CHICAGO — Any change in Washington brings the possibility, indeed the likelihood, of tax law changes. The election of Donald Trump as the 45th president of the United States is no exception. In his campaign, the president highlighted several goals of tax reform that included reducing the official corporate tax rate to 15% from its present 35%.
In addition, the president would like to see the top individual tax rate at 33%, down from 39.6%. And, it is not just Trump who would like to see the Affordable Care Act (also known as Obamacare) repealed. As an essential part of any Congressional repeal efforts, the 3.8% Medicare tax on investment income would also be repealed.
PASS-THROUGH BUSINESSES
Most incorporated businesses, so-called “C” corporations, are taxed twice — once at the entity level and again when shareholders pay taxes on dividends and capital gains. In other words, pass-through businesses such as LLCs, partnerships and S corporations don’t pay taxes at the entity level since their profits are passed to the owners and taxed at the individual income tax rate.
That’s long been a stumbling block for would-be tax reformers. There’s general agreement that the marginal tax rate on C corporations is too high, but if that’s cut, pass-throughs wouldn’t get a reduction and may even face a tax increase. Some proposals consider cutting the ordinary income tax rate but, according to many experts, that could be expensive.
One alternative is to give pass-throughs a reduced rate compared to wage income, which has been proposed by Trump (a 15% rate cap) and the House GOP (a 25% rate cap). Both plans have a top ordinary rate of 33%, according to published reports.
However, creating a special rate for pass-throughs can encourage gaming, according to the Tax Foundation, the Washington-based think tank, because business owners would have an incentive to re-categorize their wage income as business income.
The president’s campaign materials seemed to include rules that would prevent pass-through owners from converting their compensation income taxed at higher rates into profits taxed at the proposed 15% rate.
The most likely scenario appears to tax pass-through entities at 15% but again on distributions. That’s good news for coin-operated laundry businesses that retain a substantial share of their income. It would also increase the tax differential between corporate investment and pass-through investment.
CORPORATE TAX EXPENDITURES ELIMINATED
Most corporate tax expenditures, except for the research and development (R&D) tax credit, could be eliminated in exchange for a lower corporate tax rate. That’s right: in order to pay for lower business tax rates, Trump proposes the elimination of certain unspecified “corporate tax expenditures.”
Congressional Republicans have run into trouble with lobbyists whenever they get too specific about what tax breaks they would eliminate in return for lower corporate rates. In all likelihood, this will continue to be a difficult hurdle to overcome, especially without specifics.
FIRST-YEAR WRITE-OFFS
Of interest to many small businesses, Trump has proposed a doubling of the Code Sec. 179 small business expensing election from $500,000 to $1 million. That would mean that up to $1 million for new equipment and other business property could be written-off as an “expense” in the first year. Presumably, the ceiling for all capital expenditures after which the first-year expensing is lowered dollar-for-dollar would also be raised.
AS CONGRESS PROPOSES
As the new Congress is seated, it’s more than likely that Trump’s proposals will be incorporated into a host of other changes. Where this will end up is hard to predict. When Congress undertakes the 2018 budget this spring, the process will likely include:
- Creating a new business rate for small businesses that are organized as sole proprietorships or pass-through entities instead of taxing them at individual rates;
- Reducing the corporate tax rate to 20%;
- Providing for immediate expensing of the cost of business investments;
- Allowing interest expense to be deducted only against interest income, with any net interest expense carried forward and allowed as a deduction against net interest income in future years (with special rules that will apply for financial services companies);
- Allowing net operating losses (NOLs) to be carried forward indefinitely and increased by an interest factor, and eliminating NOL carry-backs;
- Generally eliminating certain (but unspecified) special interest deductions and credits;
- Shifting to a territorial tax system; and
- Moving “toward a consumption-based tax approach.”
PAYING FOR THE CUTS
Any tax cuts, real or proposed, must be paid for in some way. Some estimates put the 10-year deficit increase at $9 trillion for the proposals of President Trump. Obviously, there is some sleight of hand that can be used to ignore at least part of the problem currently, but it’ll show up quickly.
Obviously, the economy will have to grow faster than it has in some time to solve the problem. If not, tax rates could creep higher after the initial cuts. That also has happened in the past. It might be avoided with significant spending cuts, but that approach has proved elusive in the past.
In the long run, the overall tax bills of most taxpayers — including many coin-operated laundries — are almost sure to be lower, while deductions for individuals are almost certain to be scarcer. There could be cutbacks in certain tax credits and other deductions for particular industries. In other words, some taxpayers may benefit less than others, making it more important than ever to keep an eye on our lawmakers.
Information in this article is provided for educational and reference purposes only. It is not intended to provide specific advice or individual recommendations. Consult an attorney or tax adviser for advice regarding your particular situation.
If you missed Part 1, you can read it HERE.
Have a question or comment? E-mail our editor Bruce Beggs at [email protected].