While it will take some time to understand all of the effects of the new tax law, and most of it has to do with reducing the corporate tax rate from 35% to 21%, here’s some of what we know that relates to individual taxpayers. But before we get into the details, be aware that almost everything listed below sunsets after 2025, with the tax structure reverting to its current form in 2026 unless Congress acts between now and then. The corporate tax rate cut does not sunset. Here are the principal changes:
- Estate Taxes. If you weren’t worried about federal estate taxes before, you really don’t need to worry now. With the federal exemption already scheduled to increase in 2018 to $5.6 million for individuals and $11.2 million for couples, the Republican’s in Congress and President Trump have now doubled this to $11.2 million and $22.4 million, respectively, indexed for inflation. The tax rate for those few estates subject to taxation remains at 40%. To learn what I really think about this, click here.
- Tax Rates. These are slightly reduced and the brackets adjusted with the top bracket dropping from 39.6% to 37%.
- Standard Deduction and Personal Exemption. The standard deduction increases to $12,000 for individuals, $18,000 for heads of household and $24,000 for joint filers, all adjusted for inflation. Personal exemptions largely disappear.
- State and Local Tax Deduction. Now referred to as “SALT,” this is now subject to a cap of $10,000,
- Home Mortgage Interest Deduction. The limit on deducting interest on up to $1 million of mortgage interest stays in effect for existing mortgages. New mortgages taken on after December 15, 2017, are subject to a $750,000 limit. The deduction for interest on home equity loans disappears.
- Medical Expense Deduction. After much outcry in response to the House version of the tax bill which would have elminated the medical expense deduction, it survived. And, in fact, in was enhanced by permitting medical expenses in excess of 7.5% of adjusted gross income to be deducted. Under existing law only expenses in excess of 10% were deductible.
- Alternative Minimum Tax. This survived, but exemption amounts have been increased, though they phase out for individuals with income in excess of $500,000 for individuals and $1 million for couples filing jointly. If you don’t understand how this works, I can’t help you; I don’t either.
- Pass-Through Entities. This is incredibly complicated. If you receive qualified business income from a partnership, S corporation or sole proprietorship, you get a deduction of 20% of your “qualifiied business income,” which does not include your compensation for working in the business. In addition, if you’re in a profession, such as doctor, lawyer, architect or accountant, and your income exceeds $157,500 for individuals and $315,000 for couples there’s a complicated formula that limits your deduction. Click here for an article in Forbes that gives some examples of how these calculations should work. These limitations do not apply to non-service industries, such as President Trump’s real estate empire. These changes, supposedly, are meant to give small businesses the same tax cut being given to large businesses. But I don’t get it. A corporation pays taxes on income it earns and then it’s employees pay taxes on their salaries and stockholders pay taxes on their dividends. Small business owners (and owners of large ones, like the Trump family) only pay once, for the business income. It’s not clear why owners should be treated more favorably than employees. If you can explain this, please respond.
- Carried Interest. This is the loophole that permits hedge fund owners and employees to pay capital gain tax rates rather than income tax rates on their income. They get to keep this preferential treatment.
- 529 Plans. These accounts permitting tax free accumulation of capital gains and dividends to pay college expenses can now be used for private school tuition of up to $10,000 a year.
So, what does all of this mean? Depending on your income and the amount of state and local taxes you have been paying, you may get a small tax cut. If you receive pass through income, you may get a large tax cut, especially if you do not work as a service professional. For everyone else, the changes should be relatively small. The bigger question is how are we going to pay for the projected reduction in tax revenues of $1.5 trillion over the next ten years. This amount may simply be added to the deficit. It may squeeze out other spending, such as investment in infrastructure. And House Speaker Paul Ryan may well use it as justification for his anticipated proposals for entitlement “reform.”