Hello Everyone,
Please do not ask me about the rock that I have been under, but be rest assured that I have been thinking of getting a post published non-stop since my last submission. I have no excuses, so let’s get on to our discussion of the day – TAXES.
Yesterday, the “working group” of Republican leadership in the House of Representatives, the Senate and the White House released a framework for a tax proposal. This framework expands on a previously announced tear sheet that outlined a proposed Republican tax reform plan (May 2017). Here are the highlights of the potential tax bill (with many details forthcoming):
General Themes/Principles of Tax Reform – President Donald Trump has laid out four general principles of his vision for tax reform. They include (1) simplifying the tax code, (2) providing everyday Americans a “pay raise” by reducing their tax burden, (3) lowering tax rates for American businesses in order to make the US more competitive for US jobs and operations, and (4) repatriate trillions of dollars in offshore profits in hopes that its presence and circulation in the US economy will expand economic growth through the tax multiplier effect.
This post will focus on the personal tax side of the proposal, but we will summarize the business tax and international tax proposals in our next post.
Proposals to Taxes Affecting Individuals
- Contraction of Tax Rates: In our current progressive tax scheme, we have seven tax rates/brackets that individuals fall into based on the level of their income: 10%, 15%, 25%, 28%, 33%, 35, 39.6%. The proposed framework calls for reductions of this brackets to three: 12%, 25%, and 35%. This is nothing new, previous administrations have (i.e., George W. Bush) have provided tax cuts by “reducing the rates while widening the base”. There are also suggestions that the brackets will be indexed for inflation so that there will be little need to expand them in the future.
- Doubling the Standard Deduction: Under the proposed framework, the Standard Deduction will essentially double from its current amount of $6,300/$12,600 to $12,000/$24,000 for Single/Married Taxpayers. It is assumed that the same doubling will occur for Head of Household filers as well (i.e., $9,250 to $18,000). In addition, the proposal eliminates personal exemptions (valued at $4,000 per taxpayer and dependents and subject to an income phaseout).
- Enhanced Child Credit: The framework increases the Child Tax Credit from its current max of $1,000 and increases the income levels that can qualify for it. In addition, the Chil Tax Credit is proposed to become refundable, which means that you DO NOT have to owe taxes in order to receive it (like the Earned Income Tax Credit and part of the American Opportunity Education Tax Credit). Lastly, the framework allows for an additional $500 non-refundable tax credit (i.e., you have to have taxes to take advantage of it) for non-child dependents (i.e., elderly parents or other individuals that meet the dependent definition under the Tax Code).
- Changes to Itemized Deductions: The framework eliminates itemized deductions for (1) Medical Expenses, including Long-Term Care Insurance, (2) State and Local Taxes, and (3) Job-related Expenses and Miscellaneous Deductions. Preserved are the itemized deductions for Charitable Contributions and Mortgage Interest. Just for your information, itemized Deductions are deductions that individuals can take instead of the standard deduction. In general, you only take these deductions if they exceed the standard deduction (i.e., provides a tax benefit).
- Elimination of Alternative Minimum Tax: The framework eliminates the Alternative Minimum Tax (a dual tax that is placed upon high-income earning families that have relatively
- Elimination of Estate Tax: The framework eliminates the Estate Tax (a tax that is levied on estates greater than $5.49 million).
What does this mean? How would it affect you?
That’s really the long and short of it, right? How would these changes affect the everyday US family if these proposals became law? There are a plethora of tax change scenarios that can present itself, but here are the major themes that you can expect to see across the board:
- Low-income taxpayers get some (but very little) additional relief – By doubling the standard deduction (but taking away the personal exemption), and enhancing the child tax credit, some low-income families may possibly see lower taxes, but the tax savings will not be significant. Remember, that many families in this sector don’t pay much by way of taxes at all. In addition, most if not all of their tax returns result in refunds either because their income is so low relative to deductions, or due to the application of certain tax credits that are both non-refundable (reduces your taxes dollar for dollar) or refundable (you don’t have to owe taxes to get it – its “free money”) like the Earned Income Tax Credit. So Trump really isn’t doing the working poor any favors tax-wise.
- While high-income families that are subject to the Alternative Minimum Tax will find relief, they will be hurt by the loss of exemptions and the loss of state & local income and property tax deductions – High income families (households with incomes higher than $200,000) who live in high income tax states with high property taxes will be ultimately harmed by the new tax laws due to the loss of itemized deductions for state and local income taxes and property taxes. One rebuttal is that this same couple is spared the Alternative Minimum Tax, so the taxpayer is made whole. There are phase-in arguments that you can make against this position, but the overall loss of exemptions and income phaseout of tax credits may ultimately harm taxpayers in this situation.
- Seniors who have significant medical and property tax outlays are at risk of being hurt by the proposed tax rules – Many retirees who are homeowners and have no mortgage debt still have property taxes to pay and enjoy the potential tax benefits associated with them (especially in states with relatively higher property taxes like NJ). In addition, a significant amount of retirees income is paid out to medical-related expenses (i.e., insurance, prescription drugs, etc.) – even if the retirees are on Medicare (a typical couple pays on average ~$1,000/month for Medicare Part B, D & F premiums along with Long-Term Care). Even with a 7.5% floor, many seniors can clear this hurdle and get some tax benefits for the significant outlays they make toward healthcare costs. With the proposed tax reforms, retirees would lose both.
- Getting Rid of the Estate Tax benefits who? – The spin is that the repeal of the estate tax supposedly provides relief to successful small business owners, owners of farms and real estate… the so-called “first generation job creators”. That might be slightly true, but for individuals with wealth like this, there are plenty of strategies in place in the tax code that provides ways for them to avoid the estate tax (i.e., trusts, spousal exemption, lifetime gifting, etc.). I will discuss this topic in more detail during my Part II post.
In Part II, I will briefly discuss the proposed business and international tax changes and their potential impact on businesses and you the taxpayer. In addition, we will do some fact checking on tax change claims using actual federal tax data. Thanks so much for taking the time to read my posts.