Overview
The new GOP proposal for taxes is titled a “Unified Framework for Fixing Our Broken Tax Code.” The plan specifies the following four objectives regarding tax reform:1
- Make the tax code simple, fair and easy to understand
- Give American workers a pay raise by allowing them to keep more of their hard-earned paychecks
- Level the playing field for businesses and workers in order to position America as the job magnet of the world
- Bring back trillions of dollars currently patriated offshore to reinvest in the U.S. economy
However, much like health care, trying to define guiding principles for a nation of more than 300 million people is a diverse and moving target. Tax reform consists of a broad range of factors and, despite the attempt to position this new framework as a means to simplify the U.S. code, we believe it is unlikely to have that effect.
According to analysts at Morgan Stanley, the first step in this process will be for the House and Senate to pass a budget resolution with reconciliation instructions for tax reform. The earliest this would happen is mid-October, but given the myriad changes proposed — and the growing rift of partisan politics among Democrats, conservatives and moderate Republicans — efforts for “tax reform” are more likely to devolve into a few simple tax changes. The timeline is unclear, but it is ambitious to expect full passage by year end.2
Income Tax Rates
The new framework calls for consolidating the current seven tax brackets into three (12 percent, 25 percent and 35 percent), with possibly another for the highest-earning income taxpayers. There are actually four proposed tax rates, but the first one is zero percent — eliminating any tax on the first $12,000 earned by an individual and $24,000 earned by a married couple. This is worth differentiating because the current tax code starts at 10 percent on the first $9,325 earned (individual; $18,650 for married filing jointly).3
The framework also recommends repealing the alternative minimum tax (AMT), which was deployed to help ensure that wealthy taxpayers with substantial deductions and exemptions still have to pay their fair share of taxes. The AMT is a separate calculation that requires the taxpayer to pay his or her normal tax liability or the AMT, whichever is higher.
Deductions
The new plan would eliminate most itemized deductions except for home mortgage interest and charitable donations. Therefore, taxpayers would no longer be able to deduct:
- Personal exemptions
- State and local income or sales taxes
- Real estate taxes
- Personal property taxes
- Interest rate points
- Mortgage insurance premiums
- Investment interest
- Medical and dental expenses that exceed 7.5 percent of adjusted gross income
- Casualty or theft losses
- Unreimbursed employee expenses, such as for job travel, education or union dues
- Tax preparation fees
- Investment expenses
- Safe deposit box fees
To compensate for these lost deductions, the plan calls for increasing the standard deduction to a little less than twice the previous amount. While there are no specific deduction recommendations regarding payments for higher education or retirement contributions, the plan encourages lawmakers to “simplify these benefits to improve their efficiency and effectiveness.”4
Credits
While the plan would repeal the $4,050 personal exemption for each dependent, it would increase the child tax credit (currently worth up to $1,000). The plan also recommends increasing the income levels at which the child tax credit begins to phase out (currently $75,000 AGI for single and heads-of-household, $110,000 married filing jointly and $55,000 married filing separately).
The plan also calls for a new $500 credit for non-child dependents that is non-refundable, meaning that it cannot reduce the amount of tax owed to less than zero
The New Unified Framework for Fixing Our Broken Tax Code:
“Numerous other exemptions, deductions and credits for individuals riddle the tax code. e framework envisions the repeal of many of these provisions to make the system simpler and fairer for all families and individuals, and allow for lower tax rates.”5
Estate Taxes
One of the biggest benefits for wealthy households is the elimination of estate taxes (also known as the “death tax”) on all wealth and property bequeathed to heirs. According to the Tax Policy Center, this tax cut would result in a loss of about $19.9 billion in annual revenues to the federal government.6 The plan also repeals the generation-skipping transfer tax.
Corporate Tax Reform
One component of the tax reform plan that enjoys a degree of bipartisanship is the reduction of the corporate tax rate to 20 percent. The current federal rate is 35 percent, making it the highest top corporate tax rate among advanced economies. When you add in state corporate taxes, the rate actually averages about 39 percent. Both Democrats and Republicans have long decried the U.S. rate as too high and thus a deterrent to attracting foreign company headquarters and providing an incentive for American corporations to patriate abroad.
