How the White House’s Tax Plan Would Affect High-Net-Worth Investors

In addition to drastically lowering the corporate tax rate, President Trump’s proposed tax plan includes a host of changes that would directly affect high-net-worth investors, such as reducing the top income and capital gains rates, repealing the estate tax, and eliminating deductions for state and local taxes.

Wednesday, May 3, 2017

On April 26, the Trump administration unveiled what Treasury Secretary Steven Mnuchin described as the “core principles” of the president’s tax reform plan. In addition to significantly lowering taxes on large corporations and pass-through entities, the proposal includes several changes that would directly affect high-net-worth investors.

The goals of these reforms, Secretary Mnuchin said, are “to make business rates competitive, bring back trillions of dollars to create jobs, simplify personal taxes, (and) create a middle-income tax cut." Secretary Mnuchin called these core principles “non-negotiable.”

Secretary Mnuchin and National Economic Council Director Gary Cohn laid out the Trump administration’s tax reform priorities during a press conference at the White House. While Secretary Mnuchin and Director Cohn did not address many of the important details that will be critical elements of any tax-reform bill, which would be ultimately introduced in Congress, both men said that these issues would be determined through ongoing discussions between the White House and lawmakers in the House of Representatives and the Senate.

Core Elements of Trump Administration Proposal
Secretary Mnuchin and Director Cohn said that President Trump would push for a host of changes to individual and business taxes as part of Republicans’ efforts to pass the nation’s first comprehensive tax reform since 1986.

Individual taxes:

  • Estate tax and alternative minimum tax repealed: President Trump’s plan would eliminate the estate tax, which currently applies a 40% tax to estates larger than $5.49 million per individual or up to $10.98 million when combined with a spouse’s unused exemption. The plan also would seek to simplify the tax code by eliminating the alternative minimum tax (AMT).

  • Top marginal tax rate lowered to 35% and number of tax brackets reduced: Currently there are seven marginal tax brackets for individual income, with the highest being 39.6% for individuals earning more than $418,400 and married couples earning more than $470,700. President Trump is calling for a reduction to just three tax brackets: 10%, 25%, and 35%. The plan, however, did not state the income levels where those rates would start and stop.

  • Top capital gains rate lowered to 20%: When the Affordable Care Act (ACA) was passed, it created a 3.8% tax on capital gains, dividends, and other investment income for high-income taxpayers. This raised the top rate on investment income to 23.8%. President Trump’s plan would eliminate the ACA surtax, returning the top rate on investment income to 20%.

  • Standard deduction doubled: Designed as a way to simplify tax filing for millions of Americans, President Trump’s plan would double the amount of the standard deduction, which currently is $6,350 for individuals and $12,700 for married couples. The plan did not say whether the personal exemption, which is $4,050, would change.

  • Deductions eliminated, except for mortgage interest and charitable contributions: One of the primary ways that President Trump’s plan would recoup some of the revenue lost from the tax cuts would be eliminating most deductions for individuals who itemize their returns. The most significant of these is the ability for taxpayers to deduct state and local taxes, including state income tax and property tax, from their federal taxes. This deduction will save taxpayers about $103 billion this year, according to the bipartisan congressional Joint Committee on Taxation.

    This is shaping up to be one of the most contentious elements of President Trump’s plan because the benefit of this deduction is spread unevenly among the states. The Wall Street Journal reported that 38% of this deduction’s value goes to residents of California, New York, and New Jersey, three of the highest-tax states.

    The two deductions that President Trump’s plan would retain are the deductions for mortgage interest and charitable deductions. These deductions will save taxpayers $65 billion and $57 billion this year, respectively, according to the Joint Committee on Taxation. If the standard deduction were doubled, fewer taxpayers—especially those with moderate incomes—would claim these deductions.

  • Child care tax benefits increased: President Trump’s plan would expand tax benefits for families that incur childcare expenses. The administration has not provided any details about how this tax relief would be structured.

