As the Obama administration winds down and the Trump administration is about to begin, we wanted to recap a few things…
Elections – and Taxes. The surprising outcome of the November elections means that we are likely to see tax law changes that significantly depart from the tax proposals consistently put forth in the Obama administration’s budgets (these include the “Buffett Rule” (or “Fair Share Tax”) that would mandate an effective rate of 30% for taxable income over $1 million, and a capital gains tax at death for most of a decedent’s appreciated property). Last month’s Tax Topics (see the 11/28/16 edition) discussed some of those possible changes, including proposals from “A Better Way” (ABW), the House Republican blueprint for tax reform that was released on June 24th. As stated in ABW, the goal of reform is to produce a tax code that is “simpler, flatter and fairer.” We wanted to revisit ABW and those three words.
“Simpler.” “Simpler” is a straightforward concept. ABW recommends, for example, streamlining and consolidating multiple provisions and rules that are ultimately designed to accomplish the same goal, such as those that benefit families with children or that encourage taxpayers to save for retirement. To this end, ABW depicts a 14-line, postcard-sized form that taxpayers could use for “simple, fair” tax filings. (This is in stark contrast to the current individual income tax return (Form 1040), with its two pages, 79 lines, and multiple schedules reporting different types of income and tax information.) If simplification were truly possible, it would be a watershed. Yet “tax simplification” seems like an oxymoron: there is rarely anything “simple” about taxes, or reform, which is bound to face resistance from affected constituencies. (In other words, no matter what happens, tax professionals are still likely to have a job!)
“Flatter.” A “flatter” tax system means fewer tax brackets and a broader tax base. Under both Mr. Trump’s proposals and ABW, our current system’s seven income tax brackets (ranging from 10% to 39.6%) would be collapsed into three: 12%, 25% and 33%. These lower rate brackets would be made possible by broadening the tax base, and eliminating most, if not all, “tax expenditures” (these are tax benefits that reduce taxable income, namely, deductions, credits, exemptions, exclusions, deferrals and preferential tax rates). A broader tax base therefore would likely tax employer-provided health care (it is currently tax-exempt), and eliminate most itemized deductions, including those for state and local taxes. Would the lower rates and broader base Tax Topics 12/19/16 2 be a wash for most taxpayers, or might it benefit some more than others? Without seeing actual legislation, it’s hard to know. Yet logic suggests that if the bulk of a taxpayer’s income is subject to the current top rate of 39.6%, for example, that same taxpayer could presumably save significant tax dollars if that top rate became 33%.
“Fairer.” A “fairer” system relies on a baseline definition of “fairness,” something that depends, of course, on underlying beliefs. To illustrate, from ABW’s perspective, the current tax system is unfair because it is “biased” against savings by taxing investment returns; this situation is only partially mitigated by the lower tax rate for long-term capital gains and dividends. (This position reflects the belief that a dollar should only be taxed once, namely, when it is earned.) By contrast, from the Democratic perspective (see the “Buffett Rule” above), it is unfair that many salaried workers pay a higher effective rate of tax than a high-income individual whose income chiefly stems from investment returns. (This position reflects the belief that income is income, and that our tax code shouldn’t play favorites.) And so forth.
…which means…Given these deep philosophical differences, it is hard to envision a bipartisan meeting of the minds on, say, individual income tax reform. The lack of bipartisan agreement won’t matter in the House, where there are sufficient Republican votes to pass legislation, even without Democratic support; the Senate, however, is a different story. There, if the Republicans use “reconciliation” to pass their “simpler, flatter and fairer” tax legislation, they only need 51 votes (as opposed to 60) – but the law will not be permanent and will need to “sunset” after 10 years. Stay tuned.
Other Things to Watch Out for Next Year:
- Basis Reporting and Consistency Rules – Final Regulations Coming. The Treasury Department has indicated that the final regulations on the basis reporting and basis consistency rules are likely to be out in late January. (The 03/31/16 edition of Tax Topics discussed the proposed regulations on this topic). Some key points to remember about these rules are that:
- Executors who must file an estate tax return because the decedent’s gross estate plus “adjusted taxable gifts” are over the estate tax return filing threshold ($5.45 million in 2016 and $5.49 million in 2017) must also file a basis reporting statement (Form 8971 and related Schedules A) with the IRS within 30 days of filing the return (penalties apply for failure to file).
- Executors of estates under this filing threshold who are merely filing an estate tax return to elect “portability,” so that the deceased spouse’s unused exclusion amount carries over to the surviving spouse, do NOT need to file the basis reporting statement.
- The proposed regulations had some controversial requirements, including: 1) heirs who receive property that was reported to them on a Schedule A must also file a basis reporting form if they later give this property to a “related transferee,” such as a family member; and 2) “after-discovered” property will generally have a zero basis until it is reported.
- Whither the Proposed Regulations on Valuation Discounts? These proposed regulations have been discussed in prior issues of Tax Topics, starting with the 08/31/16 edition. As mentioned before, these rules are designed to eliminate perceived valuation abuses in transfers to family members of family-controlled entities, such as partnerships and limited liability companies. Yet because these rules aim broadly, family businesses – and not just entities funded with cash and marketable securities – are also in the crosshairs. This has resulted in unprecedented criticism from family business owners and groups, advisors and many Republican members of Congress. At the December 1st hearing on these regs in Washington, D.C., only one of the approximately 37 people testifying supported the regs; the message from the other individuals was that the regs were irreparably flawed and should be withdrawn. The question, then, is not when these proposed regs will be made final, but whether they will be withdrawn and completely revamped, or simply withdrawn. As a practical matter, it seems doubtful that the incoming Trump administration will be interested in fixing them.
To Sum Up… It has been an interesting year, and will be even more so next year!
[About the January 2017 7520 rate – it is not yet out at this writing and will be in next month’s Tax Topics.]
**This article was posted with the permission of Blanch Lark Christerson.
Blanche Lark Christerson is a managing director at Deutsche Bank Wealth Management in New York City, and can be reached at blanche.christerson@db.com.
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