“All things are ready, if our mind be so.”
– William Shakespeare, Henry V
You’ve probably heard that Republicans in Congress are working to enact the first major tax reform since the Reagan administration. Rewriting our nation’s tax code is a major undertaking, and if successful, will impact everyone’s finances. I’ve had a lot of clients ask me about it lately, so while I do not give tax advice, I thought it would be good to do a quick rundown of the Republicans’ tax plan and what the effects might be.
Taxation is a politically-charged subject, of course. In this case, things are further complicated by the fact that tax reform is being coupled with tax cuts. Add to that raging debates over everything from health care to our national deficit, and you can see why it’s so hard for meaningful reform to happen. Everyone has an opinion, because everyone’s got a stake.
I have opinions of my own, of course, but I’m not a political analyst. I’m your financial advisor. So, I’ve tried to write this letter to be as neutral as possible. For that reason, you’re about to see a lot of numbers.
Taxes are a big part of life, and while it’s impossible to know all the ramifications, I believe if we start mentally preparing ourselves for change, we’ll be better equipped to handle it when it comes. Hence the quote by Shakespeare: “All things are ready, if our mind be so.”
So, without further ado, let’s have a Question & Answer session. On the following pages are my answers to some of the most frequently asked questions I’ve been hearing on tax reform. If you have any further questions, or would like to discuss more about how tax reform may affect you, please don’t hesitate to let me know.
Republican Tax Plan Q&A
Q: What exactly are Republicans trying to do – and why?
Might as well start with the basics. During last year’s presidential campaign, Donald Trump promised significant tax cuts, something long advocated by most Republican politicians. But because Republicans now control the White House and both chambers of Congress, they decided to pair tax cuts with a more ambitious goal: rewriting the entire tax code.
Over the decades, our nation’s tax code has ballooned in size. It contains so many provisions, credits, loopholes, and deductions that it takes a true professional – or a well-coded piece of software – to understand it all. In fact, Republicans claim the tax code has inflated 169% over the past thirty years.1
Both parties generally agree tax reform is needed, but it’s there that consensus ends. That’s because tax reform inevitably means changes…and even members of the same political party often disagree on what those changes should be. That’s why there hasn’t been a significant overhaul of the tax code since 1986.
Q: What have Republicans done so far?
On September 27, President Trump unveiled his version of tax reform, as decided on by members of his cabinet and certain key members of Congress. From there, the action moved to the House. (That’s because Article I of the Constitution dictates all bills raising revenue must originate in the House.)
After over a month of debate, the House Ways and Means Committee released the “Tax Cuts and Jobs Act.” On November 6, the Committee began what’s called a “markup” of the bill, where members can propose changes and rewrites before the bill goes to the rest of the House for a vote.
On November 9, the Senate Finance Committee released their own version of the bill, which contains some significant differences. Let’s start by examining the House version.
Q: What does the “Tax Cuts and Jobs Act” do, exactly?
Okay, take a deep breath. There’s a lot of ground to cover here. Broadly speaking, the bill does the following:
- Reduce the number of personal income brackets
- Remove or restrict many different tax breaks
- Abolish both the estate tax and the alternative minimum tax
- Cut corporate tax rates
Let’s take each of these one at a time.
Personal Income Brackets
Currently, there are seven tax brackets. This bill will reduce that number to four. (This differs from President Trump’s original plan, which called for only three brackets.) See the table on the following page for more information. 2
|Current Tax Brackets||Proposed Tax Brackets||Income for Individuals||Income for Married Couples|
|25%||25%||Up to $200,000||Up to $260,000|
|33%||35%||Up to $500,000||Up to $1 million|
|39.6%||39.6%||Above $500,000||Above $1 million|
For most individuals earning $12,000 or less, and couples earning $24,000 or less, the tax rate is essentially zero.
Naturally, whether people actually pay more or less will come down to a variety of factors, not just which bracket they fall in. That’s because of changes to both…
Standard & Itemized Deductions
As the IRS explains it, the standard deduction is a “dollar amount that reduces the amount of income on which you are taxed.”3 Under the Tax Cuts & Jobs bill, the standard deduction would go from $6,350 to $12,000 for singles, and from $12,700 to $24,000 for married couples filing jointly.4
But when it comes to the standard deduction, there’s a catch: you can’t take it if you itemize deductions. So, while the bill doubles the standard deduction, that benefit could be offset for many people because of changes to itemized deductions.
