Highlights of the Latest Republican Tax Plan

Republicans seem to have cleared the first hurdle for tax reform by passing budgets respectively in the House and the Senate. What are some highlights of the Republican tax plan and how will it affect taxpayers?

The new Republican tax plan calls for a collapse of seven tax brackets into three.

The new brackets will be at 12, 25, and 35 percent. What’s the goal behind this? Simplicity. Three tax brackets are a lot easier to keep up with than seven. It will be easier for both tax professionals and for those filing their own taxes. With these changes, the majority of the middle class would likely be in a lower tax bracket than they are currently.

The standard deduction will double to $12,000 for individuals and to $24,000 for couples.

A tax deduction reduces the amount of taxes you owe by decreasing your total taxable income. For example, if you earned $60,000 in the tax year, the standard deduction of $12,000 would mean that you only owe taxes on $48,000 of what you earned, leaving the $12,000 of the deduction as tax free income.

This will be great for many. It will increase the amount of deductions and will reduce the overall amount of taxes that most taxpayers pay. However, those who itemize their deductions may not receive any benefit if they normally deduct more than the new standard deduction. The two most common items that are deducted are business expenses for small business owners and charitable giving. One criticism of this plan is that there would be less of an incentive to give because it would take a much larger amount of giving before it would become beneficial to accept itemized deductions over the doubled standard deduction.

The same argument can be said about the taxpayers ability to deduct home mortgage interest expenses. This deduction in the past has been an incentive for individuals to purchase homes, reducing the overall cost of debt by allowing the interest paid on your mortgage to be tax free. With the increased deduction, fewer people will be able to take advantage of this savings, and some argue that this may make home ownership less appealing for these individuals. However, it’s not likely that many home buyers have this tax deduction in mind when purchasing their home, preventing this from being a driving factor in the housing market as some argue.

The Alternative Minimum Tax and the Estate Tax would disappear.

These changes would only affect those who either are high income earners or those who have a substantial net worth to pass on to the next generation. Farmers with large amounts of land are a primary example of individuals who could benefit from these new rules. Currently, farms worth roughly $5.5 million are eligible for estate taxes which take almost half of any amount over the $5.5 million. This means that if a farm is worth $10 million it would require roughly $2.25 million in estate taxes to transfer the farm to the next generation. This rule has a great effect on business owners trying to pass their business on to the next next generation. One argument for its removal is that it will incentivize business growth that can be passed on to the next generation. The removal of this tax would be huge to those affected by these rules.

The other tax that will disappear is the Alternative Minimum Tax, which primarily affects those who are higher income earners. While the increase of the standard deduction provides tax relief for the lower and middle income taxpayers, the removal of the AMT and the Estate Tax will similarly decrease taxes for the wealthy.

The corporate tax rate for C-corporations will be reduced from 35% to 25%.

What is the rationale behind this? Why do corporations need to pay less in taxes? On the world stage, many developed countries have lower taxes than the Unites States, so lowering the tax rate would make the U.S. more competitive on a global scale and cause more businesses to locate themselves and pay taxes in the U.S. For S-Corporations, LLC’s and Partnerships the tax rate would decrease to 25%. Currently, taxes are passed through these entities to the individual tax rate which, at times, is higher than 25%. This will make most corporations pay less in taxes than the current system. This tax decrease would anticipate these corporations spending more money on their employees and on equipment and therefore increasing wages and boosting the economy. This could increase the overall prosperity of the country.

Overall, the theme is lower taxes for all. The possible down side of this is that short term gains could lead to long term pain if the economy doesn’t grow to offset the tax revenue that is lost. The success of this tax proposal is primarily and fundamentally dependent upon a growing economic tax base. If this is the case, even though the government may be getting a smaller percentage of the dollars that are produced in the economy, the tax base could grow so that the total number of dollars would actually increase. This is the discussion that is currently taking place and will continue to take place over the next few weeks and months.

Now the chances of this proposal being passed without some compromise does not look good based on Congress’s record so far in 2017. It’s possible, but unlikely. A revised and/or diluted version of the bill that wouldn’t create the same level deficit concerns seems more probable. This would help assuage the more fiscally conservative Republicans and may even be able to swing a few Democrats. Even this is not guaranteed, but it is more probable than the plan as it stands now. Individuals, consumers, and businesses all have a stake and are probably rooting for tax reform of some sort. The question is whether they will be able to get it done and at what long term cost.

MBC/Foundation Bank does not engage in tax advice. Please consult your tax professional for advice specific to your financial situation.