Early Thursday morning the House GOP released an outline of its much-anticipated tax plan. The highlights provide a good perspective of what the House leadership considers important and also, where they may break from President Trump’s earlier tax reform proposals.
Simplification of Income Tax Brackets
There are currently seven tax brackets and the new plan would reduce it down to just four. The lowest earners would have to pay 12%, the next tier would have to pay 25% (most of these earners currently pay 28%), the next tier would pay 35% and then, the top 1% of Americans would maintain their current bracket at the 39.6%.[i]
The simplification of the income tax brackets can help people save money on their taxes and also, with the help of a financial advisor, find strategies that can help them plan how they spend, save and invest their money to potentially avoid having to pay the full income tax percentage of their earnings. One of the things that we try to do for our clients is streamline their taxes and look for opportunities where they can earn their retirement income in a tax efficient manner. We are hopeful that, with this plan, we can help our clients find even more opportunities to keep more of their money in their own pockets.
Corporate Tax Rate Lowered to 20%[ii]
The current corporate tax rate is 35% and this substantial reduction of the corporate tax rate is being used as an incentive to get companies to come back to American soil from overseas where they enjoy much lower corporate tax rates. The GOP predicts that the lowering of the corporate tax rate will boost the economy and improve employment for many Americans.
Capping Taxes as Pass-Through Income
This complex system can help reduce someone’s taxable income rate by enabling people to recharacterize portions of their income as “pass-through” business income. As financial advisors, we often use this tax incentive to help clients take advantage of a lower tax rate on certain income.
Increase in the standard deduction
The standard deduction will increase from $6350 to $12200 for individuals and almost double to $24400 for married couples.[iii] While some deductions are to be eliminated in order to make room for this sizeable deduction to have a place in the plan, it looks apparent that this will benefit many middle-income families who do not itemize.
Challenges for those who utilize deductions
For those who do itemize, there will be some challenges to help ensure you are maximizing your opportunity for potentially reducing your tax liability. For example, in the current tax code, there is a medical expense deduction which has been of tremendous help to some of our clients who have had high medical expenses. If you are not yet eligible for Medicare, you may wish to consider an HSA strategy or a Roth conversion to mitigate the tax impact that the elimination of this deduction could create.
For those who live in states and cities with high taxes, there may be a bit of a hit due to the fact that the deduction for state and local income and sales taxes will be repealed. Although there will be a deduction for property taxes, it will be capped at $10,000.[iv] For those whose homes have high value and are located in high tax areas, the property tax deduction may not be enough to make up the difference on what is lost from the elimination of the income tax deduction.
There will also be a change to the mortgage interest rate deduction which is currently capped at $1,000,000. The cap will be reduced to $500,000 although current mortgages will be grandfathered in and not be impacted.[v] For new home buyers in areas where prices are high, this could act as a disincentive to buy and the real estate market and construction market could be negatively impacted at least for the short term.
For those who do itemize, one big deduction will remain and this is good, not only for our clients but also for the charities that depend on their generous support. The charitable deduction was one item that President Trump had considered removing from the tax code, however, the House GOP as well as many financial professionals and their clients, expressed concern for how that would impact philanthropy and the organizations who benefit from charitable giving. So, the charitable giving deduction will remain on the books and we think that is something positive both socially and fiscally.[vi]
Relief from the Death Tax
The death tax, or Estate Tax, has long been the thorn in the side of anyone whose family wanted to leave an inheritance to their children, spouse, and loved ones. Being taxed twice for hard earned money hardly seemed fair. Donald Trump and the House GOP heard their requests and, if the tax reform bill is passed, there will be immediate relief from the death tax by doubling the exemption to $11,000,000 and then, repealing the tax fully in six years.[vii]
Though largely a tax cut for corporations and businesses directly, the Trump and GOP tax plan stands to improve the stagnant economy, increase wages and lift average household incomes. While there are some changes in the reform that may appear to negatively impact many of our clients, our motto is that we cannot run from change but rather, embrace it and adapt. As financial advisors, we seek out the opportunities that the market, the economy and the tax code provide us. We determine ways that we can manipulate your retirement strategy so that it is working for your goals and plans no matter what the government or Wall Street is doing.
Contributing Author, AES Virtual Consulting
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