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The President-Elect's Tax Plan

(posted: January 5th, 2017)

Tax: As with any new tax plan, there are winners and losers.

Donald Trump's election victory, along with Republican control of both houses of Congress, means that there will likely be big changes in tax law coming soon.

In reviewing Trump's tax plans, two points should be kept in mind:

1) His tax plans are largely broad-brush, with few specifics. The plan is briefly stated on his website and he didn't fill in many details in his campaign speeches; and

2) The House GOP has its own "Better Way" tax reform blueprint. While that blueprint shares some similarities with Trump's proposals, there are also many differences. There will likely have to be compromise if a quick consensus cannot be reached.

Basic individual changes

Trump's plan would collapse the current seven tax brackets to three brackets:

Tax Rate Married, Filing Joint Single
12% Less than $75,000 Less than $37,500
25% $75,000 to $225,000 $37,500 to $112,500
33% More than $225,000 More than $112,500

These rates correspond somewhat closely to current rates, with the exceptions of the current 35% and 39.6% rates. For example, the current 25% rate for married filing joint kicks in at a taxable income of $75,300, whereas under the Trump plan it would be $75,000. The 33% rate under current law begins at $231,400, versus $225,000 under the Trump plan. However, under the current law there's an in-between rate of 28% that starts at $151,900.

Further changes to basic individual taxation are:

  • Personal and dependent exemptions are eliminated;
  • The head of household filing status is eliminated; and
  • The standard deduction is increased to $30,000 for joint filers and $15,000 for single filers.

The increase in the standard deduction means that about 60% of taxpayers who currently itemize will no longer itemize. This is likely to remain true as long as mortgage interest rates are low and taxpayers pay relatively little in home mortgage interest.

Also, the increase in the standard deduction will likely mean that most low to mid-income taxpayers will have a slightly reduced tax burden. However, with the loss of head of household filing status and the loss of exemptions, a single parent will likely pay more, especially if that single parent has more than one dependent child.

Example: Bruce is a single parent who has two dependent children. He files as head of household and has a salary income of $70,000 and takes the standard deduction.

For 2016, his taxable income is $48,500 consisting of his $70,000 income less three exemptions of $12,150 (3 x $4,050) less his standard deduction of $9,300. He is in the 15% tax bracket. His tax liability is $6,620.

Under the Trump tax plan, his taxable income is $55,000 consisting of his $70,000 income less his standard deduction of $15,000. He is in the 25% tax bracket. His tax liability is $8,875.

Other Individual Tax Changes

Other individual tax changes occurring under the Trump tax plan include:

  • Itemized deductions will be capped at $200,000 for joint filers and $100,000 for singles;
  • The alternative minimum tax will be eliminated;
  • The tax plan specifically eliminates the 3.8% Net Investment Income Tax. However, under other portions of his platform, Trump intends to repeal the Affordable Care Act (ACA). This will presumably also eliminate the 0.9% Additional Medicare Tax, the penalty for not having insurance, the Premium Tax Credit, and other taxes under the ACA; and
  • The existing capital gains rate structure (maximum rate of 20%) will be retained "with new tax brackets."

It is not clear what capital gains rates will be associated with what new tax brackets.

Under current law, capital gains are taxed at a 0% rate for taxpayers in the 10% and 15% tax brackets, 15% for the 25%-35% brackets and 20% for taxpayers in the 39.6% tax bracket. Obviously, those tax brackets do not correspond to the tax brackets under Trump's plan.

Child and elder care

The Trump plan puts a great deal of emphasis on child care and elder care, replacing the current Child and Dependent Care Credit with a more complex but broader system.

Eligible taxpayers will get an above-the-line deduction for child care for children under age 13 and for elder care for a dependent parent.

The deduction would be available to families who "use" stay-at-home parents or grandparents to provide child care.

There are several limitations on the deduction:

  • No deduction is available to taxpayers with "total income" over $500,000 for joint filers or $250,000 for single filers;
  • The deduction for child care is limited to four children per taxpayer;
  • The deduction for child care is limited to the "state average for a child of the child's age."

The child care benefits might significantly offset the increase in tax for single parents noted in the previous discussion and example.

Business Provisions

There are several provisions benefitting business taxpayers. Chief among these provisions is that the plan will lower the "business tax rate from 35% to 15%." Further, this provision provides that "this rate is available to all businesses, both large and small, that want to retain the profits within the business."

As broad-brush as many of the plan's provisions are, this one is causing considerable speculation. The provision is simple when applied to a C corporation. But the phrase "is available" seems to imply that other business entities may elect to be treated like a C corporation. It would seem to mean that a partnership, for example, may elect to pay a 15% tax at the partnership level with the partners paying tax on distributions. It is not clear at all whether any such election would be made on an annual basis or whether the election, once made, is in effect for all future years.

Moreover, the phrase "all businesses" would seem to indicate that even sole proprietors operating a Schedule C business can take advantage of the 15% rate.

Business Tax Incentives

The Trump plan will raise the expensing cap from $500,000 (adjusted for inflation) to $1 million. Moreover, businesses engaged in manufacturing in the U.S. could make an election to expense all equipment purchases and lose the deductibility of interest expense. The election can only be revoked within the first three years of making the election.

The plan eliminates "most corporate tax expenditures," except for the Research and Development Credit. The phrase "most corporate tax expenditures" is not defined.

The plan also greatly enhances tax benefits for on-site child care expenses and for businesses that pay a portion of an employee's child care expenses.

Death Taxes

The Trump plan states: "The Trump Plan will repeal the death tax, but capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms."

The most common interpretation is that, if an estate has a valuation of more than $10 million, the estate will be taxed on its built-in gains at the capital gains rate of 20%. It appears to be a cliff test. It is assumed that after paying the tax, the heirs will receive the assets at a stepped-up basis.

Another interpretation is that, if the estate has a value of more than $10 million, the heirs will pay tax when they sell the assets. This interpretation means that the heirs receive the assets without a stepped-up basis.

Apparently, if the estate has a value of under $10 million, the heirs receive the assets with a stepped-up basis.

GOP Plan

The House GOP's "Better Way" plan shares these similarities with the Trump plan:

  • A reduction of the top tax rate to 33% with three tax brackets;
  • The elimination of the AMT;
  • A larger standard deduction;
  • A reduction of the corporate tax rate to 20%.

The Trump plan is significantly different from the "Better Way" plan in that it will:

  • Eliminate all itemized deductions except for home mortgage interest and charitable contributions;
  • Completely repeal the estate tax; and
  • Allow interest expense to be deducted by businesses only against interest income.

The biggest difference pertains to itemized deductions. Trump wants to limit overall itemized deductions to $200,000 for joint filers and $100,000 for singles. The GOP wants to eliminate all itemized deductions except for home mortgage interest and charitable contributions, but without an overall dollar limit.

No one knows if any changes will be effective in the 2017 or 2018 tax years.

Photo: Michael Vadon CC BY-SA 2.0, via Wikimedia Commons

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