The GOP has released its tax reform structure, without a lot of detail (it is being left to Congress to determine), and as we all know the devil is in the details. But remember this is only a proposal and a lot can happen before it becomes law, assuming it even gets to that point. Here are some highlights of the proposal:
Standard Deduction:
Married Filing Jointly: $24,000 (Currently* $12,700)
Others: $12,000 (Currently* $ 6,350, $9,350 HH)
Add’l Std (Age & Blind): Eliminated (Currently* $1,250/$1,550)
Exemptions: For those taking the standard deduction the personal exemptions are considered included in the standard deductions.
Age & Blind Add-ons: These additional standard deduction amounts have been wrapped into the proposed amounts as a simplification measure.
Head of Household: There is no provision for head of household under the plan so presumably HH would be single.
*2017
Devil in the Details: So based on the GOP’s news release we know for sure that the filer's, and spouse's if married joint, personal exemptions are included in the new standard deduction amounts (taxpayers get no separate exemption deductions when taking the new standard deduction amounts). We also know that the child tax credit (discussed further on) will be increased to compensate for the loss of dependent exemptions and a new nonrefundable credit is proposed for non-child dependents. What we don’t know is will the taxpayer and spouse who are itemizing their deductions be able to claim exemptions for themselves? This can make a significant difference since a married couple would only have to have $15,900 in itemized deductions to beat the standard deduction of $24,000 (if the 2017 exemption amount of $4,050 continues to apply).
Individual Tax Brackets:
Proposed tax brackets: 12%, 25% and 35% and possibly a 4th bracket for the “highest-income” taxpayers.
Current Tax Brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%
Devil in the Details: To determine how these new rates apply we need to know the taxable income ranges they will apply to. This is a detail not included in the GOP’s framework. The framework is also silent on what, if any, changes might occur to the long-term capital gains tax rates.
Itemized Deductions:
Most itemized deductions will be eliminated except for:
- Home mortgage interest, and
- Charitable contributions.
Devil in the Details: The wording “most” itemized deductions leaves a lot of unanswered questions. Most people associate itemized deductions with medical, taxes, home mortgage interest, charitable contributions and employee business expenses. But also currently included in itemized deductions are:
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Casualty losses – Does this mean casualty losses would no longer be deductible? Our recent hurricane victims would bristle at that change.
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Gambling losses – Will recreational gamblers have to pay tax on all their winnings, even though most actually lose money?
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Claim of Right Deduction – Meaning when individuals have to repay income that was taxed in a prior year they would not get a deduction for it.
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Attorney Fees – Attorneys commonly take 40% of damage awards. Without this deduction taxpayers would have to pay taxes on money they never received.
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Others – Other deductions include amortizable bond premium, impairment-related work expenses, unrecovered investment in pensions, investment interest, tax return preparation fees and investment management fees.
Not discussed in the framework is whether the same mortgage interest rules we currently have will be retained. Some commentators have speculated that the $1 million acquisition debt limit may be reduced to $500,000. Also not mentioned is whether the deduction will be limited just to the taxpayer’s main home, or if the interest on a second home will continue to be allowed.
One of the larger issues is the loss of the deduction for state and local income taxes. This will impact taxpayers living in states with an income tax and in some cases city income tax. Of course those impacted the most would be states with very high income taxes such as CA, NJ and NY. Also apparently to be eliminated is the deduction for real property taxes.
Medical Deductions
As part of the Affordable Care Act, the medical deduction threshold was raised from 7.5% to 10%. Then, as part of the GOP’s failed ACA repeal act, that threshold was to be reduced, allowing more individuals with high medical costs to deduct more of their medical expenses. However, the GOP’s framework appears to have reversed earlier thinking and eliminated the medical deduction altogether. This could have a devastating impact on taxpayers burdened with high medical costs.
Net Investment Income Tax
As part of the Affordable Care Act (ACA) a 3.8 percent net investment income tax was added to the tax code. This tax would have been eliminated under the GOP’s failed ACA repeal legislation earlier this year. Now it seems they have decided to let it remain in the code, unless they intend to address it in a later attempt at repealing the ACA.
AMT
The GOP plan would repeal the Alternative Minimum Tax (AMT) for individuals.
