Business executives are excited about the prospect of tax reform, according to some of Orange County’s top accountants.
The Business Journal’s financial editor, Peter J. Brennan, asked the professionals to tell us what their clients are saying about tax proposals and the advice they’re giving clients. They discussed the various possibilities, which include:
• Corporate tax rate cut to 15% or 20%
• Individual tax rate topping out at 33%
• A 15% or 20% tax rate on companies that pay through
S corporations or partnerships, down from a top rate of 39.6%
• Elimination of alternative minimum tax
• Elimination of death tax
• Changes in carried interest
• Cut in capital gains and dividends from 23.8% to 20%
• Reduced corporate tax of 10% on repatriated profits
• Immediate business expensing rather than depreciation
Here are edited excerpts of the accountants’ responses:
Mark G. Cook
Tax Partner
SingerLewak
Irvine
There is much talk these days about tax reform.
Will it be a comprehensive overhaul like the 1986 Tax Reform Act or the 2016 House Republicans’ ‘A Better Way’ proposal? Will it be revenue-neutral or debt-funded? Will it be a modest attempt at simplification like reducing tax rates and limiting deductibility of such items as state and local taxes, charitable deductions and mortgage interest?
Whatever the outcome, the clock on 2017 may be running out.
A quick look at the remaining 2017 legislative calendar provides some insight into the prospects for a significant legislative overhaul of the tax system, a task so daunting that it hasn’t happened since 1986.
From July 11, there are only 13 legislative days until the August recess. Things get interesting when Congress returns in September. They will have until Sept. 30 to agree on funding the government for the next fiscal year. In the current political environment, that will likely consume most of September, particularly given that the debt ceiling will also need to be raised.
Additionally, the budget resolution may be used for tax legislation if the Republicans want to pass it without Democratic support. That comes with a 10-year sunset provision, and congressional Republicans are open to extending it, but that would take more time.
Both houses of Congress are not in agreement on tax reform. A cornerstone of the House Republican plan is the Border Adjustment Tax, which is shorthand for saying imported goods are not deductible. The Senate isn’t on board. And without it, the revenue-neutral aspect of tax reform is at risk. That is all exacerbated by the need to get healthcare passed because the savings from the effort will be used to lower the tax rates.
With all of those hurdles, comprehensive tax reform seems more and more unlikely. If we see tax reform in 2017, it will likely be a watered down version. The forecast diminishes in 2018 for several reasons, including the congressional midterm elections.
Cook is chairman of a tax committee at the American Institute of Certified Public Accountants.
Jim Curtis
International Tax Senior Manager
Hall & Co.
Irvine
It appears lately that foreign companies are eager to do more business and increase their investments within the United States, but our high corporate tax rate makes them hesitant to take any action at this point. This wait-and-see attitude has resulted in companies maintaining the status quo until they become more certain of upcoming tax changes or reform next year.
Foreign companies, ranging the gamut from manufacturers to wholesale distribution and retail industries, remain concerned about their U.S. federal and state tax liability and ever-growing compliance burden.
The proposed reduction of the U.S. federal corporate tax rate from 35% to 15% might seem too good to be true for most foreign companies at this point. However, even a more modest reduction of the corporate tax rate to 25% or 27% would result in significant inbound investment opportunities from foreign companies looking to grow or expand their U.S. businesses.
While there is a general consensus that corporate tax reform is on the horizon, things are too uncertain at this point to plan ahead based on the current proposals.
Therefore, we are advising clients to plan for a variety of scenarios and to stay abreast of further changes that will occur in Washington over the rest of 2017 and into 2018.
Vito Francone
Tax Partner
Deloitte Tax LLP
Costa Mesa
President Trump and congressional Republicans hope to enact comprehensive tax reform by the end of the year that could cut marginal rates for high-wealth individuals and pass-through businesses. But based on the plans released so far—a one-page fact sheet from the White House and a campaign-style ‘blueprint’ from House Republicans—those lower rates are likely to come with trade-offs that taxpayers will need to bear in mind as the debate unfolds.
First the carrots: Individuals would see a top rate of 35% under the administration’s proposal, or 33% under the House GOP blueprint. Pass-through rates also would be cut, to 15% under the Trump Administration plan, or 25% under the House blueprint. The administration presumably would leave the top long-term capital gain rate at 20%, while House Republicans would tax capital gains and dividends as ordinary income subject to a 50% exclusion, for an effective top rate of 16.5%. Both plans would repeal the 3.8% net investment income tax, the AMT, and the estate tax.
