Not everyone is happy about tax reform
Would you believe that the tax industry is loaded with stress and anxiety? I suppose I should be suffering these ailments as well, but I am not. I suppose I should join many large players are who actively fighting against reform because they fear a simplified tax code will reduce the need for their services. But I won’t. Why?
We look at the future a bit brighter for the new challenges and opportunities available. These opportunities are not just for tax attorneys and accountants but for Americans who want to see other Americans succeed.
Up to now, there existed just general outlines for proposed tax reform, yet the themes have been consistent. In this article I will go over those themes — things I am quite certain will make it in. However, the devil is in the details, so all of this is subject to change.
There are no US losers
As I review the outlines and proposals and talk to my sources on Capitol Hill, I see no group of US taxpayers who will be paying more (I will mention the group that will lose below, but hint…they aren’t US taxpayers).
There are some that will pay about the same with tax reform. Those are high income waged earners, specifically those who don’t pay the Alternative minimum tax (AMT). They will see the fewest changes. Their tax rate may come down slightly to 35% but it should wash out in limited deductions.
The winners — Not the AMT — it gets shown the door
Speaking of AMT, high-income earners who pay the AMT will be winning, as the proposal plans to eliminate the AMT. The AMT has been criticized as overly complicated and not quite needed as many of the loopholes it was designed to close have been closed through other means.
Low-income earners pay a negative tax rate. That is, they get more money in refunds than they paid during the year. However, many low-income earners need to pay a tax preparer $400-700 to file their return. Simplified reporting will help them out, much to the chagrin of tax preparation firms like H&R Block.
The proposal plans to increase the child credit. What this means is at least an extra $1000 in the pocket of families. Our clients come from all over the economic spectrum. I can certainly think of a few clients where that extra $1000 will make a huge difference.
The middle class will see lower rates and higher deductions.
Small businesses and the self-employed get hammered by the tax code. Self-employment taxes at around 17% and the fact that they can’t scale regulatory burdens put them at a disadvantage making growth very difficult. Many small businesses won’t be small for long. In fact, I predict we will see a decentralization in many fields, in particular medicine. For the past 15 years, due many to compliance costs and not just tax, the trend has been for hospitals and other medical groups to buy-out stand-alone practitioners. The practitioners then become employees.
Because high-wage earners will see little benefit from tax reform, and small business will see huge benefits, many doctors who are currently working as employees may be tempted to go back out on their own. Also, there is another benefit that will work hand-in-hand to encourage highly paid employees to open their own business which I will discuss next.
Businesses with capital investments
It’s not just doctors who have a lot of high-end equipment that will benefit from this next proposal. Any business that invests in large projects will have the benefit of being able to write-off the entire cost in one year, as opposed to having to amortize only a portion of the expense a year.
Under the old rules, just because a business has a business expense, it doesn’t mean they get to write off the entire expense in a year. So you see the difficulty. If you make a large investment, your taxable income could still be very high, even though you don’t have the cash —because you made the large capital investment. This bind forced many businesses to forge expansion. They have to governor their growth according to the tight cash flow caused by the current tax system — or face disaster. As a tax attorney who has helped many businesses who find themselves in tight spots, over-expansion was a common root cause of distress. Well, it used to be. Since 2008, most businesses have been too afraid to expand.
This proposal will eliminate many of those fears.
For who? Corporations who can’t afford to strip out income overseas, and corporations who like huge influxes of foreign investment.
The tax rate for “C” corporations will be dropped to 20% from a high of 35% (that can actually be 38% in some cases). Despite this, a tiny percentage of federal revenues are paid by corporations — around $200 billion a year out of $3 trillion in receipts.
One of the reasons is that large players can afford to move around their income to pay effectively low US tax rates, leaving large corporations (but not big enough) with a disadvantage. But a 20% corporate tax rate will be low enough to make going overseas for tax advantages not so advantageous. It will be simpler, cheaper and have lower opportunity costs to not engage in all the hoops and hurdles. This is going to help many corporations who are poised to become huge, to actually be able to become huge. They won’t have the disadvantage of being big enough to tax very heavily, but not big enough to avoid that tax.
Foreign investors are going to be incredibly attracted to the US with these low tax rates. Remember, when a business avoids US taxes, it likely doesn’t avoid all taxes. It is paying taxes to someone. I am not the only one to conclude that the opportunity to invest in the world’s largest economy and pay a low tax rate is going to create a huge influx of capital.
Many family businesses might not make a lot of income, their owners might not consider themselves to be rich, but if you actually sold the assets, you would find it exceeds more than $5 million. If the asset exceeds more than $5 million ($4.55 to be exact) it is subject to the death tax. In many cases, these death tax bills require families to borrow against the asset or force a sale. In either case, the business will likely never be the same. Of course, good tax planning can avoid these heartaches, but many people don’t think to plan, because they never thought of themselves as being wealthy enough to be hit by the death tax. Think of family farmers and retailers. These are the types of business often devastated by a surprising death tax bill.
Goodbye US expats, hello foreign investors
A big part of the proposed reform and something we have been a part of is a hoped-for switch from citizenship based taxation to a territorial system, along with the reality of the incredibly costly Foreign Account Tax Compliance Act (FATCA). What this means is that many of our US clients who live overseas will no longer need to be our clients, unless they have US-sourced income.
What this also means is that foreign investors, who up to now haven’t been paying US income taxes, will need to do so. We expect large numbers of new foreign investors, who will look to move their operations in the US in order to take advantage of corporate tax rates that are likely going to be lower than the country they are currently located in.
But what about the deficit?
With the current federal deficit at around $20 trillion many people quite rightfully ask, can we afford to give these kinds of tax benefits to pretty much everyone who pays taxes? To which I respond:
It is the current tax system, not the proposed tax system that has lead to a $20 trillion deficit. We have to face the fact and look for some other solution other than hoping the status quo will lead to a different outcome.
Our business outlook, our firm’s outlook
Our outlook is incredibly positive. First, there are going to be large areas of tax law that will need new interpretations. Regulatory challenges may be less of a foregone conclusion with certain justices and judges, like Neil Gorsuch, critical of the Chevron deference to administrative agencies such as the IRS.
While we expect that for many of our clients, the hourly tax work we do for them decreases, we anticipate a significant number of new clients. I know there are so many people on the sidelines, itching to get back into the game, but not able to because the current tax code leaves too little room to make all the risk, toil and sweat worth it. I know because I’ve had them as clients.
Ultimately, we see a tax reform plan that favors risk takers and families. You don’t need to be a fan of Donald Trump to realize these are two critical things that need to be encouraged if we want this country to grow and to flourish.
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