It’s that time of year again. No, I don’t mean the holidays, but rather tax projection and planning season.
Some years present unique challenges to this process. For instance, will “tax extender” provisions that may have a material impact be enacted by year-end? This year again there are extender provisions that will impact some taxpayers; however, for the most part the effect should not be material for most of us.
The hot topic this year involves what may lie in store for 2017 in the form of tax reform initiatives advocated by President-elect Trump. Most crystal balls remain fairly cloudy in this regard; however, here are a few theories for which there appears to be consensus relating to business and personal income taxes:
- The tax rate on business income could be lowered from 35 percent for corporations and 39.6 percent for pass-through entities to 15 percent across the board.
- The top tax rate on personal income could come down from 39.6 percent to 33 percent.
- Personal itemized deductions may be subject to an increase in limitations from current law.
- The alternative minimum tax and net investment income tax may go away.
- The tax rates on dividends and capital gains are not likely to change significantly.
However, the devil will likely be in the details. There may be some friction in how the proposed tax reform initiatives announced by President-elect Trump during his campaign mesh with congressional GOP plans as well as the impact of potential short term decreases in tax revenues while also implementing infrastructure spending stimulation initiatives.
A recurring issue in any tax reform process involves the impact of changes in behavior patterns arising from changes in the rules. For instance, if a 15 percent tax rate will apply to pass-through business income, how will it actually work when calculating the tax on owners’ tax returns? How will owners of such entities respond in connection with other sources of income such as wages, interest, and rents, which would not share in the same tax rate reduction (potentially subject to tax at a 33 percent rate)? A reduction in salary in exchange for an increase in distributions potentially yields a beneficial trade-off in paying tax at 15 percent rather than 33 percent (plus FICA and Medicare) assuming reasonable compensation issues can be addressed.
Should the 15 percent rate on business profit ultimately only apply to regular corporations and not to pass-through entity business income, a change in behavior may involve movement to regular corporation status. In the context of an S corporation, this could involve filing elections to revoke pass-through status. For limited liability companies currently taxed as partnerships, this could involve so-called “check the box” filings electing to be taxed as a C corporation. Various types of reorganization activities may occur in other circumstances. Life could certainly be more interesting as owners of companies reevaluate their traditional focus on minimizing or avoiding double taxation and using those freed-up funds to expand business operations and ultimately grow enterprise value.
What impact does all of this have on the 2016 year-end planning process? The simple answer is that traditional planning concepts should continue to hold true – defer recognition of income and accelerate deductions to the extent prudently possible under the particular circumstances of each taxpayer. The net delay in recognition of taxable income and payment of related income tax from 2016 to 2017 will yield a time value benefit as well as the very real potential for a permanent savings should rates go down.