by DeEtte L. Loeffler, J.D., LL.M. Taxation
Although the leading candidates for President of the United States appear to agree that the federal tax code needs reform, they have very different visions for what that reform should look like. This article provides an overview of their tax proposals and the potential impact on our clients. Plan details have been obtained from the websites of the candidates.
Hillary Clinton. If elected, she would seek to retain the current tax system, but make changes to the following tax rates, credits, and exemptions:
Analysis: Hillary Clinton would not replace the current tax code, but rather, amend it (making it more complex). According to the Tax Foundation, imposing tax on medium-term capital gains would likely cause taxpayers to postpone realizing these gains. Changes to the income tax rates would cause income of the top 1.0% of taxpayers to fall by about 2.7%, but other taxpayers would also see declines of between 0.9% and 1.0%. Wealth transfers would be delayed by the gift tax. The change to the estate tax exemption would increase the number of estates subject to the estate tax from 1 in 700 to approximately 1 in 300 deaths. Changes to the foreign ownership rules would likely slow corporate tax inversions and are along the lines of some proposals currently being considered by Congress. Only taxpayers with millions in retirement accounts would likely be impacted by the proposed cap on contributions, because this cap is based on the level necessary to finance the maximum annuity permitted for a defined benefit plan.
Income Tax. Increase the marginal tax rate for taxpayers with more than $5 million in adjusted gross income (AGI) from 39.6% to 43.6%, impose a minimum tax rate of 30% (phasing in between $1 and $2 million of AGI), introduce a new graduated rate tax for “medium term” capital assets (held more than 1 and less than 6 years), tax carried interest as ordinary income, and limit itemized deductions for those in the top two tax brackets to a tax value of 28%. New credits would be allowed for caregiving expenses for elderly family members, high out-of-pocket health care expenses, and college expenses.
Corporate Tax. Eliminate the reinsurance deduction for payments to foreign subsidiaries; allow credits for investment in community development, fundamental infrastructure and apprenticeships, and profit sharing; impose an exit tax on un-repatriated earnings; increase required foreign ownership from 20% to 50% to discourage tax inversions; limit deductions on performance-based income; and eliminate tax breaks for fossil fuels.
Estate and Gift Taxes.Reduce the Estate Tax exemption to $3.5 million, reduce the Gift Tax exemption to $1 million, and increase the tax rate from 40% to 45%.
Retirement. Prohibit further contributions to retirement accounts by taxpayers who have very large accounts.
Ted Cruz. If elected, he would seek to completely replace the current tax system as follows:
Analysis: Ted Cruz would completely replace the current tax system and its collection agency. These changes would take time to implement and, according to the Tax Foundation, the national debt would increase. The Business Flat Tax is a form of Value Added Tax (VAT). A VAT is normally imposed on business at each step in the production process (on the value added to the product) and so ensures tax is collected. The proposed BFT would differ from that used in Europe in two ways: it would be imposed only one time and the tax would apply to all wages, benefits, profits, interest, services and materials. The federal government does not currently impose a tax on services (although some states do so). The effective tax rate would be higher than the stated 16%, because the cost of the tax would be included in the cost of the goods and services sold causing the consumer to ultimately pay tax on the tax (an iterative calculation). According to Alan Cole of the nonprofit Tax Foundation, the actual tax rate would be close to 19%.
Eliminate the IRS and replace it with a new agency.
Income Tax. Replace the income tax with a “Simple Flat Tax” of 10%; increase the standard deduction to $10,000 for singles and $20,000 for married couples; and limit credits and deductions to the Child Tax Credit, the Earned Income Tax Credit (expanded and with greater fraud protection), the mortgage interest deduction (capped at $500,000), and the charitable deduction.
Corporate Tax. Replace the corporate tax with a “Business Flat Tax” of 16% on revenue (not profit) and allow business to deduct only the cost of capital investments and payments to other businesses (to avoid a double tax).
Payroll Tax. Eliminate the Payroll Tax.