However, corporate tax filers presently enjoy a plethora of credits, deductions and exemptions, whereby most businesses do not pay taxes at that high a rate. Much like on the individual side, corporate filers would give up many of these filing advantages in favor of the new lower rate. As these specifics are ironed out in the coming months, there is likely to be pushback on curtailing various credits and deductions. Some experts believe that it is likely many of these will be retained and that the actual corporate tax rate will inch higher into the mid-20s.
One deduction the framework retains is the immediate expensing of 50 percent of new investments in depreciable assets (other than structures) over five years. This extends the current policy, which was scheduled to reduce the write-off in 2018 and 2019. However, an analyst at Morgan Stanley observed that this option is currently used by only half of U.S. companies and is not likely to have a material impact in the corporate tax debate.7
Lively discussion likely will ensue regarding the recommended 25 percent limit for business income of small and family-owned businesses operating as a sole proprietorship, partnership or S corporation. Lawmakers will need to develop specific provisions to prevent personal income from being recharacterized as business income by wealthy business owners seeking to avoid the top personal tax rate.
Other measures proposed in the new framework include:
- Limiting the deduction for net interest expenses incurred by C corporations
- Eliminating the current domestic production deduction
- Retaining business credits for research and development
- Retaining business credits for low-income housing
- Exempting offshore profits that are repatriated to the United States
- Imposing a one-time tax on previously earned foreign revenues by U.S. companies
- Reducing the tax rate on foreign profits of U.S. multinational corporations
Final Thoughts
For investors concerned about their retirement portfolio and future income plans, the new framework offers no guidance as to the tax treatment of capital gains and dividends. However, it has been reported that senior administration officials stated the interest exemption for municipal bonds would not be eliminated.8
While this new tax plan was developed by GOP leaders, it is likely to meet opposition even among Republican lawmakers because tax cuts would add substantially to the already burgeoning national deficit. Thus far, the plan offers only robust and taxable economic growth as a means to “pay for” reduced government revenues.
As with all tax legislation, and largely the reason why the corporate tax rate has not been successfully reduced in the past, nearly every provision will have supporters, detractors, lobbyists and special interest groups weighing in on the debate. The reality is that while tax rates may decrease, so will many significant credits and deductions. Each person’s and business’ tax return will be impacted differently.
1 The White House. Sept. 29, 2017. “Unified Framework for Fixing Our Broken Tax Code.” https://www.treasury.gov/press-center/press-releases/Documents/Tax-Framework.pdf. Accessed Oct. 3, 2017. 2 Michael Zezas. Morgan Stanley. Sept. 29, 2017. “9 Key Takeaways from the GOP Tax Framework.” https://www.morganstanley.com/ideas/tax-reform-framework/. Accessed Oct. 3, 2017. 3 Kelly Phillips Erb. Forbes. Oct. 25, 2016. “IRS Announces 2017 Tax Rates, Standard Deductions, Exemption Amounts and More.” https://www.forbes.com/sites/kellyphillipserb/2016/10/25/irs-announces-2017-tax-rates-st andard-deductions-exemption-amounts-and-more/#4fe580a35701. Accessed Oct. 4, 2017. 4 The White House. Sept. 29, 2017. “Unified Framework for Fixing Our Broken Tax Code.” https://www.treasury.gov/press-center/press-releases/Documents/Tax-Framework.pdf. Accessed Oct. 3, 2017. 5 Ibid. 6 Tax Policy Center. “Briefing Book.” http://www.taxpolicycenter.org/briefing-book/how-many-people-pay-estate-tax. Accessed Oct. 11, 2017. 7 Michael Zezas. Morgan Stanley. Sept. 29, 2017. “9 Key Takeaways from the Big 6 Tax Framework.” https://www.morganstanley.com/ideas/tax-reform-framework/. Accessed Oct. 3, 2017. 8 Ibid. Investment advisory services offered through AE Wealth Management, LLC. The advisory firm providing you this report is an independent financial services firm helping individuals create retirement strategies using a variety of investment and insurance products to custom suit their needs and objectives, and is not an affiliate company of AE Wealth Management, LLC. Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. The information and opinions contained herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by AE Wealth Management. This information is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation. None of the information contained herein shall constitute an offer to sell or solicit any offer to buy a security or insurance product.