Tax Reform Framework Released

President Trump announced a nine-page framework for tax cuts on September 27, 2017. The Framework capitalizes on many ideas previously presented in the President’s Tax Outline and in the House Republican Blueprint. Congressional tax-writing committees have a lot of work to do in refining the details, but it gives us an idea of where tax reform may be headed.

Individual Tax Rates

The current rates now fall into seven brackets, ranging from 10% to 39.6%. The proposed plan would consolidate the current individual tax brackets into three: 12%, 25% and 35%. An additional top tax rate may be added and apply to the “highest-income taxpayers,” but it fails to mention the income level at this might take effect, or the rate that would be imposed.

The plan also does not specify which income levels would be taxed at each rate— and if the highest rate is set at 35 percent—it would greatly benefit the wealthiest taxpayers, who currently pay a top rate of 39.6 percent on income greater than $418,400 for single filers.

Child and Dependent Care Credits

Although the rate applied to the lowest income bracket would increase, typical families in the existing 10 percent bracket may be better off because of a larger child tax credit as well as an increase in the standard deduction. The child tax credit would be “significantly” increased, including a refundable portion offered to taxpayers who have higher levels of income than current law allows.

A new, non-refundable credit of $500 for those caring for non-child dependents (such as an elderly parent) would be added.

Standard and Itemized Deductions

Most itemized deductions would be eliminated, meaning that large medical expenses, state and local income taxes, real estate taxes, investment expenses and investment interest expense would no longer be deductible. However, home mortgage interest, charitable contributions, and tax benefits encouraging work, higher education and retirement savings would be retained.

The standard deduction and personal exemptions would be combined into one larger standard deduction: $12,000 for single filers and $24,000 for married taxpayers filing jointly. Home mortgage interest, charitable contributions, and tax benefits encouraging work, higher education and retirement savings would be retained. This means that Such a revision of the tax code, if enacted, would greatly increase the number of taxpayers choosing the standard deduction. The new, single deduction would be higher for many filers, except those who claim multiple children

The Alternative Minimum Tax (AMT) and the federal estate tax and generation-skipping transfer tax would be repealed under this framework. It is suspected that that the repeal will apply to gift taxes, as well.

Business and Corporate Taxes

The tax rate would be reduced for regular or “C” corporations from 35% to 20%. The corporate Alternative Minimum Tax (“AMT”) would be eliminated along with other methods to reduce the double taxation of corporate earnings.

Many small businesses are structured as “S” corporations, partnerships, limited liability companies (LLCs), or sole proprietorships; all of which pass through business profits and losses to their owners’ personal tax returns. Thus, “C” corporation income taxes may be avoided but the owners face personal tax rates as high as 39.6%. Pass-throughs now make up about 95 percent of businesses in the country and the bulk of corporate tax revenue for the government.

Under the proposed framework, business income from these “pass-through entities” would be taxed at a rate no higher than 25%. Such a measure would need to be drafted carefully in order to prevent personal income of wealthy individuals from being reclassified into lower-taxed business income. Whether these distributions would then be subject to a second level of tax at the individual owner level also needs to be addressed.

Deductions and Tax Credits

Most special deductions and tax credits, other than the R&D credit and the low-income housing tax credit, would be eliminated. It’s not clear which deductions will be eliminated; however, the Section 199 deduction was specifically mentioned as being eliminated.

Replace system of taxing companies’ worldwide income with a 100% exemption for dividends from foreign subsidiaries in which U.S. parent has a 10% stake or more. Reduce tax rate and tax on a global basis the foreign profits of U.S. multinational corporations.

Tax Write Offs for Depreciable Assets

Businesses that invest in depreciable assets, other than buildings, after September 27, 2017 would write them off immediately. This tax benefit, with no upper limit, would be in place for at least five years. As a tradeoff, the tax-deductibility of interest expense incurred by most taxable corporations would be partially limited.

If you have questions about how the proposed tax reform might affect you, please call us.

 

Deductions Eliminated Under Trump’s Tax Reform Proposal

One of President Trump’s key tax reforms is to eliminate all individual tax deductions except for those that incentivize home ownership, charitable contributions and retirement contributions. Although the administration’s one-page outline of the proposed tax reforms provides little detail, if all of the deductions except those noted are eliminated, the reform will impact both itemized deductions and income adjustments. This article will explore the deductions that the president’s proposal retains and those that it would eliminate, so you will be able to see how these changes could play out for your particular circumstances.

Deductions the Proposal Retains

Incentives for Home Ownership – Although Trump’s proposal provides no details about what “incentives for home ownership” means, this category would presumably include deductions for home-mortgage interest and property taxes. However, it is unknown if the plan will include the existing restrictions that limit the home-mortgage interest deduction to $1 million of home-acquisition debt and $100,000 of equity debt. It is also unclear if the incentives for home ownership would include second homes.

