Hogan Lovells Publications | Tax Alert | 28 November 2016

2017: The Year for U.S. Tax Reform

In light of the presidential election victory of Republican Donald Trump, and the Republican Party's success in maintaining control of both the U.S. House and Senate for the upcoming 115th Congress, we believe that there is a very good chance that the U.S. Congress will pass, in 2017, the most significant U.S. tax reform in a generation.

This bill will affect any individual or company — U.S. or foreign-based — with income in the U.S., and will likely completely revamp the nation's current tax code as it applies to multinational corporations. The road to enactment of this legislation will be far from smooth — there will be turf battles and disagreements, not only between the parties, but between industries and different interests — and it will take time. Given the hurdles the bill will face — notwithstanding Trump's and Chairman Brady's pledges to get tax reform done in 100 days — getting a bill to the President's desk will almost certainly take much of 2017, if not more time. Much of this reform legislation will be positive for businesses and individuals alike, but there will be trade-offs as well that may divide industries or even different companies in the same industries.

In addition to Trump's and Chairman Brady's pledges to get tax reform done next year, Speaker of the House Paul Ryan, (now Speaker nominee for the 115th Congress) has indicated that accomplishing tax reform in 2017 is his highest priority. The starting point for tax reform is likely to be the Tax Reform Blueprint, issued by Speaker Ryan and Chairman Brady in early 2016. The Blueprint was the product of extensive work by a Republican congressional task force and represents a major re-write of the tax code; far beyond changes in rates. The Trump tax reform plan is similar in many respects to the Blueprint, and Trump and his team thus far have indicated support for Speaker Ryan's plan to start with his own bill in the House. In the Senate, Republican Majority Leader Mitch McConnell and Senate Finance Committee Chairman Hatch have also indicated strong support for moving tax reform.

Although House and Senate Republican leaders have all indicated in recent days their hopes that Congress will be able to move a tax reform bill with bipartisan support, we believe that in the end there is a good chance that Republicans will end up moving a bill with little to no support from the Democrats. The reconciliation process under the Budget Act of 1974 would allow Republicans to do this without the risk of a Democrat filibuster in the Senate, which would otherwise require 60 votes to overcome.

Moving a bill through reconciliation, though, will make the process much more complicated. This would require that the House and Senate pass a budget resolution, and that the Senate comply with the Byrd rule, requiring 60 votes to overcome a point of order if the bill results in any revenue loss after the years included in the Budget Resolution. In addition, if Republicans attempt to address Obamacare reforms through reconciliation, as has also been contemplated, and perhaps an infrastructure revenue source as well, the process would be even more complicated and difficult to get through. And the Republicans may have trouble maintaining support within their own caucus.

Although Trump, during his campaign, did not express much concern about the growing national debt, the issue remains a concern among many Republican deficit hawks. Recent analysis has estimated the U.S. revenue loss associated with the Trump plan at US$4-US$6 trillion on a static basis, and the static loss associated with the Brady/Ryan Blueprint at US$2-US$3 trillion. Using dynamic scoring, as the Republicans plan, could improve these numbers considerably, but it will make the process more difficult yet again if Congress is going to try to achieve revenue neutrality.

The following are some of the primary elements of the Trump and Ryan/Brady Blueprint tax reform proposals. Neither Trump nor Ryan/Brady released legislative language for their proposals, though the Ryan/Brady Blueprint is far more detailed than the current Trump proposal.

Ryan/Brady Blueprint:

• 20 percent corporate tax rate 
• 25 percent rate for pass-through business income
• A cash-flow consumption tax structure for business –
• Full expensing for capital investments
• No deductibility of interest expense beyond interest income
• Territorial tax system with one-time tax on accumulated foreign E&P (8.75 percent cash/3.75 percent non-cash rates)
• Border adjustment mechanism: tax imports and deduct exports
• Industry-specific tax preferences and other unspecified tax preferences would be repealed
• Transition rules – Blueprint: "The Committee on Ways and Means will craft clear rules to serve as an appropriate bridge from the current tax system to the new system, with particular attention given to comments received from stakeholders on this important matter"
• Individual income tax rates lowered to 12 percent, 25 percent, 33 percent
• Individual investment income (taxed at half of earned income rates)

Trump Tax Reform Plan:

• 15 percent corporate tax rate
• 15 percent rate for pass-through business income 
  • Manufacturers have option to fully expense capital investments if they opt to waive deduction of interest expense 
  • Campaign expressed support for a one-time tax on accumulated foreign E&P, but the plan appears to retain the U.S. extraterritorial system
  • Repeal most corporate tax expenditures, except R&D credit 
• Individual tax rates lowered to 12 percent, 25 percent, 33 percent
• Caps itemized deductions at US$100k, US$200k

Outlook:

Both the Congressional tax-writers, and (to a lesser extent, as the players are not as firmly established) the Trump transition team, have been asking for ideas, thoughts, and criticisms of their tax reform proposals. When tax reform starts moving in 2017, it will be more difficult as time goes on to influence the process. Today, the bill is being written, but there is still time for all parties to influence its direction.

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