Comprehensive Tax Reform Outlook
“Don’t Tax You, Don’t Tax Me, Tax the Fellow Behind the Tree”—Famous Quote from Former Senate Finance Committee Chair Russell Long (D-LA)
Overview
Tax reform is expected to be a major focus in the next Congress, with the tax provisions of the Tax Cuts and Jobs Act (TCJA) set to expire on December 31, 2025. As the quote in the title suggests, there is likely to be a scramble to keep tax provisions and to find others to tax to pay for them.
Since its enactment in 2017 under former President Donald Trump, the TCJA made several significant changes to the individual income tax, including reforms to itemized deductions and the alternative minimum tax, an expanded standard deduction and child tax credit, and lower marginal tax rates across brackets. Specifically, per the Tax Foundation:
Increased the standard deduction from $6,350 to $12,700 for singles and from $12,700 to $25,400 for married joint filers in 2018, adjusted annually for inflation
Increased the child tax credit (CTC) from $1,000 to $2,000, with the maximum refundable portion increased from $1,000 to $1,400 in 2018, adjusted for inflation until it reaches $2,000; lowered the CTC phase-in threshold from $3,000 to $2,500; and lifted the phaseout thresholds from $75,000 to $200,000 for single filers and from $110,000 to $400,000 for married couples filing jointly
Created a nonrefundable $500 credit for certain dependents who do not meet the CTC eligibility guidelines
Suspended the personal exemption, which had previously allowed households to reduce their taxable income by $4,050 for each filer and dependent, adjusted annually for inflation
Doubled the estate tax exemption from $5.6 million in 2017 to $11.2 million in 2018, adjusted for inflation moving forward.
Introduced requirements to amortize research and development (R&D) expenses over five years for domestic R&D and 15 years for foreign-sited R&D beginning in 2022 and limit deductibility of interest expenses initially based on earnings before interest, taxes, depreciation, and amortization (EBITDA).
For noncorporate businesses, the TCJA established a temporary 20 percent deduction that effectively reduced marginal tax rates by 20 percent (Section 199A). The deduction is limited to the greater of (1) 50% of the W-2 wages with respect to the trade or business, or (2) the sum of 25% of the W-2 wages, plus 2.5% of the unadjusted basis immediately after the acquisition of all qualified property.
For corporate businesses, the TCJA permanently reduced the corporate tax rate to 21 percent, from a previous top rate of 35 percent. The TCJA temporarily enacted full expensing for most short-lived business investments, such as equipment and machinery, through a provision known as 100 percent bonus depreciation. The provision began phasing out by 20 percentage points each year after the end of 2022 and will fully expire after the end of 2026.
R&D amortization, tighter limits on interest deductions, and the phaseout of bonus depreciation are all policies put in place by the TCJA to reduce or offset the cost of the corporate provisions. Making the TCJA permanent thus entails restoring the individual, noncorporate, and estate tax reforms as well as 100 percent bonus depreciation, R&D expensing, and the EBITDA-based interest limitation.
Several Think Tanks like the Tax Foundation and the Brookings Institute have their own ideas for what Congress should consider as they take up the expiring provisions of TCJA. In the Tax Foundation report they consider the “bang for your buck” that TCJA provides and the 199A passthrough deduction for non-corporate businesses is examined. The argument for including the pass-through deduction, which reduced the tax rates faced by noncorporate businesses, was to achieve parity with the rate reductions C corporations received. But rather than parity, estimates of effective tax rates by business type show that noncorporate businesses face lower marginal tax rates than corporate businesses, in large part due to the pass-through deduction. Other provisions are examined for their effectiveness as well, so the idea of extending the whole package may be in question.
Biden’s Plan of Action
Back in March, the White House released a fact sheet demonstrating how President Biden’s newly proposed budget “cuts taxes for working families and makes big corporations and the wealthy pay their fair share.” The President’s budget would:
Set the corporate tax rate at 28 percent, still well below the 35 percent rate that prevailed prior to the 2017 tax law but above the current 21 percent under the TCJA.
Proposes a new policy to deny deductions for all compensation over $1 million paid to any employee of a C corporation.
Eliminates special tax treatment for oil and gas company investments, as well as other fossil fuel tax preferences.
Read all tax proposals in President Biden’s budget here. Biden’s budget is merely a guide, and nothing is set in stone. Congress must now create its own appropriations bills and tax proposal.
Tax Discussions in Congress
On April 24th, House Ways and Means Committee Chairman Jason Smith (R-MO-08) and Tax Subcommittee Chairman Mike Kelly (R-PA-16) announced the formation of ten Committee Tax Teams, comprised of Ways and Means Republican members, to study key tax provisions from the 2017 Trump tax cuts that are set to expire in 2025 and identify legislative solutions. The focus areas include American manufacturing, working families, the American workforce, Main Street, new economy, rural America, community development, supply chains, U.S. innovation, and global competitiveness. To view the chairs, vice chairs, and general members of each team, click here.
“Whether it’s Democrat or Republican, there’s people on both sides of the aisle that believe that the corporate tax rate is not enough,” Smith said adding that he plans to move promptly on a bill in 2025. “When we return in the next Congress it is my expectation for the House Ways and Means Committee to get a tax bill passed in the first quarter,” he said. That, of course, presumes Republicans keep control of the House.
Conversations in the House and Senate have focused on several key issues including Section 199A, SALT cap, and several provisions from the Biden Administrations Green Book that are likely to impact S-Corps. In the Senate, Republicans are working to ensure everything is paid for and Ways and Means Chairman Jason Smith (R-MO) “is doing everything he can to help get our Senate Republican friends into a good spot” on ensuring Republicans will work together on these issues. Republicans are also split over revenue offsets for 2025, and during the hearing in late April with Secretary Yellen asked about responsible ways to offset the costs of any TCJA extensions. Suggestions included increases in the stock buyback excise tax, Corporate Alternative Minimum Tax (CAMT), and corporate rate, and imposing a billionaires' tax. She also committed to prioritizing changing the tax treatment of carried interest.
Will Tax Reform Extensions Need to Be Paid For?
A major issue for the GOP to resolve for themselves, especially if they take control over both houses of Congress in November’s election, is whether legislation should be paid for and how to handle the state and local tax deduction cap.
New estimates from the Congressional Budget Office (CBO) warn in a new report that extending the tax cuts for individuals, small businesses, and estates would cost $4.6 trillion over a decade—more than double the cost of the 2017 law signed by former President Donald Trump.
CBO Director Phillip Swagel said on Bloomberg Television’s “Balance of Power” that the sooner lawmakers act to address deficits, the less painful spending cuts or tax increases will be.
“We know the current situation is not sustainable. But we don’t know when that moment will come, when markets lose faith in the willingness of the United States to take on the deficit,” he said.
He also said personal income tax cuts don’t stimulate economic growth as much as the permanent business tax cuts.
Private conversations with key lawmakers from the tax-writing committees indicate that solely focusing on tax cuts and not on addressing mandatory spending provisions like Medicare, Medicaid, and Social Security with the level of our deficit and the solvency of these funds at risk shouldn’t happen.
Taxes will be a major focus between now and the end of the year and will likely be one of the top issues facing the new president and the next Congress.