Keep It Simple
Last week we considered how President Trump's and the House of Representatives' corporate tax policy could indirectly affect your personal taxes. This week, we consider the direct effect of individual income tax policy.
The theme is simplification, but the approaches are different. Trump's plan compresses tax brackets but does not simplify many other aspects. The House plan truly is simplification, to the point where many taxpayers' forms could fit on a standard postcard.
Trump would simplify tax rates from the current seven brackets to three brackets: 12%, 25%, and 33%. The threshold values would be $75,000 (25%) and $112,500 (33%) for single taxpayers, and twice that for married filing jointly (MFJ).
Winners and losers are spread throughout the bracket because of the difference in Trump's threshold values and current law. The higher 33% bracket would apply to more people, increasing taxes for singles making between $112,500 and $191,650 but providing a significant break for those making above $416,700. Trump also intends to repeal the Alternative Minimum Tax (AMT) that limits tax benefits for higher earners.
At the other end of the scale, singles making $9,325 or less will see their bracket increase, while those earning between $9,325 and $75,000 will see a tax cut — especially those between $37,950 and $75,000 who will see their rate drop from 25% to 12%.
With respect to rates, the House agrees with Trump's rates of 12%, 25% and 33%, but the thresholds for the 25% rate and 33% rate are left as is. Only the current 10% bracket will be adversely affected.
Under Trump's plan, itemized deductions would be capped at $100,000 for singles, $200,000 for married filing jointly. It's not clear if all deductions would survive and be subject to that limitation, or if exceptions will exist.
For those choosing the standard deduction, it's a good news/bad news situation. Trump would greatly increase the standard deduction from the current $6,300 single/$12,600 MFJ to $15,000 single/$30,000 MFJ, but would eliminate all personal exemptions (currently $4,050). Lower income, single parents may struggle, especially those with more than one child, and Trump's proposed child-care credit and Dependent Care Savings Account (analogous to a Health Savings Account, or HSA) are unlikely to bridge the gap.
The House eliminates most itemized deductions but retains mortgage interest and charitable contributions. Those would become "above the line" deductions that subtract directly from taxable income. The House plan would also retain contributions to certain savings plans as an above-the-line deduction.
Conversely, there are three tax credits in the House plan that can subtract directly from your tax bill: a child credit, earned income credit (EITC), and higher education credit. The EITC and child credit ($1,500 per child) blunt the effect of a higher tax rate on low-income Americans.
Investments And Capital Gains
With respect to capital gains, Trump prefers to keep the existing 0%/15%/20% brackets but align them with his threshold brackets on income. As with income tax, a block of taxpayers in the lower six-figure income range will see an increase in their capital gains taxes.
The House takes a different approach by aligning the capital gains and dividends brackets with the income tax brackets of 12%/25%/33% while allowing taxpayers to deduct 50% of their investment income as an above-the-line deduction. This deduction, combined with a 50% deduction of interest income, should result in an effectively lower capital gains tax rate for all.
Both Trump and the House propose that unincorporated business income be taxed at a lower flat rate, with Trump proposing 15% and the House proposing 25%. With such a huge differential between the 33% bracket and the 15% flat tax, there's great incentive for this income to be reclassified as "pass-through" business income instead of wages — essentially making us a nation of self-employed contractors. Stay tuned, as both approaches are short on details.
Both plans are designed to lower taxes across the board, but there are winners and losers spread throughout the income brackets, and overall those with higher incomes look like clear winners. Both plans are also likely to produce huge deficits without significant growth; hopefully, the rosy predictions for tax-cut stimulus come true and prevent an explosion of federal debt. It seems unlikely, but if Donald J. Trump can be elected President, clearly nothing is beyond this great country of ours.
We can't predict what the final tax plan will look like, but we can make one prediction with certainty with respect to Trump and taxes: we will never see him release his personal tax returns. Never, never, never.
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