Estate and Gift Taxes. Eliminate the Estate ("Death") Tax.
Retirement. Replace pensions and IRAs with a “Universal Savings Account” allowing taxpayers to save $25,000 on a tax deferred basis each year. He also intends to fully fund Medicare and Social Security.
The Simple Flat Tax would be easier to understand and implement than the current tax code, because it eliminates most credits and deductions and imposes a single tax rate. It is unclear, however, how effectively this tax would be collected without the simple enforcement mechanism of the payroll tax which forces taxpayers to file returns to get refunds. A shift in the method of tax collection could result in a revenue gap between the date the new system goes into effect and the date the first tax payments are required. However, the earlier collection of the BFT may mitigate part of this gap.
It is unclear if these proposed tax changes would result in taxpayers having more discretionary income, or less. The business tax system would shift more of the tax burden to low and middle class taxpayers in the form of higher costs for goods and services and could result in reduced consumption of luxuries primarily among those in the lower tax brackets. Over time, it would likely raise more tax revenue than the current system, if income tax collection issues are resolved.
Bernie Sanders. If elected, he would keep the current tax system, but make the following changes:
Analysis: Income taxes would increase significantly for top earners. There would also be significant increases in the Social Security tax imposed on employers (6.2% of all income subject to the tax) which could lead to lower wages and fewer jobs. According to the Tax Foundation, his plan would result in a higher national debt. The elimination of “like kind” exchanges would dramatically impact businesses and individual investors dealing regularly in real estate or stocks and could impact numerous investments including REITs. More estates would become subject to the estate tax than under Hillary Clinton’s proposal due to the limits on the use of GST trusts, IDGTS, and the denial of valuation discounts to family transfers. The limits on GRATs would prevent grantors from simply terminating a poorly performing GRAT. More irrevocable trusts would become subject to transfer tax due to term limits on GST trusts.
Income Tax. Replace the top three income tax rates with 37%, 43%, 48%, and 52%; impose the Social Security Tax on income above $250,000 (not indexed for inflation); impose ordinary income tax rates on capital gains income for married taxpayers with AGI more than $250,000; impose immediate capital gains tax on transfers of capital assets by gift or upon death (with exclusions for homes and some other assets); eliminate tax deferral for “like kind exchanges”; replace the Alternative Minimum Tax and personal exemption phase-outs with a 28% cap on deductions; and provide a credit to low income taxpayers (less than $50,000 AGI for single, and $75,000 for married filing jointly).
Corporate Tax. Eliminate tax deferral on overseas profits, tax all foreign corporations which maintain management and control operations in the United States, tax foreign corporations that are majority-owned by US interests, eliminate tax breaks for fossil fuels, and tax carried interest as ordinary income.
Estate and Gift Taxes. Reduce the Estate Tax exemption to $3.5 million and impose a graduated tax rate of 45% on estates between $3.5 and $10 million, 50% on estates between $10 and $50 million, 55% rate on those more than $50 million, and 65% on estates more than 1 billion; deny the generation-skipping transfer tax exemption to trusts designed to exceed 50 years; limit Grantor Retained Annuity Trusts (GRATs) to prohibit grantors from recovering trust assets; prohibit the use of Intentionally Defective Grantor Trusts (IDGTs) which shift the income tax burden from beneficiaries to the grantor; restrict the use of annual exclusion gifts to trusts; put limits on valuation discounts for transfers to related parties; grant farmers a $3 million reduction in tax value for estate tax purposes; and increase the conservation easement exclusion to $2 million.
Retirement. No specific proposal. His focus is on saving the Social Security system.
Donald Trump. If elected, he would keep the current tax system, but make the following changes:
Analysis: According to the Tax Foundation, reductions in the tax rates would result in a drop in federal revenue of more than $9.5 trillion over the next ten years. Unless coupled with dramatic spending cuts (which have not been proposed) the federal deficit would grow by more than $9.5 trillion before considering the interest cost (assuming such borrowing could be obtained). Wages would increase and taxpayers in all tax brackets would have increased AGI of 10% or more with the largest benefit (almost 20%) predicted for the top 1%. The gap between the highest and lowest wage earners would increase.
