Donald Trump rode into the White House on a wave of campaign promises, including a complete reform of the U.S. tax code. It has been three decades since the tax code has been through any major reform, enough time for it to reclaim its status as one of the most complex and voluminous tax systems in the world.
There is fairly broad consensus that it is time again for significant tax reform, and Trump has introduced his much-anticipated proposal. Although it is very short on details, and it is certain to go through several iterations before it is voted on, we can at least see the direction he is taking and the potential impact it could have on our pocketbooks.
Fewer Tax Brackets
The first place to look is the tax brackets, which have been reduced from seven to three — 10%, 25% and 35%. While this is certain to simplify tax filing, it is unclear how it translates into tax savings. We won’t know until more details emerge on the income ranges within the brackets.
Doubling the Standard Deduction
The larger impact would come from the doubling of the standard deduction. For joint filers it would double from $12,700 to $25,400. That means a married couple would owe $0 in taxes on their first $25,400 in income. For itemizers, many of whom would have a hard time coming up with enough deductions for the $25,400 threshold, it greatly simplifies the process.
The plan would further simplify matters by eliminating all deductions except mortgage interest and charitable donations. The deductions for state income and sales taxes are also eliminated, which could hurt high earners in states like California and New York. However, for most people, the higher standard deduction would offset the loss. The plan would keep the favorable tax treatment of 401(k) and IRA contributions.
The proposed plan would do away with a major tax headache — the Alternative Minimum Tax — which has been the scourge of an increasing number of taxpayers. It was designed to make sure the wealthy paid their fair share, but over the years it has spread down the income ladder to earners now considered middle income. For higher earners, eliminating the AMT would reduce taxes on certain items; for everyone it will simplify their taxes.
Eliminating Estate Taxes
Throughout his campaign, Trump specifically targeted the “death tax” for elimination. Currently it is a 40% tax on estates valued at more than $11 million for married filers. While this would affect only 0.2% of taxpayers (opens in new tab), it would be a huge relief to the farmers and business owners who would otherwise face liquidation in order to pay the tax.
Cut the Corporate Tax Rate
Trump’s rant on high corporate taxes was a centerpiece of his campaign. Now, the reduction of the corporate tax from 35% to 15% is the centerpiece of his proposed plan. This should be good for business growth and the economy.
For Small Businesses, Too
While retirement investors may see a boost in dividends from businesses growing due to lower corporate taxes, the impact on individual taxpayers is probably negligible. However, for individual business owners who operate as a pass-through entity, such as a sole-proprietor or partnership, the corporate tax reduction to 15% also applies. Many business owners could see their tax rates cut by more than half, which would be a huge boon for entrepreneurs and small business owners, and it could spur the economy.
I’m not an economist, I’m a financial adviser, so I won’t address the impact of the president’s plan on the deficit or the national debt. The details are still very sketchy. But from what I can see, there is a lot of simplification and elimination, which is almost always a good thing for clients and investors.
I wouldn’t rush out to change your W-4 withholding. How this plays out on Capitol Hill is far from certain. But there is expected to be tax relief across the income spectrum, and that would be a good thing in my book.
Woodring is founding partner of San Francisco Bay area Cypress Partners, a fee-only wealth consulting practice that provides personalized, comprehensive services that help retirees and busy professionals to enjoy life free of financial concern.
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