Don’t Hold Your Breath: The Tax Reform Proposal Revealed on April 26th, 2017

A look at the April 2017 tax reform proposal – what it means for your personal and business income and real estate decisions in the near future.

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On Wednesday, April 26th, the White House unveiled its much-anticipated tax reform proposal.

Treasury Secretary Mnuchin and Economic Advisor Gary Cohn presented a conceptual outline of the proposal that was long on concept and short on detail. To be sure, the proposal represents a major change over the current system, which many believe hinders economic growth and wealth creation.

It operates on the simple premise that businesses and individuals are better suited than the federal government in terms of how capital should be deployed, and that is quite appealing to those who take the risks to grow businesses and create the jobs for American workers.

Interestingly, the proposal differs sharply from the GOP plan known as The Better Way, but both plans share a common purpose: stimulate sustained economic growth of 3% or more going forward, a tall order in the minds of many.

In this post we take a high altitude look at the basic components of the plan and what has to happen to turn concept into reality. By necessity, we speak in generalities because the proposal announced on April 26th fits on a single sheet of paper that lacks specificity. Here are the basics of the plan:

For Personal Income

• The current 7 personal income tax brackets, which top out at 39.6% would be reduced to 3 brackets, 10%, 25% and 35%.
• The personal exemption will double, which means no income tax would be due on the first $24,000 in income and fewer taxpayers would have to itemize deductions
• State and local taxes would no longer be deductible on federal tax returns
• Many deductions, other than home mortgage interest, charitable donations and retirement savings would be eliminated
• The Alternative Minimum tax provision would be eliminated
• The Estate Tax, also known as the Death Tax, would be eliminated
• The 3.8% tax on investment income related to Obamacare would be eliminated

For Business Income

• The tax rate on corporate earnings will be reduced from 35% to 15%
• Income for so-called pass-through entities like S-Corporations, Partnerships and LLC’s would also be taxed at 15% instead of the current personal income tax rates that top out at 39.6%
• Income earned outside the US would be taxed at a lower rate or not at all (but is unspecified in the proposal)

The White House plan differs significantly from the GOP proposal in several ways. Perhaps the biggest of those differences is the border-adjustment tax the GOP plan proposes by eliminating the deductibility of costs associated with the importation of goods sold in the US. This is a highly controversial provision of the GOP plan, but was included to “help pay” for the other proposed tax reductions.

Also, the GOP plan would eliminate the deductibility on interest expense but would also allow for the immediate expensing of capital items rather than using traditional depreciation as a means of recouping invested capital.

Neither of those issues are even mentioned in the White House plan. Secretary Mnuchin indicated that the proposal is just a preliminary outline meant to kick-start the dialogue with both houses of Congress, and that these important aspects of tax reform would be addressed later.

The most welcome part of the plan, especially to most of you who are reading this post, is the reduction of the tax rate on pass-through income. Most small businesses operate as pass-through entities, so the idea of a 15% rate versus 39.6% will be welcome relief and should stimulate further economic activity. The lower rate for big corporations is bound to have a stimulative effect, as well, as billions of dollars will still be cash on hand rather than a check in the mail to the IRS.

Without further detail on interest deductibility and depreciation rules, it’s hard to say what impact the plan will have on real estate values, but we will be tracking that progress very closely. Although, logic would dictate that anything that helps businesses grow should stimulate lease and sale activity that would stimulate rent growth and value appreciation. As the old saying goes; the devil is in the details.

The biggest question of all is; what chance does any tax reform proposal have of becoming law. That’s why we titled this blog post Don’t Hold Your Breath.

The announcement on April 26th is a bold first step in a process that could take more than a year to complete. The hurdles are many and the debate will be fierce and partisan. That’s the one thing we can predict with a high level of confidence.

Deficit hawks on the right will insist on not adding to our budget woes and ballooning national debt.

Democrats on the left will decry the plan as another break for the rich, and given the polarized nature of our political scene these days, that combination might be all that’s necessary to gum up the works indefinitely. Despite majorities in both houses of Congress and control of the White House, tax reform is far from a slam dunk.

Even if all 52 Republicans in the Senate could reach agreement on a plan, it is highly unlikely to attract the votes of 8 Democratic Senators, which is what it will take to pass.

The alternative legislative rule known as reconciliation may not available because any reform plan will have deficit implications that exceed the 10 year limit contained in the rule.

So, tax reform legislation is still a long shot, and we are recommending to our clients not to hold off on making real estate decisions based on what might happen sometime in the future.

Current market conditions are challenging enough without trying to factor in all the potential impact of a change in the tax law.

Worst case is that no new law is passed and we have what we have in terms of taxation, and that is not necessarily such a bad thing. Markets like certainty, and business owners always seem to figure out a way to make things work.

We promise to follow the progress of tax reform closely and pass along as much as we can as soon as we can. If you have thoughts on the topic you’d like to share, give us a call.