In an effort to simplify the individual tax code, the administration proposes nearly doubling the standard deduction and eliminating personal exemptions, while consolidating the number of tax brackets. These changes will have some impact on nearly every taxpayer, but as with most changes like these, there will be some winners and some losers.
Currently, individual tax brackets range from 0% - 39.6% and would range from 12% - 35% under the proposed plan. It’s hard to analyze the exact impact of that change, since no bracket cut-offs were provided with the proposed brackets, however, you can see that there is an elimination of the 0% bracket and a reduction in the top bracket. The current standard deduction is $6,300 for singles and $12,600 for married couples. In addition, we each get a personal exemption (deduction) for each individual person included as a taxpayer, spouse, or dependent of $4,050. Under the proposed plan, singles would get a $12,000 standard deduction and a married couple would get $24,000, however we would all lose our personal exemption.
For example, under the current tax structure, a married couple would receive a standard deduction plus personal exemptions totaling $20,700 and the next $18,650 they earn would be inside the 0% tax bracket. This means that they would not pay any tax on the first $39,350 they earn each year. They would pay 15% on the next $57,250 they earn and 25% on the next $77,200 they earn and so on. Under the proposed plan, the same couple would not pay any tax on the first $24,000 they earn each year and would pay 12% on the next unknown amount, and 25% on the next unknown amount. How this effects most people will truly depend on how large that proposed 12% bracket becomes. It will need to be pretty large in order not to adversely impact the first $100,000 earned each year by a married couple.
Those taxpayers with dependent children currently pay no tax on an additional $4,050 for each child under the current tax structure, but would be treated the same as the taxpayer with no children under the proposed plan which assumes the elimination of the personal exemption. However, the administration wants to enhance the current child tax credit by increasing the income levels at which this credit phases out. Currently, the credit phases out at $110,000 for married couples. So, if you make more than $110,000 and are currently missing out on this credit, you may benefit from this change. In addition, they are proposing a similar credit to include others currently included as dependents but at a lower credit amount of $500. This could be used to offset the loss of those dependents’ personal exemptions discussed above.
The elimination of the Alternative Minimum Tax is one item proposed that nearly everyone agrees would save taxpayers money and also simplify the tax code. Many taxpayers living in higher state income tax states are hit with this tax each year. If you are one of them, this change would benefit you.
In general, the administration hopes that they can eliminate many of the current itemized deductions while keeping the most popular items, such as mortgage interest and charitable contribution deductions.
They also intend to eliminate the federal estate tax which would benefit those individuals with estates exceeding $5.49 million and married couples with joint estates exceeding $10.98 million.
Tax reform proposals appear to have an even bigger potential for impacting businesses. The vast majority of small businesses are either sole proprietorships, partnerships, or S corporations and the income from those businesses are taxed on the individual owners’ tax returns in the same tax brackets discussed above (max of 39.6%). The administration’s plan would like to cap the tax on this type of income at 25%. If you own one of these types of businesses and your taxable income is generally more than $173,800, you could benefit a great deal from this change.
Corporations would also receive the benefit of a lower top rate of 20% instead of the current 35% top rate. Corporations with taxable income exceeding $50,000 would benefit from this change. Very few small businesses have remained a C corporation in recent years due to the double taxation that can occur in these entities when dividends are taken by the owners, so the impact of this rate change would be lower on small businesses.
In order to help offset the substantial decrease in tax rates for businesses, the administration proposes to eliminate the Domestic Manufacturing Deduction which businesses involved in manufacturing, software development, and construction type activities are able to take advantage of currently. The administration has also proposed eliminating some business credits, but are promising to keep the research & development credit and low-income housing credits which are some of the most popular credits currently available.
As you ponder how all of these changes would affect you personally, keep in mind that this “plan” is still just an outline that Congress may or may not use to create a Bill, which after much debate and committee work, will inevitably look very different. Much of this may never get anywhere at all. Continue to check in with RLH for updates as the tax reform process continues to move forward in the coming months.