I’ve been fortunate enough to live on this wonderful earth for 32+ years. During that time, I’ve come to realize two things as certainties. First, the New York Jets are never going to win a Superbowl in my lifetime and second, taxes are unbearably complicated.
One day, I hope to vote for a President who vows to take care of the former. For now, I’d like to discuss Donald Trump’s first attempt to take care of the latter.
Yesterday, Secretary of the Treasury Steven Mnuchin, and Director of the National Economic Council Gary Cohn, went to the WH briefing room podium and spent a good 20 minutes providing a brief outline of the new tax-cutting plan that they hope to pass through Congress. No timetable was provided (because it’s going to take a while), and specific details were not given (because they don’t know them yet). But the first draft of what Donald Trump hopes will be the new tax code was announced.
If you hate paying taxes, and by some small miracle this (or something close to it) is the plan that passes through the House and the Senate, you can start practicing your smiling now.
Donald Trump’s Tax Cut Policy
Here’s a basic rundown of what the new tax cut policy proposes:
- Tax brackets will be cut from seven tiers to three, and the top bracket will be 35%.
- The standard deduction for individual and married filers will double.
- The only deductions that can be added to a return are the home mortgage deduction and charitable donations.
- The AMT tax is phased out.
- The death tax (estate tax) will be repealed immediately.
- The capital gains rate will be lowered to 20%.
- The corporate tax rate will be lowered to 15%.
Let’s tackle these one at a time. We’ll explain how each of them will likely affect a middle class, tax-paying citizen of the United States.
(1) Tax Brackets Simplified
The Donald Trump tax cuts plan proposes to reduce the number of tax brackets from seven down to three. The three levels of taxes would become 10%, 25%, and 35%. This is a notable simplification of the current tax code, with brackets of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
What is likely to happen is that the brackets will merge, meaning the first two income groups will now move into the new 10% bracket (currently 10% and 15%), the next three merge into the 25% tax bracket (currently 25%, 28%, and 33%), and the top two merge into the new 35% tax bracket (currently 35% and 39.6%).
For a married couple that earns $200,000 in taxable income in 2017, the federal taxes owed would be $42,884.50 with the current brackets. That same couple in the new tax brackets above would pay only $38,615.00, which is a savings of just over $4,000.
(2) Standard Deduction Bump
The standard deduction is one that most tax filers take. For 2017, it is currently set at $6,350 per person and $12,700 for individuals. This means that if you don’t have a lot of deductions to claim on your tax return after this year is done, you can simply take the “standard deduction” and reduce your taxable income by this amount. The newly-proposed standard deduction is $12,000 for individual filers and $24,000 for married filers, though, making it nearly double what we see right now.
Effectively, this means that the first $12,000 of every tax filer’s income is earned federal income tax free. So, for those earning less than $75,000 a year (who would likely fall in the new 10% income tax bracket), this is a savings of $565 per person. My mother and father, God bless ’em, have taken the standard deduction every single year, so this one feature of the tax cuts plan would add $1,100 to their wallets each and every year.
(3) No More Deductions
Now, the bad news. To offset the savings, Donald Trump and his economic team have decided to remove all deductions, except for the mortgage interest deduction and charitable donations.
Anyone who doesn’t routinely take the standard deduction could potentially suffer a bit on this front. Of course, it mostly makes sense to itemize if your eligible deductions are higher than the standard deduction. With the standard deduction being raised, however, this might be a moot point for a lot of people. If you were itemizing in years past because your deductions were a couple thousand dollars over the standard deduction, they should now be below that line… meaning that itemizing is no longer your best option anyway.
Some of the most common deductions that will disappear are:
- Moving expenses to take a new job
- State income tax
- Student loan interest
- Home office deduction
- Property taxes
- Self-employment tax
I can tell you that from the list above, my wife and I take FIVE of those deductions every year. The total of them is greater than the new, proposed standard deduction of $24,000 so, unfortunately, this means we could be paying a little bit more in taxes due to the removal of deductions.
(4) Alternative Minimum Tax Phaseout
Essentially, the government says to every high-earning tax filer, “No matter how good you think you are at saving money on your taxes, we’ve got you.”
The Alternative Minimum Tax (AMT) is a safeguard of sorts for the IRS, which makes higher income earners run their taxes twice. Once through the regular tax code and again through the AMT tax code. Whichever number is the highest is the amount of taxes they need to pay. This particular tax has generated tens of billions of dollars in revenue over the years from skilled tax loophole extraordinaires, who would have otherwise avoided a large(r) tax payment.
No specific details were discussed by the White House just yet, in terms of how the AMT would be phased out. However, simply using the term “phase out” would suggest that it will take a few years before the tax is repealed entirely.
(5) Bye Bye, Death Tax
While the death tax gets a lot of publicity, it affects only around 0.2% of Americans. When someone with less than $5.49 million in assets passes away, they can transfer their wealth to their loved ones, tax-free. However, for those with assets greater than that amount, a very heavy estate tax of between 18% and 40% is imposed on what their heirs inherit. Twelve different tax brackets were created for the estate tax (why they needed that many, I have no idea) but the new tax cuts proposal would axe the whole thing immediately.
My personal assumption? The annual gift tax limit— which allows people to give no more than $14,000 to anyone they want each year tax-free–would also be removed as a result of the removal of the estate tax. Again, this is simply my assumption… there’s no fact-based evidence to back it up just yet.
(6) Capital Gains Rate Down
A capital gains tax (CGT) is a tax on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a cost amount that was lower than the amount realized on the sale. What was that?
I know it sounds complicated, but as an example: let’s imagine that you decided to buy $50,000 in either Apple stock or a fixer-upper home. When you go to sell either of those, you may be subject to capital gains taxes. The capital gains tax kicks in on any profit made from the sale of your Apple stock or home renovation project… so if either of them are worth more than $50,000 when you sell, you’re taxed on the growth (or gain).
The highest capital gains tax rate is currently 28%, but the Trump administration has said it wants to reduce that rate to 20%. This is a tax cut that is most likely to affect wealthy filers, as heavy profits made from investments would be taxed at a lower rate. However, this would also impact some small business owners and entrepreneurs, such as SPEC home builders.
(7) Corporate Tax Drop
The current corporate tax rate has a few brackets of its own, but any company that earns more than $335,000 falls into the 35% tax bracket. One of the biggest talking points of Donald Trump’s campaign was reducing the corporate tax rate to 15% to make companies in the United States more competitive. After a few months of, ”Well, maybe we’ll get it to 20%,” the decision was made to attempt a tax code overhaul where the corporate tax is 15%.
The immediate effect this has on the US taxpayer would not be found in their tax filing, but rather in the general overall health of the US economy. A lower corporate tax rate is likely to bring more overseas companies back to the United States, which means more jobs and higher-paying jobs for those already here. Small businesses would also see higher margins, allowing for an increased ability for growth, expansion, and hiring.
Doesn’t it all sound terrific? Well, the truth of the matter is that what you see above and what is to become legislation–if it becomes legislation at all–will probably be very different. Concessions are likely to be made, both to appease the House and Senate and to ensure the US doesn’t increase the deficit to the point of no return.
Three brackets may become four, the corporate tax rate may go from 15% to 25%, and the Alternative Minimum Tax may simply be reduced rather than phased out. No matter what, though, getting tax reform passed this year is something that most American would welcome with open arms.
We’re a long way away from the finished product. So, put your feet up, relax, and enjoy the show! It’ll be a while.
Updated April 30, 2017 and originally published April 27, 2017.