxed at ordinary income rates for individuals, which can be as high as 39.6%. It isn’t clear if personal services firms would qualify for the tax break.
- The lower rate on income for pass-through entities be coordinated with tax law provisions that don’t permit wages to be treated as business profits.
- Congress be required to determine the ramifications for pass-through entities and sole proprietorships of the partial limits on interest expense deductions.
This series of tax reforms could change the thinking of business owners. In theory, the shift away from the current tax format is designed to align C Corporations and pass-through entities. However, some professionals fear that this could lead to an unfair tax advantage for wealthier business owners.
With the top tax rate now set at 39.6% and a proposed maximum 35% rate, owners may have an opportunity to slash their tax bills. Restricting these changes to qualified small businesses has been discussed and could be put into effect.
International Tax Proposals
The Trump campaign pledged to bring business back from overseas. In support of that objective, the tax reform plans proposes several changes relating to manufacturing:
- Impose a one-time repatriation levy on offshore profits to encourage a return of U.S. multinational corporations from so-called tax havens. However, the proposals don’t specify a rate or time period for this change.
- Adopt a territorial method of international taxation that would include an exemption for dividends from foreign subsidiaries if the U.S. company owns at least 10% of the subsidiary.
- Authorize a global minimum tax on foreign profits of U.S. multinational corporations. Congress would be directed to “even the playing field” between companies headquartered in the United States and those based in foreign jurisdictions.
If these proposals have their desired effect, certain multinational corporations would be encouraged to shift more business operations to the United States. This would represent an historic shift in the way that companies are taxed. But the proposed guidelines leave as many questions as they provide answers, including how foreign tax credits would be used against repatriated earnings.
Individual Tax Proposals
The new tax plan features a wide variety of changes that would affect individuals, including:
- Consolidating the current seven income tax brackets into three brackets of 12%, 25% and 35%. There are no details about the potential bracket thresholds. An add-on tax for the wealthiest taxpayers was discussed, but not finalized.
- Increasing the standard deduction from $6,500 to $12,000 for single filers and from $13,000 to $24,000 for married couples filing jointly. All personal exemptions would be repealed.
- Repealing most itemized deductions other than those for charitable contributions and mortgage interest.
- Eliminating the AMT.
- Condensing several tax breaks for families. Along with the repeal of dependency exemptions, the new plan features a proposed $500 credit for non-child dependents.
Again, the professionals are divided as to whether these changes would mostly benefit the low-to-middle or upper-income classes. In many cases, it makes sense for individuals to accelerate deductions into 2017, unless there are special circumstances that prevent that.
Expect Some Modifications
Although the tax reform plan has some momentum, there’s still a long way to go before it becomes law. Even if key tax reforms are enacted, some modifications can be expected.