by Stephen G. Travis, Managing Principal
I spent time perusing the 429 page document released yesterday. Information and thoughts on how these proposals would impact our clients at KWC are below. I want to emphasize that taking any action on the proposed legislation at this point would most likely not be prudent. We saw what happened with the ACA (Obamacare) repeal, so it is entirely unknown what, if any, of these provisions will ever become the law of the land. But for CPAs it is interesting reading.
Please feel free to contact your KWC advisor with any questions about these proposed changes.
In general, the WINNERS appear to be the heirs of wealthy people, business owners in low tax states, middle class taxpayers with few tax deductions, and “C corporations”.
LOSERS would be highly paid employees in high tax states, future buyers utilizing mortgages over $500,000, owners of second homes, taxpayers who take medical deductions, high income taxpayers selling their primary residence, and taxpayers making alimony payments for divorces effective after 2017 (and Tesla Motors).
First, these are the proposed new tax rates. The big changes in this plan are not so much the tax brackets, but the proposed limitations on deductions (mortgage, state income taxes, etc.) and tax rates on business income discussed below.
NEW TAX BRACKETS:
12%: Applies to taxable incomes up to $45,000 for an individual and $90,000 for a married couple.
25%: Applies to taxable incomes up to $200,000 for an individual and $260,000 for couples.
35%: Applies to taxable incomes up to $500,000 for an individual and $1 million for couples.
39.6%: Applies to taxable incomes over $500,000 for an individual and over $1 million for couples.
For single parents that are heads of households, the thresholds would be the midpoint between individuals and joint filers, except for the highest bracket which would still kick in at $500,000.
The following table illustrates the proposed changes:
There is a quirk in the tax brackets that taxpayers with taxable incomes over $1 million will pay a 45.6% tax rate on income between $1 million and $1.2 million to offset the rates in the lower tax brackets.
CAPITAL GAINS RATE – No changes.
CORPORATE TAX RATE – reduced from 35% to 20%. The “C Corporation” entity type has fallen out of vogue for small businesses in favor of LLCs, partnerships and S Corporations. The reduction in the corporate tax rate will help reduce the tax burden on large publicly traded corporations, but I don’t think this proposal taken as a whole will result in small businesses formed as LLCs, partnerships and S Corporations converting to C Corporations. But more study will be needed if it becomes law.
SPEAKING OF TAX RATES ON INCOME FROM LLC’S, PARTNERSHIPS, AND S CORPORATIONS – One of the most closely watched areas of this proposed legislation is the taxation of pass-through businesses such as S corporations and partnerships.
Passive owners of pass-through businesses would get the 25% rate, but those actively involved in the business would have a different standard. The bill starts with the presumption that 70% of that pass-through income is attributable to labor and would be taxable at higher individual income-tax rates. For some that would create a blended top tax rate of about 35%, which those businesses and their influential trade groups will not be happy about.
For professional services firms, including lawyers, accountants (!), and financial-services professionals, the default rate would be 100% labor income, meaning they would get none of the benefit of the 25% tax rate for pass-through businesses.
This is a big area of interest for many of our clients so we will be closely monitoring and updating you as the legislation progresses.
EXPENSING OF BUSINESS EQUIPMENT– all business use equipment 100% deductible in year placed in service (no need to depreciate over time).
ALTERNATIVE MINIMUM TAX – would be repealed, but the overall impact on each persons tax would vary depending on specific circumstances.
ESTATE (DEATH) TAX – The current estate-tax exemption, set for $5.6 million per person and $11.2 million per married couple, would double immediately. The tax would be repealed starting in 2024.
STANDARD DEDUCTION – This increases quite a deal, which is great if you don’t itemize deductions. Most of our clients do itemize, but some may not itemize any more due to proposed limitations on itemized deductions mentioned below.
Current law for 2017: $12,700 (married); $9,350 (head of household); $6,350 (single)
Proposed for 2018: $24,400 (married); $18,300 (head of household); $12,200 (single)
STATE AND LOCAL TAXES – Now we get to a big one. This is the loss of a potentially huge deduction for upper income tax payers and even “middle class” tax payers in high tax states such as NY, CA, DC, NJ and some others. Expect to see a lot of negotiations on this in Congress.
One tax planning idea may be to make sure you pay all 2017 state income taxes by December 31, 2017, as they will not be deductible in 2018.
Current law: Itemized deduction
Proposed: Deduction capped at $10,000 for property tax only
CHARITABLE DONATIONS – No change here. No politician wants to be seen as anti-charity. But less people itemizing deductions will result in less tax motivated charitable contributions.
Current law: Itemized deduction
MORTGAGE INTEREST DEDUCTION – Flashing red alert on this one. Another one that hurts those in high cost areas (such as the DC metro area). Note: the new limitation applies only to new purchases as of TODAY. That’s a technique that legislators often use to prevent people from accelerating transactions to get around a proposed change. The proposal would also prevent people from taking the mortgage interest deduction on second homes and on home-equity loans. In the past, lawmakers and businesses from coastal and mountain areas have prevented changes to the second-home provision. And the residential real estate industry will attack these provisions with all its might.
Current law: Itemized deduction on loans up to $1 million
Proposed: Itemized deduction for loans up to $500,000 on new home purchases
PERSONAL EXEMPTION – Repealed. Most likely not good for families with a lot of children.
CHILD TAX CREDIT – This credit phases out for those at higher income levels. And it is only approved for 5 years, so this increased credit may or may not offset the permanent loss of personal exemptions.
Current law: $1,000
Proposed: $1,600 plus $300 each for the taxpayer, a spouse, and any non-child dependents
SECTION 529 PLANS – Funds in these plans can now be used for K-12 education expenses, whereas previously they had to be for post-secondary education.
DEDUCTIONS ELIMINATED – We shall see if any of these repeal proposals survive final legislation (if any).
– Repeals itemized deductions for medical expenses, a big loss for households with extraordinary health-care costs
– Eliminates dependent care flexible spending accounts of up to $5,000
– Repeals the $7,500 tax credit for purchases of electric vehicles (ex: Tesla vehicles and Chevy Volt)
– Eliminates tax deduction for alimony payments for divorces finalized after 2017 (alimony received would not be taxable to recipient)
– Repeals deduction for moving expenses
– Employer paid tuition no longer tax free to the employee
– Repeals the tax credit for adoption
– Repeals the deduction for student-loan interest
– Businesses would no longer be able to deduct entertainment expenses, though today’s rules for business meals would remain
– Repeals rehabilitation credit for historic buildings
– Repeals work opportunity credit for hiring employees from certain disadvantaged groups
– Additional standard deduction for the elderly – gone
– Repeals tax credit for employer-provided child care
THE SALE OF YOUR PRIMARY RESIDENCE MAY BE TAXABLE
The plan would remove a benefit for high-income homeowners: The ability to declare that most profits from home sales aren’t taxable capital gains.
The proposal retains the current exclusion—$500,000 for married filers and $250,000 for others. But unlike the current law, the benefit would phase out for high-income taxpayers, being reduced once adjusted gross income hits $500,000 for married couples and $250,000 for others.
The proposal also brings back an older rule for claiming the benefit: To get the exclusion, taxpayers must have used the home as their principal residence for five out of the previous eight years. Current law requires the taxpayer to have lived there for two of the previous five years.
Current law: 401(k) plans allow pretax deferral of up to $18,000
Proposed: No changes except extended period for terminated employees to repay loans from plans.
One final thought from a CPA’s perspective: This does not simplify the tax law for our clients.