Charitable Contributions – Presumably, the plan would continue to be subject the 50%, 30% and 20% adjusted gross income (AGI) limits. The proposal does not address one of the most complicated areas (and one that is significantly abused) –contributions of overly valued property.

Retirement Contributions – Retirement contributions are deducted as an adjustment to income; this is frequently referred to as an above-the-line-deduction. Presumably, in the new plan, this still would include traditional IRAs and self-employed retirement plan contributions.

Itemized Deductions the Proposal Eliminates

Medical Itemized Deductions – Currently, medical deductions are already limited to those that exceed 10% of a taxpayer’s AGI. The Trump plan eliminates the medical deduction altogether, which would significantly impact senior citizens, especially those requiring significant elder care, and taxpayers who have incurred extraordinary medical expenses. What is curious about the elimination of the medical deduction is that, just a couple of months ago, as part of the failed ACA repeal, the administration wanted to reduce the medical AGI limitation and allow larger medical deductions. Now, it wants to eliminate them altogether.

Deduction for State And Local Taxes – Currently, deductions are allowed for state income tax, city and other income taxes, real and personal property taxes and (under certain circumstances) sales taxes.

Eliminating this deduction would have the most significant impact on taxpayers living in states that have income taxes. Taxpayers residing in those states would no longer be able to deduct their state and local income taxes and thus would be double-taxed on the same income. All but seven states have income tax, with California, New York and New Jersey imposing the highest rates. Support for this change is questionable, even among Republican senators, as representatives from states with income taxes will certainly want to retain the state income-tax deduction for their constituents.

Investment Interest Deduction – Currently, a deduction is allowed for investment interest in the amount of net investment income (investment income minus investment expenses). This means that the interest taxpayers pay on money that they borrow to purchase investments would no longer be deductible.

Casualty & Theft Losses – Every year, Americans deal with casualty losses from accidents, fires, floods, tornados, hurricanes, earthquakes and other natural disasters. Currently, those taxpayers can deduct casualty losses – generally to the extent that they exceed $100 per event and 10% of their AGI. Under Trump’s plan, this deduction would be eliminated, which penalizes taxpayers who are in the greatest need – those who are recovering from a disaster.

Employee Business Expenses – Currently, employee business expenses, including the home-office deduction for employees who work out of their own homes, are deductible as miscellaneous itemized deductions, but these deductions are limited to those expenses that exceed 2% of AGI. Under the Trump plan, this deduction would be eliminated. This could pose a serious handicap for telecommuting employees, who would then have the bear the cost of their own offices, office equipment and supplies. Another example are mechanics who must pay for their own (expensive) tools.

Legal Fees – Currently, legal fees are deductible when they are incurred for the protection or production of taxable income. This includes taxable awards as a result of winning or settling a lawsuit. Typically, legal fees are contingent upon the taxpayer winning the suit; they often represent a large percentage of the award. Without this deduction, the taxpayer would have to pay taxes on the entire award even though a significant portion went toward attorneys’ fees.

Gambling Losses – Currently, gambling losses are only deductible in an amount equal to gambling winnings. Under Trump’s plan, these losses would no longer be deductible, meaning that taxpayers would have to pay taxes on all their winnings – even if they have net losses. Senior citizens and others who gamble recreationally could be hit with significant taxes even when they actually lose money.

Other Deductions the Proposal Eliminates

The following deductions are not itemized deductions but are considered adjustments to income. This includes retirement-plan deductions (such as those for IRAs and self-employed retirement plans, including SEPs, SIMPLE and other qualified plans); all of these deductions would be retained. However, if all other deductions are eliminated, the eliminated deductions would include:

Teacher’s Expenses – This is the educator’s deduction for classroom supplies (up to $250 per year). The 2015 PATH Act recently made this deduction permanent.

Health Savings Account (HSA) Deduction – Individuals with high-deductible health insurance can currently deduct contributions to HSA plans when the funds are used to pay qualified medical expenses. It is doubtful that this deduction will actually be eliminated, as HSAs are a key element of the administration’s plan to replace Obamacare.

Moving Expenses – Individuals who move over 50 miles as a result of a change in work location and who work at the new location for a minimum period of time can deduct the cost of the move.

Self-Employed Health-Insurance Deduction – Self-employed individuals, including partners and those who hold more than 2% of an S corporation’s shares, can deduct the cost of their own medical insurance as well as that of their spouse and dependents, subject to certain conditions.

