Any time a new president takes office, there is a degree of uncertainty. Will the president stick to what he said on the campaign trail? Will Congress support his agenda or take things in a different direction?
For many people, the biggest question looming over any new President is: what’s going to happen with my taxes? It’s a practical consideration, especially with tax season upon us.
And it’s one that can have a direct impact on a family’s bottom line.
The focus since President Trump took office has been largely on matters of immigration and foreign policy, but at some point, it is probable that his attention will shift to the tax code.
Here are four ways the Trump administration might change tax reform.
1. He Wants to Reduce the Number of Tax Brackets from Seven to Three
The proposal that is most likely to affect families around the United States is the President’s plan to reduce the number of income tax brackets from the current seven down to three.
At present, the tax brackets range from a 10% tax for making less than $9,275 per year ($18,550 per couple) up to 39.6% for individuals making $415,051 per year ($466,950 per couple). High-income taxpayers are also required to pay a 3.8% income tax on certain investments.
The President’s proposal would reduce the number of tax brackets as follows:
- Individuals making up to $37,500 and couples making up to $75,000 would pay 10% income tax.
- Individuals making between $37,500 and $112,500, and couples making between $75,000 and $225,000, would pay 25% income tax.
- Individuals making more than $112,500 and couples making more than $225,000 would pay 33% income tax.
The net result is a tax increase for people at the lowest end of the income spectrum and a significant decrease for people at the high end of the spectrum.
However, the President’s plan would have to be reconciled with current proposals drawn up by Congress. One of the things that their plan does is to increase the standard deduction, something that they argue would result in a net decrease even for the poorest families in the country.
To get an idea of what this change would look like in practice, let’s look at two examples. The first is an individual making $37,000 per year. Under the current tax code, that person would pay a base tax rate of 15%.
The President’s proposed plan would put that person into a significantly higher tax bracket of 25%. Before considering standard deductions, the net increase would be $3,700.
By contrast, a high-income family earning $400,000 per year would see a very different result. Under the current tax code, they would pay a 39.6% income tax, or $158,400 before deductions.
Under the new, simplified plan, this family’s tax rate would cap at 33%, reducing their taxes to $132,000 – a change of $26,400 before deductions.
2. He Proposes Eliminating Personal Exemptions and Raising the Standard Deduction
The next change that President Trump proposes to make in the tax code is a significant one, and it can be difficult to determine the impact it would have without crunching the numbers.
At present, the standard deduction for single people is $6,300, and the standard deduction for married couples filing jointly is $12,600. At the current time, approximately 67% of all taxpayers take the standard deduction when they file their tax returns.
President Trump’s proposal is to eliminate personal exemptions, which people who itemize their returns use to reduce their tax base. At the same time, he proposes increasing the standard deductions as follows:
- $15,000 for individuals
- $30,000 for families
Clearly, that change could mean a reduction in income taxes for people who take the standard deduction and don’t normally itemize, particularly for families at the low end of the income spectrum.
Where it gets tricky is when we look at those who do normally itemize deductions. They will still be able to do so, but the President’s plan puts caps on the number of deductions they can take.
Individuals will be permitted to itemize up to $100,000 in deductions, while families will be limited to $200,000. This cap applies to charitable giving and all other line-item deductions.
The net result will certainly vary from family to family, but higher-income individuals and families may end up paying more under the President’s proposal than they do under the current plan. That is particularly true if they are accustomed to itemizing huge amounts of charitable giving.
3. He Proposes the Elimination of the Estate Tax
One part of the tax code that traditionally gets a great deal of attention from Republican candidates is the estate tax, which they sometimes refer to as the death tax. It’s the tax that requires people who inherit large sums of money and property to pay taxes over a certain amount.
The current estate tax exempts couples that inherit up to $10.9 million dollars. In practical terms, 99% of the people in the United States will never have to worry about the estate tax.