But now the sticks:
• Fewer deductions. Both plans would eliminate most current-law tax incentives, although neither includes a definitive list of targeted provisions. The administration and House Republicans specifically call for keeping the deductions for mortgage interest and charitable giving, possibly with modifications. But both would repeal the state and local tax deduction, a move that could undo the benefit of lower rates for itemizers living in high-tax states like California.
• Pass-through anti-abuse rules—both plans would pair a lower pass-through rate with anti-abuse rules to prevent individuals from recharacterizing wage income as more lightly taxed business income. Under the House GOP blueprint, pass-throughs would pay, or be treated as having paid, reasonable compensation to owner-operators that would be deductible by the business and subject to tax at graduated rates for families and individuals. The administration has promised that anti-abuse rules will be put in place but has not yet offered a specific proposal.
• Possible changes for carried interest—the Trump plan would treat carried interest income as ordinary rather than capital gain. The House blueprint doesn’t specifically address carried interest income, so it presumably would continue to be treated as long-term capital gain, though the top effective rate on long-term capital gain income would be reduced to 16.5% from 23.8%.
Both plans are short on specifics, so it is difficult to determine the impact of the potential trade-offs. The picture could become clearer this fall. Administration officials and Republican leaders are negotiating an agreement on a single plan that they hope can clear both chambers of Congress.
The administration hopes to present a detailed proposal based on that agreement after Labor Day, when lawmakers return from the August recess.
Richard Gabaldon
Partner
BDO
Costa Mesa
On April 26, President Trump released his proposed changes to fulfill his promise of comprehensive income tax reform.
Our individual clients are mostly excited by the following: reducing the number of tax brackets from seven with a maximum rate of 39.6% to a three-bracket system of 10%, 25%, and 35%. Other favorable proposed changes include the repeal of the 3.8% tax on interest, dividend, and real estate income. The maximum capital gains tax would be reduced to 20%. The plan also includes the repeal of the alternative minimum tax, or AMT, and estate tax generally referred to as the death tax.
The one concern our clients have expressed is elimination of state income and real estate taxes as an itemized deduction. Under the president’s plan, only mortgage interest and charitable contributions would be deductible.
Our business clients are mostly excited by the reduction of the corporate tax rate to 15%. In addition, certain small and medium sized pass-through entities would be taxed at 15%. Other favorable changes include transiting from a worldwide tax base to a territorial system. That would eliminate the current foreign tax credit regime. There is also excitement surrounding the one-time charge to bring profits back to the U.S.
Our business clients have expressed concern about the elimination of tax breaks for special-interest groups. Details are not available, but some believe the IRC 199 deduction claimed by domestic manufacturers may be at risk.
At this juncture, Congress’ reaction has been lukewarm. As such, we are advising clients to monitor but to not take action solely based upon the president’s plan. Once the healthcare issue is addressed, we may see real action on tax reform in the fall.
Scot Grierson
Tax Partner
KPMG
Irvine
The outlook for federal tax reform continues to be uncertain, but it’s inescapable that the ultimate outcome will have an impact on state corporate taxes. Sitting back and waiting to see how things could unfold at the state level is not a winning strategy. Modeling various scenarios now is.
The question that should be top of mind for CFOs and chief tax officers is whether there will be tax rate reductions at the state level similar to those proposed at the federal level, given the various linkages between state and federal taxes?
Here are drill-downs from that question for California companies to consider:
• What is our tax posture for California and any other state where we conduct business? Where is our tax liability the greatest, and what is driving that liability? What are the key characteristics of the tax systems in those states?
• How will the key aspects of potential federal reforms likely affect the tax base and our liability in those states? Have we modeled the impact of the changes on our tax position?
• What are key officials in those states saying about the impact of federal reform at the state level and the likelihood that they will or will not model the federal changes at the state level?
• What is the overall fiscal outlook for the next two to four years in our key states?
• How might federal changes impact the valuation of deferred state tax assets and liabilities?
• Are there steps we can take now that might mitigate any undesirable outcomes from the federal reform at the state level, or conversely, enhance desirable outcomes?
Despite today’s uncertainty, the time to analyze and prepare for managing the impact of federal tax reform at the state tax level is now.
Jon Huckabay
Tax Principal
Ells CPAs & Business Advisors
Santa Ana
Donald Trump and the Republican-led Congress have been touting tax reform for the past two years. They have said that our federal tax system is too complicated, taxes are too high, and that we need to reduce the tax burden for all Americans. However, a reduction in taxes may not be the case for everyone if the plan goes through as President Trump has laid out.
