Every change in Washington brings the possibility, indeed the likelihood, of tax law changes, and the election of Donald Trump as the 45th President of the United States is no exception. In his campaign, the President-elect highlighted several goals of tax reform that included reducing the official corporate tax rate to 15 percent from its present 35 percent.
In addition, the President-elect would like to see the top individual tax rate at 33 percent, down from 39.6 percent. And, it is not just the President-elect who would like to see the Affordable Care Act (Obamacare) repealed.
President-elect Trump’s campaign promise to work with Congress to introduce broader legislative measures within the first 100 days of his administration included the following:
- Middle Class Tax Relief And Simplification Act. An economic plan designed to grow the economy four-percent per year and create at least 25 million new jobs through massive tax reduction and simplification, in combination with trade reform, regulatory relief and lifting restrictions on American energy.
- End The Offshoring Act. Would establish tariffs to discourage companies from laying off their workers in order to relocate in other countries and ship their products back to the U.S. tax-free.
- American Energy & Infrastructure Act. This would leverage public-private partnerships, and private investments using tax incentives, to spur $1 trillion in infrastructure investment over 10 years. It is revenue neutral.
But, what would this mean for a nursery or growing business?
Of interest to the owners of nursery businesses – and their heirs – the estate tax would be repealed if the president-elect’s proposals bear fruit. However, capital gains on property held until death and valued over $10 million would be subject to tax – with an exemption for small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives would be disallowed.
Corporate tax rate reduction
Both President-elect Trump and House Republicans want the corporate tax rate cut from its current top rate of 35 percent (the highest worldwide) to 15 percent and 20 percent, respectively. The Trump plan “would be a bold step that leapfrogs the United States all the way to having one of the lowest rates in the developed world,” according to the campaign’s Web site.
Trump specifically proposed reducing the top corporate tax rate to 15 percent while extending the same 15 percent top rate to the income of pass-through entities and sole proprietorships. The current top corporate tax rate is 35 percent, and the current top rate on business income from pass-through entities and sole proprietorships is the top ordinary, personal income tax rate of 39.6 percent.
The House Republican’s plan, on the other hand, is more moderate. Their tax plan includes so-called “base broadeners,” which would counter the revenue lost from the rate drop. Trump’s plan doesn’t have those. As a result, under the president-elect’s proposal, the corporate income tax raises less revenue for the government than the House GOP’s plan.
Trump has proposed some sort of tax, similar to the tax on corporate dividends, that would be applied to distributions of business income from other business entities. The Trump campaign has stated that it hopes to include provisions that would prevent the conversion of ordinary income into business income, but more about that below.
With congressional concerns about deficit projections resulting from the Trump proposals, the proposed rates may have to come up somewhat. Congress may also be concerned about extending the corporate tax rate to other business income due in part to the deficit.
The majority of incorporated businesses, so-called “C” corporations, are presently 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 since their profits are passed through to the owners and taxed at each individual’s personal 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 is cut pass-throughs would a tax increase rather than a reduction. Some proposals consider cutting the ordinary income tax rate but, according to many experts, that could be expensive to the government’s coffers.
One alternative might be to give pass-throughs a reduced rate compared to wage income – as proposed by Trump (a 15-percent rate cap) and the House GOP (a 25 percent rate cap). Both plans have a top ordinary rate of 33 percent, according to published reports.
However, creating a special rate for pass-throughs can encourage “gaming,” according to the Tax Foundation, a Washington-based think tank, because business owners would have an incentive to recategorize their wage income as business income. The president-elect’s campaign materials seemingly include rules that would prevent pass-through owners from converting their compensation income taxed at higher rates into profits taxed at the proposed 15 percent rate.
The most likely scenario appears to tax pass-through entities at 15 percent but taxed again on distributions. Good news for nursery and growing businesses that retain a substantial share of their income within the business. It would also increase the tax differential between corporate investment and pass-through investment.
Corporate tax expenditures eliminated
Most corporate tax expenditures, except for research and development (R&D), could be eliminated in exchange for a lower corporate tax rate. That’s right, in order to pay for lower business tax rates, President-elect Trump proposes eliminating certain, unspecified “corporate tax expenditures.” He has indicated the research and development credit would be spared.
In the past, 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.
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 of expenditures for new equipment and other business property could be immediately written-off as an “expense.” Presumably, the ceiling for all capital expenditures after which the first-year expensing is lowered, dollar-for-dollar would also be rasied.
The lame duck congress
As Congress meets in a “lame duck” session it is expected they will tackle taxes. Exactly what tax legislation Congress will consider remains to be seen but will likely include:
- Legislation to renew some expiring tax provisions, especially energy extenders.
- Legislation to fund the federal government, including the IRS, through the end of the 2017 fiscal year.
- Legislation to enhance the retirement savings of individuals.
- Legislation to help citrus farmers, small businesses and more.
As the new Congress is seated, it’s more than likely that Trump’s proposals will be incorporated into a host of already proposed changes. Where this will end up is difficult to predict because a number of tax proposals might emerge on the congressional drawing board in the lame-duck session. More likely, when Congress undertakes the 2018 budget this spring, the process will 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-percent;
- 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 carrybacks;
- retaining the research credit (but evaluating options to make it more effective); generally eliminating certain (but unspecified) special interest deductions and credits; and
- moving “toward a consumption-based tax approach.”
Paying for the cuts
Obvioiusly, the government must find a way to pay for any tax cuts, real or proposed. Some estimates put the 10-year deficit increase at $9 trillion for the proposals of the president-elect. 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.
The economy will have to grow faster than it has in some time to solve the problem. If not, after the initial cuts, tax rates could creep higher. That has happened in the past, although it might be avoided with significant spending cuts. That approach has, however, proved elusive in the past.
In the long run, the overall tax bills of most taxpayers – including many growers, garden centers and nursery retailers – are almost sure to be lower. Reduced individual deductions may, unfortunately, result in higher personal tax bills. Plus, there could be cutbacks in certain tax credits and other deductions for particular industries meaning some taxpayers may benefit less than others, making it more important than ever to keep an eye on the actions of our lawmakers.