Corporate taxes:

  • Tax rate for corporations and pass-through entities lowered to 15%: With a top marginal corporate tax rate of 35%, the United States currently has the highest nominal tax rate on business profits among large industrialized nations. President Trump’s plan calls for lowering this rate to 15%. The new lower rate would apply to large C-corporations, as well as to S-corporations, limited liability companies, partnerships, sole proprietorships, and other businesses where the company’s profits pass through to the owners’ personal tax returns. During the April 26 press conference, Secretary Mnuchin said that the administration would work to create rules that would prevent owners of pass-through entities from claiming an inappropriately low level of compensation and using the business as a way to avoid paying taxes.

  • “Territorial” tax system adopted for foreign profits: The United States currently has a system that taxes a company’s income (less certain credits), regardless of where that income is earned, if those profits are brought back to the United States. Thus, the United States is unusual among industrialized nations in that it taxes foreign profits. President Trump’s plan calls for moving to a “territorial” system where foreign profits would not be taxed.

  • One-time repatriation tax created: As a result of the United States’ current corporate tax system, which taxes foreign profits at 35%, U.S.-based corporations have an estimated $2.6 trillion of profits that are essentially trapped outside of the country, according to the Joint Commission on Taxation. To encourage companies to bring some of this cash back to the United States, the Trump administration is proposing a one-time tax on repatriated income. The administration has not yet proposed a rate for that one-time tax, but it presumably would be 15% or even lower.

Next Steps in the Legislative Process
While the Trump administration’s announcement of these core elements marks an important step in Republicans’ efforts to reform the tax code, major roadblocks remain before any of these proposed changes become law. President Trump’s plan is merely a broad-based outline that does not address many of the critical details that would go into a bill. Secretary Mnuchin has previously said that the administration plans to have a draft of legislation ready by June with the goal of having the final bill passed before Congress breaks for August recess. Rep. Kevin Brady, (R-Texas), chairman of the House Ways and Means Committee, has publicly discussed the possibility of a longer timeline, with the goal of having a law passed before the end of 2017.

Regardless of when the bill is introduced, the White House will need to work with Republicans in Congress to draft legislation that irons out some of the significant differences between the White House proposal and the “A Better Way” proposal, introduced last year by House GOP leadership. Two of the most important decisions that Republicans must make is whether to make the bill revenue-neutral and whether to push for permanent tax cuts vs. temporary ones, which would sunset after 10 years. A revenue-neutral bill is one in which the revenue lost from any tax cuts is offset by increases in projected revenue as a result of higher economic growth and/or increases in tax collections via other methods, such as eliminating deductions.

If the bill is projected to add to the federal deficit beyond a 10-year period, Republicans would need some Democratic support to avoid a filibuster in the Senate. But if the bill either 1) is projected to not add to the federal deficit or 2) is not revenue-neutral but the tax cuts expire after 10 years, then Republicans, who hold a majority in both the House and the Senate, can pass the law with a simple majority through a legislative process known as reconciliation. The reconciliation process would allow the bill to avoid a Democratic filibuster in the Senate.

The House GOP “A Better Way” plan calls for making up for lost revenue, in part, through a tool known as border adjustment, which would tax imports but exclude exports from taxation. The Trump administration has indicated that they don’t support using border adjustment and that they would be willing to pursue a plan where the tax cuts expire after 10 years, if necessary.

Keeping an Eye on Washington
The next several months should be informative in terms of which path Republicans plan to pursue in their efforts to pass tax reform. While negotiations between the White House and Republican leadership in Congress will largely take place behind closed doors, elements of the ultimate plan likely will begin to emerge before a bill is introduced.

At William Blair, we think it is still too early for high-net-worth investors to begin implementing any changes to their investment or wealth-transfer strategies in anticipation of any of the proposed tax reforms coming to fruition. Passing legislation as complex and wide-ranging as tax reform is extremely challenging, even when one party controls the White House and both houses of Congress. We will be closely monitoring the developments in Washington and keep you updated as the details of the tax reform legislation come into focus.

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William Blair produces educational and timely communications on a variety of wealth management topics of interest to individuals and families at all generational stages of life, philanthropic foundations, and not-for-profit organizations.

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