President’s Trump proposal for the estate tax isn’t quite as straightforward as it sounds. The specific wording also says this: “Capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms.”
The way many accountants interpret this wording is that people who inherit wealth and do not sell it – those who do not make a capital gain on what they inherited – may never have to pay tax on their inheritance.
On the other hand, people who get small inheritances – the kind that are more likely to be sold – would be subject to a capital gains tax.
This certainly does pose some challenging questions. Some of us remember 2010, when, for a brief period, the estate tax expired and people who inherited wealth had to pay capital gains tax on the appreciated value of their inheritance.
Calculating the appreciated value proved to be difficult since most people don’t keep records of what price they paid for stocks and bonds when they originally bought them.
Some critics of the President’s plan have pointed out that the nature of this proposal is to encourage and enable the accumulation of dynastic wealth while making it difficult for those who inherit small amounts to gain any real benefit in the long run.
Regardless of where you fall on the political spectrum, it is certainly true that the wealthiest 1% of Americans will benefit if this particular aspect of the President’s plan is enacted.
An interesting side note to this particular proposal has to do with charitable giving. There are some who have hypothesized that the very wealthy will no longer be incentivized to give large amounts to charity under the President’s plan.
That’s the kind of thing that can be difficult to predict. While it is certainly true that the wealthiest taxpayers will not be able to deduct as much as they can under the current plan, it does not necessarily follow that they will give less to charity as a result.
4. He Wants to Greatly Reduce the Tax on Corporations
This last proposal is one that will require significant reconciliation with the Republican Party’s plan to become part of the tax code.
At present, the corporate tax paid by companies is 35%. Major corporations have long advocated for a reduction in that tax rate, arguing that the next result would be a positive one for the economy, as companies would have more money to spend on employees.
President Trump’s proposal is to decrease the corporate tax rate from 35% to 15%. That’s a massive decrease and one that could have far-reaching effects.
For one, the President’s plan would put no limits on the number of employees who could identify themselves as sole proprietors. Under the current code, sole proprietors – also known as pass-through entities similar to LLCs – must pay a 28% tax.
The President’s new plan would tax sole proprietors at the same 15% rate as corporations. Certainly people who are in business for themselves might be relieved – but is that reduction really possible?
This particular aspect of the President’s plan has received a great deal of scrutiny. The Tax Policy Center, a non-partisan watchdog group, has estimated that the reduction in corporate tax could lead to a budgetary crisis of unprecedented proportion.
Their estimates are that President Trump’s proposed changes to the corporate tax would result in an enormous increase in the federal debt. Specifically, they have said that in the first decade after such a change was enacted, the debt would increase by as much as $6 trillion in the absence of commensurate spending cuts.
The plan proposed by Congressional Republicans still reduces the corporate tax, but not by as much as the President’s plan.
Their plan calls for reducing the corporate tax rate from its current 35% down to 20%. It would also create a new maximum tax rate for sole proprietors and other pass-through entities, reducing the amount of tax they pay to 25%.
Before any changes to the corporate tax can be enacted, the President’s plan will have to be reconciled with the Congressional plan. It remains unclear whether Republicans in Congress will go along with a plan that will have such a dramatic impact on the national debt.
Some watchdog organizations have pointed out that the President’s spending proposals make his tax plans problematic. Plans to rebuild the country’s crumbling infrastructure and construct a border wall may make the reduction in corporate taxes a real problem when it comes to finding money to pay for the President’s campaign promises.
At present, the new Trump administration is still focused on expediting the confirmation of the President’s remaining cabinet appointees and settling into their new jobs in Washington.
With so much on the new administration’s agenda, it is unclear when reforming the tax code will move to the forefront. Certainly it will take some time to reconcile promises made on the campaign trail with the realities of governing a country.
However, it is probable that before long we can expect some significant changes to the tax code – changes that are likely to affect personal and corporate taxes. We’ll be there to help when they take effect.