There are some big gaps in the plan that was released earlier this year, but the major changes for individual taxpayers include a reduced number of tax brackets from seven brackets to three; a reduction in the top tax rate from 39.6% to 35% under Trump’s plan; elimination of itemized deductions except for mortgage interest and charitable contributions; doubling of the standard deduction to $12,700 for single taxpayers and to $25,400 for married filing joint taxpayers; and elimination of personal exemptions, $4,050 per taxpayer, spouse, and dependents.
Let’s look at a simple example of a married couple with two children who live in California and own a home. Assume the couple has total gross income of $150,000 from wages, mortgage interest of $25,000 per year, charitable contributions of $1,000, property taxes of $5,000, and state taxes of $5,000. They would also have $16,200 in personal exemptions, further reducing their taxable income to $97,800. Under current law, the couple would owe federal tax of approximately $16,000. Under Trump’s plan, they would lose all itemized deductions except for mortgage and charitable contributions, and they would lose personal exemptions, leaving them with taxable income of $124,000. Under current tax law, the 25% tax bracket starts at approximately $75,000 of gross income. Assuming that’s the same under Trump’s plan, the couple’s tax could increase to approximately $19,000.
There is no telling what, if anything, will happen this year in regards to tax reform. However, you won’t know how the changes will affect your tax bill until you run the numbers.
Candace Huie
Tax Partner
Director of Tax and Advisory Department
White Nelson Diehl Evans LLP
Since the conclusion of the presidential election, many people are anxiously awaiting the proposed changes in tax laws. As tax professionals, our clients look to us for guidance and to help them navigate business decisions and transactions that may be greatly impacted by the potential changes.
Where we had hoped for some timely resolution, we are now taking a wait-and-see approach. It appears that with the efforts being expended on the repeal and replacement of the Affordable Care Act, tax reform has clearly taken a back seat.
Although the tax reforms proposed by President Trump and the GOP differ, there are enough similarities that we expect significant changes to occur. However, the timing of the changes is the challenge that every taxpayer faces.
The most anticipated tax law change seems to be the lower tax rates for both individuals and business entities, specifically pass-through entities, with the elimination of the alternative minimum tax coming in a close second. Owners of closely held companies in particular are holding off on tax planning moves until closer to year-end and will most likely be advised to defer income and accelerate deductions in anticipation of lower taxes next year.
Business owners are well-advised to postpone any sales of businesses until the new tax reform has been enacted, with the hopes of lower capital gains rates, lower individual income tax rates, and the elimination of the Net Investment Income Tax.
Staying in close contact with your tax professional through the remainder of the tax year is my best advice for taxpayers.
Scott Jackson
Principal
Squar Milner LLP
Newport Beach
Tax reform is supposed to hit center stage later this year. Whether or not that will happen, and what the results will be, is debatable. The tax reform discussion is centered around the detailed House GOP Tax Reform Blueprint released last year and the single-page summary release by the White House earlier this year. While the details and proposed rates differ, the plans are conceptually consistent in many ways.
Tax rate reduction—15% or 20% top rate for corporations, 33% or 35% top rate for individuals, 15% or 25% top rate for pass-through entities. Reduction of tax rates is the most visible and discussed item of tax reform, but flying under the radar is the tax reduction on pass-through income, which could have a huge impact on a substantial portion of our client base of real estate and closely held businesses.
Opportunities for the current year—as a large regional firm with clients in all industries and business in all parts of the world, our clients are anxious about a number of those proposals. As tax rates are presumed to decline in the future, deductions and credits become more valuable in the current year. We are advising clients to accelerate deductions and utilize any credits that have been deferred in the past. Conversely, pushing income recognition into the next year, if possible, is now even more beneficial as the rates will likely be lower. If the Alternative Minimum Tax is repealed, delaying the exercise of certain stock options could be beneficial. A one-time reduced rate of tax for repatriation of foreign income is also expected to be included with the new tax bill.
No one really knows what the future has in store for taxes, but there are planning opportunities for businesses and individuals that should be effectuated this year.
