On Wednesday September 27th, President Trump and Republican leaders in Congress unveiled a new tax plan that, if passed in its current form, could create dramatic changes to the current tax code.
Highlights of the new tax reform include[i]:
- Compression from the current 7 income tax brackets (ranging from 10% to 39.6%) to 3 brackets: 12%, 25% and 35%. Congress can add a fourth bracket above 35%.
- Doubling the standard deduction from $6,350 to $12,000 for individuals, and from $12,700 to $24,000 for married couples
- Boosting the child tax credit from $1,000 to an unspecified higher amount
- A new $500 credit for caring for elderly relatives
- Reducing the corporate tax rate from 35% to 20%
- A lower top tax rate for small businesses at 25%
- Taxpayers in high tax states such as California and New York could lose the ability to deduct state and local income taxes and property taxes on their federal return
- Elimination of the corporate and individual Alternative Minimum Tax
- Elimination of estate taxes on large inheritances
- Elimination of many other (currently) non-specified tax deductions
How will this affect me?
President Trump declared his proposal will “protect low-income and middle-income households, not the wealthy and well-connected.” However, Democrats are already opposed to the tax reform, calling it a tax break for the wealthy.
On the surface, it appears that the lowest tax bracket is increasing from 10% to 12% and the highest tax bracket is lowering from 39.6% to 35%. However, the specific income levels tied to each of the new tax brackets is yet to be revealed, so it’s not certain where everyone will fall or how they’ll be affected. Republicans say those who are paying 10% now might not be subject to taxation at all under the new plan, so they are going down to 0%, not pushed up to 12%.
The National Association of Realtors argues that having a higher standard deduction could make home ownership less valuable in comparison to renting. Further, it could decrease the value of existing homes. This is because as the standard deduction rises, people are more likely to take the standard deduction and less likely to itemize their taxes. Mortgage interest expenses and property taxes can only be deducted if a person itemizes their taxes.
Other analysts have said that the proposed tax reform will greatly benefit corporations and stock holders. Although the details aren’t clear yet, the plan proposes a shift from a worldwide tax system to a new territorial system. International companies based in the U.S. would not be taxed on income earned overseas. This would allow companies to bring back the profits earned overseas without incurring additional taxes. To discourage companies from shifting all profits to countries with low tax rates, the plan also includes an unspecified minimum foreign tax. The goal is to make US companies more competitive internationally and for foreign profits to reinvest back into the US market, furthering the economy and job growth.
Analysts believe that other tax deductions and credits must be eliminated to make up for the tax cuts proposed in the reform. However, exactly which deductions will be eliminated is yet to be seen. Some worry that public programs and benefits for the countries neediest will be eliminated. The elderly are particularly worried about the benefits under Social Security and Medicare; programs and benefits they depend on to make ends meet.
Experts predict that the current tax reform proposal could reduce government revenue by more than $2 trillion dollars[ii] over the next decade. This will add to the current $20 trillion dollars of debt carried by the US currently.
President Trump’s goal is to implement the new tax code by the end of 2018, but it’s unknown what revisions will be made to gain more support for passage. Next week the Senate is to begin deliberating the new tax bill. Currently the Republicans dominate both the House and the Senate. Some guess that the President has left areas for negotiation that will help to gain greater support from Democrats – such as the possible fourth tax bracket.
Truly, nothing is certain at this point and each proposal is a bargaining chip for the Republican and Democratic parties until the reform is passed. However, the economic market and stock market are never predictable. This further reiterates the need for an investment strategy that is highly diversified and balanced. Rather than trying to predict where the market will go, investors should have a predetermined exposure to each asset class and capture gains wherever they arise.
Once the new tax laws go into effect, consult with your CPA or Financial Advisor to ensure you are taking full advantage of opportunities. Hopefully the new tax system will benefit all Americans.