Recently, President Trump unveiled some high-level items contained in his tax reform agenda. The information shared did not include details and many questions are still to be answered: How likely is it that some of these agenda items are passed? If they are passed, what will the impact be? Many of the questions are difficult to answer at this time due to lack of detail, but this blog aims to address some of the bigger items contained in the tax reform proposal.
General – A Senate rule prevents any tax plan from adding to the Federal deficit outside of a 10 year window if it is enacted with a simple majority rather than 60 votes, a procedure known as reconciliation. Clearly, President Trump is aiming for a low tax rate environment. So, if he cannot put something else into effect to offset the loss in government revenue, the tax provisions enacted will be temporary in nature and set to expire in 10 years.
Income Tax Rates / Brackets – Rates overall would come down under President Trump’s proposed tax plan. There would be three income tax brackets of 10%, 25%, and 35% (slightly different than the rates outlined during his campaign). This would bring the top rate down from 39.6%, while consolidating the number of brackets from the current seven to three. In theory, President Trump is anticipating a reduction in income taxes overall which will allow individuals to take more of their pay home, spend more, thus spurring increased economic activity. Despite his desired rates being known, it remains to be seen what levels of income would be subject to which rates.
Capital Gains Tax Rates – Trump’s tax reform plan would have capital gains taxed at half of the ordinary income tax rate. So, someone paying at the top income tax rate of 35% would pay tax on their capital gains at 17.5%. This change would benefit higher earners with capital gain income. Considering this is another instance where tax rates would be coming down, such a provision would make it difficult for President Trump’s proposed tax agenda to be revenue neutral.
Given the potential decrease of capital gain tax rates, keeping a close eye on the types of investments owned in both taxable and tax-deferred accounts will continue to be of great importance, as to maximize after-tax return.
Standard / Itemized Deductions – Under the proposal, the standard deduction would double for each filing status. Many of the currently available itemized deductions would be eliminated (except for mortgage interest and charitable contributions). This would simplify things for many taxpayers and allow those with lower incomes to utilize a higher standard deduction. Also, because of the increased standard deduction, things would be made much simpler for many people when preparing their own taxes (a trend that has been increasing).
Arguably, the biggest change in itemized deductions is the potential elimination of the state income tax deduction. This has been tried in the past, only to be met with heavy pushback by larger states with high state income tax rates. Many residents of high tax states have been able to rationalize paying high state taxes because of the deduction they receive at the Federal level. If the state income tax deduction goes away, states with high tax rates may fear that individuals, especially higher income residents, may no longer be able to rationalize paying high taxes at the state level and perhaps move out of the state. Also, the lack of a state income tax deduction in a high tax state could greatly influence residency decisions during both working years and retirement.
Overall, there is still a long way to go in getting any sort of tax reform passed. There are a number of provisions contained in Trump’s tax agenda, and it remains to be seen how the proposal will unfold. At BDF, we always do our best to help clients navigate their financial lives with taxes as a consideration.
Matt Foltz, CPA is a senior financial planner at BDF. He earned his Bachelor of Science in Accountancy from Saint Joseph’s College and his Masters of Science in Accountancy from the University of Notre Dame. Matt is a Certified Public Accountant and has passed the CERTIFIED FINANCIAL PLANNER™ exam.