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Teplitz Financial Group

May Commentary: The Tax Reform Gauntlet

Last week Secretary of the Treasury Steve Mnuchin stepped into the White House Briefing Room and laid out the broad strokes of Trump Administration's much-hyped tax reform plan. Whether it was the ticking of the "100-day clock" or the first salvo towards delivering on a popular campaign promise, Wednesday gave us the first few drips about where this complex legislative negotiation will begin.

The centerpiece of the Administration's proposed tax cut is a drastic decrease in the business tax rate, where corporations and small businesses alike would see their tax bill cut by more than half--from 35% to 15%. Moreover, this new 15% business tax rate would include "pass-through" entities (businesses formed as partnerships, LLCs, and even some larger entities like hedge funds) which have typically seen their income taxed at individual rates.

Some of this should come as no surprise. The United States has among the highest corporate tax rates in the world...and in some cases it is not even close. Some of our biggest trading partners, Canada, Germany, South Korea, Japan and the United Kingdom, all have corporate tax rates south of 25%, with most lower than 20%. Whether lower tax rates contribute directly to employee growth, expansion and innovation is a more complicated discussion, and one we will leave for another time. Still, there is no question that the current corporate tax rate has been a deterrent to businesses incorporating and staying Stateside and the Trump Administration seems hell-bent on eliminating that obstacle.

Where the surprise factor comes in is with the Administration's extension of the corporate tax rate to so-called "pass-through" entities like partnerships, LLCs and even some larger entities like hedge funds and real estate companies. These companies have typically been taxed an individual tax rates (hence the name pass-through), but under the proposed tax reform they too would benefit from significantly decreased tax burdens. In fact, in some cases, these businesses would see the biggest tax breaks of all.

Before you scream, there is more here than meets the eye. While there is plenty of justified angst about hedge funds and real estate companies receiving these massive tax cuts, there is real benefit to the millions of mom-and-pop shops of the country...the one, two, ten, and twenty-person small businesses that have been most negatively impacted by higher tax rates and the Affordable Care Act. A boost in the small business sector could in fact lead to more entrepreneurship, more employment and more expansion.

On the personal side, we have to start by being one has ever said they were upset to see their taxes go down. For many, the proposed tax plan does point their taxes in the right direction. Higher standard deductions will certainly help. A simplified tax code, with just three tax brackets (10%, 25% and 35%), will make it easier to not only do your taxes, but understand them. And larger tax credits for families and not on the first $24,000 (married, filing jointly) will certainly help many who are in desperate need of assistance.

The wealthy will also see their fair share of help. A lower short-term capital gains tax; the elimination of the alternative minimum tax and the 3.8% Affordable Care Act surcharge on investment and business income; and the immediate termination of the estate tax, which only applies to those with taxable estates north of $11M, are significant savings for the top 1% of the individual tax paying universe.

As for the middle class, well, this is where the Trump Administration will have to do some work...because there simply is no middle class tax cut of any substance. While some will benefit, in small ways, from changing tax brackets and growing standard deductions, many will suffer from the elimination of popular deductions. Under the Trump Administration plan all personal tax deductions with the exception of the mortgage interest and charitable gift tax deductions would be eliminated.This includes currently deductible items such as student loan interest, personal property tax, real estate tax, union expenses, moving expenses, unreimbursed business expenses, and most other Schedule A deductions.

From an economic perspective, the discussion of tax reform is what pundits mean when they say "elections have consequences". One way or the other, tax reform is coming. It was predictable on the day that the American people put a Republican in the White House. But before the panic sets in, remember: no President, nor their Treasury Department, get to unilaterally determine tax policy. This has to go through Congress and on this point, there is likely to be more than a little bit of push back. Why? Well, imagine a Democrat or Republican from states like New Jersey, Illinois, California, Connecticut, Texas or others with high property taxes having to face their constituents after voting for an elimination of that deduction. Seems like political suicide...and we all know how much politicians value their own political lives. Proponents of the tax proposal will say that the doubled standard deduction softens this blow, but still, elimination of popular deductions is something that will take some heavy negotiation.

So it is not time to start counting the dollars you will save (or not save) in the Trump plan. History tells us that tax reform, whether Democrat or Republican, whether in a good economy or weak one, takes a very long time. Presidents Kennedy, Reagan, and George W. Bush have all ventured down this path in different forms and at different points in history. For President Bush, it took three years to finish his tax cuts, with two separate bills in 2001 and 2003. President Reagan was in office two years before Reaganomics really took hold. President Kennedy did not live to see the passing of his 1963 tax proposal—rather, it became a signature piece of President Johnson's re-election campaign in 1964.

As for President Trump's plan, it is hard to tell whether or not this will end up being "the biggest individual and business tax cut in American history". However, in our polarized political state, it seems more than likely that it will be the longest slog. So buckle up...we might be here awhile.