Tax reform has achieved a near-mythical status inside the halls of Congress, where simple spending resolutions are paralyzed by ubiquitous gridlock.
Reality intervened on Nov. 8 when Republicans swept into power. Tax reform became a reality, if only because it is a top priority for both House Speaker Paul Ryan, R-Wis., and President Donald J. Trump.
The financial services industry has plenty to lose in any tax reform package, especially if past proposals are any indicator.
As of mid-April, various ideas were circulating, with Politico reporting that the Trump team developed a new tax plan between the election and the inauguration.
That plan reportedly includes reducing the corporate tax rate to 15 percent and giving people a child care tax credit. Capital gains rates would be left alone in the new plan.
Otherwise, it is unclear how Trump will propose to change tax laws. On Feb. 9, he promised a “phenomenal” tax plan in two or three weeks, but has yet to release anything concrete.
His tax proposals changed over the course of his campaign — by Election Day, his plan had moved closer to the blueprint that Ryan and other House leaders prefer. Both plans would consolidate the number of individual income-tax rates to three from the existing seven; the top rate would drop to 33 percent from 39.6 percent currently.
Whatever plan comes from the White House, it is sure to look different when Congress gets done with it.
Here are a few things to look for in any tax proposal:
The “three thin threads” crucial to life insurance: tax-free inside buildup; the tax-free death benefit; and the ability to remove life insurance from a taxable estate.
Corporate and capital gains tax rates. Republicans historically favor cuts here, but Trump’s populist backing casts a long shadow.
The estate tax. Long on the GOP chopping block, the estate tax continues to survive.
Tax deductions. Tax debate always includes negotiations on deductions. Republicans hope to streamline allowable deductions.
Threads of Life (Insurance)
Life insurance relies on a set taxing formula to work, what the Association for Advanced Life Underwriting (AALU) describes as the three thin threads. Take those tax benefits away, and the product becomes much less attractive.
Although the insurance industry has gone to battle many times to protect the tax treatment of life insurance, threats remain.
In February 2014, then-House Ways and Means Committee Chairman David Camp, R-Mich., released a proposal for tax reform containing detailed provisions modifying the taxation of insurance companies.
The Camp draft includes seven tax ideas related to life insurance that are not found in the proposals from Trump and the House Republicans. Those tax ideas deal with life insurance reserves and elimination of deductions.
While lurking in the background, Camp’s ideas could be incorporated into any draft tax reform legislation. Michael Lewan, longtime Democratic strategist, doesn’t think any changes are coming on the tax treatment of life insurance.
“The life guys have done the spade work over many years to protect buildup and other tax-free or deferred benefits,” he said. “My sense is there is little appetite to hurt widows and orphans, even filthy rich ones.”
If the House Republican tax blueprint carries the day, tax reform has the potential to be “the most substantial change in a century to how businesses are taxed,” wrote the accounting firm KPMG in a recent analysis.
“Rather than taxing companies based on income generated in the United States, the proposal would tax a company’s U.S. cash flow, while exempting foreign sales and taxing imports,” KPMG explained. “The proposal, which is aimed at boosting U.S. business and exports and reducing the U.S. trade deficit, could have material implications to the U.S. dollar, as well as other economic effects.”
Trump’s plan would reduce the top corporate tax rate from 35 percent to 15 percent, and would allow many non-corporate businesses, like sole proprietors and partnerships, to pay that low rate. The House would cut the corporate rate to 20 percent.
“The reduction in corporate tax rates would require companies to revalue their existing inventory of deferred tax assets and liabilities,” KPMG concluded. “The immediate consequence would go through the income statement as income or expense depending on whether the insurance company is in a net deferred tax liability or asset position.”
The pressure is on lawmakers once again to repeal the estate tax, which both Trump and Ryan want to do.
A coalition of 32 agricultural groups recently sent a letter to House Ways and Means Committee Chairman Kevin Brady, R-Texas, and Ranking Member Richard Neal, D-Mass., asking that any tax reform package include permanent repeal of the estate tax.
Sometimes referred to as the “death tax,” the levy is imposed on the net value — less an exemption — of an owner’s assets transferred at death to an heir or heirs.
For the 2016 tax year, the exemptions for the estate tax are $5.45 million for an individual and $10.9 million for couples. Transferred estates valued at more than those figures are subject to a maximum tax rate of 40 percent on the amount of assets above those levels.
Those landowners often take out large life insurance policies to ensure their heirs can pay that tax bill.
The estate tax will generate about $275 billion over 2017-26 under current law, according to the Congressional Budget Office.
There are several bills floating around Congress to eliminate the tax, but it is unclear how they would be reconciled, or whether the estate tax will again survive.
Several changes in tax deductions are making the rounds between the White House and Congress. Many of the ideas impact the business world. Here are three big ideas:
Full Expensing – House Republicans have called for full expensing (in lieu of depreciation and amortization) for investments in both tangible property and intangible assets. Trump has proposed to allow only U.S.-based manufacturers the option of electing full expensing of plant and equipment.
Interest — As part of the proposals to move to full expensing for business investments, a limitation on the ability to deduct interest expense has been proposed. The GOP plan eliminates the current deduction for net business interest expense associated with debt incurred to finance such investments. U.S.-based manufacturers that elect full expensing for investments would be required to give up the ability to deduct interest expense under Trump’s plan.
Net Operating Losses (NOL) — The deduction allowed with respect to an NOL carryforward in any year “will be limited to 90 percent of the net taxable income for such year determined without regard to the carryforward,” reads the GOP plan.
NOLs will be allowed to be carried forward indefinitely, and will be increased “by an interest factor that compensates for inflation and a real return on capital.” The Trump proposal does not discuss the treatment of NOLs.
Deal or No Deal?
Coming off the disastrous attempt to repeal and replace the Affordable Care Act, both Congress and the White House have a lot riding on tax reform.
Consultant Kenneth Kies expects a more deliberate process that could last until the August recess.
“If it doesn’t get done by the August recess, then the probability of it happening will start to decline, because when the House members, particularly the House Republicans, come back in the fall, they will be focused on the 2018 elections,” said Kies, managing director of the Federal Policy Group.
While Kies puts the odds of a tax reform bill passing Congress and landing on Trump’s desk at 70 percent, Lewan doesn’t see it happening.
“In practice, any legislation that does not explode the deficit and debt will have a few winners and lots of losers,” said Lewan, former chief of staff to Sen. Joseph Lieberman, I-Conn. “Losers make noise and trouble.”