By Haddon Libby
The Republican Party proposed the Tax Cut and Jobs Act (TCJA) last week. If approved, taxes will be reduced by $1.51 trillion over the next ten years. While there are many pros and cons to the plan, let’s look at the bill as proposed:
Reduces the number of tax brackets from seven to four with the top tax bracket being 39.6% and the bottom tax bracket being 10%. The bottom tax bracket is $45,000 for individuals and twice that for couples. The top bracket starts at $500,000 for individuals and $1,000,000 for couples.
Increases the standard deduction to $12,200 for individuals and twice that for couples while limiting state and local tax deductions to $10,000 per person.
Increases the standard child tax credit from $1,000 to $1,600 plus $500 for each non-child dependent.
These increases in standard deductions may cause charitable giving to go down as most people will have lower adjusted gross income making this tax loophole less valuable to many.
Eliminates the Alternative Minimum Tax, itemized medical expenses, moving expenses, tax credit for adoption and tax deduction for student loans.
Makes no changes to 401(k) retirement savings accounts, capital gains and dividend income tax rates.
Limits the home mortgage interest deduction to the interest paid on up to $500,000 of debt. Current mortgage holders with more than $500,000 in debt are grandfathered in meaning that they can continue to get the full interest deduction on current loans but not on future loans. Additionally, the interest deduction on second homes and home equity lines of credit are being eliminated.
Currently, a home owner can exclude $250,000 (twice that for couples) of profits on the sale of a home. Going forward, the homeowner would have to live in the home for at least five of the preceding eight years to get this tax break.
When it comes to divorces from 2018 on, alimony will no longer be tax deductible. Those divorced before that can continue to receive the tax break.
The tax deduction that grandparent’s get for funding a grandchild’s education will go away.
Doubles the estate tax exemption to $11.2 million per person and $22.4 million per couple until the estate tax is abolished in 2024.
For corporations, the top tax rate would decline from 35% to 20%. For pass-through businesses like sole proprietorships and partnerships which make up 95% of all businesses in the United States, the top tax rate would be 25%. As most of these are small businesses, this will reduce tax costs significantly as these types of businesses have been taxed at the higher personal tax rate.
As large corporations have trillions of dollars held offshore, the United States wants those assets to return home. As such, there will be a one-time 5% tax on non-liquid assets and a one-time 12% rate on cash.
Companies can expense the cost of business investments in the year incurred. In the past, that expense had to be deducted over the life of the investment.
Universities with endowments of more than $100,000 per student will pay a 1.4% excise tax on net investment income.
Repeals the Johnson Amendment that prohibits tax-exempt nonprofits from making political endorsements.
Eliminates the tax deduction on interest paid on bonds for the construction of sports stadiums.
Generally stated, these changes are good for people residing in low tax states and potentially bad for those of us in high tax states like California.
As wealthier Californians will be most affected by the bill, those who own businesses can avoid potential personal income tax increases by contributing up to $59,000 per year (individual, twice that for couples) via deferred compensation plans.
While this is the basic construct of the Republican tax cut package, expect changes as the bill winds its way through the halls of Congress and the House of Representatives.
Haddon Libby is the Managing Partner of Winslow Drake Investment Management. For a free assessment of your investment portfolio, contact Haddon at 760.449.6349 or HLibby@WinslowDrake.com. For more information, please visit www.WinslowDrake.com.