This week will mark a year since the election of President Trump. Since then, much of the buzz around his agenda has been about the possibility of tax reform. Last week we finally got a look at the proposal. Keep in mind that, at this point, it is simply a proposal. No laws have been changed. All we have is a plan from the Republicans in the House. Now we’ll start the process of congressional compromise (or lack thereof) and see how the plan takes shape and if it becomes law.
The purpose of this post is to highlight the major parts of the proposed plan and to point out some potential planning opportunities. It’s important to keep in mind that a lot can change between now and the time the plan becomes law, if it does. Major provisions of the Tax Cuts and Jobs Act could be changed, some could be abandoned, and some could be added. Also, we don’t know yet if the law will go into effect for 2018 or if there will be provisions that we’ll need to address on our 2017 returns. And of course, it might not pass at all.
We should note that this is the first significant proposal for tax reform in 30 years and that any major tax reform will have some folks who lose a deduction or tax credit and will not be happy about it. It’s also important to note that this post will cover only the provisions that will affect most taxpayers on an individual basis. For example, one of the most-talked-about provisions of the bill is the reduction of the corporate tax rate from nearly 35% to 20%. We will not address that provision in this post.
With all those disclaimers out of the way, let’s look at some of the key parts of the proposal.
For individual taxpayers, one of the main provisions of the bill is a near doubling of the standard exemption, from $6,400 to $12,000 for an individual and $24,000 for a married couple filing jointly. If this provision becomes law, it will mean that more income will be tax-free, and estimates are that more than 30 million of us will no longer have to itemize deductions. However, the change does come with a cost. The $4,050 personal exemption goes away. So, a family with a lot of kids could end up worse off, although the increase in the child tax credit from $1,000 to $1,600 will help.
Currently, we have seven tax brackets. The proposed plan squeezes the brackets down to four: 12%, 25%, 35%, and 39.6%. I’ve heard the effects of this provision described as “tax bracket bingo.” Some will be better off; some will be worse off. How you are specifically affected will depend on the level of income and filing status.
To simplify the tax law, several tax credits are going away. They include the credit for the elderly and the disabled, the adoption credit, and the credit for electric vehicles.
Divorce settlements may get a bit more complicated—and contentious. Currently, if your ex-spouse pays you alimony, you have to report it as income, and your ex gets to deduct it from their income. The new law would make the income tax-free to the recipient, and the deduction for the paying spouse would go away. This would go into effect for any divorce decree executed after the end of this year. So, if divorce is in your future and alimony is an issue, you will want to see how this affects you.
Homeownership and the related tax consequences may undergo some major changes. The interest paid on a mortgage on a second home will no longer be deductible, and the deductibility of a mortgage on a primary residence will be limited to $500,000 of debt. Currently, that deduction is available on mortgages up to $1 million. Also, the capital gains treatment of your personal residence may be affected. Under current law, you are able to exclude capital gains up to $250,000 for a single taxpayer, and $500,000 for a married couple, if you lived in your home for two of the last five years before the sale. That will change under the new bill to five of the last eight years. Also, the exemption will phase out for singles who earn more than $250,000 and couples who earn more than $500,000.
The new bill allows parents to use $10,000 a year from a 529 plan to pay for private elementary and high school costs. Currently, the tax-free benefit is only available for college costs.
Another proposal in the bill is to eliminate the deduction for medical expenses. Under current law, those expenses must total more than 10% of your adjusted gross income (AGI). Because of that limitation, very few people can deduct medical expenses.
There are many other parts of the proposed bill that are too specific to address in this post. We simply wanted to point out the ones that could affect the most people. Provisions like the repeal of the alternative minimum tax and the doubling and future repeal of the estate tax and generation-skipping tax are important but do not affect most of us. If you would like to discuss how the proposed changes might affect your personal situation, don’t hesitate to reach out.