The US House and Senate are considering extensive income tax reform. The table below outlines current law and the bills for each chamber as they were at the close of business on Monday, December 4, and provides indications of the bill that has emerged as the “final deal” on Wednesday, December 13. While this “final deal” has been announced, it has not been ratified. Details are sparse, and nothing will be certain until the President has signed a bill.
The two chambers’ tax reform bills differ from each other, but both propose significant changes from current law, and they are very similar in many respects. The shading in the table highlights some of the strongest similarities (one might suspect that these are likely to survive in the final bill).
What are the clearest implications of the proposed tax reform?
- As the standard deduction will be larger, fewer people will itemize. For example, fewer people will benefit from the mortgage interest deduction and from charitable deductions. If you itemize now, but probably won’t under the higher standard deduction, it may make sense to accelerate charitable giving, payment of sales and property taxes, and paying medical bills early. Consult your tax adviser before making any moves like this!
- The Alternative Minimum Tax is likely to apply only to those with higher incomes – those families with incomes between $200k and $1M who live in high tax states are likely to benefit.
- The deductibility of state and local taxes will be reduced, both directly and because fewer people will itemize. In the short term, total taxes will tend to rise for people living in high tax states (we’re looking at you, Massachusetts, New York, California…). In the longer term, there may be internal political pressure on higher tax states to lower their tax rates. [Yes, I realize that this directly contradicts the previous bullet point. No one will know the net effect for certain until they file.]
- The maximum mortgage interest deduction will be smaller – this may reduce home sale prices somewhat, even if interest rates don’t rise.
- Owners of some “pass through” businesses such as LLCs are likely to benefit due to lower tax rates, and others are likely to attempt to restructure their businesses to benefit.
|Individual Brackets||10%, 15%, 25%, 28%, 33%, 35%, 39.6%||12%, 25%, 35%, 39.6%||10%, 12%, 22%, 24%, 32%, 35%, 38.5%||Top rate 37%|
|Standard Deduction||$6.5k single, $13k married||$12.2k single, $24.4k married||$12k single, $24k married||$12k single, $24k married|
|State and local tax deduction||Property taxes, state and local income taxes||Property taxes only up to $10k (but business owners can deduct state and local income taxes as business expense)||Property taxes only up to $10k (but business owners can deduct state and local income taxes as business expense)||$10k of property taxes or income and sales taxes|
|Mortgage Interest deduction||For interest on up to $1.1M principal ($1M primary, $100k one other)||Only up to first $500k of principal for new mortgages, existing mortgages grandfathered||For interest on up to $1M principal, but only for purchase debt, not home equity debt||Interest on up to $750k principal (new mortgages?)|
|Medical deduction||Medical expenses over 10% of AGI||Eliminated||Over 7.5% of AGI, but only for the next two years||Deduction retained|
|Tuition waivers for graduate students||Untaxed||Taxed||Untaxed||Untaxed|
|Child tax credit||$1k (incomes up to $75k single, $110k married)||$1.6k (incomes up to $75k single, $110k married)||$2k (incomes up to $500k single, $1M married)||$2k (refundability uncertain)|
|Personal Alternative Minimum Tax||There is one||Repeal||Retained, but with larger exemption||Retained, threshold is $500k single, $1M married|
|Estate Tax||Exemption $5.49M single, $10.98 married||Exemption $10.98M single, $21.96 married, repeal after 2023||Exemption $10.98M single, $21.96 married||Exemption $10.98M single, $21.96 married|
|ObamaCare individual mandate||Americans who can afford health insurance but don’t purchase it must pay a fine or a fee||No change||Repeal||Repeal|
|Pass through income||Taxed as ordinary income||Taxed at 25% except for professional services||Allowed a 23% deduction except for professional services (expires 2025)||20% deduction|
|Roth conversion re-characterizations||Permitted||Not Permitted||Not Permitted||?|
|Capital gain tax rules||Taxpayers can specify tax lots when realizing gains||No change||Requires first in, first out approach||?|
|Corporate tax rate||35%||20% starting in 2018||20% starting in 2019||21% starting in 2018|
|Corporate tax base||Worldwide income||US profits only||US profits only||US profits only|
Important tax reform caveats:
- The tax reform bills have now been reconciled (a “final deal” has been struck), but details are limited as of this writing, and the “final deal” has not been ratified by both houses.
- The provisions (and changes to the provisions) interact. You probably won’t know whether your taxes will go up or down until you file.
- Taxpayers and tax advisers will require time to figure out the most advantageous approaches to minimize taxes – the impact on each person will take time to emerge.
We’ll update you as we know more.
Rick Miller is the founder of Sensible Financial Planning and Management. To ask Rick or another member of our team about planning for your financial future, please get in touch!