Written by Glen E. Frost of Frost and Associates
Follow along as DC tax lawyer Glen Frost details the different proposed tax law changes and how they can impact you and your firm.
Donald Trump has proposed to make several tax law changes now that he has entered office. It’s important to examine the possible tax changes that could result from this new plan. Making you more aware of the potential advantages and disadvantages to you and your firm.
Trump’s proposed tax plan consists of replacing the current seven tax brackets with only three: those making under $75,000 would have a 12% tax rate, those making at least $75,000 but less than $225,000 would have a 25% tax rate, and anyone making more than $225,000 would be taxed at a maximum rate of 33%.
Overall, the new tax brackets would lower taxes for everyone. This change will also eliminate the net investment income tax which was an additional 3.8% tax on certain taxpayers.
For people with an individual retirement account (IRA) or a 401K, the lowered taxes could make pre-tax retirement contributions less valuable. When you make a pre-tax IRA contribution you can use the amount you contributed as an income tax deduction. The retirement account holder will be taxed on any money taken out of the account, with an added 10% penalty fee if any money is taken out prior to the owner reaching 59.5 years old.
Now, because in the new plan, overall income tax would be lowered, the benefits a person could receive from deducting IRA contributions would not be as great.
A Roth IRA or a Roth 401k contribution, on the other hand, could have a higher value under the Trump tax plan.
Unlike the pre-tax contributions to an IRA or 401k, Roth contributions are made with after-tax funds. If an owner of a Roth IRA is over 59.5 years old and the account has been opened for at least 5 years, a distribution can be taken without tax, otherwise, early withdrawals are subject to taxation as well as a 10% penalty fee.
Under the Trump tax plan, the overall lower tax environment means that fewer taxes would be initially deducted, giving the Roth IRA greater value.
The new plan intends to replace the current standard deduction of $6,300 for single filers and $12,600 for married filers with a new standard deduction of $15,000 for single filers and $30,000 for married filers.
Due to the standard deduction increasing, this means that fewer people will need to itemize deductions. Some people choose to buy rather than rent. This way they can use this as an itemized deduction to receive a tax break. But due to the increased deductions, people may now not have an incentive to buy as opposed to renting and this could affect the taxing market.
This is also the same with the benefit of charitable giving. With such a high standard deduction, the incentive for giving, is in turn, reduced. Trump’s proposed plan will also create a cap on all itemized deductions. This cap would prevent singles from deducting more than $100,000 and limit couples to no more than $200,000. This cap will only affect a small number of taxpayers but will raise millions of dollars per year for the government.
Eliminating Certain Taxes
The new plan would also eliminate the Net Investment Income Tax, which currently applies at a rate of 3.8% to certain individuals, estates and trusts whose incomes above certain threshold amounts ($250,000 for married filing jointly, $125,000 for married filing separately, $200,000 for single filers, $200,000 for heads of households, and $250,000 for qualifying widow(er)s with dependent children).
Trump’s plan also proposes to eliminate the Alternative Minimum Tax, which uses a separate tax calculation for certain people; disallowing many of the common tax deductions such as children or other dependents. There is no specific threshold at which the Alternative Minimum Tax is applied, but those making between $200,000 and $500,000 seem to be the most vulnerable to this requirement.
The new plan will introduce an additional deduction for taxpayers with children. This deduction will be capped at the average cost of care for the state of residence, although anyone under the threshold can utilize the deduction whether they use childcare or not. Individual filers earning more than $250,000 will not be eligible for the deduction, joint filers are capped at $500,000. It will also offer child care spending rebates to lower-income taxpayers through the Earned Income Tax Credit (EITC).
Trump’s plan will also eliminate estate tax which will benefit families inheriting money.
Under the new plan, carried interest would be taxed as ordinary income.
Carried interest is the income of general partners of private investment funds (for example a hedge fund) and is currently taxed at the preferential capital gains rate. This change will increase the tax for partners because that income will now be taxed as ordinary income, putting them in a higher tax bracket.
Corporations currently pay a 35% tax rate, and Trump’s plan is to reduce this to 15% but he would also eliminate most business deductions. Trump has also suggested that LLCs, partnerships and S Corporations should pay a 15% tax rate as well, which is a decrease from the current tax rate. For people with overseas profits, this plan would also include a 10% one-time repatriation tax on profits of foreign subsidiaries of U.S companies. Trump’s goal is to make funds flow back to the U.S by using this repatriation tax.
Overall, taxpayers should be aware of the lower income tax brackets, the reduced standard deductions, and the tax rebates they could receive for childcare.