Financial advisers identified potentially lower tax rates on businesses structured as pass-through entities as a boon under the tax plan presented Wednesday by President Donald J. Trump, but identified several unknown variables, such as capital gains tax rates, that could have big implications for clients.
In its nine-page tax framework, the Trump administration said the maximum tax rate applied to business income of pass-through structures like limited liability corporations would be set at 25%, down from the current maximum rate of 39.6%. Registered investment advisers commonly structure their businesses this way.
"They're going to love this pass-through 25% deal, because my guess is 75% of financial planners will fall into that field," said Paul Auslander, director of financial planning at ProVise Management Group.
The 25% rate is up from the 15% tax rate outlined in a previous Trump administration proposal for both traditional corporations and pass-throughs.
While traditional corporations under the most recent outline would be taxed at a lower 20% (as opposed to the current 35%), observers said pass-through entities would likely end up paying a lesser net tax rate under the new proposal. This is due to a second layer of tax on traditional corporations — on dividends passed to business owners — that doesn't apply to pass-throughs. Under current law, that additional rate could be as high as 23.8%, said Tim Steffen, director of advanced planning in Robert W. Baird & Co.'s private wealth management group.
Advisers were quick to point to the in-flux nature of the tax-reform debate, and that the blueprint didn't include much information beyond what had already been telegraphed.
"None of it was particularly surprising. But it does finally give some kind of an outline of what the president would like to see from Congress," said Lorraine Johnson, president of Triangle Financial Advisors. "The difficulty is Congress does not work for the president, and they will do what they want to do."
The issue of capital gains taxes, which could have a large effect on advisers' clients, is omitted from the new outline.
"If you're talking about wealthy individuals, and many advisers obviously serve that demographic, capital gains tax brackets are key," Ms. Johnson said. "It makes an awfully big difference if you're paying 0% or 20% taxes on capital gains."
Currently, there's a tiered level of long-term capital gains taxes depending on where an individual falls among the marginal income-tax rates. Individuals in the 10% and 15% tax brackets pay a 0% long-term capital gains rate; those in the 25%, 28%, 33% and 35% income-tax brackets pay a 15% capital gains rate; and those in the highest tax bracket pay 20%.
In addition, high-income taxpayers pay an extra 3.8% tax on certain investment income.
"I think it's pretty much in the bag that capital gains won't go up," Mr. Auslander said. "They'll probably get rid of the [3.8%] surcharge. If I'm a betting person, I'd say at a minimum it's going to be 20%, not 23.8%. My guess is it will go to 15%."
He also said it's an open question whether one year still will be the time threshold to be considered a "long-term" capital gain.
Mr. Steffen pointed out a few other unknowns.
The Trump administration continued its support for repeal of the estate tax, for example, but didn't address the fate of the gift tax or what would happen to the current tax-basis adjustment at death, he said. Right now, for example, the capital gain of a highly appreciated asset disappears at death, but would that continue under the new tax plan?
The outline also calls for a repeal of the alternative minimum tax. Currently clients can potentially recover AMT tax credits, but what would happen to those unclaimed credits under the new tax plan, Mr. Steffen said.
And advisers still don't know when tax legislation, if it's ever finalized, will come to fruition.
"Advisers, I think, are still in the same place they've been for a while," Mr. Steffen said. "Until we get an idea on the effective date of this, I think advisers need to hang tight right now."