Ben Franklin once wrote, “In this world, nothing can be said to be certain, except death and taxes.” That being said, due to annual changes to the tax code, it is hard to be certain how much you will pay the IRS. This is especially true in years following the election of a new president. As a result of Donald Trump’s election as the 45th President of the United States, as well as the Republican Party retaining control over the House and the Senate, taxpayers can expect to be in for some fairly significant changes to tax policy in the upcoming years.
Proposed Changes in Brackets and Deductions
Under the current tax code, ordinary income (essentially, all forms of income other than long-term capital gains and qualified dividends) is taxed at graduated rates. So, as income increases, tax rates increase.
There are currently seven tax brackets, with corresponding tax rates ranging from 10% to 39.6%. For a Married Filing Jointly tax return (MFJ), the taxpayers will pay a 10% tax rate on taxable income up to $18,550 and a 15% rate on taxable income between $18,550 and $75,300. After $75,300 in taxable income, the rate increases to 25%, and so on.
President Trump has proposed significant changes when it comes to taxes. One element of his plan is that there will only be three tax brackets, as opposed to the current seven. For MFJ filers, all taxable income earned up to $75,000 would be taxed at 12%. The second bracket, including taxable income between $75,000 and $225,000, would be taxed at 25%. Any taxable income earned over $225,000 for a Married Filing Jointly return would be taxed at the 33% rate. The brackets for single filers are half of these amounts.
The above examples are based on taxable income coming from ordinary income sources; any long-term capital gains or qualified dividends are taxed at lower rates, which increases the complexity of the tax calculation.
Another key proposed change is the increase in the standard deduction and the cap on itemized deductions. The current tax code allows a standard deduction of $12,600 for MFJ filers ($6,300 for single filers), and allows for an exemption of $4,050 for all dependents in your household, including yourself and your spouse. The proposed Trump plan calls for an increase in the standard deduction to $30,000 ($15,000 for single filers), but an elimination of personal exemptions. He also plans to cap all itemized deductions at $200,000 for MFJ filers ($100,000 for single filers).
Additionally, President Trump has already taken steps to facilitate the repeal and replacement of the Affordable Care Act. This change will likely impact many tax returns. The penalty for not maintaining health insurance probably will be removed, as will the 3.8% surtax on investment income for high-income taxpayers.
Business Taxes and Estate Taxes
While business tax proposals and estate tax proposals haven’t been as flushed out as the individual income tax plans, there are likely changes coming in these arenas, as well.
Regarding businesses, the current top corporate tax rate of 35% would be changed to 15% under the proposed Trump plan. He would also permit the immediate deduction of most asset acquisitions, while eliminating many other deductions.
His plan also calls for the 15% tax to be applied to all businesses, including S Corps and Partnerships. Previously, these entities allocated income to owners, who were then taxed at their own individual rates Under the new plan, this income would still “flow through” to the individual’s tax return; but, the rate would be 15%, which is frequently lower than the individual’s tax rate.
The estate tax, under Trump’s plan, would effectively be eliminated. The only potential estate tax would be taxed at the beneficiary level, but only after he/she sells an asset that had appreciated in value by over $10 million at the date of death.
Implications on the Taxpayer
Depending on your tax situation, you could see a wide range of impact from this potential tax revision. A low-to-middle income married couple filing together, without kids or itemized deductions, could see their tax liability drop significantly due to Trump’s increased standard deductions. However, a family of five with similar income may see an increase in taxes due to the loss of personal exemptions.
The proposed changes to may also cause more people to pick the standard deduction rather than using itemized deductions. For instance, an MFJ filer with $22,000 in itemized deductions finds it more beneficial to itemize instead of taking the (current 2017) standard deduction of $12,700. But, under the Trump plan, the taxpayers would pick the $30,000 standard deduction. This, and the $200,000 ($100,000 for single filers) cap on itemized deductions, could lead to decreased tax incentives to make tax-deductible charitable contributions or to take on new mortgages (mortgage interest is currently an itemized deduction).
Meanwhile, this could have a great tax impact for business owners that were previously taxed on pass-through income at up to 39.6% and would now be taxed at a 15% rate. This could also lead to a shift from W-2 employees to 1099 independent contractors, as many employees may be willing to take the additional risks associated with performing as an independent contractor if they were to be taxed at a much lower rate.
Possible Roadblock – Republican-Led Congress
Despite both the executive and legislative branches of the federal government being controlled by Republicans, President Trump’s tax reform proposal is not guaranteed to pass. President Trump wants to make up for the lost revenue of his tax reform proposal by cutting funding for certain areas of the federal government. Many of these spending cuts will be a tough sell, even in a Republican-led Congress.
While the proposed details on the tax cuts themselves differ slightly between Trump and the Congressional Republicans (for example, the Congressional Republicans would restrict itemized deductions further than Trump would), it would appear that these disparities would be an easier hurdle to overcome than the spending cut differences mentioned above.
Finally, it takes 50+ votes to pass a bill in the Senate. While Republicans hold 52 seats in the Senate, it would take a “no” vote of only three Republican Senators (combined with 100% Democratic opposition) to kill a tax reform bill. A few moderate Republicans who may oppose some of Trump’s spending cuts and/or a few conservative Republicans who may not think it goes far enough to address deficit reduction could defeat or delay comprehensive tax reform, at least in the short run.
There are likely to be many changes to the proposals during the negotiation process. We’ll keep you updated as tax reform moves ahead in 2017.
Regardless of your situation, any new plan will have an impact on your tax filing and liability. Contact our team today to start your tax planning.