Congressional Members and others say simplification of the cumbersome federal income tax code is on track and details will emerge after August.
White House legislative director Marc Short, for example, recently said the plan is to start hearings and a markup of the bill after Labor Day so a version can get through the House in October and the Senate in November. Despite the likelihood that at least some components of the tax plan will be tweaked—observers believe that the Administration is committed to comprehensive change.
With that in mind, we recently reviewed a report on the likely impact of the most recent Trump tax plan, issued by the Urban-Brookings Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution. While there are a few twists for individuals and businesses, the results are generally positive.
As things stand now, the new tax scheme would reduce the top individual income tax rate to 33 percent from the current 39.6 percent, drop the corporate rate to 15 percent from the current 35 percent, and allow owners of pass-through businesses like sole proprietorships, partnerships, and S corporations to elect to be taxed at a flat rate of 15 percent.
Capital gains and dividends would be taxed under the current preferential rate structure. Owners of “large” pass-through businesses—the term “large” appears to be undefined at this point—who get distributions and elect the 15 percent flat rate would find that the distributions are taxed as dividends.
The plan would increase the standard deduction and add a new deduction and other tax benefits for child and dependent care. The latest reports are that the regular standard deduction, additional standard deductions for age or blindness, and the personal exemptions for tax filers and dependents would be consolidated into new standard deduction amounts of $15,000 for single filers and $30,000 for joint filers.
A recent Bloomberg report speculates that the higher standard deduction, along with a proposed end to local property-tax deductions, could potentially hurt home sales in areas where buyers are stretching to afford their purchases. With New Jersey having some of the highest overall property taxes in the country, this could really hit “home” in the coming years.
Another Bloomberg report also says that a Trump tax proposal to eliminate the deductibility of local and state income taxes is likely to prove burdensome to many New Jerseyans. Currently, some 41 percent of residents take this deduction, which reduces their adjusted gross income (AGI) by an average of 8.7 percent.
Getting Into The Details
The Urban-Brookings Tax Policy Center crunched some numbers under both the current Tax Code and the most recent iteration of the Trump changes, and came up with a mixed bag of winners and losers under the new plan. The analysis focused on single filers, and married joint filers without children. In both cases, the assumption was that the filers use the standard deduction, since those who itemize deductions would generally not benefit from the proposed increase in the standard deduction.
Single filers with AGI of more than $423,700 will be subject to a 33 percent marginal rate, down from the current rates. Those above $200,500 but with AGI of no more than $423,700 will be assessed a 33 percent marginal rate, unchanged from the current rate. But those with more than $127,500 and not more than $200,500 will be hit with a 33 percent marginal tax liability, up from the current 28 percent.
Married joint filers without children with more than $433,750 of AGI will see a 33 percent marginal tax rate, down from the current rates, while those with AGI of more than $172,600 up to $255,000 will see their marginal rate fall to 25 percent, down from current rates.
News For Individuals And Businesses
The good news is that plan would eliminate the alternative minimum tax (AMT). Additionally, the new tax regime would eliminate estate and gift taxes. But there is a tradeoff here, since a step-up in basis for inherited assets would also be eliminated. This could leave heirs with the burden of paying capital gains tax on inherited investments, when under the current rules they had no tax to pay at all. It would also leave them with the cumbersome and sometimes impossible task of calculating the original basis of inherited investments, making good record keeping imperative. In addition, unrealized capital gains in excess of $5 million for single filers and $10 million for married couples could become taxable at death. It would seem that despite the elimination of the estate tax, it will not eliminate the need for good estate planning.
Both corporate and pass-through businesses could elect to immediately deduct capital investments—instead of expensing them through depreciation or other deductions spread over a period of time—but then they not be allowed to deduct interest expenses. The proposed plan would also repeal certain business tax expenditures.
Some of the proposed changes would simplify the tax code, while others appear to make it more complex. For example, the move to significantly increase the standard deduction and repeal personal exemptions would reduce record-keeping and reporting requirements. Eliminating the head of household filing status, the complex AMT, and the ACA’s 3.8 percent rate on net investment income would also simplify tax preparation. For some businesses, the proposal to elect expensing and the elimination of certain tax expenditures would appear to simplify record keeping and tax preparation.
But some elements of the plan may add complexity. Some high-wage earners, for instance, would have a strong incentive to structure their company as a pass-through entity, and new rules would be required to address this. Also, since businesses that elect expensing would lose their interest deductions, capital investment decisions could become more complicated, possibly encouraging complex financing arrangements that isolate investment and borrowing activities over time or in separate entities.
The Trump plan, as it currently stands, would cap the total amount of itemized deductions that could be claimed at $100,000 for single filers and $200,000 for joint filers. Besides repealing the individual AMT, it would amend the taxation of “carried interest,” or the income of certain investment managers that is currently treated as preferentially taxed capital gains.
Under the proposal, carried interest would be treated as wages subject to ordinary income tax and payroll tax. But hedge funds and private equity partnerships, which generally earn a substantial portion of income in the form of carried interest, will qualify for the special 15-percent business tax rate, a substantial tax advantage compared to wage earners.
As we noted earlier, the Trump tax plan is still in flux, so these details are preliminary. They do, however, offer a sense of the plan’s priorities and can serve as an early guidepost to what may lie ahead. Of course the professionals here at Bederson will continue to stay on top of developments and we’ll share them, as well as our insights, with you.
Michelle A. Silvestri, CPA
Supervisor, Accounting and Auditing