This is a follow up blog from our original post on the winners and loser of potential tax changes.
What is the objective of tax reform anyway?
The Republican Party and President Trump set out on tax reform to achieve three major deliverables. Below we breakdown what those deliverables are and why they are important:
- Reduce the income tax burden on middle class citizens. A major push for tax reform was to provide a break to the middle class while creating more jobs. By consolidating the tax code from seven brackets today to four brackets and nearly doubling the standard deduction, the average American is projected to save roughly $1,000 in taxes per year.
- Reduce the corporate income tax to make U.S. companies more competitive with those overseas. At 35 percent, the U.S. currently has one of the highest top marginal business tax rates among developed nations. The new plan reduces the top rate to 20 percent. This is intended to help U.S. corporations increase profits so they can reinvest tax savings in capital projects and new employees.
- Simplify the tax code and reduce reporting complexity. A trendy hallmark in Washington is to simplify the current tax code so you can complete your taxes “on the side of a note card.” The proposed tax code would consolidate the current seven tax brackets down to four and nearly double the standard deduction, eliminating the majority of itemized deductions. This is intended to reduce the necessary hassle and recordkeeping that comes with all those itemized deductions. Further, there will no longer be an alternative minimum tax (AMT), which has its own set of rules for mostly affluent Americans to ensure a minimum tax is paid.
How is the government going to pay for the tax breaks?
Due to government deficit constraints, the budgetary impact of the tax reform is limited to $1.5 trillion over 10 years. Therefore, the committee had to figure out how to achieve their goals of cutting business and middle class taxes while staying under this deficit constraint. In order to accomplish this, certain perks will have to be repealed or amended to fund the new tax breaks. The major changes that could impact you are outlined below:
- Home mortgage interest deductibility changed from $1 million to $500,000. Currently, you can itemize mortgage interest expenses on up to $1 million of outstanding loans. This is one of the most popular tax breaks that encourages homeownership. By limiting the interest deduction to only $500,000, a lot of middle class citizens (especially on the coasts where real estate is most expensive) will actually be hurt. Due to the popularity of this tax break, it is being hotly debated in Washington and can possibly change with future iterations of the bill.
- Top tax rate unchanged. Since this bill is meant to provide tax breaks to the middle class, the current structure is still progressive and maintains the highest individual tax bracket at 39.6 percent. This will provide a tax break to the rich. However, couples filing jointly wouldn’t hit the highest marginal tax bracket until they have more than $1 million in income. Previously, couples filing jointly would hit this marginal tax bracket beyond $457,600 of income.
- Limiting most state and local tax deductions. Currently, taxpayers can deduct their state and local taxes from their federal income tax return. A few popular state and local taxes include state income taxes, local sales taxes, and property taxes. To help fund the new bill, all of these deductions will be removed, with the exception of the property tax deduction, which will be limited to $10,000 per year. This will be especially painful for folks in high income tax states such as California, New York, and New Jersey.
- The proposed tax reform includes many additional changes not covered in this summary.
- Not all analysts agree that the proposed changes will result in the professed outcomes.
- The proposal is extremely likely to undergo many changes before it becomes law.
- We will continue to monitor the proposed tax reform as it evolves.
Please contact us if you would like to discuss how such changes may affect your financial plan.