03 Nov 2017 The Tax Cuts and Jobs Act
The U.S. House of Representatives released their tax bill to the public yesterday with great fanfare to a mix of joy on the one side and wailing and gnashing of teeth on the other. If the devil’s in the details – Halloween is not over by a long shot. We can expect an uprising of self-interested lobby-banshees that will make the rampage of the ghoulies and hobgoblins from the movie Ghostbusters look tame by comparison.
The bill, H.R. 1 offers sweeping changes to the tax code in cuts and policy, and not everyone comes out a winner. The cuts, by design, are aimed at the middle class and corporations, both small and large to fuel growth of the U.S. economy beyond its relatively paltry 10-years past average of 2+%.
Policywise, the bill aims to correct some excesses and imbalances that have gone unaddressed for decades; such as the subsidizing through federal tax-deductions the high taxes imposed on citizens of states like New York, California, New Jersey, Maryland, Massachusetts, and Illinois. Taxpayers from better managed, low-tax states, have complained for years that many of their tax dollars go to support states that are more poorly managed. The states just mentioned claim that they send more tax dollars to the federal government than they get back. Couple this complaint with the fact that they are all blue states, and you have a recipe for loud opposition in the Senate and to a lesser degree in the House.
The housing bubble leading up to ’07 and ’08 was part blamed on the deductibility of mortgage interest, making homeownership more affordable than renting. The rapidly rising cost of a college education is also due in large part due to the government subsidizing the cost through low-interest loans, low-penalties for default, and the deductibility of interest. The deduction goes away in the House bill.
Other potential losers include high-earning home sellers, people who claim large medical deductions, and alimony payers after 2017. Gone also will be the directly-perceived benefit of deductions from mortgage interest, some property taxes, and charitable gifts. The near-doubling of the standard deduction largely covers these deductions for some 90% of taxpayers (according to the bill’s proponents). Opponents, including the home industry and many in the philanthropic community, fear they will see declines as taxpayers lose the perceived tax savings of writing off interest and gifts.
- Chops the corporate tax rate from 35% to 20% permanently, not temporarily as was earlier considered.
- Businesses would lose the ability to deduct certain executive compensation above $1 million, which they can now do for performance-based pay.
- Tax-exempt bonds could no longer be used to build professional sports stadiums.
- Sets a top 25% rate for pass-through businesses such as S corporations and partnerships. The plan includes complicated guardrails that limit people from turning what would otherwise be wage income taxed at up to 39.6% into business income taxed at a lower rate.
- New limits on corporate interest deductions, which would be capped at 30% of earnings before interest, taxes, depreciation and amortization, which is a measure of cash flow. Real-estate firms and small businesses would be exempt from that limit.
- Creates a new one-time tax on overseas profits set at 12% for cash holdings and 5% for illiquid holdings, a provision meant to force companies to repatriate overseas profits. Creates a new 10% tax on U.S. companies’ high-profit foreign subsidiaries, calculated on a global basis, but active overseas profits wouldn’t otherwise be taxed.
- Reduces seven individual income tax brackets to four at 12%, 25%, 35% and 39.6%.
- Top tax bracket set for married couples earning $1,000,000 per year and individuals earning %$500,000. Bottom tax bracket extends up to $90,000 for couples and $45,000 for individuals.
- The proposal doesn’t change the top tax rates on capital gains and dividend income.
- Individuals wouldn’t be allowed to take a deduction for state and local income or sales taxes.
- Individuals can continue to claim an itemized deduction for real-estate taxes up to $10,000.
- The bill would preserve head-of-household filing status, often used by single parents. The standard deduction for that group is midway between individuals and married couples.
- Nearly doubles individual standard deduction to $24,400 for married couples and $12,200 for singles in 2018.
- Increases child tax credit from $1,000 in 2017 to $1,600 plus $300 for each taxpayer, spouse and non-child dependents.
- Places new limit on home mortgage-interest deduction at loans up to $500,000, down from $1,000,000, but existing loans would be grandfathered.
- The estate-tax exemption, set for $5.6 million per person and $11.2 million per married couple, would double immediately. The tax would be repealed starting in 2024.
- Keeps 401(k) existing plan rules largely intact.
- Repeals the alternative minimum tax
- Repeals an itemized deduction for medical expenses.
- Repeals the tax credit for adoption.
- Repeals the deduction for student-loan interest.
The winners from the bill include corporations, which in time should benefit all Americans in terms of improved, lower-price goods and services, as well as wage-driven rising incomes. The bill includes provisions to make it easier for companies holding $1.3 trillion overseas to bring those dollars home to invest in plants, equipment and jobs here. The bill charges a tax of 12.5% on those funds, if paid over 8 years in equal installments and increases tax receipts for the government by $223.1 billion over the 2018 to 2027 fiscal years. Of significant importance for companies, future foreign profits could be brought back into the U.S. tax-free.
Business owners in low tax replica states are also potential winners in this bill. They stand to see income tax rates fall from 39.6% to 25% on business income that ‘passes through’ onto their personal tax form, freeing up tens of thousands to be reinvested into growth and jobs.
The table graphic below from the Wall Street Journal efficiently summarizes House Bill 1 changes to the new brackets.
The bill may undergo significant changes as it travels through sausage grinder of Congress, but Republicans are motivated to get it done or risk losing control of government should they fail. In order for them to get passage without Democratic support, which looks doubtful, the cuts and reforms will have to be deficit-neutral, meaning any revenues the government loses due to tax cuts must be offset by comparable increases in tax revenues. The House Ways and Means Committee says this one meets that hurdle. Trump and Congressional say they want to get it done by Christmas to largely impact the 2018 tax year. We will keep you apprised.