Penalty for Early Withdrawal of Savings – When taxpayers withdraw from term savings accounts, they may incur interest penalties, which are deductible. This deduction was implemented to avoid having taxpayers pay taxes on interest income that they did not receive.

Alimony Paid – When a taxpayer pays alimony to a former spouse, that alimony is taxable for the recipient. To avoid taxing both parties on the same income, the one who makes the payments is allowed to deduct the alimony paid. Eliminating this deduction would have a significant impact on taxpayers who pay alimony.

Student-Loan Interest Deduction – This rules allows for a deduction of up to $2,500 for interest paid on student loans.

Domestic-Production Activities Deduction – Tax law includes a special tax deduction that encourages domestic production (as opposed to foreign production). C-corporations take this deduction on their corporate tax returns; self-employed individuals, partners and S-corporation shareholders must take this deduction on their 1040. It is doubtful that Congress would continue to allow this deduction for corporations while also discriminating against self-employed taxpayers by not allowing them to take the deduction.

We can only wonder if the president expects all of these deductions to be eliminated; perhaps he only proposed the eliminations as a tool to start negotiations with Congress. Details are not promised to arrive until June, so we will have to wait and see how this plays out.

This is the second in a series of articles related to President Trump’s tax reform outline. Click here to read the first summary of the Trump Tax Reform.

What Trump’s Tax Proposals Mean To You And Your Business

This is the first in a series of articles related to President Trump’s tax reform outline. Click here to read the second summary of the Trump Tax Reform.

On April 26, 2017, with some fanfare, the Trump administration has provided information on proposed tax law changes, many of which mirror his previous tax policy statements. Although these proposals lack significant detail, here is what the president proposes and how it might impact your tax liability:

Business Tax Rates: Trump’s proposal would cut the top rate on corporate taxable income from 35% to 15%. Presumably, the 15% rate would apply to all business income, including small family-owned businesses.

Individual Tax Rates – Under Trump’s proposal, there would only be three tax brackets, 10, 25, and 35%, down from the current seven tax brackets: 10, 15, 25, 28, 33, 35 and 39.6%. The brackets are applied in steps, so as a taxpayer’s income increases the increase is taxed at increasingly higher rates. The table below illustrates the current 2017 tax brackets.

Filing
Status
Single
Head of
Household
Married Filed
Jointly
Married Filed
Separately
10%
$9,325
$13,350
$18,650
$9,325
15%
$37,950
$50,800
$75,900
$37,950
25%
$91,900
$131,200
$153,100
$76,550
28%
$191,650
$212,500
$233,350
$116,675
33%
$416,700
$416,700
$416,700
$208,350
35%
$418,400
$444,550
$470,700
$235,350
39.6%
$418,401+
$444,551+
$470,701+
$235,351+

The current proposal generally mirrors the rates Trump proposed while on the campaign trail. Under the previous proposal, for married taxpayers filing jointly, the lowest rate would apply to income less than $75,000; the 25% rate would apply to income more than $75,000 but less than $225,000; and the 33% rate would apply to income of more than $225,000. Brackets for single filers were 1/2 of joint filer amounts.

However, the income brackets where the rates apply have not been specified in the current proposal and are subject to negotiations with Congress. Regardless, the reduction of the top tax rate from 39.6 to 35% will provide a huge tax saving for wealthy taxpayers.

Standard Deduction – Trump originally suggested a standard deduction of $25,000 for singles and $50,000 for married couples. He has since toned that down and is now proposing to double the standard deduction, which is currently (2016) $12,600 for a married couple filing jointly and $6,300 for single taxpayers. Under Trump’s proposal the standard deductions would increase to approximately $24,000 for married couples and $12,000 for single taxpayers. According to an estimate by the nonpartisan Tax Policy Center (TPC), 27 million (60%) of the 45 million filers who would otherwise itemize in 2017 would opt for the standard deduction. This change would generally provide a small tax benefit to lower-income taxpayers.

Itemized Deductions – During the campaign, Trump proposed limiting itemized deductions to $100,000 for single filers and $200,000 for joint filers, which would cause an increase in taxes for the wealthiest taxpayers and not impact middle-income taxpayers. However, the current proposal would do away with all itemized deductions except those that incentivize home ownership and charitable deductions. The theory is that the other deductions primarily benefit the wealthiest taxpayers. However, this would also have a significant impact on other taxpayers as well. Here are a few examples of its effects:

  • Medical deduction – Medical deductions would be eliminated, impacting seniors with significant medical costs during the year.
  • State & Local Tax – Taxpayers living in states with income tax would no longer be able to deduct the state and local income taxes they pay.
  • Employee Business Expenses – It would also eliminate the deduction for employee business expenses.
  • Recreational Gambling – Those who gamble recreationally would have to pay taxes on all their winnings and would not be able to deduct losses.