Here are some changes to common itemized deductions.
Mortgage interest: Currently, people can deduct up to $1 million on mortgage interest payments for newly purchased homes. The bill retains this deduction, but lowers the cap to only $500,000. Additionally, homeowners can only deduct mortgage interest on their principal residence. This deduction does not apply to a second home.4
State and local taxes: A popular deduction is to write off state and local tax payments from federal tax payments. Originally, the Republican tax plan called for removing this particular tax break altogether, and you may have seen that reported in the news. This did not sit well with representatives from high-tax states, however, so a compromise was reached. Now, the bill specifies that people can still deduct up to $10,000 on local property taxes, but can no longer deduct other state and local taxes, like income or sales taxes.4
Medical expenses, tax preparation fees, alimony payments, student loan interest and moving expenses: All these tax breaks are eliminated under the bill.5
On the other hand, the bill expands the child tax credit from $1,000 to $1,600 for any child under seventeen. Additionally, this credit would be available to more people. Currently, married couples making over $110,000 a year are ineligible for the tax credit; the bill raises that level to $230,000.5
Eliminating the AMT and Estate Tax
The Alternative Minimum Tax (AMT) is a tax on a certain range of high-income people, specifically those who make between $200,000 and $1 million. It was designed to “prevent taxpayers from escaping their fair share of tax liability through tax breaks8”; however, the AMT has often been derided as unfair and needlessly complex. The House Republican tax plan would abolish the AMT, which is welcome news for many investors.
The estate tax, meanwhile, has long been in the cross-hairs of many Republicans, who believe it’s inherently unfair to tax someone’s estate after death, since they have already paid taxes on that estate while alive. The bill would repeal this tax entirely, albeit not until 2024.
Corporate Tax Rates
One of the centerpoints of the bill is what it does for businesses. Here are some of the most significant changes:
- Permanently reduce the top corporate tax rate from 35% to 20%. Additionally, the bill would abolish the corporate version of the AMT.6
- Allow businesses to write off any new equipment costs. However, this deduction expires after five years. 6
- Decrease the pass-through rate to 25% from 39.6%.6 A pass-through is a type of business where business income is passed directly to the owners. That means only the owner is taxed, not the business itself. This is designed to prevent business owners from effectively having to pay taxes twice, on both their personal income and their business income.
- Create a minimum tax on foreign earnings so corporations can’t just move their money overseas and not pay taxes. 6
Q: What does the bill NOT do?
During the runup to the bill’s release, the media reported many possible changes, some of which didn’t end up making it into the final bill. For example:
- Previously, it was reported that some Republicans were considering lowering the cap on 401(k) pre-tax contributions. This is NOT in the current bill.
- The bill also does NOT make any changes to the Earned Income Tax Credit, a break specifically for lower-income families.
- Most importantly for investors, the bill leaves taxation on investment income untouched. This includes taxes on dividends and capital gains. However, it should be noted that some investors may pay less in taxes on investment income because the plan would move them to a lower tax bracket.
Q: Okay, so what happens now?
In two words: a lot.
In more words: as of this writing, Senate Republicans have just released their own tax plan. (More on this in a moment.) Assuming both bills pass in their respective chambers, the Joint Committee on Taxation would take over. This is a small group of senators and representatives whose job is to meld the two bills into one before sending it to the White House for the president’s signature.
Here’s the thing: while all that sounds simple enough, politics make it anything but.
Currently, Republicans own a much slimmer majority in the Senate than they do in the House. As a result, they have two options when it comes to passing a tax bill: recruit Democratic support, or use a process called budget reconciliation.
Given the unlikelihood of the two parties working together, Republicans are likely to use the second approach. Reconciliation allows certain bills that change spending, revenue, or federal debt to be passed with a simple majority. That means Republicans in the Senate can pass their bill with only 51 votes. To use budget reconciliation, though, the bill must not increase the Federal deficit by over $1.5 trillion over ten years.7
While budget reconciliation effectively gives Republicans a way to hold off Democratic opposition, it also creates a problem. They cannot afford any dissension in their own ranks. If more than a few Republicans decide not to back the bill, reconciliation dies – and in all likelihood, the bill with it. This is what happened when Senate Republicans tried to repeal the Affordable Care Act earlier in the year.
