Donald Trump was elected the 45th President of the United States last night, and while I allow that to sink in for a bit, it’s also worth noting that Republicans retained control over the House and Senate. As a result, the GOP has unfettered control over the future of tax policy, meaning we may be in for some big changes. What can you expect?
Under current law, we pay tax on “ordinary income” — things like wages and interest income — at graduated rates, meaning as income increases, so does the tax rate. There are currently seven rates, stretching from 10% to 39.6%, with the top rate kicking in once income exceeds about $470,000 (if married, $418,000 if single). It looks like so:
|If taxable income is:||The tax due is:|
|0 – $18,550||10% of taxable income|
|$18,551 – $75,300||$1,855 + 15% of the amount over $18,550|
|$75,301 – $151,900||$10,367.50 + 25% of the amount over $151,900|
|$151,900 – $231,450||$29,517.50 + 28% of the amount over $151,900|
|$231,451 – $413,350||$51,279.50 + 33% of the amount over $231,450|
|$413,351 – $466,950||$111,818.50 + 35% of the amount over $413,350|
|$466,951+||$130,578.50 + 39.6% of the amount over $466,950|
|If taxable income is:||The tax due is:|
|0 – $9,275||10% of taxable income|
|$9,276 – $37,650||$927.50 + 15% of the amount over $9,275|
|$37,651 – $91,150||$5,183.75 + 25% of the amount over $37,650|
|$91,151 – $190,150||$18,558.75 + 28% of the amount over $91,150|
|$190,151 – $413,350||$46,278.75 + 33% of the amount over $190,150|
|$413,351 – $415,060||$119,934.75 + 35% of the amount over $413,350|
|$415,060+||$120,520.75 + 39.6% of the amount over $415,060|
Of course, the top rate isn’t really 39.6%, because as part of Obamacare, high-income taxpayers pay an additional 3.8% surtax on “net investment income” – things like interest, rents, royalties, and passive business income – bringing the top rate to 43.4%.
We don’t pay these rates on all forms of income, however. Certain types of income – namely, qualified dividends and long-term capital gains (the sale of certain assets held together longer than one year) – are taxed at preferential rates, which under current law are 15% for most taxpayers, but reach a maximum of 20% for taxpayers in the 39.6% brackets shown above, before tacking on an additional 3.8% for the Obamacare net investment income tax.
Donald Trump has proposed cutting the seven brackets down to three: with 12%, 25% and 33% rates. He would then align the preferential rates afforded dividends and capital gains to the new brackets, while also eliminating the net investment income tax – along with the rest of Obamacare. As a result, the top rate would be a true 33%, with the top rate on capital gains and dividends a true 20%. It would look like this (courtesy of the Tax Foundation).
|Ordinary Income Rate||Capital Gains Rate||Single Filers||Married Joint Filers|
|12%||0%||$0 to $37,500||$0 to $75,000|
|25%||15%||$37,500 to $112,500||$75,000 to $225,000|
Under current law, if you die with an estate valued in excess of $5.45 million, you pay a tax of 40% on the excess value. Any appreciation inherent in the assets that make up your estate, however, is untaxed at your death; rather, the beneficiaries of your estate take the assets with a tax-free, “stepped-up” basis.
Donald Trump’s proposal would eliminate the estate tax. The opportunity to pass a valuable estate on to your heirs tax-free is a rare one; but understand, according to Trump’s proposal, it won’t be completely without tax. His plan would tax the appreciation inherent in the assets of an estate valued in excess of $10 million, but only when the beneficiary sells the assets; the assets won’t be taxed immediately upon death.
Corporations currently pay tax at a rate of 35%, which President Trump likes to point out is the highest rate in the industrialized world (It’s not). His proposal would cut the rate to 15%, while eliminating most business deductions. Businesses would be permitted, however, to immediately deduct the cost of asset acquisitions, a monumental divergence from current law, under which businesses have to depreciate the cost of purchased assets over a number of years, greatly reducing the tax benefits. Those businesses that fully deduct asset costs will not be permitted to deduct interest expense on any borrowing, a provision that’s intended to reduce corporate dependence on debt.