Income Tax. Replace the current tax brackets with 0%, 10%, 20% and 25%; increase the standard deduction to $25,000 if single, $50,000 for married couples; tax dividends and capital gains at 0%, 10% and 20%; eliminate the marriage penalty, the Alternative Minimum Tax, and the New Investment Income Tax (NIIT); impose phase-outs on personal and itemized deductions beginning at the 10% tax bracket; deny the life insurance interest deduction to high income earners; retain the charitable and mortgage interest deductions; and tax carried interest as ordinary income.
Corporate Tax. Eliminate tax deferral on overseas profits, impose a one-time 10% tax on all income held offshore, reduce the tax rate to 15% and apply it to pass through entities (S corps, partnerships and LLCs) as well as corporations, and put a cap on the deduction for interest expenses.
Estate and Gift Taxes. Eliminate the Estate Tax.
Retirement. No specific proposal.
How Might This Affect You?
Regardless of who is elected, comprehensive personal and business tax planning will remain important.
Under a President Clinton or Sanders, estate and gift tax planning would become important for more American families who would be subject to these taxes. The estate and gift tax exemptions have never been reduced, but it is possible they could be. Two groups of people would want to spend additional time looking at their options: (1) Surviving spouses who have claimed portability of a deceased spouse’s exemption in recent years may want to consider using this benefit for immediate lifetime gifts, and (2) those with an estate in excess of $3.5 million ($7 million for married couples) may want to consider making lifetime gifts to lock in the benefit of the current higher exemptions from gift and estate taxes. Transfers (by gift or sale) of business interests to related parties should also be considered since discounts for these could be eliminated. Other things to consider doing include interfamily sales to Intentionally Defective Grantor Trusts (IDGTs) to avoid triggering capital gains tax, gifts to long term generation skipping trusts, and maximizing annual exclusion gifts to trusts.
Income taxes would change the least under a President Clinton, with only the top tax bracket impacted by increases. Under a President Clinton or Sanders, a more complicated tax code would increase tax preparation costs for some taxpayers. Those in the highest income tax brackets would need increased planning to maximize the use of available deductions.
Under a President Trump, despite loss of deductions for higher income taxpayers, lower income tax rates would result in lower taxes for all taxpayers, but would most benefit those with higher incomes. Those with a lot of income from pass through entities would also benefit greatly (from the reduction of tax to 15% from ordinary income rates). Under President Cruz, Sanders, or Trump, rising interest rates related to the increased national debt would make borrowing more expensive and difficult.
Under either President Clinton or Sanders, tax on United States-based businesses would increase (mostly due to the loss of current deductions and credits). Such increases may make US companies less competitive or profitable for investors. Rising interest rates would negatively impact small business owners and discourage start-ups.
Implementation of a VAT under President Cruz would be initially complicated and expensive for business to implement, especially if states do not adapt their laws by also shifting from an income and/or sales tax to a VAT. Negative perceptions could also depress foreign investment in US corporations during this conversion process (as happened when European countries adopted the VAT). Increased costs would likely be shifted to consumers, but could also result in lower dividends for investors. Finally, under a VAT, the new tax on services would impact a number of service industries, consequently causing increased costs to consumers for tax preparation and advice, legal advice and services, and medical care.
Finally, most of the candidates want to impose tax on accrued, taxed-deferred corporate income held offshore and to discourage further corporate tax inversions. Congress is equally focused on these goals with the primary disagreement being how to spend the proceeds from a one-time tax on these earnings. It is reasonable to assume some agreement will be reached before the new president is sworn in. Another area of agreement is to tax carried interest at ordinary income instead of capital gains rates.
Those individuals in the highest tax brackets, holding multiple real properties as a major portion of their wealth, and/or investing in companies with positons off-shore should pay closer attention to these plans. We will continue to monitor and keep you informed of changes in the tax arena.