Here’s why this little civics lesson matters: the Senate Republicans’ plan contains significant changes from the House version, in order to win the support of both moderate and conservative Republicans senators, who tend to have different priorities.
Q: What differences does the Senate version of the bill contain?
A few examples: under the Senate version, the new corporate tax rate described above does not go into effect until 2019, whereas the House version kicks in immediately.9 Additionally, the Senate bill does not repeal the estate tax, in order to appease members of the party’s moderate wing.
But those probably aren’t even the biggest changes. Remember how the House plan reduced the number of individual tax brackets from seven to four? The Senate bill retains those seven brackets, although the rates for some of those brackets have changed. The top tax bracket, for instance, would decrease from 39.6% to 38.5%.9
Furthermore, the Senate version “fully removes the ability of households to deduct their state and local taxes” from their federal taxes.9 (The House version, you’ll recall, allows people to still deduct their state and local property taxes.)
These are major departures from both the House bill and President Trump’s original plan. It remains to be seen how the two bills will be reconciled…or if they even can be.
Q: So that means we don’t really know what the final tax bill will look like?
Exactly. In the end, it could be fairly close to everything we talked about in this letter. Or, certain provisions could look very different.
Q: Then why do I need to know about any of this?
Preparation! When it comes to your finances, it’s always good to avoid surprises. By knowing which changes are being considered, we can start to prepare ourselves for how those changes will affect us. As Shakespeare said, “All things are ready, if our mind be so.”
Or, as I like to put it: “No one ever wished they were less prepared.”
Q: What do we do now?
My team and I will continue to monitor all the news coming out of Washington. As both the Senate and House bills move down the pipe, we will keep tabs on any changes and how they may affect you.
This letter is not intended to be a complete, exhaustive breakdown of everything in the Republican tax plan. So, here’s what you should do: stay informed, and write down any questions you have whenever they occur to you. Hear something on the radio that doesn’t make sense? Write it down. Read something in the newspaper and want to know what it means? Write it down. Then, feel free to contact me with any questions. As always, I’ll do my best to answer them.
Additionally, if you would ever like me to confer with your personal tax advisor, I would be happy to do so.
Finally, always remember that we at Schwartz Financial are here to help you feel confident about your financial future. Please let us know if there’s ever anything we can do.
1 “A Better Way: Our Vision for a Confident America,” Speaker of the House, June 24, 2016. https://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf
2 Alice Parlapiano, “Six Charts That Help Explain the Republican Tax Plan,” The New York Times, November 2, 2017. https://www.nytimes.com/interactive/2017/09/27/us/politics/six-charts-to-explain-the-republican-tax-plan.html
3 “Standard Deduction at a Glance,” Internal Revenue Service, https://www.irs.gov/credits-deductions/individuals/standard-deduction-at-a-glance
4 “What’s in the Republican tax reform bill,” The Washington Post, November 2, 2017. https://www.washingtonpost.com/graphics/2017/business/tax-bill-q-and-a/?utm_term=.4b27a352d293
5 Jeanne Sahadi, “What’s in the House tax bill for people,” CNN Money, November 3, 2017. http://money.cnn.com/2017/11/02/news/economy/house-tax-reform-bill-individuals/index.html?iid=EL
6 David Floyd, “Trump’s Tax Reform Plan,” Investopedia, November 9, 2017. https://www.investopedia.com/news/trumps-tax-reform-what-can-be-done/
7 Bob Bryan, “Republicans just passed a huge tax reform test by the skin of their teeth,” Business Insider, November 2, 2017. http://www.businessinsider.com/trump-gop-tax-reform-bill-deficit-debt-budget-2017-11
8 “Alternative Minimum Tax – AMT,” Investopedia, https://www.investopedia.com/terms/a/alternativeminimumtax.asp?lgl=myfinance-layout-no-ads
9 Richard Rubin, “Senate Tax Plan Differs from House,” The Wall Street Journal, November 9, 2017. https://www.wsj.com/articles/senate-tax-plan-differs-from-house-on-individual-rates-timing-of-corporate-rate-cut-1510257621