Tax Changes Coming

In my July blog, I wrote about the likelihood of meaningful tax reform, possibly in 2017. The premise was that such an undertaking is long overdue, and the context was that political reality still will make it exceedingly difficult to accomplish.

In this blog, I want to discuss a few specifics that may be a part of such an effort; however, before that, I want to touch on changes that may occur in the balance of 2015 or in 2016. 

First, the fate of multiple so-called “extender” provisions remains up in the air. These tax breaks are typically renewed year-by-year to bypass budgeting hurdles in Congress. They include such items as bonus depreciation, asset expensing provisions, state and local sales tax itemized deduction and various tax credits, among others.

The current thinking is that they will all be re-extended for one year (2015) or even two years (2015 and 2016) to push this issue beyond the 2016 elections. If they are only renewed for 2015, Congress will have to work on another extension next year when they would rather be home campaigning.

The timing on this extension remains fluid but could run late into the year or even have to be done early in 2016.

Second, the outcome of next year’s elections will obviously have the most substantial effect on potential legislation in 2017. Now that the presidential campaign is rounding into shape, most of the major candidates in both parties have expressed a desire for tax reform. However, the definition of “tax reform” varies greatly from a single low-rate, flat tax concept all the way to a huge hike in tax rates for upper income taxpayers and a slew of new deductions, credits, and incentives for more moderate-income taxpayers.

We will hear quite a bit about the controversial portions of the candidates’ plans, but none of this will be overly instructive until the two parties have their nominees. Also, as we mentioned in July, the only certainty in next year’s elections is that the Republicans hold the House of Representatives. Anti-incumbent feeling aside, the majority is simply too great for the Democrats to overcome. Therefore, even if a liberal, high tax candidate like Bernie Sanders were elected, his plans would be significantly changed by the legislative process.

In fact, given the Republican lock on the House, the best chance for comprehensive tax reform would be a Republican sweep of the Presidency, Senate and House. This is not meant to be a partisan statement, but merely a nod to reality. Then, Republicans would have to come to grips with raising some taxes to lower others.

So, going back to the original question, what kind of specifics might be included in any reform plan?

The most likely area for agreement is in several aspects of international tax. The first involves a change from a worldwide tax system to a territorial tax system. This would bring the U.S. in line with most other developed countries. Another change would be a possible reduction of the overall corporate tax rate to around 28 percent from the current 35 percent by reforming various credits and deductions.  Right now, we have the highest corporate tax rate in the world. A corollary to that is an interesting proposal for the creation of a low tax rate entity called an “innovation” or “patent” box. The theory would be to tax various intellectual property assets at a very low rate, perhaps as low as 10 percent, to take full effect of our competitive advantages in the area of innovative technologies both at home and abroad.

Another aspect of international tax change would be a possible one-time tax on repatriation of earnings held in overseas subsidiaries. Again, a 10 percent tax rate could be imposed on the more than $2 trillion held offshore by companies such as Apple, rather than the normal higher rates. The lower rate, it is believed, would incentivize them to bring that money home. The taxes such changes would generate could be the basis for a substantial infrastructure program that is long overdue.

Beyond these items, there seems to be a growing realization that Social Security and Medicare are reaching a critical juncture. This has been a talking point for years, but the retiring Baby Boomers are starting to make the actuarial facts a burning reality.

Simply stated, the system will go broke. When? Well, that’s subject to debate – and math. But few dispute the inevitable.

The changes under consideration include means testing of benefits, higher retirement ages that are phased-in over a number of years, increasing the cap on wages and types of income subject to Social Security taxes, changes in the way the inflation index is calculated for benefit payments, and increased percentages of benefits subject to income tax. All of these options would potentially be on the table during negotiation.

Finally, a separate tax rate for business income on individual returns is a popular idea that has been gaining traction. Such a provision might apply a maximum 28 percent tax on items like wages, farm income, partnership and S corporation earnings, and sole proprietor earnings. This would be in conjunction with the aforementioned 28 percent corporate tax rate to equalize the tax effect on both C corporations and individuals.

If all these provisions were enacted, it would certainly constitute meaningful tax reform. Other ideas that are sometime mentioned include making various tax credits or deductions permanent and raising or lowering tax rates on capital gains and dividends, while eliminating the alternative minimum tax.

Anything could happen, and we will keep you updated as things heat up on the tax reform front.

One thing is for certain though – tax reform will never be confused with tax simplification!

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