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GOP Tax Reform Proposal

On Behalf of | Oct 4, 2017 | Estate Planning |

The GOP has released its “Unified Framework for Fixing Our Broken Tax Code”.  Unfortunately, the framework is heavy on generalities and light on specifics, so there is still a long way to go.  Nonetheless, I wanted to take this opportunity to discuss the proposals, and provide some observations, as follows:

Standard Deduction/Personal Exemptions.  The plan roughly doubles the existing standard deduction – making it $24,000 for married taxpayers filing jointly (as compared to $12,700 under current law), and $12,000 for single taxpayers ($6,375 under current law).  In doing so, however, the former personal exemptions for the taxpayers (currently $4,050 per person) are eliminated.  The idea behind this increased deduction is to exclude more income, thus reducing the tax burden and even reducing the number of taxpayers required to file a tax return.

Observation 1 – By eliminating the personal exemptions and increasing the standard deduction, the plan results in only a modest increase in the aggregate deduction, shown as follows:

                                                                     Single Taxpayers                   Married Filing Jointly 

                                                                   Current       Proposed               Current           Proposed

Standard Deduction                           $   6,350       $ 12,000              $ 12,700          $ 24,000

Personal Exemptions                          $   4,050       $          0              $   8,100          $          0

Total Deduction/Exemptions           $ 10,400       $ 12,000              $ 20,800          $ 24,000

Observation 2 – The above example assumes no children or other dependents. If you include one dependent in the above example, the Personal Exemption amounts would go to $8,100 and $12,150 respectively. Thus, the Total Deductions/Exemptions for a single person with one dependent would be $14,450; and for a married couple with one dependent it would be $24,850. Therefore, with only one dependent, under the current law the amount of the aggregate deduction would be higher than the new standard deduction under the proposed law.

Observation 3 – The standard deduction benefits only those taxpayer who do not itemize their deductions.  In other words, if a taxpayer does not have itemized deductions in excess of the standard deduction, then they can claim the standard deduction.  If, on the other hand, the taxpayer’s itemized deductions are in excess of the standard deduction, the taxpayer would forego the standard deduction and choose instead to itemize.  Under current law, a taxpayer who itemizes deductions would nonetheless still receive the benefit of the personal exemptions (although taxpayers with adjusted gross incomes in excess of $313,800 for MFJ and $261,500 for individual saw those exemptions phased out).  Taxpayers who itemize under the proposed law will no longer receive the benefit of the personal exemptions, thus lowering their aggregate deduction.

Planning Idea – Taxpayers whose itemized deductions in any given year are close to the standard deduction amount will want to consider doubling up the payment of itemized deductions every other year.  The idea would be to itemize in year one, take the standard deduction in year two, itemize again in year 3, and so on.  This will maximize the total deductions benefitting the taxpayer.

Individual Income Tax Rates.  Under current law, the income tax rates on individuals consist of seven brackets – 10%, 15%, 25%, 28%, 33%, 35% and 39.6%.  The proposal is to reduce this to three brackets – 12%, 25% and 35%.  The lowest bracket is higher under the proposal than under current law; however, the idea is that the increased standard deduction and the increased child tax credit (discussed later) will offset any additional cost.

The proposal also leaves open the possibility of an additional top tax rate on the highest-income taxpayers, although there is no indication of a proposed tax rate or the income threshold over which that rate would apply.

Observation 4 – There is no indication of the income thresholds to which each of the newly-proposed brackets would apply.  As a result, there is no way to compare the tax burden under the current law versus the proposed law.

Observation 5 – There is also a provision whereby the individual income tax rate on business income from small businesses operated as sole proprietorships, partnerships, or S corporations would be limited to a maximum of 25%.  This is to reduce the tax burden on the owners of small businesses that operate as pass-through entities.  It is unclear how the proposed law will define the distinction between business income and non-business income for this purpose.

Child Tax Credit.  The proposal is to increase the amount of the refundable and non-refundable child tax credit for low and middle-income taxpayers, and to increase the threshold of income levels at which this credit is phased out.  However, the plan proposal specifies neither the amount of the credit, nor the applicable income threshold.

Middle Class Tax Relief.  The proposal contains a sentence stating “the committees will work on additional measures to meaningfully reduce the tax burden on the middle-class.”  The proposal provides no specifics in this regard, nor what will be considered “middle-class.”

