President Trump’s federal tax reform plan proposes broad changes to the current tax system in the United States, including repeal of the federal estate tax, consolidation of income tax brackets, and changes to deductions. In this interview, Lance D. Christensen , a CPA and partner at Margolin, Winer & Evens LLP, shares his thoughts on federal tax reform and what it could mean for taxpayers on the state level. Christensen largely believes the effects of tax reform will vary from state-to-state and individual-to-individual. He also highlights the importance of CPAs staying up-to-date on current and future legislation to adequately advise clients on their tax planning needs.
Bloomberg BNA: President Trump took office on Jan. 20. As administrations change, how do CPAs prepare their clients?
Christensen: We are aware of the current tax law, but we also need to be aware of the changes that may come in the future. Tax law is continuously changing, so we need to be aware of both the current tax law and what we see coming down the pike with proposed legislation at the federal level and at the state and local levels as well.
Bloomberg BNA: How have states responded in the past whenever federal tax reform is proposed?
Christensen: Historically, when there are changes for federal tax purposes, states will need to react because certain deductions may be eliminated and income may be generated—additional taxable income revenue. States take that into consideration and often either conform or “decouple” from certain provisions.
For example, one of the proposals being made as part of the current federal tax reform is to allow current expensing of capital acquisitions of machinery and equipment. A state may say, “We are not going to allow that. We are not going to conform to that rule. We are going to decouple and not allow our taxpayers to currently deduct those expenditures and, instead, continue to capitalize and depreciate them over time.”
So states will likely react if, in fact, there is legislation at the federal level.
Bloomberg BNA: Do you think federal tax reform will be enacted this year?
Christensen: We aren’t making any predictions at this time. Certainly, just as an observation, there are significant headwinds at this time. In addition, there are issues to overcome as there are other items, such as health care, that need to be dealt with, the budget, and other distractions that we all read about and watch that are going on in Washington, D.C. Those are what I would call headwinds—items that could defer the enactment of any tax reform past the end of this year.
Bloomberg BNA: A main goal of Trump’s plan is to simplify tax filing for individuals and families. He notes that there are over 100 individual income tax forms and 90 percent of Americans need help filing their taxes. As a CPA, what are your thoughts on this goal?
Christensen: It’s true that most Americans need help filing their taxes. More importantly, they need help with their tax planning. The tax law is very complex today, so taxpayers need help not only with preparing their tax returns but with planning to minimize their taxes. I suspect that the tax reform that has been proposed both by President Trump and the House Republicans will simplify the tax law if it is enacted and will simplify the tax preparation for many Americans. However, for other Americans, it will add complexity—particularly for corporations and partnerships.
Bloomberg BNA: In the House Republicans’ plan, their goal is to try to reduce all the tax forms into one form for individuals, which would be about the size of a postcard. What are your thoughts on that goal?
Christensen: Yes, there is a form in the House Republican Blueprint. For many Americans, the form would contain their wages, and perhaps investment income, only two deductions—mortgage interest and charitable contributions—or, alternatively, a standard deduction and a tax rate. The information would fit on one page and could be completed by some people without the assistance of a CPA. But, again, it is very much uncertain whether tax reform will be enacted in that form.
Bloomberg BNA: Should states consider simplifying their own tax codes if federal tax reform is enacted?
Christensen: First of all, it should be noted that most states derive a significant—if not majority—of their state tax collections from non-income based taxes, such as sales and use taxes, excise taxes, and personal property taxes. They get more of their revenues from these other types of taxes.
Most states rely extensively on the Internal Revenue Code as the starting place in order to calculate state taxes. Then, they make somewhat unique adjustments from the federal taxable income. It will vary based on the state whether they need to simplify further what is already been done at the federal level or, alternatively, add some complexity because the states may not go along with some of the simplifications that have been added for federal purposes. So, it’s really going to be a state-by-state analysis.
Bloomberg BNA: Trump’s plan would also likely eliminate the state and local tax deduction. How would this impact taxpayers in states with higher income taxes like New York?
Christensen: Again, it is going to be an individual-by-individual basis. Many taxpayers in these high-rate states, like New York, are paying what is called the Alternative Minimum Tax currently. So they’re not getting a benefit for their state deduction on their federal return anyway. These are typically individuals with income between $200,000 and $500,000. Low-income individuals may also be taking what is called the standard deduction, so they are not getting much benefit from their state taxes anyway.
Higher net worth individuals may, in fact, be losing a benefit under federal tax reform because they do have a significant state tax deduction and they are not in the Alternative Minimum Tax. For those people, it would be detrimental to lose that state tax deduction. Now, it may be offset because the federal income tax rate for those people is going from a maximum of 39.6 percent to a maximum of perhaps 35 percent tax rate, which has been in the tax proposal by President Trump.
It’s really an individual-by-individual, and not a one-size-fits-all, answer.
Bloomberg BNA: What effect would this deduction elimination have on state income tax rates?
