While no tax reform is ever final until the president signs it into law, it seems increasingly likely that congressional Republicans will enact some significant tax changes soon.
As of this writing, both the House of Representatives and the Senate have passed tax reform bills. The two pieces of legislation have yet to be reconciled through the conference committee process, so it is not entirely clear which provisions will make it into the version that arrives on President Trump’s desk.
For taxpayers, all this uncertainty can be unnerving. After all, good tax planning happens with an eye to the future, and when a major shift in taxation is imminent, it can feel as if planning grinds to a halt. But taxpayers can consider the most likely of these changes now without succumbing to either panic or pressure.
The full impact of the Senate bill would be beyond the scope of this article; the text of the proposed legislation is nearly 500 pages long. The biggest change for most individuals, at least in the short term, will likely be the new set of individual income tax brackets. This is one area where the House and Senate bills significantly differ, though we can be reasonably sure that the final result will impose some reduction in rates across the board.
The House bill proposes reducing the number of individual income tax brackets from seven to four. The Senate bill preserves the seven existing brackets, but cuts tax rates for all of them. The Senate also raises many of the thresholds at which taxpayers move up to the next bracket, and reduces the top marginal rate from 39.6 percent to 38.5 percent.
One of the biggest pieces of the puzzle for taxpayers trying to engage in long-term planning is the duration of these cuts. The Senate bill sunsets individual tax cut provisions after 2025, largely to control projected effects on the national deficit. The House bill makes most of its changes permanent.
Both bills also approximately double the standard deduction. Under the Senate bill, the standard deduction will become $12,000 for individuals and $24,000 for married couples filing jointly. The House bill pegs these amounts at $12,200 and $24,400, respectively. Both bills get rid of the personal exemption taxpayers can currently claim for themselves, their spouses and each dependent, though the child tax credit is increased from $1,000 to $1,600 in the House bill and to $2,000 in the Senate version.
For many taxpayers, the change to the standard deduction will represent a major adjustment to the way they approach their income taxes, making the threshold for usefully itemizing deductions much higher. Those who do still itemize, however, will likely find that many of the deductions they are used to have vanished. For example, both bills eliminate deductions for state and local income taxes, as well as sales taxes, a major concern for taxpayers in high-tax states like California or New York. In addition, while property taxes remain deductible, both bills cap such deductions at $10,000.
The mortgage interest deduction, a long-standing sacred cow, escaped outright destruction but will likely face new limitations. Current law allows taxpayers to deduct qualifying mortgage interest on up to $1 million of debt, plus an additional $100,000 for equity debt, on a primary residence and one additional home. The House plan would grandfather in current mortgages, but would cap deductible mortgage interest for new ones at $500,000 and would restrict the deduction to only a primary residence. The Senate version does not reduce the $1 million cap, but eliminates the deduction for equity debt outright. Depending on which of these versions makes it through the conference committee, and in what form, these provisions could create major changes for homeowners.
Both houses of Congress left the charitable deduction in place. And while the House bill eliminated the medical expense deduction, the Senate bill preserved it, even expanding it slightly for tax years 2017 and 2018 by applying it to expenses over 7.5 percent of adjusted gross income, rather than 10 percent as under the current tax code.
Other than the deductions I have discussed, however, congressional Republicans are poised to eliminate most other itemized deductions. Deductions for moving expenses, tax preparation expenses and unreimbursed employee expenses are all set to vanish, among others. Legislators also took aim at some above-the-line deductions, which are deductions you can take even if you don’t itemize. Most of these will also go away, though the Senate preserved the deduction for student loan interest that the House eliminated. The Senate also preserved the deduction for tuition waivers for graduate students removed in the House tax bill.
While many individuals are most eager to understand tax reform’s impact on their personal income taxes, arguably the biggest focus of the GOP’s plan is corporate taxation. Both bills reduce the top corporate rate from 35 percent to 20 percent; the major difference is whether this change is immediate or delayed until 2019. Either way, the change is set to be permanent, a major win for businesses subject to corporate income tax.
Another major victory for corporations comes in the form of an overhaul to the treatment of multinational ventures. The formerly worldwide tax regime will shift to a territorial system, where U.S. companies will pay tax only on profits earned in the United States. Congress will also encourage multinational companies to bring back assets they have held abroad through a one-time repatriation tax, around 14 percent for liquid assets and 7 percent for illiquid assets, though the exact figure will need to be reconciled in committee. It is clear that congressional Republicans are eager to make the U.S. tax regime more competitive in a globalized economy.
There is less clarity about how Congress will ultimately treat pass-through business entities, such as limited liability companies and partnerships. The House plan sets a 25 percent taxation rate for pass-through business income, which is usually subject to the owner’s income tax rate. The Senate took a different approach; instead of adjusting the business income tax rate for pass-throughs outright, the Senate bill allows owners of pass-through entities to deduct 23 percent of business income, subject to certain limits. In both instances, these benefits do not apply to “professional service” businesses; lawyers, architects and a variety of other professionals will not see the benefits of whichever system makes it into the final legislation.
Going into the tax reform process, both the estate tax and the alternative minimum tax (AMT) were particular targets for lawmakers. At this point, their respective futures are unclear. Both the House and Senate bills raised the estate tax exemption from about $5.5 million to $11 million for individuals (and from $11 million to $22 million for married couples), but the House plan goes further, eliminating the estate tax entirely in six years. Raising the exemption so sharply means that even fewer taxpayers will have to worry about the estate tax at all, with obvious implications for a variety of estate planning techniques designed to provide tax shelter.
The House bill also eliminated the AMT outright. The Senate did not go so far. Instead, it left the AMT in place, effectively unchanged for corporations and with an increased threshold for individual taxpayers. Again, even if the AMT does not vanish, it seems likely that far fewer individual taxpayers will need to factor it into their tax planning.
A provision of the Senate bill that made many headlines was the elimination of the individual mandate for health insurance, a major provision of the Affordable Care Act. It seems unlikely that this provision will raise sufficient objection from House Republicans to risk elimination in committee. While this change may have large ramifications in health care policy, the existing tax penalty for not having health insurance is a relatively small amount – meaning that while it may create a variety of financial and insurance planning issues, it is unlikely to mean a radical change to anyone’s tax picture specifically.
Both versions of tax reform also include a variety of miscellaneous provisions. One potentially major example is a proposed change to 529 savings accounts. These plans have, to this point, been earmarked for the cost of higher education only. However, both tax plans propose allowing parents to use 529 funds for tuition at private K-12 schools as well. The Senate version goes even further, allowing some home school expenses too. While the details are still in flux, this change could represent a major shift in planning for educational expenses.
Another change with potentially wide application is a modification to taxes on selling a primary residence. Under the current tax regime, sellers can exclude up to $250,000 in capital gains on the sale of their home if they have lived in it for at least two of the past five years; the new law is poised to change this requirement to five of the past eight years instead.
One major change that did not arrive in the GOP’s tax plan: a value-added tax, or VAT. Some observers thought this overhaul might incorporate such a change, but neither bill included it.
As my colleague Rebecca Pavese observed in late 2016, the basic principles of tax planning will not change any time soon. Good recordkeeping and thoughtfully considering the timing of income you can accelerate or delay will remain important, regardless of what’s ahead. And for many taxpayers, the prospect of a much higher standard deduction means that planning may become much simpler in the near future.
For the time being, however, most taxpayers should remain calm and wait to see what final form tax reform will take, now that it seems likely it will arrive in one guise or another by New Year’s Day.