The bigger changes under the Trump plan come in the treatment of so-called “pass through” taxation. Under current law, S corporations and partnerships do not pay entity-level tax; instead, the income is allocated to the owners, who pay the corresponding tax at the individual level, based on the applicable individual rates laid out above.
Trump, however, would provide a unified business rate of 15%, meaning not only would corporations pay tax at that rate, but all business income – even the income earned by an individual from an S corporation, partnership, or sole-proprietorship and reported on the individual’s tax return — will be subject to the same 15% rate. This means that a taxpayer earning business income would experience a drop in top tax rate from 39.6% to 15% under the Trump presidency.
It also means that under the Trump plan, the difference in top tax rate between being paid as an employee (33%) and as an independent contractor (15%) is extremely significant. As a result, my employer may consider this column my resignation as an employee, as I will now be providing services only as a consultant so as to pocket the extra 18%.
Every taxpayer gets to claim on their tax return the greater of 1. certain “itemized deductions,” – think charitable contributions, mortgage interest, real estate taxes, etc… or 2. a “standard” deduction.” The standard deduction currently sits at $12,600 (if married, half that if single). In addition, each taxpayer may claim a $4,050 personal exemption for themselves, their spouse, and any dependents.
Trump’s proposal would cap itemized deductions at $200,000 (if married, $100,000 if single). In addition, he would increase the standard deduction from $12,600 to $30,000 ($15,000 if single), and eliminate personal exemptions.
So if you’re scoring at home, a family of five that currently claims the standard deduction will actually lose deductions under the Trump plan: under current law, they would be entitled to a $12,600 standard deduction and $20,250 of personal exemptions, for a total tax benefit of $32,850. Under the Trump plan, that would be replaced with a $30,000 standard deduction and no personal exemptions.
In addition, as highlighted above, the bottom rate of 10% will be replaced with a new bottom rate of 12%. Combine this with the lost deductions described above — as well as the elimination of the “head of household” filing status under the Trump plan — and according to a study performed by Lily Batchelor at NYU, you have a perfect storm in which approximately 7.8 million low-income large families will experience increased tax bills under the Trump plan.
According to the Tax Policy Center, the totality of the Trump plan will reduce federal tax revenue by $6.2 trillion over the next ten years. Of those tax cuts, nearly 47% will go to the richest 1%. To put it into dollar terms, those earning less than $48,400 will experience an annual tax cut of less than $400, while those earning in excess of $700,000 will walk away with an average of an extra $215,000 per year.
The reasons for the disparity are fairly obvious: when a tax plan reduces the top rate from 39.6% to 33%, while also cutting business tax rates from 39.6% to 15%, those at the high end of the income scale will walk away huge winners, regardless of any offsets found in the plan in the form of limited itemized deductions. Those making more than $700,000 will benefit far more from a 6% reducing in income tax rates — and a 24.6% reduction in business rates! — than they can ever be harmed in the form of forfeited itemized deductions.
Of course, this isn’t inherently bad; some economists will argue that by putting more money in the hands of business owners and decision makers, businesses will expand, hire more people, pay hire wages, etc… with more income thus trickling down to lower income levels. Where you stand on that position is up to you.
So here we are. For the next four years, Congressional gridlock should no longer be an issue. We’ve got a Republican President, and Republican control of both the House and Senate. We’ve got a Republican Speaker of the House in Paul Ryan who considers himself a tax wonk. There has been much talk about the need for tax reform — a move to a more simple, fair, manageable system free of loopholes and special interests. There is nothing stopping the GOP from doing just that over the next four years.
Let’s see what happens.
Please contact a member of Withum’s Tax Services Group at email@example.com with any questions.