Christensen: The effect would be if, for example, some higher earning individuals living in New York see themselves in a higher overall tax position because they lost the deduction for the state taxes, they may decide to move to a lower tax state such as Florida, Nevada, or Texas. Regarding those people, if they move out, the state would suffer a loss of revenue and the state may need to make it up by raising the tax rates on other people who remain residents of New York.
Bloomberg BNA: President Trump also proposes eliminating the federal estate tax. Do you think a repeal of the federal estate tax would result in an increase or decrease of estate taxes on the state level? For example, California may consider reenacting their estate tax if that did occur. While recently, Delaware is considering repealing their estate tax.
Christensen: About 30 states have actually eliminated their estate tax based on prior legislation. The remaining states generally model their estate tax independent of the federal estate tax.
It would be highly speculative to prognosticate on how states may react to the repeal of the federal estate tax. Some may need to model their estate tax based on prior federal law if the estate tax is repealed for federal purposes. These states may say, “We’re following the federal estate tax generally as it was before the repeal made by this federal tax reform.”
Bloomberg BNA: How does the possibility of repealing the federal estate tax affect clients?
Christensen: Clients should still do estate planning and succession planning outside of the tax implications. Outside of the tax implications, there are other benefits of estate planning or succession planning in terms of protecting assets from creditors by putting assets in trusts, protecting against potential matrimonial disputes, and making sure that the business gets transferred to the next generation. These things are done with what often comes under the definition of estate planning, but there are other benefits that are business and legal benefits outside of the world of estate tax planning. Clients are still looking at transactions where they transfer assets to the next generation or into trusts and things like that for nontax reasons.
In addition, if the estate tax is repealed it may in fact be brought back again in the next administration or future administrations. Estate tax is imposed for the year of death, so it only matters what the law is during the year of death. Even though it’s repealed in 2017 or 2018, the federal estate tax may be reenacted down the road. Clients need to be aware and continue to consider estate planning for tax and nontax reasons.
Bloomberg BNA: The Trump plan would consolidate the existing seven income tax brackets into three brackets. Should states also consider revaluating their own income tax brackets if this change is enacted on the federal level?
Christensen: I don’t think so, but states may need to change their brackets to balance their budget and get the revenue needed in the event that some of the other provisions impact the taxable income of individuals. For example: the immediate expensing and deduction of capital improvements. If that reduces the state taxable income the way it would for federal purposes, then states would need to adjust their tax rates and perhaps their tax brackets to get them back to where they need to be for budget purposes.
Bloomberg BNA: How are CPAs preparing for all these possible changes at the federal level?
Christensen: We are looking every day at what’s happening on Capitol Hill and the White House. We are staying on top of what is happening. We’re discussing the proposals with our clients. In some situations, clients have pending transactions, acquisitions of businesses, sale of a business, or sale of an asset.
Right now, we don’t have a prediction as to whether there will be federal tax reform, but we are advising our clients and staying on top of what is going on in Washington, D.C., in order to make our clients aware of the possibilities.
Bloomberg BNA: Historically, how have you and other CPAs prepared for possible tax reform in the past?
Christensen: Just like this, we monitor it closely. That’s how it’s always been, and that’s how it always will be. Staying on top of what’s happening in Washington and talking to clients about the impact that it potentially may be on their current and future taxes.
Bloomberg BNA: What advice are CPAs giving to their clients in terms of tax planning?
Christensen: Well, it’s so uncertain, but again it’s only June, so we have time left in the year; however if clients can wait to execute a transaction—if it’s economically feasible and okay for them to wait, then it may not be a bad idea to wait. It’s not a one-size-fits-all solution though. But if they can wait and perhaps get the benefit of a lower rate if they sell an asset or a business, then they should wait.
Or, in another example, if they can wait to make an acquisition because next year, after the enactment, perhaps they would be able to currently expense the acquisition costs—the machinery and equipment, the intangible assets, and items like that—then they should wait. However, sometimes transactions need to get done and waiting is not feasible.
We don’t want tax to necessarily be the key driver, but it’s really a conversation that needs to be had between us and the clients to make sure they understand what is happening and what the potential consequences are.
Bloomberg BNA: Do you have any other comments?
Christensen: We are keeping a close eye on what is happening daily. There are both favorable changes and unfavorable changes to the law depending upon the client’s situation, business structure, etc.
So, as we get closer to year end and we continue to measure what is going on in Washington, D.C., we will talk to individuals and business about their transactions and plan accordingly.
It’s going to become more and more interesting if we do get some momentum but currently, as I mentioned earlier, there are quite a number of headwinds, whereby perhaps this legislation will get deferred.
Personally, I’m not taking vacations at the end of this year, or anything close to it, because I suspect there will be a lot of opportunity—if any federal tax reform is enacted—to plan for the minimization of taxes.
Interview by Jaslyn Maddox
Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: How do you think states will respond to federal tax reform?
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