We’re just months into Donald Trump’s presidency, but I think we already can agree it’s going to be an interesting four years.
Based on his tax plan, a first draft of which was released on April 26, one thing we probably can count on is that our tax structure will go through some changes. The plan calls for a reduction in tax brackets from the current seven down to three: 10%, 25% and 30%. And it proposes to eliminate the dreaded alternative minimum tax.
Those proposed changes — and any others that may come with this administration — could have a big effect on annual tax returns and retirement investment plans. So, of course, people are curious about how they should prepare.
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Here are five of the questions I’m most often asked about possible tax changes.
1. Will contributing to my 401(k) become less valuable from a tax perspective if Trump succeeds in restructuring the current tax bracket system?
It’s something to look at if you think you will end up moving into a lower tax bracket. But remember, your bracket may be lower in retirement than it is now or will be even with Trump’s changes. Also, your 401(k) earnings grow faster because they’re tax-deferred. And if your employer offers some kind of match, you don’t want to miss out on that money. Plus, Trump may be president for only four years, which means those lower rates could be short-lived.
2. How would the proposed cap on itemized deductions impact higher-income earners?
It could effectively neutralize any reduction in marginal tax rates, but only for very high earners. According to Howard Gleckman of the Tax Policy Center, singles and couples who make $1 million or more could take a hit with the $200,000 cap (though some individuals making less also would lose some deductions).
One really significant proposal that would benefit some higher-income earners would be the elimination of the alternative minimum tax. Those who live in higher-tax states, or who have stock options or other alternative minimum tax preference items, would no longer have to pay the non-graduated alternative minimum tax rates on their income.
3. Does a Roth 401(k) make more sense than traditional retirement plans?
That is largely an individual choice as it involves taking a realistic look at the tax bracket you’ll be in when you retire. I usually recommend focusing on the net after-tax cost of the account. If you believe the assets will appreciate substantially, the Roth is the better option because those gains are exempted from additional tax. If you don’t anticipate significant gains, or you’re able to plan your income to maintain a lower marginal tax rate, then a traditional non-Roth approach may be advantageous. The deduction now, under higher marginal rates, slightly favors the non-Roth option. But in my experience, it is really an individual choice based on your personal circumstances.
4. How would the removal of the 3.8% Medicare surtax affect returns for wealthier investors?
It will increase their net after-tax return on assets and income subject to the surtax. There would be less planning involved with respect to income timing, as well as the type and timing of income or sales from their holdings.
5. How would Trump’s plan affect long- and short-term capital gains?
Trump’s proposals would not change the current rate structure for long-term capital gains; however, short-term capital gains, which are taxed at ordinary marginal income tax rates, would be reduced to reflect the new marginal rate structure.
At this point, it’s difficult to know if or when Trump’s tax proposal will become a reality. Still, there’s a chance his proposals could become policy, so plan to meet with your tax adviser now to talk about what these changes would mean to you.
Bruce Willey, JD CPA, and Kim Franke-Folstad contributed to this article.
The above article does not constitute tax advice, and is for informational purposes only. Consult a tax adviser before attempting any tax strategy.
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