2017 will bring Republican control to D.C. It will also potentially bring tax reform. Both President Elect Donald Trump and House Republicans have proposed sweeping changes to the U.S. tax system, which we have briefly summarized below.
Individual Income Taxes
The U.S. tax system currently has seven individual tax brackets ranging from 10% to 39.6% and four filing statuses (single, married filing joint, married filing separate, and head of household). The Trump Plan proposes three tax brackets of 12%, 25%, and 33%. It also proposes eliminating the head of household filing status.
The Trump Plan proposes repealing the alternative minimum tax, repealing the 3.8% tax on net investment income (commonly known as the Medicare surtax), and taxing carried interest at ordinary income rates. The current taxation of carried interest allows certain owners of private equity and hedge funds to tax their compensation at capital gain rates as opposed to higher ordinary income tax rates and is viewed by many as a tax loophole that needs to be closed. Interestingly, the Trump Plan does not propose lowering the current maximum capital gains rate of 20%. Alternatively, the House Plan proposes excluding 50% of capital gains, interest income, and dividends from tax but taxing the remaining 50% at ordinary income rates.
The Trump Plan proposes several changes to both the standard deduction and itemized deductions. The proposals include increasing the standard deduction for single filers from $6,300 to $15,000 and increasing the standard deduction for married filing joint filers from $12,600 to $30,000. The Trump Plan proposes capping itemized deductions at $200,000 for married filing joint filers and $100,000 for single filers. Alternatively, the House Plan proposes eliminating all itemized deductions other than the charitable contribution and mortgage interest deductions. The Trump Plan also proposes eliminating personal exemptions. Under current law, taxpayers are allowed personal exemptions of $4,050 for themselves and for each dependent.
The Trump Plan makes several proposals aimed at helping those with childcare expenses. For married filing joint taxpayers with income under $500,000 and single taxpayers with income under $250,000, The Trump Plan proposes a deduction for childcare for children under the age of 13, which would be capped at the state average and for eldercare for a dependent. The deduction would be limited to four children per taxpayer, but the use of a stay-at-home parent or grandparent would be permitted. The deduction for eldercare would be capped at $5,000 per year. For certain low income taxpayers, the Trump Plan proposes rebates for childcare expenses through the Earned Income Tax Credit. The Trump Plan also proposes allowing taxpayers to establish Dependent Care Savings Accounts. Contributions would be limited to $2,000 per year with the government providing a 50% match on parental contributions of up to $1,000 for low-income taxpayers.
The Trump Plan proposes taxing corporate income at 15%, eliminating most deductions and credits (other than the research and development credit), and eliminating the corporate alternative minimum tax. Alternatively, the House Plan proposes taxing corporate income at 20%.
The Trump Plan also proposes that the annual cap for the business tax credit for on-site childcare be increased to $500,000 from the current amount of $150,000 and that the recapture period be reduced from ten years to five years.
Under current law, profits earned abroad by U.S. corporations are taxed only when they are brought back to the U.S. The Trump Plan proposes a deemed repatriation of corporate earnings and profits not previously subject to U.S. tax at a rate of 10%.
Under current law, most pass-through entities (partnerships, S corporations, and disregarded entities such as single member LLCs) do not pay tax at the entity level. Instead, the income flows through, and is taxed to, the owners. The Trump Plan proposes a 15% tax at the entity level on reinvested earnings. Alternatively, the House Plan proposes a 25% entity level tax for active business income.
The Trump Plan proposes a repeal of the estate tax. It also proposes a repeal of the step-up in basis. In lieu of the estate tax, the Trump Plan proposes eliminating the estate and generation-skipping transfer taxes and instead taxing beneficiaries when they dispose of property inherited from a decedent.
Neither The Trump Plan nor the House Plan has made proposals concerning the gift tax.
Should taxpayers do anything in anticipation of tax reform? With Republican control in D.C., it is almost certain that some tax changes will occur, however, President-Elect Trump and Republican leaders do not wholly agree on what those tax changes should be. It is also likely that Republicans in the House and the Senate may be hesitant to enact broad changes that would increase the deficit and national debt.
Another thing to keep in mind is that tax bills that are not revenue neutral (i.e., those that increase or decrease the amount of money coming into the federal government) must either have supermajority support (60 senators) or be adopted through the reconciliation process, which would mean that the new laws could likely not be effective for longer than 10 years (think of the Bush tax cuts that sunset after 10 years).
For those wanting to take action, certain things to consider are postponing taxable gifts until more is known about the possible repeal of the estate tax, accelerating payment of itemized deductions that would be in excess of the cap proposed by the Trump Plan, and postponing the realization of taxable income until 2017 in anticipation of lower tax rates.