Scott Jaconetty
Tax Partner
Ernst & Young LLP
Irvine
U.S. companies could see sweeping changes in taxes under proposals being considered by Congress, and business leaders should act now if they want to be prepared for the impending historic tax reform. The transformation has understandably raised many questions, but it shouldn’t prevent you from taking the proper steps to prepare your company for the changes. What many of my clients are asking me is what action steps they should take now and what they should delay. There are three critical steps that I advise business leaders take to set themselves up for success in the face of all the change:
The first is to model the House Republican blueprint for your specific situation, to understand the effect of proposals on your federal and state tax liability and your business. For example, the border adjustment tax element of the House blueprint is top of mind right now. The provision represents a major departure from the current corporate income tax by incentivizing exports, penalizing imports and moving the current tax system toward a destination-based cash flow tax. While the border adjustment tax has recently lost some momentum, I still recommend that companies have a plan in place in the event that it is enacted in some form—because of the potential far-reaching impact. It’s important that businesses do the calculations on their supply chain to better understand how they might fit into the new tax system.
Next, execute ‘no regrets’ planning strategies prior to the enactment of any legislation. With rates expected to go down across the board, we could currently be at an all-time high tax rate. Most business deductions and credits are also expected to be eliminated. Make sure you’re using the right strategy for the environment. Businesses should work with their tax providers to review tax accounting methods to help ensure that they’re maximizing deductions at the current high tax rates.
It’s also worth taking the time to develop an advocacy plan for your company. The president is listening to businesses right now. As such, it behooves every CEO to make his or her voice heard and be part of the dialogue on tax reform—either directly with your representatives or as part of an industry group.
It’s up to us as business leaders to comprehend, prepare for and navigate the changes to come.
Stacie Kitts
Tax Partner
Haskell & White LLP
Irvine
Living in a desirable location such as Southern California does come with some hurdles. Most notable of those would include navigating the nation’s highest individual state income tax rate of 13.3%. Combine that with the top federal tax rate of 39.6%, excluding the 3.8% net investment tax that has yet to be repealed, and you are looking at some hefty tax bills. That makes us incredibly interested when we hear about upcoming tax reform.
Billed as ‘The Biggest Individual and Business Tax Cut in American History,’ the administration’s one-page summary is sure leaving a lot to the imagination. The reductions, whether they are historically the biggest or not, are welcome. It’s just a matter of wait-and-see right now.
The summary features relief for middle-income families, and the elimination of tax breaks that benefit the wealthiest taxpayers. The one-page plan presented by the Trump administration indicates that the highest proposed individual tax bracket is 35% rather than the 33% initially anticipated. You don’t have to be Warren Buffet to see those two percentage points adding up to millions of dollars.
For middle-market companies like those I serve, a similar compromise on corporate taxes can mean a big loss to the bottom line, and it’s the difference between opening a new factory or not; hiring new web programmers or not; launching a new product line or not; or even a foreign company looking to move to the U.S. or not.
Without better insight into the current administration’s plan, it would be unwise to make significant life or strategy changes based on uncertain tax reform. During this time of uncertainty, taxpayers should first look to strategies that help maintain wealth and reduce or defer tax, such as utilizing and maximizing retirement vehicles, diversifying investments, rebalancing portfolios, or harvesting tax losses.
Manuel J. Ramirez
Chairman
RJI International CPAs
Irvine
Which of the changes are RJI’s international corporate and individual clients most excited about? The proposed reductions in the corporate income tax rate from 35% to 20% under the Ryan plan, the elimination of the alternative minimum tax and gift/estate taxes, and significant changes to the U.S. international taxation system, i.e., creation of a fully territorial tax system, exempting 100% of dividends from foreign subsidiaries and enactment of a deemed repatriation system at a tax rate of 8.75% or 3.5%, depending on the characteristics of the income.
We are advising clients to plan for changes, should they be effectuated this year as the Trump administration is anticipating. We are also advising them of the possibility that tax reform may not occur until next year, as there are competing proposals that have emerged from both branches that vary in significant ways from the Trump administration’s proposal. The Senate has already indicated that tax reform won’t occur before the August recess and that it will need to use a special procedure known as ‘reconciliation’ to pass with a simple majority. That means if tax reform is passed, it will most likely expire in 10 years.
Some of the substantive proposed provisions we are advising clients in 2017 tax planning meetings are: the cash flow tax; the border adjustment tax; elimination/reduction of interest deductions; elimination of all business credits and the Section 199 deduction; and the full deduction of capital expenditures.
Why do we recommend planning for those proposals? Well, like the old saying goes, ‘Good planning and hard work lead to prosperity, but hasty shortcuts lead to poverty.’
