“Don’t tax you, don’t tax me, tax that fellow behind the tree,” quipped Senator Russell Long, who chaired the powerful Senate Finance Committee from 1966 to 1981.
This past year, Halloween was barely over when House Republicans introduced their version of tax reform. Few observers thought such a massive undertaking could be signed into law within seven short weeks.
But that is exactly what happened. In the hectic days that preceded Christmas, the president signed into law the most sweeping change in the tax code since 1986.
“The legislation will result in substantive tax reform for corporations, with the elimination of the corporate alternative minimum tax (AMT) and consolidation down to a single 21% tax rate (from 35%), all of which are permanent,” Michael Kitces, a respected authority on tax issues, wrote on Kitces.com.
“However,” he added, “When it comes to individuals, the new legislation is more of a series of cuts and tweaks, which arguably introduce more tax planning complexity for many, and will be subject to another infamous sunset provision after the year 2025.”
Tax Simplification – Not So Much
I know the often-stated goal of tax reform was simplification. But simplification means that much lower tax brackets can only be achieved if cherished deductions and credits are done away with.
It’s easier said than done.
Sure, simplification is a lofty ideal, but, “Don’t take my deductions or credits from me,” has always been the taxpayers’ battle cry. And yes, Congress heard and listened to several of those pleas.
While some deductions will disappear, others remain or have been reduced. Senator Long probably would have sported a grin when President Trump signed the massive bill.
Sharpen your pencils – the new tax code and tax planning
Over 80% of Americans will get a tax cut next year, while just 5% of taxpayers are expected to pay more (Tax Policy Center, Washington Post). In most cases, cuts are expected to be modest; however, much will depend on individual circumstances.
Due to the complexities of the new law, I am always happy to talk with you, but I also encourage you to check with your tax advisor. Many experts are struggling with the details of the bill, and that’s to be expected this early in the game.
What I would like to do is touch on the high points. It’s not all-inclusive and not a deep dive, but given many of your questions lately, I believe an overview is in order.
So, let’s get started. (Sources for this review include Kitces.com and the Tax Policy Center). This applies to tax year 2018.
- The 10% bracket remains unchanged, while the 15% bracket declines to 12%, the 25% to 22%, the 28% to 24%, the 33% to 32%, the 35% holds steady, and the 39.6% slips to 37%. The thresholds are modestly adjusted above the new 22% bracket.
- The standard deduction nearly doubles to $12,000 for single filers and $24,000 for married filers, reducing the incentive to itemize and simplifying for some taxpayers.
- The $4,150 personal exemption is eliminated, and the $1,000 child tax credit doubles to $2,000. In general, rules for charitable contributions remain unchanged. By itself, the combination of points one, two, and three will provide modest tax relief for most families. But I must caution, it depends on your individual circumstances.
- Those in high-tax states could see the biggest hit, as there will be a $10,000 cap on state, local and property tax deductions.
- For investors, the preferential treatment for long-term capital gains and dividends remains intact, as is generally the case for retirement accounts. One important change – the new law repeals rules that allow for recharacterization of Roth conversions back into traditional IRAs. Once you convert into a Roth, there’s no going back.
- The 3.8% Medicare surtax on investment income for high-income taxpayers was retained. Since the levy entered the tax code, we have crafted strategies that reduce its bite; however, the tax survived tax reform and is likely to remain a permanent feature of the tax code going forward.
- The AMT for individuals was not repealed, but exemptions have been widened.
According to the Tax Foundation, Congress passed the AMT in 1969 after the Secretary of the Treasury said 155 people with adjusted gross income above $200,000 had paid no federal income tax on their 1967 tax returns.
The AMT was never adjusted for inflation and grew into an onerous feature for many Americans. In inflation-adjusted terms, those 1967 incomes would be roughly $1.2 million in today’s dollars. Ideally, it would have been eliminated from the tax code. But Kitces points out, “While the AMT commonly impacted those around $150,000 to $600,000 of income, in the future, AMT exposure will be much smaller, and it will be extremely difficult to be impacted at all, especially given more limited deductions.”
- The estate tax survived, but the exemption will double from $5.6 million to $11.2 million, and $11.2 million to $22.4 million for couples.
- The new tax bill also repeals the Obamacare mandate that requires all individuals to obtain health insurance. It becomes effective 2019.
Finally, it’s important to point out that many of the more popular changes in the tax code for individuals will sunset in 2025. While many may eventually be made permanent, as we saw with the Bush tax cuts of 2001 and 2003, there’s no guarantee this will happen again.
- And for businesses: Given that the 21% corporate tax rate applies only to C-corps, there will be a 20% deduction for pass-through entities, such as S-corps, partnerships, and LLCs. I believe this will be a welcome benefit for many business owners, but complex rules may limit the pass-through for some entities.
I fully expect that the rewrite of the tax code will produce unintended benefits and unexpected consequences.
From an economic standpoint, Congress and the president hope to unleash the “animal spirits” that have been lethargic for much of the economic expansion. They hope that changes, especially as they relate to business, will encourage firms to open new plants, expand in the U.S., and level the playing field with the global community.
Prior to reform, the U.S. corporate rate was the third highest among 188 nations (Tax Foundation).
The $64 million-dollar question – will it work? About 90% of economists surveyed by the Wall Street Journal expect a modest boost to growth in 2018 and 2019, but after that, opinions diverge.
If tax incentives boost productivity, it could lift long-run GDP potential, which would yield a significant benefit. If the economic benefits end after a two-year sugar high, it will likely be deemed a failure.
Early anecdotal data offer some encouragement, as several large firms announced year-end bonuses or wage hikes tied to the lower corporate tax rate.
At a minimum, the lower tax rate increases longer-run after-tax earnings, which played a big role in the late-year stock market rally. It could also boost corporate stock buybacks and dividends going forward, which would create an added tailwind for stocks.
That said, I’m cautiously optimistic it will encourage entrepreneurship and economic growth, which would benefit hard-working Americans.
Again, I understand that uncertainty breeds questions and concerns. If you would like to talk, I’m simply a phone call or an email away. I’d be happy to talk with you and answer any questions you may have.