29 Sep 2017 Our New Tax Structure
While it’s way too early to know what our new tax code will look like next year for planning purposes, Mr. Trump and his administration have laid out a broad policy framework that addresses at least some of the major issues.
The opposition is already in high gear, but if Mr. Trump effectively takes his message to his base, to small business, and to independents, he may just raise enough national fervor to drown out the powerful Washington establishment, political opponents, and the good-ole-boy corporate lobby who are already squealing at high pitch.
In his “Unified Framework for Fixing Our Broken Tax Code” Mr Trump has laid out four principles for tax reform:
- Make the tax code simple, fair and easy to understand.
- Give American workers a pay raise by allowing them to keep more of their hard-earned paychecks.
- Make America the jobs magnet of the world by leveling the playing field for American businesses and workers.
- Bring back trillions of dollars that are currently kept offshore to reinvest in the American economy.
The framework piece suggests that the Trump Administration, the House Committee on Ways and Means, and the Senate Committee on Finance have developed a “unified framework to achieve pro-American, fiscally-responsible tax reform.” It promises “tax relief for middle-class families, the simplicity of a ‘postcard’ tax filing for the vast majority of Americans, ending incentives to ship jobs, capital, and tax revenue overseas, and broadening the tax base and providing greater fairness for all Americans by closing special interest tax breaks and loopholes.”
Tax Brackets Reduced from Seven to Four
Tax brackets are reduced from seven to four, if you count the new broader zero bracket. By doubling the standard deduction to $24,000 for married taxpayers filing jointly, and $12,000 for single filers, the authors suggest that as a result, families will see less of their income subject to federal taxes and benefit from a “simpler fairer system.” A nuance of the higher standard deduction is that the traditional deductions of mortgage interest and charitable contributions, preserved under this legislation, will be less significant to more people.
The other three brackets are 12%, 25%, and 35%. We do not yet know the income levels that each of these brackets kicks in. As if to head off early criticism, the framework notes that “typical families in the existing 10% bracket are expected to be better off under the framework due to the larger standard deduction, larger child tax credit and additional tax relief that will be included during the committee process.”
The authors leave open the option of adding another bracket at the high end 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.” A “more accurate measure of inflation for purposes of indexing the tax brackets and other tax parameters” is also envisioned.
Repeal of the AMT
Due to rising wages and inflation against a tax system that is not indexed for inflation, an increasingly large number of Americans are being hit by the Alternative Minimum Tax. It is a separate tax that ensures that we all pay our ‘fair share.’ It was enacted way back in 1970 when Congress discovered that some 22 to 155 people (depending on the source) with high incomes were paying little or no taxes by using legal deductions. But according to IRS statistics, by 2008, the number of taxpayers affected by AMT had jumped to 3.9 million, or about 4% of individual taxpayers and 27% of that total had income of $200,000 or less. The new legislation aims to eliminate the AMT.
Most Itemized Deductions Going Away
Most itemized deductions will also be eliminated in order to simplify the code and replace lost revenues from lower brackets. Only the deductions of mortgage interest and charitable contributions remain in the code.
There was immediate push back from politicians and residents of high-tax states like New York and California with high income taxes that will no longer be deductible on federal taxes. Republicans can’t afford to lose all of the 33 representatives who represent the highest tax states of NY, NJ, CT, CA, and MD.
According to the WSJ, more than 90% of filers with incomes over $200,000 claim the deduction, according to the Tax Policy Center. Overall, 38% of the deduction’s value goes to California, New York and New Jersey, which have 21% of U.S. households, the center said.
Rep. Kevin Brady (R., Texas), the chairman of the House Ways and Means Committee, said he is listening to lawmakers from high-tax states and is open to further discussions. This one’s a wait-and-see.
Enhanced Child Tax Credit and Middle Class Tax Relief
This one seems to be a ‘trust us.’ The new framework “repeals the personal exemptions for dependents and significantly increases the Child Tax Credit” refunding the first $1,000 of the credit “as under the current law.” Trouble is, we don’t know how much the new measure will ‘significantly increase the Child Tax Credit.’
Potential Huge Break for Small Business
The new measures limit the maximum tax rate applied to business income of small and family-owned businesses conducted at sole proprietorships, partnerships, and S corporations to 25%. “The framework contemplated that the committees will adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.” Regrettably, this one is likely be too good to be true according to tax specialists we queried.
The aim is to reduce the corporate tax rate to 20%, which is below the 22.5% average of the industrialized world, according to the publication. Trump originally wanted 15% and has said he will not accept below 20%. The new legislation also strives to eliminate the AMT for corporations as well as reducing the double taxation of corporate earnings.
Corporations would be able to immediately write off, or expense, the cost of new investments in depreciable assets for at least five years. The publication suggests an ‘unprecedented’ level of expensing of eligible assets, including a focus on relief for small businesses. C corporations will lose some of their interest expense deductions.
Business credits for research and development and low-income housing will continue. The framework publication highlights these as “effective in promoting policy goals important in the American economy.”
Bringing the Jobs and Money Back Home
The new legislation will aim to end “the perverse incentive to keep foreign profits offshore by exempting them when they are repatriated to the United States.” It exempts dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake). Additionally, foreign earnings that have accumulated overseas under the old system can be repatriated.
The legislation will also tackle the problem of companies shifting profits to tax havens by taxing at a reduced rate on a global basis the foreign profits of US multinational companies. It basically eliminates the differences between US-headquartered parent companies and foreign-headquartered companies.
Some Things We Do Not Yet Know
A Wall Street Journal article this morning offered a number of helpful questions and answers regarding the new tax legislation.
A biggie is what will happen to the capital gains tax as well as the 3.8% surtax on investment income that came with Obamacare. Mr. Kevin Brady, Chairman of the House Ways and Means Committee said Thursday that the cost of cutting the capital-gains tax was probably too great to fit into the plan, but that he was still considering whether it was possible.
We don’t know if or how the loss of the medical deduction for taxpayers with excessively large medical bills will impact the taxability of their Social Security. The deduction today currently shelters their income which in many cases can be dwarfed by medical expenses.
We don’t know when the changes will take effect. The only mention of a retroactive feature has to do with write-offs for business investment.
If the estate tax is repealed, what happens to the step-up in income-tax-cost basis at death? Current law allows for heirs of property and securities to increase their basis to the market price at time of death, eliminating the unrealized or unpaid capital gain.
History Shows Tax Cuts and Tax Reform Work
Back in 1963 President John F. Kennedy cut the top tax bracket from 90% to 77% saying “the final and best means of strengthening demand among consumers and business, is to reduce the burden on private income and the deterrence to private initiative which are imposed by our present tax system.” By 1966, the US economy was growing at a rate of 6.6% with an unemployment rate of 3.8%.
In 1981 President Ronald Reagan cut taxes from 70% to 28%, which seems huge in absolute terms, but he did away with many of the loopholes and deductions making the reduction in actual taxes being paid similar to those of Mr. Kennedy’s 18 years earlier. Three years later, the benefits of Mr. Reagan’s tax were inarguable. The longest bull market in history was underway, GDP rose by 7.3% and 23 million new jobs had been created.
Most people in America today agree that tax cuts are required to get this economy moving again. Question is, can broken Washington actually fix our broken tax code? Let us know what you think by casting your vote.