House Republicans unveiled a first draft of the Tax Cuts and Jobs Act last week, offering a glimpse into the direction tax reform discussions are likely to take over the next several months.
In short, the biggest winners would be large corporations, taxpayers who don’t take lots of itemized deductions and large estates passed along to heirs. The highest earners also would benefit.
But a lot could change between now and the time a tax reform package reaches Congress for a vote and the President’s desk for a signature. With that in mind, we offer this brief overview of the House bill as it stands today, with a focus on changes that could impact our clients.
The underlying premise of the GOP’s tax plan is that a lower corporate tax rate will spur the US economy, create jobs and improve the average American worker’s standard of living. US corporations would pay a flat income tax rate of 20%, down from the current maximum of 35%, and smaller pass-through entities such as family-owned businesses that operate as sole proprietorships, partnerships and S corporations would pay a maximum rate of 25%, down from 39.6%.
The GOP’s proposal also attempts to encourage capital spending by allowing companies to immediately deduct 100% of their expenses for qualified property that is purchased between September 27, 2017 and January 1, 2023. Any dividends a business receives from an overseas subsidiary could also be deducted as long as the company owns 10% or more of the foreign corporation. US corporations also would be required to bring accumulated foreign earnings back home to the US—a practice known as repatriation—at a special tax rate of 12% for cash and equivalents and 5% for illiquid assets. Businesses can elect to make this liability payable over the course of eight years.
Another common refrain among proponents of tax reform is that the US tax code is unwieldy and overcomplicated. The GOP attempts to address this criticism by reducing the number of individual tax brackets from seven to four (12%, 25%, 35%, 39.6%).
In general, it appears that most Americans would see a tax rate reduction, but the bill is especially generous to taxpayers who are subject to the current maximum rate of 39.6%. While that top bracket remains in effect, it would apply to individuals earning over $500,000, up from $418,400, and married couples with income exceeding $1 million, almost twice the current threshold of $470,700. The alternative minimum tax would be repealed.
On the other hand, most taxpayers who are now in the 33% tax bracket would be bumped up a notch into the 35% bracket. Qualified dividend income and long-term capital gains generally would be unaffected by the new tax proposal. Both would continue to be taxed at 0%, 15% or 20%, depending on individual circumstances. The bill does not address the Obamacare surcharge, which is a 3.8% tax on net investment income over a certain amount, or the 0.9% additional Medicare withholding tax on earned income that exceeds certain thresholds.
While it appears that tax reform will materialize in some form or fashion, the plan unveiled by House Republicans represents only the first step in what could be a long, contentious legislative process. Tax reform is an ambitious undertaking and hasn’t been changed to the extent proposed here in more than 30 years.
The GOP’s bill now goes to the House Ways and Means Committee for markup, then to the entire House of Representatives for a vote. The Senate Finance Committee is also drafting its own tax reform legislation, but it is unclear how that proposal might differ from the House bill or when it might be formally introduced.
How Can You Prepare for the Changes that Might Be Coming in 2018?
In line with our traditional approach to tax planning, consider:
1. Postponing income. If possible, delay bonuses or commissions that might be taxed at a lower rate in 2018.
2. Accelerating any itemized deductions. Taking deductions this year may reduce your 2017 tax bill, especially if those deductions are not allowed in 2018. For example, if you expect to pay fourth quarter 2017 state income taxes in January, or a state tax balance due in April, consider pre-paying those amounts. But be mindful of the alternative minimum tax (AMT), which remains in effect this year.
3. Setting up or contributing to a donor advised fund. If you are looking to move charitable contributions you otherwise would make in 2018 into 2017, consider a donor advised fund. Contributing some or all of the additional income to a donor advised fund could allow you to take an immediate charitable deduction for the full amount, subject to income limitations, and provide you with the flexibility to make recommendations on how those funds should be distributed to charity in future years.
If you have questions about tax reform and how it might affect your estate plan, please reach out to your Fiduciary Trust representative. We will continue to monitor developments in Washington and provide more specific guidance as the process unfolds.
Craig Richards, CPA/PFS, CFP
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