Trump-Quake: Trump's impact on private equity - Part I: Tax
As unpredictable as Donald Trump was as a candidate, the impact of his presidency seems equally difficult to forecast.
As a candidate, Trump’s economic and fiscal policies lacked detail, shifted frequently, and at times, were contradictory. As President-elect, he has already walked back several of his more signature campaign promises. Once his cabinet appointments are made and confirmed, and Republican leadership in the House and Senate galvanize around a set of legislative priorities, his administration’s policy objectives may become clearer. In the meantime, early signs of consensus between the incoming administration and Republicans on Capital Hill suggest significant changes could be looming for the U.S. private equity industry and deal-makers more generally.
Two areas of interest that will likely see significant attention are tax reform and regulations impacting the financial services industry and M&A activity. In this first installment, we take a brief look at the tax changes that may be afoot.
Donald Trump’s electoral win and Republican control of Congress make it likely that significant tax reform is coming, perhaps in 2017. If passed via Congress’ budget reconciliation process, the bill could conceivably be enacted without Democrat support.
Key features of President-elect Trump’s business tax proposals include:
- reducing the corporate tax rate to 15%;
- limiting the top individual tax rate on pass-through income to no more than 15%;
- a limit on the deductibility of interest expense (as a trade-off for full business expensing for manufacturers);
- simplified individual income taxes, with a top income tax rate of 25% and a top rate of 20% for capital gains and long-term dividends; and
- taxing carried interest at ordinary income, rather than capital gains, tax rates.
The tax reform “Blueprint” released in June 2016 by Speaker Paul Ryan and House Ways and Means Chairman Kevin Brady is similar in many respects to the Trump plan, though with smaller rate cuts. Highlights of the Blueprint include:
- reducing the corporate tax rate to 20%;
- reducing the top rate for pass-though business income to 25%;
- a limit on deductibility of interest expense to no more than interest income;
- full expensing for capital business expenditures;
- simplified individual income taxes, with a top rate of 33%; and
- significant cuts in rates on investment income, allowing individual filers to exclude half of their income from capital gains, dividends and interest.
The Blueprint is silent on carried interest.
The proposed rate cuts to pass-through income could be a focal point of debate, even among Republicans. Some observers note that if pass-through income rates fall dramatically lower than ordinary income rates, or even capital gains rates, taxpayers will restructure their business and income generating activities to take advantage. According to the Tax Policy Center, a consequence would be that, “carried interest would be taxed at a much lower rate than under current law, notwithstanding its reclassification as ordinary income (rather than capital gains), because the entities that earn carried interest income are organized as partnerships.” Carried interest is currently taxed at a rate of up to 23.8%, while under the Trump plan (absent higher rates for carried interest) it would be taxed at a maximum rate of 15%. Trump’s campaign advisors, including Wilbur Ross the announced nominee for Commerce Secretary, insisted during the campaign that a set of rules would be adopted to exclude carried interest from eligibility for the 15% rate. So far, it remains unclear what these rules will be and when they will be advanced.
Whatever emerges on tax reform will likely involve a compromise of both the Trump Plan and the Ryan-Brady “Blueprint.” Even Senate Democrats appear prepared for compromise. Incoming Senate Minority Leader, Senator Chuck Schumer, has signaled a desire to compromise on a plan that would cut corporate taxes if proceeds from Trump’s proposal for a one-time tax on accumulated foreign earnings -- an estimated $2.6 trillion -- are reinvested in infrastructure improvements. Nonetheless, it remains unclear the extent to which Democrats in the House and Senate will be involved in shaping any compromise tax reform legislation and what any final reforms will ultimately entail.
If enacted, these changes will raise a number of important questions for funds, their investors and tax planning more generally. We will continue to monitor these changes closely. For more information on the details of potential tax changes coming in 2017, please see our recent update here.
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