Individual Tax Reform: A Quick Summary for a Slow Process
Now that the Trump administration has taken office, potential policy changes are beginning to take form. With the Republican Party fully in charge for the first time since 2006, it would seem that the stars are aligned for long-proposed tax reform to finally occur. Comprehensive tax reform, however, is difficult to achieve, and since the election we have already seen differences develop between the Trump plan and the plan drafted by House Republicans, “A Better Way for Tax Reform,” released last June. Despite the differences, reform is still expected to occur at some point and will likely impact most taxpayers in some shape or form.
So what might individual tax reform look like? Generally, the overall objective appears to be simplifying the system by broadening the tax base, which simply means increasing the amount of income subject to tax by reducing or eliminating deductions, and by lowering the rates. Let’s walk through some of the specific proposals.
Fewer Tax Brackets
One of the most likely changes is a reduction in the number of income tax brackets. The seven brackets we now have, which range from 10% to 39.6%, would be compressed into three brackets of 12%, 25% and 33%. Both plans are in agreement on the need for bracket compression and rate reduction; however, taxpayers will be subject to higher rates more quickly under the Trump plan than the House plan.
Changes to Deductions and Exemptions
Both the Trump plan and the House blueprint propose eliminating personal exemptions and increasing the standard deduction, although they vary in the amounts proposed. Both plans also propose big changes to itemized deductions; for instance, the Trump plan proposes retaining all deductions but capping them at $200,000 for married filing joint taxpayers and $100,000 for single filers. While there is no cap in the House blueprint, it does propose eliminating all itemized deductions other than the those for mortgage interest and charitable contributions.
Modifications to Taxes/Rates on Investment Income
The Trump plan would retain the maximum 20% capital gains tax rate. On the other side, House Republicans propose allowing individuals to exclude 50% of their net capital gains, dividends and interest income from taxable investment income.
Both the Trump and House Republican plans would effectively repeal the 3.8% net investment income tax, which was initially put in place to raise funds to pay for the Affordable Care Act.
Repeal of the Alternative Minimum Tax?
Both plans propose eliminating the AMT, which was initially enacted decades ago to ensure that high-income individuals were paying a fair rate of tax by limiting the benefit of numerous deductions and breaks. Until the American Taxpayer Relief Act of 2012, the AMT was not automatically adjusted for inflation, and over the years many unintended taxpayers have been forced into paying this tax. Even though the AMT no longer serves its intended purpose, it has remained a part of the tax code due to the enormous amount of revenue it raises. Practitioners and taxpayers alike hope this one goes away!
Estate Tax Changes
Significant modifications to (and potential elimination of) gift, estate and generation-skipping transfer taxes have been proposed by both plans. How they intend to replace the revenue generated by these taxes is unclear and may be a significant barrier.
Lower Rates for Business Owners
Both the Trump and House Republican plans include a lower rate on business income for sole proprietors and owners of pass-through entities such as partnerships and S-corporations. The actual rate (15% under the Trump plan and 25% in the House plan) and details regarding implementation of the tax remain unclear; however, we are hopeful any initiative to lower corporate tax rates will carry over to sole proprietors and pass-through entities as well.
Plan Now to Act Later
While it’s good to stay informed about the ongoing debate, it is important to keep in mind that tax reform usually takes a long time and very few tax policies last forever. Your current tax planning should factor in the law as it now stands, not as it may or may not be down the road. In the meantime, your Truepoint tax team is here to answer questions and discuss your options for navigating the shifting tax landscape.
About the Authors
John Wolfenden is a tax associate focusing on individual and trust tax planning and compliance for both the tax and estate teams. Ginger Ittenbach leads Truepoint’s tax team and serves as a member of the American Institute of Certified Public Accountants (AICPA) Tax Reform Task Force, which advocates for sound tax policy.