Last week, Republican leaders from the House, Senate, and Trump Administration – dubbed the “Big Six” – unveiled their much-anticipated proposal to overhaul the nation’s tax code. The nine-page document is meant to serve as a guiding framework for congressional tax writers, who will ultimately be tasked with crafting the legislation.
The framework is said to be intentionally broad in order to provide the Senate Finance and House Ways and Means Committees the flexibility to fill in details as they see fit. The result is that it leaves a number of questions unanswered, including on several issues that would directly impact NAIOP members and their companies. With that in mind, the following is a brief overview of the proposal and a look at what to expect in the coming months.
One of the framework’s main goals on the individual side is simplification. To this end, the existing seven tax brackets – which range from 10 to 39.6 percent – are condensed into three brackets of 12, 25, and 35 percent. There is also a noticeable shift away from itemized deductions to the standard deduction. Except for a handful of deductions and credits – including those for mortgage interest and charitable contributions – tax provisions on the individual side are largely scrapped. The personal exemption, a deduction available to taxpayers regardless of whether or not they itemize, would also go away.
To compensate for this, the standard deduction is roughly doubled (to $12,000 for single filers and $24,000 for joint filers), and tax credits for dependents are made more generous. The result will likely be a decrease in the number of taxpayers who itemize, which some argue could adversely affect the relative value of the mortgage interest deduction, as well as property values.
To combat the inevitable criticism that Republicans are cutting taxes for the rich (both through a reduction in the top tax bracket, as well as the elimination of the Alternative Minimum Tax and Estate Tax), the framework leaves an opening for tax writers to consider an additional top rate for the highest-income taxpayers “to ensure that the reformed tax code is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers.” It also acknowledges that the new, lowest 12 percent bracket is actually higher than under current law, but argues that taxpayers will ultimately be better off because of the expanded standard deduction. The real-world impact is impossible to predict, however, because income levels to accompany the three brackets are not provided.
From a business perspective, NAIOP members should note the proposed elimination of the deduction for state and local taxes. Without the deduction in place, firms that operate in higher-tax states, such as New York and California, could see a noticeable hit to their bottom line.
In keeping with President Donald Trump’s campaign promise to cut rates for businesses, the framework proposes a 20 percent top rate for corporations, and creates a new tax regime for pass-through businesses (those structured as partnerships and S corporations) with a 25 percent top rate. Under current law, pass-through business income is paid by owners on their individual taxes (and therefore generally face the top marginal rate of 39.6 percent). The framework seeks to separate pass-through wage and business income, and tax the latter at a separate, lower rate. Both of these new rates represent significant cuts of nearly 15 percentage points to the existing top marginal rates.
While the framework allows businesses to deduct the full cost of their investments in the first year, rather than over several years, “full expensing” is not made available for structures (under the framework, the full expensing provision would sunset after five years).
Full expensing may sound attractive, but its impact on the property value of existing buildings and debt was unknown and could have potentially been very damaging. In addition, it was feared full expensing for structures could create imbalances in commercial real estate markets, with development being driven not by market demand but by tax considerations. Instead, real estate has advocated for shorter depreciation schedules that more closely reflect the economic reality of modern-day structures.
As a trade-off and a way to offset the costs of full expensing, the deduction for interest expense would be eliminated for C corporations. For other business entities, the framework leaves it to the tax committees to limit the deduction for business interest. In terms of “base broadening” and other revenue-raising measures, the framework explicitly preserves only the research and development (R&D) and low-income housing (LIHTC) tax credits. It does not discuss tax deferral under Sec. 1031 like-kind exchanges, or the tax treatment of carried interest, both of which have been proven generators of private investment and tax revenue alike. Regarding both of these however, it is clear that they are in danger of elimination or being limited as the committees put together a draft of legislation.
There are a number of hurdles before the framework can be made into law.
First, the House and Senate must agree on a budget resolution to allow the Senate to use a process called “reconciliation.” Under reconciliation, bills can be passed in the Senate with a simple majority, rather than the normal 60 votes. But to use it they first need a budget that lays out top-line revenue parameters, which can only be calculated with a detailed tax plan. To top it off, GOP leaders can’t cobble together the votes for a budget without revealing details of what’s in the tax bill, which might draw a new wave of opposition. They are also sure to face opposition from a number of industry groups, not to mention lawmakers from the other side of the aisle.
Nevertheless, the GOP plan remains to resolve the budget issues, hold hearings, solicit input from the public and business community, overcome criticism, and pass the legislation by year’s end. At each step, NAIOP will be there to advocate on behalf of its members, ensuring that this tax reform effort, unlike 1986, does not hurt commercial real estate.