Looking Past Election Day: Tax Reform on the HorizonNovember 16, 2016
Justin R. Morneault, Tax Staff
The morning after Election Day 2016, Americans woke up to news that the Republican Party maintained majority seats in both houses of Congress, and Republican presidential candidate Donald Trump had defeated Democrat Hillary Clinton.
Donald Trump led a political campaign promising to reform immigration, global trade and federal taxation. Trump's proposed tax reform plan crosses the entire Internal Revenue Code and taxation of the middle class, high net worth individuals and businesses. Now that the election is over, the focus of many Americans will be on whether Trump will get his proposed tax policy reform passed through the Republican-held Congress and how the proposed tax policy will affect them.
How Would the Proposed Changes Affect Me?
Trump's tax plan would not only significantly reduce individual income tax rates, but would change deductions from and for adjusted gross income (AGI) commonly known by American taxpayers. In addition, Trump's proposal contains unique provisions to help alleviate the high costs of child and eldercare. Under Trump's tax policy reform:
- The standard deduction would increase from $12,600 for those married filing jointly to $30,000 ($15,000 for single filers), thus reducing the income on which individuals and families are taxed.
- The option to itemize deductions would remain, but would be capped at $100,000 for single filers and $200,000 for those married filing jointly.
- While the standard deductions get a significant bump, both the deduction for personal exemptions and the head of household filing status would be eliminated completely.
- The policy reform would replace the current seven income tax brackets with three. In the current system, marginal tax rates begin at 10% and rise to 39.6%, for taxable income above $466,950. Tax rates under Trump's plan would be 12%, 25% and 33% for AGI over $225,000.
- To provide relief from expensive dependent care costs, Trump's plan includes an above-the-line deduction for the cost of child and elderly dependents. The proposed deduction would allow taxpayers to deduct child care costs for up to 4 children under the age of 13 and eldercare costs for elderly dependents, subject to separate limits. The plan also calls for the establishment of tax-favored accounts called Dependent Care Savings Accounts (DCSAs).
Fewer Supplemental Taxes on the Wealthy
Some of the most notable changes would occur in taxes which supplement the standard income tax and typically only affect high net worth individuals. Trump's tax plan includes language regarding the Alternative Minimum Tax (AMT), Net Investment Income Tax (NIIT) and Estate Tax.
The AMT is a supplemental tax designed to ensure high income taxpayers pay a minimum amount of tax. The AMT is derived from applying a flat tax rate to an alternative taxable income calculation. The NIIT, on the other hand, is a 3.8% tax on interest, dividends and other investment income above statutory threshold amounts. The estate tax (often called the "death tax" in political arenas) is a 40% tax on amounts greater than $5.45 million in a deceased's estate. Under Trump's tax policy reform:
- The alternative minimum tax levied on individuals will be completely eliminated.
- In conjunction with Trump's campaign promise to repeal and replace The Affordable Care Act ("Obamacare"), the net investment income tax will be completely eliminated.
- The current estate tax would essentially be repealed. Instead, only capital gains at the time of death above a $10 million exemption would be taxed at capital gain rates.
- Favorable capital gains rates would remain, to a maximum rate of 20%.
Tax Changes for Businesses
Perhaps the most drastic changes found in the reform plan involve business taxation. Currently, businesses are taxed as corporations or as pass-through entities. As a corporation, businesses pay an income tax at the entity-level. However, pass-through entities (including LLCs) are not taxed at the entity-level. Rather, profits and losses "flow-thru" to each owner and any income is subject to tax at each owner's individual tax rate. Under Trump's tax policy reform:
- Corporate and pass-through income is subject to a flat 15% entity-level tax rate on income.
- Many business deductions currently allowed now, will be disallowed.
- Companies would be allowed to either deduct interest expense or make an irrevocable election to immediately expense the cost of asset acquisitions. Current tax law generally requires asset acquisition costs be capitalized and recovered over time via depreciation expense.
- The alternative minimum tax levied on corporations will be completely eliminated.
Current corporate and individual tax rates max out at 35% and 39.6%, respectively. This means the flat rate should appeal to corporate management and owners of profitable pass-through entities alike. Nevertheless, if all business income is subject to a single entity-level rate, the "flow-thru" advantage found in pass-through entities may be threatened.
Looking Towards the Future
Although comprehensive, Donald Trump's tax plan is still subject to legislative revision in the coming months. It is important to remember, however, that the President does not have the authority to change or create tax laws. The constitutional authority to levy taxes is granted only to Congress, a Congress currently held by a Republican majority.
As tax changes and developments occur, we will continue to alert you.
Justin R. Morneault is a tax professional with BlumShapiro, the largest regional business advisory firm based in New England, with offices in Connecticut, Massachusetts and Rhode Island. The firm, with over 400 professionals and staff, offers a diversity of services which includes auditing, accounting,taxand business advisory services. In addition, BlumShapiro provides a variety of specialized consulting services such as succession and estate planning, business technology services, employee benefit plan auditsand litigation supportand valuation. The firm serves a wide range of privately held companies, government and non-profit organizations and provides non-audit services for publicly traded companies.
Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statues, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.