Our Thoughts on the New Tax Bill
New Changes To The Tax Code
With the Senate passing tax legislation early Saturday morning, the prospect of tax reform is now one step closer to being signed into law. With both the House and Senate each having passed their own versions of legislation, it is expected that there will be a formal committee to merge the two bills. While we do not know what the final terms will look like, we do know that there is a lot of confusion regarding the legislation. It seems that almost everyone has some form of opposition to the plans, but the broad strokes from an individual standpoint seem to be that most middle-class taxpayers and small businesses will get a tax cut, while high-income residents in high-tax states like New York and California will probably see an increase.
Both the House and Senate versions have some similarities, such as limiting itemized deductions of mortgage interest, charitable contributions, and property taxes, but there are also significant differences. THIS ATTACHMENT compares both plans in more detail, but these are what we would consider the most important provisions for individuals.
The House plan aims for simplification of the tax brackets, from the current seven to the four below. The Senate plan keeps most of the original brackets in place but lowers the thresholds.
|12%||up to $45,000||$90,000|
|39.6%||above $500,000||above $1,000,000|
The personal exemption deduction will be eliminated, but the standard deduction will increase from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples.
State and local taxes will no longer be able to be deducted from your Federal return under the House plan. This will be a major hit on clients in high-tax states such as California and New York, but will have a much smaller effect on residents of Texas. State and local property taxes will still be deductible, but with a limit of $10,000. The Senate plan eliminates this property tax deduction completely.
The mortgage interest deduction will be limited to interest on a $500,000 loan value on newly purchased homes. Those who currently have a loan above this threshold will be grandfathered. This will have repercussions on real estate values in higher property value areas in the higher tax states such as New York, California, Connecticut, and Illinois.
Student loan interest deduction is eliminated under the House plan. The Senate plan leaves this deduction intact.
Estate Tax exemption will double to $11.2 million. This is scheduled to be completely repealed in six years, but it affects a very small percentage of Americans and could likely be extended again.
What Can You Do Now?
While it is usually not a good idea to make big changes in the face of uncertainty, there are some things that you can do now that may protect against some likely changes coming in 2018, regardless of what’s included in the final bill. You should start planning now and consult with your tax advisor to determine the best course of action for your circumstance. However, the following are things that should be considered:
Accelerate Itemized Deductions That Are Scheduled for Elimination – The itemized deductions that are targeted for elimination or may be limited under these bills include state and local income tax, property tax and medical expenses. Accelerating these into 2017 may provide a benefit that may go away in 2018.
Accelerate Potential Income – You should also consider accelerating income that would otherwise be recognized in 2018 or 2019, as the benefit of the state income tax deduction in 2017 may result in a lower overall tax bill.
Recognizing Tax Losses Prior to Year-End – Taxpayers may benefit from recognizing losses in 2017 while the current rules regarding assignment of cost basis are still in place. The Senate bill would require a first-in, first-out method of assigning cost basis for sold securities. This may limit the availability of tax loss harvesting, since identification of specific tax lots for capital gains purposes would no longer be allowed. There appears to be no detrimental effect for taking capital losses this year because they can be carried forward indefinitely to shelter future gains.
Consider Delaying Gifts That Incur Gift Tax Until 2018 – If you are considering making any wealth transfers that may result in a gift tax liability, you may want to delay these gifts until 2018 to capitalize on the increased gift exemption. This doesn’t include gifts that won’t cause a gift tax liability, such as annual exclusion gifts, gifts that are covered by the existing $5.49 million gift exemption, gifts covered under the unlimited spousal exclusion, or unlimited tuition or medical gifts. Since the increased gift exemption is included in both versions of the bill, it makes sense to delay gifting, and waiting until next year may prove beneficial from a total tax perspective.
The uncertainty regarding these potential changes, and what will ultimately be included in the definitive version of the bill are concerning to many of our clients. However, we believe that understanding how these potential changes will affect your personal and investment income and having a plan to deal with these changes will minimize any potential damage. You can get an idea of how your taxes will be affected under each version by using this “tax estimator” at https://www.marketwatch.com/story/the-new-trump-tax-calculator-what-do-you-owe-2017-10-26?link=MW_latest_news. While the ultimate bill will probably be different, it should give you a reasonable estimate.
Effect on Investment Portfolio
While these changes will affect each of you differently depending upon your individual circumstances, the changes to the tax code for corporations will be more universally felt in the investment markets. Overall, we feel that these changes will be beneficial for equities, but the changes will not be felt across the board.
Some of the highlights of the corporate changes are as follows:
Corporate Tax rate reduced to 20% from a current top rate of 35%. While many large corporations pay less than the top rate, this change will help many smaller businesses. Treatment of pass-through income for small business and changes to the expensing of capital investment will ultimately help smaller business owners and contribute positively to economic growth.
Corporations with offshore earnings will have a one-time opportunity to repatriate them at tax rates from 5% or 12% depending upon the nature of the asset. This could have a very beneficial effect on capital reinvestment for the US economy.
Elimination of net operating losses (NOL) deduction. This deduction has been used by value oriented “vulture investors”, who have acquired companies with large NOL’s to shelter profitable current operations from taxes.
There are other significant tax considerations, which are summarized in the attachment below, but the above represents the major focus of the two plans. At the end of the day, we believe that the net effect of these changes will be beneficial to the overall market and to the US economy in general, but there will be some sectoral rotation as the effects are played out.
|Small Cap||High Yield Bonds|
|High-Tax paying Large Cap||Highly Levered Companies|
|US Companies with High % of Foreign Sales|
As always, if you have any questions, please reach out to our office.
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Please note: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own CPA or tax professional before engaging in any transaction.