It’s been about 9 months since President Trump took office and no matter your political opinions and views, I think we can all agree he seems determined to make changes while he’s in office. Whether those are for the better or worse remains a mystery. As of the writing of this post, he’s already attempted to repeal healthcare, and subsequently reform it healthcare, neither of which have had much success. His next target is tax reform, rather, the largest tax reform seen in the United States in about 30 years. If he is successful, this could dramatically change how millions of Americans are taxed each year. It also stresses the importance of tax planning, especially for this year and next year.
Late last year I wrote about Trump’s first tax reform proposal. You can read that here and see how it stacks up against his new plan. Below are the top 10 highlights from his new proposal that are likely to have an impact in some way on every taxpayer.
#1 – Adjust tax brackets (revised from last year’s proposal)
Trump’s latest proposal would collapse the current seven brackets into three. The new tax brackets (slightly higher than last year’s proposal) would be adjusted to 12%, 25%, and 35%. Most married couples filing jointly with income less than $225k would likely remain unaffected, or have a reduced tax bill.
#2 – Increase standard deductions & eliminate personal exemptions (consistent with last year’s proposal)
One of the few items unchanged from last year’s proposal. Trump is proposing to double the standard deduction and eliminate personal exemptions which would likely result in a slight increase in tax deductions for most taxpayers. However, this change could serve as a blow for families of larger sizes since the number of dependents claimed would not necessarily yield any additional tax benefits.
#3 – Eliminate itemized deductions (revised from last year’s proposal)
This is different from last year’s proposal in that Trump previously wanted to cap itemized deductions for single and married filers. The itemized deduction elimination would still allow for taxpayers to itemize deductions for mortgage interest and charitable contributions. However, the changes could have significant repercussions for taxpayers when you take into account #4 below. It may also cause a ripple effect on the economy, for example, the housing market may cool off as many taxpayers would not be likely to itemize their deductions going forward and therefore would have less incentive to buy real estate.
#4 – Eliminate the deduction for state & local taxes (new from last year’s proposal)
An item not noted in Trump’s previous tax reform proposal is the elimination of the state and local tax deduction. Most taxpayers rely on the combination of state & local taxes, real estate taxes, and mortgage interest paid on their home to itemize their deductions. By removing the deduction for state and local taxes, it will become ever challenging for most American households to itemize their deductions going forward. This will make tax planning crucial to ensure that any lost tax benefits can be recovered elsewhere from other available strategies.
#5 – Eliminate the Alternative Minimum Taxes (new from last year’s proposal)
Again, not noted in the previous proposal, but one that I support, eliminating the Alternative Minimum Tax (AMT). This is a separate tax that is assessed when “high income earners” suddenly find themselves deducting a disproportionate amount of items against their income. The AMT kicks in to ensure that taxpayers don’t take advantage of excessive deduction. The problem with AMT is that it went silently by the wayside for years and was not increased to keep in line with inflation and increasing wages. As such, many taxpayers today find that they are subject to AMT and consequently paying more in taxes because of an out-of-date tax law. With itemizing deductions becoming harder to do (under the proposed plan) there will not be much need for the AMT so eliminating it only makes sense.
#6 – Increases the Child Tax Credit (new from last year’s proposal)
Another item not noted in the previous proposal, the child tax credit would actually be increased for taxpayers with children. Unfortunately, that amount has not yet been made clear. However, the phase-out for claiming the credit would be $250k for single filers and $500k for joint filers. These limits are much higher than the current limits of $75k and $110k, respectively.
#7 – Lower the maximum corporate tax rate (revised from last year’s proposal)
This applies only to C Corporations. The previous plan called for a reduction to 15% but the revised rate of 20% is still significantly lower than the current tax rate of 35%.
#8 – Lower the maximum tax rate for small businesses to 25 percent (new from last year’s proposal)
This applies to other business entity structures such as partnerships & S Corporations. Unfortunately, unless a business earns excessive profits, this will not likely have a meaningful impact on most small businesses.
#9 – Allow to fully deduct the cost of depreciable assets (consistent with last year’s proposal)
This is relatively consistent with the previous proposal. Businesses would be allowed to fully deduct depreciable assets in the year of purchase. It’s the equivalent of allowing taxpayers to use IRC Section 179 on everything they buy rather than deducting assets over time. My presumption is also that there would be no recapture rules, but the proposal isn’t clear on the surface about that. Physical structures would be excluded from this change meaning you can’t buy a building or warehouse and take a full deduction in the first year.
#10 - C corporations would no longer be able to deduct interest expense (new from last year’s proposal)
This is not an item that was seen in the previous proposal but it certainly would reduce the number of C Corporations borrowing money to fuel growth. Instead, a change like this would likely stimulate private equity investments and possibly increase IPOs to raise capital.
There has been much speculation around the likelihood of the proposed plan passing but regardless taxpayers should not make any major tax changes until new rules are passed and become effective. I’m not sure how I professionally feel about these changes. In some cases it simplifies the tax code, which is great for taxpayers. Preferably, I would rather see small bite size changes occur over time rather than such a massive overhaul all at once. My primary concern in all of this is the economic fallout that may arise from such major changes.
If you do nothing else this coming tax season, pay attention to what’s happening with these proposed changes. The end of this year could bring some surprises that might make you wish you had a year-end planning session with your tax advisor.
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