Alternative Minimum Tax.  The alternative minimum tax (AMT) has become an increasing problem for many taxpayers over the last couple of decades.  The AMT was originally designed to ensure that high income taxpayers pay at least a minimum amount of tax.  With much tinkering over the years, the AMT now impacts many more taxpayers than it was ever designed to do.  The proposal would repeal the AMT.

Observation 6 – The AMT effectively disallowed the deduction of certain itemized deductions for those taxpayers who were subject to the AMT.  Many of these taxpayers have been deferring the payment of itemized deductions because the AMT disallowed  deductions such as state income taxes, investment fees, etc., and there was the hope of a repeal.  The repeal of the AMT might benefit those persons who have been deferring these payments; however, many of these itemized deductions are now on the chopping block under the proposal anyway (see below).

Itemized Deductions.  The proposal indicates it will eliminate most itemized deductions, retaining only the deductions for home mortgage interest deduction and charitable contributions.  Most notably, the deduction for state income taxes paid would be eliminated.

Observation 7 – The proposal does not specify an effective date for the repeal of the itemized deductions.  I believe it is unlikely this change would be retroactive to January 1, 2017.  However, it could be effective as of the date the proposal was released (September 27, 2017), or perhaps prospectively from the date of passage of a new law, or some specified date thereafter.

Planning Idea – It may be beneficial to accelerate the payment of the itemized deductions that will be repealed, in order to obtain a tax benefit in 2017 for those deductions.  There is a risk, however, that those deductions may be of no benefit if the effective date of the repeal is prior to their payment.

Work, Education and Retirement.  The proposal says it will retain tax benefits that encourage work, higher education, and retirement security, and that the committees are encouraged to simplify these benefits.  There are no further specifics in this regard.

I have, however, heard other proposals regarding retirement accounts, specifically Individual Retirement Accounts (IRAs). Under current tax law, if a beneficiary inherits an IRA, then that beneficiary may be able to “stretch” that IRA out over that beneficiary’s lifetime, thereby allowing tax deferral of that IRA. However, I have heard that there is a proposal to eliminate this “stretch out” and require the beneficiary to instead liquidate the IRA within five years of the original IRA owner’s death, thereby accelerating recognition of the IRA within that five year period. This could have a significant impact on IRA beneficiary planning in the future.

Estate Tax Repeal.  The proposal is to eliminate the estate tax and the generation-skipping transfer tax.  It does not, however, eliminate the gift tax (the proposal is silent on the gift tax). I plan to expand on the impact of this in a later Blog Post.

Observation 8 – Under current law, an asset held by a decedent at death, and included in the decedent’s estate, is allowed a step-up in the cost basis of that asset to its fair market value on the date of death.  This effectively erased any pre-death appreciation on these assets that would otherwise be subject to capital gain tax. There is no mention in the proposal whether this step-up in basis would still be allowed, or whether the basis of the decedent would instead carry over to the beneficiaries, or whether there would be a forced recognition of gain at death.

Observation 9 – Under current law, the gift tax and estate tax enjoyed a lifetime exemption effectively precluding tax on the first $5,490,000 of transfers (in excess of annual exclusions and indexed for inflation each year).  While it appears the gift tax would remain in effect, there is no indication whether the amount of annual exclusion (currently $14,000 for 2017) or the lifetime exemption would remain the same, or become an entirely different amount.

Tax Rate Structure for C Corporations.  The proposal is to reduce the maximum tax rate on “C” corporations to 20%.  This is below the average tax rate for the industrialized world and is intended to keep companies from moving operations overseas.

Expensing of Capital Investments.  The proposal is to allow the immediate expensing of capital investments (other than structures) for depreciable assets purchased and placed in service any time during the five year period following September 27, 2017.

Repatriation.  There are also some proposals to encourage the repatriation of money currently held overseas by U.S. companies, as well as to discourage U.S. companies from leaving the U.S.  There is little specificity with regard to these proposals.

I had hoped, by this time this year, we would have a more specific idea of the proposed tax laws, such that we could begin the implementation of some tax planning ideas.  Unfortunately, it appears we have a long way to go before these proposals become law.  It is likely some of these proposals will be tweaked, others deleted, and still others added.

To read the Tax Proposal yourself click Here.

I hope this helps!