On Thursday, the House Ways and Means Chairman, Kevin Brady, ended months of speculation by releasing H.R. 1, the “Tax Cuts and Jobs Act,” detailed tax legislation that is the first step in possibly reshaping the country’s tax code. The bill is all-inclusive, including changes to everything from individual and business tax rates to the tax benefits of home ownership to 529 plans to the future of the estate tax. There are also significant changes to the corporate tax system and the rules on foreign income. The proposed legislation is wide-ranging, nuanced, and complicated; whether it is easier to understand and implement than the current tax system, especially for our clients, is yet to be determined.
The bill’s complexity makes modeling the effects on even a single tax return, never mind upon the entire economy, quite challenging. Taken provision by provision, the bill is essentially a tax cut of $5.8 trillion offset by a tax increase of $4.4 trillion, a massive undertaking that impacts all taxpayers and taxpaying entities, even those previously exempt from paying tax. We’ve looked at the proposed legislation, which is guaranteed to change as the process moves forward, in light of our client’s tax situations and determined the following:
- Families with large estates have the best outcome. The doubling of the gift and estate tax exemption to $10 million per person (and indexed for inflation) with the eventual repeal of the estate tax in 2023 is a windfall for the wealthiest of families. Add in the less publicized continuation of the step-up of basis at death rules – long thought to be subject to change by the imposition of a capital gains-like tax on the appreciation of assets under a full estate tax repeal regime – and these provisions likely eclipse all other proposals that impact a taxpayer’s annual income tax filing.
- Large domestic corporations – and their investors – see large benefit. The bill reduces the corporate tax rate for large, traditional businesses (C Corporations) from a maximum of 35% to a flat tax of 20%. Over the next 10 years, that is a tax savings of nearly $1.5 trillion, according to the Joint Committee on Taxation (JCT), the nonpartisan congressional committee that prepares the official revenue estimates of all tax legislation considered by the House and Senate. This provision is, far and away, the single largest tax benefit included in the 429-page legislation. The White House has stated that improving the business environment through significant tax relief will lead to stronger domestic growth through the hiring of more workers and higher wages. It could also fuel higher stock prices and dividends, a boon to investors.
- Business owners may pay substantially less. A portion of the business income from owners of entities classified as S Corporations, Partnerships, and Limited Liability Corporations would be taxed at 25% under a new complicated set of rules. Currently, this income is taxed at the owners individual rate or as high as 39.6%.
- High wage earners in high-tax states could be winners or losers. It may be too early to tell how taxpayers whose income tax return is dominated by salary income and itemized deductions will fare. The effect of a provision to maintain the highest individual rate without being able to take advantage of the lowest rate bracket effectively creates a hidden marginal rate of more than 40% for single taxpayers with more than $1 million of wages and married taxpayers with more than $1.2 million of wages. Combine that with the myriad changes the bill makes to itemized deductions – the repeal of state and local income tax, the $10,000 cap on real estate taxes, the limitation of home mortgage interest to $500,000 of debt with no deduction for the interest expense on vacation homes, among many others – and it’s difficult to make generalizations on how those taxpayers will fare. The proposed repeal of the Alternative Minimum Tax also factors into the intricate equation, likely helping some taxpayers and possibly hurting others.
The many benefits afforded to many wealthy taxpayers and their families could come at a cost, however, as the impact to be felt in the expansion of our deficit is uncertain. According to the JCT, the bill would raise the U.S. deficit by about 15% in the next 10 years. The long-run implications of that for inflation and the strength of the dollar, and for interest rate and bond prices, are hard to estimate, as the bill has the potential to push us toward the higher levels of sustained deficits than we have previously maintained for long periods of time.
So, where do we go from here? The wide-ranging tax reform bill, which is consistent with the priorities that the Trump Administration has articulated for the last year, has made it to the starting line. The Administration and the House leadership have laid out an aggressive timetable to pass a bill that the President can sign before year-end. Posturing has already begun on both sides of the Congressional aisle, and the Senate, which will shortly draft its own tax bill and tends to take more time reviewing legislation, will have its say as well. In the meantime, if you have any questions about the bill or if we can help in your understanding of how it may affect you and your family, please do not hesitate to ask.
For additional resources to help you understand the most ambitious tax proposal in a generation, we like these links:
Learn more about Adam Ochlis, CPA, MST, Partner & Senior Client Advisor.
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