By: Tim Williams
The White House first released its proposed Tax Reform Plan in April, 2017. The initial release was one page and short on details. Following that, the Secretary of the Treasury released more details on the proposed “Trump Tax Plan.”
The Trump Tax Plan would have the most dramatic changes for wealthy individuals, as well as for corporations, both large and small. Individual tax rates for the super wealthy and high income families would drop dramatically. Corporate income tax rates would decrease by 57%.
The following highlights will allow you to roughly estimate the impact of the specific proposals on your personal tax situation if the proposed plan becomes law.
The Trump Tax Plan would replace the current seven personal income tax brackets with three tax rates – 12%, 25% and 33%. The 33% tax rate is lower than the highest marginal rate today – 39.6%. In addition, the 3.8% Affordable Care Act Investment Tax and the Pease 1.3% unlimited Medicare Tax on compensation would be repealed.
Income up to $24,000 would not be taxed. As such, the present standard deduction of $12,000 would double to $24,000. All itemized deductions would be eliminated except for mortgage interest, the charitable deduction, and child care expenses. This will negatively impact taxpayers who have higher itemized deductions in relation to their adjusted gross income.
Several credible organizations have modeled the income tax impact of the Trump Tax Plan at various income levels for married persons filing jointly. It is concluded that, for the majority of the middle class, taxpayers would experience only a slight increase in net Federal Income Tax or no change at all.
Under present law, capital gains are most commonly taxed at 15%. Certain high income taxpayers pay these at a 20% tax rate. Capital gain taxes would be restructured and essentially return to the law as it was prior to Congress implementing a flat rate capital gain tax structure. The capital gain tax would be structured such that one-half of a capital gain would be taxable at the taxpayer’s regular tax rate. So, with the highest personal income tax rate at 33%, the highest capital gains tax rate would be 16.5%. The capital gain tax rate would apply to capital gains, interest and dividends.
The Alternative Minimum Tax would be repealed in its entirety. This is a tax that applies to individuals whose calculated income tax is considered to be below a theoretical “acceptable” composite income tax rate. This normally results from having a disproportionately high percentage of income coming from “passive sources” or from very high itemized deductions.
The Trump Tax Plan would reduce the corporate income tax from 35% to 15% on C corporations. C corporation taxation status is typically chosen by companies that are larger, and thus can handle the income tax burden. These companies pay tax at the company level on their net taxable income in addition to their shareholders paying tax on dividend distributions. It is believed that this change will make America more competitive with respect to attracting and retaining corporations in relation to other western economies.
The Trump Tax Plan calls for S corporations, limited liability companies and partnerships to be taxed at a rate of 15% on flow through income to the shareholders, members or partners. This rate would be payable by the shareholders, members or partners, as opposed to the current rule which taxes S corporation, LLC, or partnership income at the individual taxpayer’s income tax rate. The new structure would create a strong bias towards not paying compensation to the shareholders, members or partners which would be taxed at one of the three new tax rates. If the net S corporation, LLC or partnership income is allowed to “flow through” to the individual shareholder’s Form 1040, as opposed to reporting it as compensation, it will be taxed at a flat 15% rate, as opposed to 12%, 25%, or 33%. In addition, such a payment structure would avoid Social Security Tax of 15.3% to the extent it is not paid as wages.
With the restructuring of the C corporation and S corporation tax structure, there would be a strong incentive for C corporations to elect S corporation status to take advantage of the single 15% tax on net corporate income. Under present law, in order for a C corporation to elect to be treated as an S corporation for tax purposes, one of the key requirements is that the corporation can have no more than 100 shareholders. Thus, that avenue would not be open to large, publicly traded companies.
The estate tax proposal is radical. First, the Trump Tax Plan would eliminate the estate tax. This is a tax imposed on individuals with over $5,490,000 in total assets (adjusted annually), or $10,980,000 for a married couple. Assets over this amount are taxed at 40%.
The Trump Tax Plan would replace the estate tax with a deemed capital gain tax.
Under current law, upon death, any assets owned by the deceased taxpayer are marked up to their fair market value on the date of death. Thus, death transfers do not incur any capital gain taxes if the appreciated asset is sold immediately following death. The Trump Tax Plan would tax the capital gain that is deemed to occur at death whether or not the deceased taxpayer’s beneficiaries have sold the assets. The decedent’s tax basis would be deducted from the fair market value of the appreciated asset, and the capital gain tax immediately payable on the difference.
The capital gains tax would be payable even though the individual has no cash proceeds to pay the capital gain tax. This suggests that if this part of the Trump Tax Plan is enacted, it would make sense for individuals to purchase life insurance on the decedent’s life to pay the tax associated with the deemed capital gain tax. Otherwise, the requirement to pay the deemed capital gain tax would necessitate selling the appreciated asset to pay the tax. This would be particularly harmful if the asset is in a “value through”, such as stocks and securities were in 2007 - 2011.
Congress and the Trump Administration have set December 31, 2017 as the deadline for enacting tax legislation. Please review your specific situation and let us know if there is any aspect you wish to address.