Not long ago, we wrote an overview of tax reforms, and legislation is now underway in Congress to implement some of these streamlined tax proposals. In just six months, plans have already shifted. The passage of a new tax reform law would usher in even more sweeping changes for corporate and personal finances.
Earlier this month, the House of Representatives voted to pass a version of the Tax Cuts and Jobs Act. Later the same day, the Senate Finance Committee unveiled and passed its own version. Although the final product has yet to be written by the reconciliation committee, now is the time to prepare for tax reform. During times of great economic change, the stability a skilled accountant offers can help you with smart tax planning, allowing you to control more of your own wealth and adjust to financial shifts.
Here’s what each bill looks like in its current state, the portions of it that are likely to be included in the final version, and how it could affect your financial goals.
A Tale of Two Tax Reform Plans
Both bills are based on the one-page plan from the White House issued earlier this year, so some elements of the tax reform bill are the same in both houses of Congress. Lower income tax rates, corporate tax rate cuts, doubled standard deductions, and an end to personal exemptions are common factors in both plans. The legislation would lower corporate taxes to 20 percent across the board, down from a cap of 35 percent, and offer greater pass-through tax breaks.
Both plans also eliminate deductions for state and local taxes, a particularly notable change for residents of states that have higher property tax, including New York. More business deductions, lowered tax rates on pass-through income, and a proposed repeal of the Alternative Minimum Tax (AMT) are also part of both bills.
The plans differ in some important specifics:
- While both plans cut overall corporate tax rates, the House plan gets an earlier start on the changes, implementing them in 2018. The Senate plan would not lower the tax rate until the following year.
- The Senate bill retains deductions for medical expenses that exceed 10 percent of annual income, and the House plan removes them. Instead, the Senate program currently includes a repeal of the Affordable Care Act’s individual mandate, a move that the Congressional Budget Office estimates would remove 13 million people from the healthcare program and save roughly $338 billion.
- Another additional source of income in the Senate plan would be access to the Arctic National Wildlife Refuge (ANWR) for oil and natural gas drilling. Projected revenue would exceed $1.1 billion over the next decade.
- Although both plans remove most itemized deductions, those that remain have different thresholds in the House and Senate bills. New mortgage deductions will remain, but the Senate allows up to a $1 million value for them, while the House plan limits the deduction to $500,000. These changes are projected to apply to 6 percent of mortgages overall as current mortgages are unaffected.
- Both plans remove state and local income tax deductions for individuals, but the Senate plan grants businesses deductions on their state and local taxes. The House plan, meanwhile, allows a $10,000 property tax deduction for individuals.
- The Senate plan divides income into seven tax brackets with a maximum of 38.5 percent; the House has simplified that to four while retaining the 39.6 percent tax rate on the top bracket. Analysts are not yet sure which system will be a part of the final bill, but CPAs and financial management firms are preparing their clients for either possibility. See the tables below for proposed tax brackets.
Senate Plan for Income Tax Rate
Income Levels (dollars)
|25 – 28||25||$60,000–$169,999||$120,000–$389,999|
|33 – 35||35||$200,000–$499,999||$450,000–$999,999|
|39.6||38.5||$500,000 & above||$1,000,000 & above|
House Plan for Income Tax Rate
Income Levels (dollars)
|28 – 39.6||35||$200,000–$499,999||$260,000–$999,999|
|39.6||39.6||$500,000 & above||$1,000,000 & above|
Deductions for Individuals and Families
To defray the costs of child care and elder care for families, both plans raise the Child Tax Credit. Under the House plan, it would go up to $1,600 from its current $1,000 amount; the Senate would double this credit and allow parents to establish tax-advantaged accounts for their future children.
Under current tax programs, the Child Tax Credit contains an unintended consequence: the marriage penalty. As individuals, parents can claim the full credit if they are single and earn $150,000 or less in combined income. The same couple, if married, cap at $110,000 of joint income. The House plan removes this discrepancy so that parents may receive the same credit regardless of marital status.
As the American population ages, elder care is taking on new prominence in many households’ financial planning. To help with these additional expenses, the House bill offers a $300 credit for each non-child dependent.
Business Tax Reform
The House and Senate bills agree on lowering the highest corporate tax bracket’s rate to 20 percent but not on when the changes would take effect. By delaying the rate cut until 2019, the Senate plan would generate an additional $100 billion. The House plan, on the other hand, proposes the full tax cut for 2018 to allow business owners to reinvest, increasing overall tax revenue by fueling rapid growth.
For small businesses, tax rates would also decrease. In the House plan, businesses earning a total of under $150,000 would pay 9 percent on their income up to $75,000. This proposed plan would affect home businesses, sole proprietorships, S corporations, and partnerships in particular. Under the Senate plan, businesses would receive a standard deduction of 17.4 percent to offset eliminated deductions for office supplies, home offices, and equipment. The maximum tax rate for small businesses would drop to 25 percent.
To put these figures into perspective, a small business that currently earns $500,000 annually would currently pay $175,000 in federal taxes, barring any additional deductions or credits. After the proposed tax changes, the company’s tax liability would be $100,000, leaving an additional $75,000 in the company’s coffers for new hires, upgraded equipment, or advanced training.
One of the most significant changes for businesses is the greater ease with which pass-through entities would be able to manage their tax responsibilities. Pass-through taxation is meant to avoid doubling up on taxes for business owners and c-level executives; under both the proposed tax plans, a larger amount of pass-through income would be subject to the lower business tax rate of 20 percent instead of personal income tax rates.
These changes benefit corporations, business owners, entrepreneurs, and real estate developers. They also have the potential of benefiting employees through increased pay, greater investment in equipment, new hires, and training. As businesses grow, they become more profitable and generate more revenue – enough to pay a higher dollar amount in taxes even as the overall percentage of taxes paid is lower.
How Tax Reform May Affect You
Who benefits under the proposed tax reforms? There are many potential winners:
- Businesses: While both plans benefit corporate entities and owners, the Senate proposal is especially business-friendly. The Senate plan lowers taxes on all types of business over the next decade, including small businesses and sole proprietorships.
- Middle-income households: Although the uppermost tax brackets in both plans are at or near the current maximum, families in the middle are set to see decreases in their tax rates. For example, under the Senate plan, a couple with a combined taxable income of $100,000 that now pays $25,000 in taxes would be able to keep an additional $2,500 annually.
- Upper-middle-income families: The Alternative Minimum Tax was designed to install a floor on what the wealthiest Americans would pay, while tax brackets defined the ceiling. As the Brookings Institute notes, the families most likely to pay the AMT are those in upper tax brackets but not those at the farthest end of the bell curve. Congressional proposals would eliminate the AMT, returning wealth to households in the upper middle brackets.
- New York residents: The removal of the AMT would also benefit taxpayers in states with higher costs of living. These states, including California, Massachusetts, and New York, typically have residents with higher incomes. Ending the AMT would offset the removal of state and local tax deductions.
Your Next Steps to Prepare for Tax Reform
Whether the final tax proposal is closer to the House’s version, the Senate’s plan, or a new bill altogether, the passage of new tax reforms will create major changes in the flow of wealth. Your accountant can help you navigate these new currents with smarter tax planning and achieve your personal and professional financial goals.
Reading the financial news is a good first step, but to make sense of how legislation affects your financial status and tax liability, working with a CPA is essential. The economic picture has changed significantly just in the six months since we last wrote about tax reform; the first tentative steps toward growth have become a headlong rush. With sound financial management and tax planning, you stay ahead of the pace of change and chart your own destiny.
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