By Steve Horn, CPA and Tax Partner
It is no secret that tax reform is one of President-elect Donald Trump’s top priorities. It’s still too early to tell how his proposals will fare versus the ones put forth by House Republicans, but rest assured there will be changes. This uncertainty makes year-end tax planning for 2016 even more challenging than usual, but not impossible. Below is a brief discussion of what reforms we might see and some planning ideas to consider.
Ordinary Individual Tax Rates: Both Trump and House Republican plans reduce the number of brackets to three: 12%, 25% and 33%.
Capital Gains and Dividend Tax Rates: Trump’s plan would retain the current 15% and 20% maximum rates. The House plan would tax gains at ordinary rates but only 50% of long-term gains would be taxable.
Taxes Eliminated: Both Trump and the House propose eliminating the Alternative Minimum Tax (AMT) and the 3.8% surtax on Net Investment Income.
Itemized Deductions: Trump’s plan would cap overall itemized deductions at $200,000 for joint filers and $100,000 for single. Contributions of appreciated assets to private foundations might be further limited under Trump’s plan. The current House plan does not have a cap or phase-out, but it would eliminate all itemized deductions except mortgage interest and charitable contributions. While AMT would be eliminated per above, the loss of many deductions arguably puts everyone in an AMT-looking tax posture.
Estate and Gift Taxes: Both Trump and the House would eliminate the estate tax. However, Trump’s plan proposes to tax capital gains on the owner’s assets at death. Single filers would get a $5 million exemption and married couples filing jointly would get a $10 million exemption. Presumably, if capital gains taxes are paid, the basis of those assets in the hands of the survivors would be stepped up to their fair market value. Otherwise under the House plan, there would be carryover basis. Neither plan addresses gift taxes.
Other: The head-of-household tax-filing category and personal exemptions would be repealed under both plans. Single filers earning less than $15,000 and married earners filing jointly with incomes under $30,000 will owe no income tax under Trump’s plan due to increased Standard Deductions. These thresholds are lower under the House plan.
Corporate Tax Rates: Trump’s plan would drop the top corporate tax rate from 35% to 15% while the House plan would impose a 20% top rate. However, Trump would eliminate all credits except for research and development, and eliminate most businesses expenses. Businesses could elect immediate expensing of all capital investments or the corporate interest deduction, but not both.
Pass-Through Entities: Owners of pass-through entities such as LLCs, S Corporations and sole proprietors could elect to have their pass-through income taxed at the flat rate of 15% instead of at potentially higher individual income tax rates. Pass-through entity owners who elect the flat rate would have the distributions from their businesses taxed as dividends.
Overseas Income: Trump’s plan would impose a one-time 10% tax on deemed repatriated corporate profits now held offshore, payable over 10 years. The House plan would tax such cash profits at an 8.75% rate. Also under consideration is a territorial system of taxation rather than taxing U.S. taxpayers on their worldwide income.
Timeline and Impact
Congress convenes January 3rd and the President-elect is inaugurated on January 20th. Mr. Trump has indicated an aggressive agenda during his first 100 days in office, including tax reform, and staffers are already working on language for some of the possible tax law changes. Still, we don’t expect to see any kind of legislation until early summer. Whether some of these changes are made effective in 2017 and retroactive to January 1st is anyone’s guess at this point.
Businesses and high-net-worth individuals with high ordinary income are likely to benefit more from these proposals than the average American household. Some taxpayers may actually pay more taxes after these reforms. You would have to “run the numbers” to determine how the changes might affect you and your family.
The U.S. economy will likely continue to expand at a moderate pace, supported mainly by solid private consumption. This view is evidenced by the Federal Reserve’s moderate increase in interest rates and pledge for more hikes in 2017. But many are concerned about how these tax proposals would be paid for and the impact they would have on the U.S. deficit and national debt.
Given the uncertainties and impact of tax reform, typical end-of-year tax planning strategies would apply again this year for most taxpayers. Those generally would include:
- Deferring income and accelerating expenses for cash basis businesses.
- Purchasing business assets before year-end to take advantage of the Section 179 expensing election and bonus depreciation.
- Deferring capital gains on sales of stocks and other assets and harvesting unrealized capital losses to offset already-realized capital gains.
- Taking advantage of one or more of the many retirement vehicles available.
- Paying state income taxes before year-end, if beneficial, but with a special eye on AMT since state taxes are not deductible for AMT. The dilemma is that if tax law changes take effect in 2017, there might be no state tax deduction for regular tax purposes but there might not be any AMT, either.
- “Bunching” certain expenses such as medical expenses into 2016, if doing so will put you over the limits to enable a tax benefit. Again, medical expenses might not be deductible at all in 2017 for individuals.
- Funding charitable contributions before year end, and in particular donating appreciated securities rather than cash to reap the benefit of the same charitable contribution deduction, subject to certain limitations, without recognizing the gain on securities for tax purposes.
- Avoid making taxable gifts that will incur gift taxes until we see whether the gift tax gets repealed.
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There are other year-end strategies that might be more specific to your situation. If you have any questions or if we can help in any way, please contact us. In the meantime, we will continue to monitor the tax impact of what goes on in Washington.