Other Deductions – Under the Trump proposal, virtually all deductions other than retirement savings would be eliminated. If that is the plan, then presumably it would include moving deductions, educators’ expenses, self-employed health insurance, student loan interest, and alimony paid. None of these changes would provide any significant benefit to the wealthy but would impact lower-income taxpayers.

Alternative Minimum Tax (AMT) – Trump would eliminate the AMT, which primarily impacts wealthier taxpayers.

Estate Tax – The proposal would also eliminate the estate tax, which applies to wealthy taxpayers with taxable estates in excess of $5,450,000 (2016). The number of taxable estates in the U.S. per year is just over 10,000.

This proposal was presented as a one-page outline without any fundamental details. Assuming the proposal is not dead on arrival, expect significant changes to be made by Congress. For instance, the senators and representatives from states with income tax will certainly want to retain state income tax as an itemized deduction for their constituents, including both Democrats and Republicans. And of course, there needs to be replacement revenue for the cuts to avoid a national debt increase.

As the tax reform debate winds through Washington, rest assured we will stay on top of the latest proposals and final legislation. We will continue to keep you informed during this wild ride.

What Does the Future Hold for Taxes?

One topic that is frequently being discussed is what the future holds for individual taxation under President Trump. Numerous blog entries have been posted on the issue; many proclaim that the wealthy will be the beneficiaries of Trump’s tax policies, and some declare that lower-income taxpayers will see tax increases.

Those predictions are based upon his proposal to consolidate the individual income tax rates from seven to three: 12, 25 and 33 percent. These are the same three rates that were included in the “Better Way” tax-reform blueprint that Republicans in the House of Representatives released in June 2016.

Under Trump’s plan, the two highest current rates, 39.6% and 35%, would be eliminated, which generally favors higher-income taxpayers. However, the tax brackets alone do not tell the whole story.

Trump is also proposing more than doubling the standard deductions, which would generally benefit lower-income taxpayers. Because the marginal tax rates apply only to taxable income (which is currently defined as adjusted gross income minus personal exemptions and deductions—either standard or itemized), the increase in the standard deduction will tend to neutralize the higher marginal rates for lower-income taxpayers.

According to an estimate by the nonpartisan Tax Policy Center, of the 45 million filers who would itemize their deductions in 2017, 27 million (60 percent) would opt for the standard deduction under the proposed rules.

To see how the proposal’s combination of new tax rates, higher standard deductions, and cap on itemized deductions (discussed below) could affect your taxes, pull out your 1040 tax return from either 2015 or 2016 and complete the worksheet below. Then compare line 6 (your tax computed using Trump’s proposed three-tier tax rates and standard deductions) to line 7 (your tax as computed on a prior 1040) to get a rough idea of how these tax proposals could impact you.

Trump also proposes capping itemized deductions at $100,000 for single filers and $200,000 for joint filers. This will generally affect wealthy taxpayers. Under current law, certain itemized deductions phase out for high-income taxpayers. It is unclear whether that provision will be replaced by the proposed cap on itemized deductions or whether both will apply. If the cap is adopted, the amount entered on line 2c of the worksheet above will be limited based on the proposed cap amounts.

Although this is not clear, Trump’s proposals may include the elimination of personal exemptions. If true, this change would have the greatest effect on lower-income taxpayers because these exemptions are already phased-out for higher-income taxpayers. Those with large families could be impacted the most. If the personal exemptions are eliminated, the amount on line 3 of the worksheet above would be zero.

Not the Whole Picture – The tax-rate changes, higher standard deductions, and limitations on itemized deductions don’t paint the whole picture of the proposal. It is unclear what will happen to the numerous credits available to lower-income taxpayers under the current tax system. Approximately 48% of all U.S. taxpayers pay no tax at all, and most of them actually receive money back on their returns as a result of refundable tax credits such as the earned income tax credit, the additional child tax credit, and the American Opportunity Tax Credit (a tuition credit).

The Republicans have started the process of appealing the Affordable Care Act (also referred to as the ACA or Obamacare), and now that they have majorities in both houses of Congress and control of the White House, we are bound to see some changes in this area. The health care marketplaces have already accepted insurance coverage for 2017, so it is doubtful that there will be any changes until 2018. However, Trump has vowed to overturn the ACA’s 3.8% excise tax on net investment income; eliminating this tax would greatly benefit higher-income taxpayers.

It is probably too early to have a clear picture of future tax reforms, but change is sure to come. If you have questions about how your tax situation may be impacted, please give this office a call.