Breaking Down the New Tax Legislation

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Published by Taylor Financial Group

With tax reform becoming a main focus in Washington, and Republicans banking on a much-needed legislative victory, it is important to understand what may be happening over the next several months as it will affect all of our pocketbooks and our country as a whole.  While House Republicans released their tax plan last week and it appears likely that tax legislation will be passed, it may not be completed until early next year, and it may not be retroactive.  Based on the detailed summary of the plan that has been released, here is a summary of what we can expect as of right now.

Tax Brackets- Individual and Corporate Rates Overhauled

First, the Republican plan shrinks the current number of individual tax brackets from seven to four, with the highest tax bracket of 39.6% remaining unchanged.  As the brackets are compressed, the earnings thresholds per bracket will also increase.  We outline the proposed brackets below.  As you can see, the highest tax bracket of 39.6%, which is currently assessed on income over $470,000 (for those married filing jointly), will be increasing to income over $1,000,000.

A key area of the Republican Plan, which has been touted as “non-negotiable,” is the slashing of corporate tax rates.  The top corporate tax rate of 35% is to be reduced to 20% and the top tax rate for pass through entities such as LLC’s, sole proprietorships, and S corporations is to be reduced from 39.6% to 25%.  In response to fears that the reduction of the tax rate for pass-through entities will encourage business owners to game the system by reducing their salaries, Republican lawmakers have built in safeguards to curb abuse.    For example, for professional services firms such as law practices and financial-services firms, the default will be that all profits are taxed as labor income meaning that those business would get none of the benefit of the 25% top tax rate.  For other businesses, passive owners (for example, investors) would receive the preferential rates while the tax bill starts with the presumption that 70% of pass-through income for active participants is attributable to labor and taxed at ordinary individual income tax rates.

Alternative Minimum Tax (AMT) Repealed

The Republican plan also calls for a full repeal of the Alternative Minimum Tax (AMT), which was meant to target wealthy individuals who were using too many tax loopholes, but now every year affects more and more members of the middle class.  By making significant changes to eliminate many credits, deductions, and exclusions, Republicans contend that the AMT will no longer be necessary.

401(k) Plans and IRA Contributions Unchanged

While there was talk of limiting contributions to 401(k) plans, and conjecture that IRA’s may be next, the tax plan does not touch either. Workers will continue to be able to park up to $18,000 per year (plus $6,000 catch up contributions for those 50 and older) in pretax funds into 401(k) savings accounts.

Estate Tax Exemption Doubled

The estate tax has also been a hot topic and a major bone of contention.  The estate-tax exemption set for $5.6 million per person and $11.2 million per couple in 2018 will immediately double and will be fully repealed starting in 2024.  This will continue to be a hot item subject to debate.

State and Local Tax Deduction (SALT) Partially Repealed and Capped

The State and Local Tax Deduction was a major sticking point, especially for those in high tax states such as New Jersey, New York, and California.  When the budget was voted on in October, twenty Republicans crossed the aisle and voted no, with eleven of them coming from New York and New Jersey.  Under the proposed plan, the deduction for state income taxes will be repealed but the property tax deductions will remain, though they will be capped at $10,000.  This is a serious blow to those of us here in New York and New Jersey who face high state income and property tax rates.

Mortgage Interest Cap Lowered

Currently, mortgage interest is deductible on up to $1,000,000 in debt.  The tax plan will reduce that mortgage interest deduction cap to $500,000 in debt, though existing loans will be grandfathered.  And, it will only apply to one home.

Medical Expenses Eliminated

Currently, individuals and families can deduct medical expenses, to the extent that they exceed 10% of their income (7.5% if you are age 65 or older).  The tax plan repeals all deductions for medical expenses which will hurt those who have experienced high medical expenses, especially seniors.

Standard Deduction is Doubled

The standard deduction will be nearly doubled.  Currently, the standard deduction is $6,350 per person and $12,700 for couples. Under the tax plan, that will rise to $12,000 per person or $24,000 per couple.

Personal Exemption is Eliminated

The personal exemption, which reduces taxable income by $4,150 per person, will also be eliminated.

Charitable Contributions Unchanged- donors who itemize deductions can still take deductions as per the current tax code.

Student Loan Interest Deduction and the Tax Credit for Adoption will both also be repealed.

What Should You Do Now?

This is a tricky time, as no one knows for sure if and when the tax package will pass, if it will be retroactive, and what provisions of the plan will survive.  Having said that, we mention a few things to think about, as we watch the process unfold.  It is usually a bad idea to procrastinate, but in the case of taking retirement distributions or selling investments such as stocks, waiting may be a good idea as your tax bracket could be lower next year.

It may also be a good idea to accelerate expenses into this year that are currently acceptable itemized deductions, such as student loan payments, medical expenses, state and local income taxes and mortgage payments.

This is because in the proposed plan many of the expenses we currently get to itemize will be eliminated.  Thus, it could be a good idea to try to accelerate itemized deductions into this year, as opposed to next year when many itemized deductions could be a thing of the past.

Having said all of this, we will follow up with additional tax savings tips, but we are still taking a little of a “wait and see” approach.  As House Ways and Means Committee Chairman Kevin Brady (R., Texas) said, “We are following the Reagan example here.  Go bold.  Listen.  Make adjustments, but keep the process going forward.”  To that end, we anticipate that the final product will develop from here.  We will keep you posted in this space as the showdown in Washington unfolds.  Stay tuned!

 

  • WSJ, WSJ Wealth Adviser Briefing: Benefits of Rothifying, Advisers’ Cybersecurity Tips, Nov. 2, 2017
  • WSJ, Five Ways to Come Out Ahead with a Roth 401(k), Nov. 1, 2017
  • USA Today, Tax Plan Caps Property Deduction at $10,000, Puts New Limit on Mortgage Deduction, November 2, 2017
  • WSJ, Republicans Stick with Big Corporate Tax Cuts in House Bill, November 2, 2017
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