Estate Tax
The GOP plan would repeal the death tax and the generation-skipping transfer tax.
Devil in the Details: What’s left unsaid in the framework is how basis of inherited property will be determined – will there be a step-up/step-down basis to fair market value at the date of death as under the current law or will the inherited property take on the decedent’s adjusted basis? When the estate tax was temporarily repealed in 2010, determining the inherited basis became a complicated computation, so one would hope that in the spirit of simplification, the 2010 method isn’t resurrected.
Child Tax Credit (CTC)
- Would make the first $1,000 of the child tax credit refundable.
- Increases the CTC, by an unspecified amount, as an offset to the repeal of personal exemptions for dependents
- Adds a $500 non-refundable credit for other dependents that do not meet the child criteria.
Devil in the Details: This would presumably eliminate the current complicated calculation for the refundable portion of the CTC since the first $1,000 would be refundable. Also the income phase-out amounts are not specified but the framework intends that the phase-out ranges be adjusted so more taxpayers will be eligible for the credit.
Work, Education and Retirement Benefits
According to the GOP tax reform documents, numerous other exemptions, deductions and credits for individuals riddle the tax code. The framework envisions the repeal of many of these provisions to make the system simpler and fairer for all families and individuals, and allow for lower tax rates.
However, the framework retains tax benefits that encourage work, higher education and retirement security. The Congressional committees are encouraged to simplify these benefits to improve their efficiency and effectiveness. Tax reform will aim to maintain or raise retirement plan participation of workers and the resources available for retirement.
Devil in the Details: Reading between the lines, it would seem the EITC and child and dependent care credits would be retained since they encourage work. It also seems that most retirement plans would be retained, but we can only hope the various plans can be combined into one set of rules.
Top Tax Rate For “Small” Businesses
The GOP tax reform framework limits the maximum tax rate applied to the business income of small and family-owned businesses conducted as:
- Sole proprietorships,
- Partnerships and
- S corporations
to 25%. (Note: 25% is the middle rate of the proposed three tax rates for individuals.) The framework contemplates 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.
Devil in the Details: There are more questions here than answers. For instance what will be the definition of a “small” business? Also, how will this apply to S corporations, since they currently require reasonable compensation in the form of wages and any 1120-S K-1 income is presumed to be return on investment income not subject to SE tax?
Corporate Tax Rate
The GOP tax reform framework reduces the corporate tax rate to 20% – which is below the 22.5% average of the industrialized world. In addition, it aims to eliminate the corporate AMT, as recommended by the non-partisan Joint Committee on Taxation (JCT). The committees also may consider methods to reduce the double taxation of corporate earnings.
Expensing of Capital Assets
The GOP tax reform framework allows businesses to immediately write off (or “expense”) the cost of new investments in depreciable assets other than structures made after September 27, 2017. This provision would be in effect for at least five years. This policy represents an unprecedented level of expensing with respect to the duration and scope of eligible assets. The committees may continue to work to enhance unprecedented expensing for business investments, especially to provide relief for small businesses.
Domestic Production Deduction
The Sec 199 deduction for domestic production would be eliminated.
Business Credits
The GOP tax reform framework explicitly preserves the following credits:
- Research and development (R&D) and
- Low-income housing.
It envisions repeal of other business credits, unless the committees may decide to retain some to the extent budgetary limitations allow.
Change to a Territorial System
Under the GOP’s framework, the United States would shift to a territorial system for multinational companies. Included in the framework is a proposal to impose a repatriation tax on foreign profits stored overseas. However, the framework did not stipulate an exact rate and has left that to the Congressional tax committees.
Effective Dates
It would appear the expensing for new investments in depreciable business assets (except for structures) would take effect for purchases made Sept. 27, 2017 if the legislation becomes law.
Devil in the Details: The proposal is silent related to the effective dates of other proposed changes which can leave taxpayers in a quandary related to year-end tax planning. But it is doubtful that the provisions would be retroactive, and if they are not retroactive, one would want to prepay as many of the eliminated itemized deductions as possible in 2017 while they are still deductible. These include any state or local income tax that might be due, property taxes, medical (if the 10% threshold is exceeded), investment expenses and employee business expenses.