Multiple Choice Tax Reform


Taxes are in the headlines, and not due to the extension deadline on Monday. The New York Post quotes President Trump as saying that the new tax reform plan will boost the stock market and based off the third quarter closing numbers it looks like that may be the case since all three indexes ended in the green with S&P 500 and Nasdaq hitting record highs. As you look deeper you find: Hartford lost $325-375 million due to natural disasters and State Auto Financial reports to have lost $56.1 million. Warren Buffett stated Geico's exposure to Hurricane Harvey will be similar to that of Hurricane Sandy, where losses totaled $490 million and nearly 50,000 vehicle claims.

With so much going on; tax reform, international nuclear talks, Russia (yes Russia is still a thing) and the newly signed Executive Order affecting The Affordable Care Act it's becoming more difficult to focus. Right now, most people are worried that instead of getting true tax reform we could end up getting temporary tax cuts instead.

The Idea Behind the Tax Reform

The hole idea behind a true tax reform is to redo the whole thing from the ground up instead of relying on the system we have in place right now where the guidelines are multifaceted and are comprised of exceptions and the exceptions to those exceptions. Ultimately the idea is to embrace simplicity. If instead we only end up with tax cuts (dropping the current rates by some percentage points) while allowing all the current complexity of the taxation codes to stay in place; it creates more confusion and inequity among taxpayers from the same tax brackets and keeps the current corporate disadvantage, we already have.

The Tax Foundation has put together four options for the 115th Congress. All the options meet some or all the goals put forth by the Trump Administration, the House and the Senate. The only thing all four plans have in common is the fact that they are all pro-growth. In other words, they would all change the taxation codes to potentially improve economic efficiency and provide a long-term boost leading to higher wages and standards of living.

While none of these plans are ideal or perfect they all offer options to achieve the tax reform goals of economic growth, simplicity, lower marginal tax rates on both individuals and businesses and a broader tax base. Unfortunately, or fortunately depending on how you look at it, none of the plans contain all the priorities of all the groups involved some would call that fair or balanced however it may not be the case when all is said and done.

Tax Reform : Option A

Option A allows for full expensing of investments by converting corporate income tax into a 22.5% cash flow tax. Out of all the options this one provides the largest increase in GDP but will not noticeably change the distribution of tax burden. Under this plan all businesses would be able to deduct all capital investment for the fiscal year which it is used and non-financial businesses would not be able to deduct net interest but would be able to deduct interest expense against said interest income.

Option A consolidates the seven current individual tax brackets into three rates of 12%, 25% and 35%. Standard deductions would be $12,000 ($24,000 married filing jointly. The Trump Administration has recently proposed increasing the deduction to $15,000 & $30,000 respectively.  It would also get rid of the AMT (alternative minimum tax) and the phase out limits on itemized deductions. These would be offset by eliminating all itemized deductions other than home mortgage interest deductions which would be capped at $500,000 for acquisition debt. The personal exemption changes to a $500 non-refundable credit for non-child dependents and the child tax credit would be changed by increasing the dependent credit to $1500 ($1000 of which could be refundable). These new changes would be phased out at $150,000 for married filing jointly and $75,000 for single or head of household. Capital gains and dividends will be treated like ordinary income with the exception, of a 40% deductibility of qualified dividends and long-term capital gains from taxable income. Interest income would continue to be taxed the same would also be allowed a 40% deduction and estate tax would be gone under this option.

Tax Reform : Option B

Option B would scale down income tax while replacing revenue with broad-based low-rate consumption tax. This plan is based off Michael Graetz’s Tax plan, Sen. Ben Cardin’s progressive consumption tax and Rep Jim Renacci’s simplifying America’s tax system plan. The idea for this plan is to cut taxes for middle-income taxpayers while reducing corporate tax rates to 15% and federal revenue the same as it is now, note that it would not reduce the tax for the top 1% of income earners. This plan is slated to grow the economy and increase wages both by about 3% to gain the decrease in the middle tax brackets the upper tax brackets would pick up the slack creating a higher tax burden the higher up the tax brackets you fall.

This plan, like Plan A, would create three tax brackets out of the current seven; 10%, 25% and 38% with standard deductions increasing greatly. Personal exemptions and all personal credits will be replaced with a new work credit, a new child credit, and a new additional child credit (based on Sen. Cardin’s rebates). Capital gains, dividends and interest would be considered ordinary income and the only itemized deductions retained would be State and local tax deductions, home mortgage interest, and charitable contributions. The Net investment, Pease limitation and the AMT would all be eliminated. On the corporate side this plan broadens the tax burden by eliminating nonstructural business tax expenditures and makes bonus depreciation permanent. To afford the cuts there would be a 13% broad based value-added tax according to WTO (World Trade Organization) standards including imports and exports.

Tax Reform : Option C

Option C will lower business tax rates the most while leading to lower federal revenue in the long run. Option C and D are almost identical other than adding additional business tax cuts. The corporate tax rate would drop to 25% with the same 50% bonus depreciation and elimination of all non-structural expenditures just like Option C. This option even keeps the net interest expenses limited to 30% of pre-taxed earnings also like Option C. As for individual income tax it is the same as in Option C from the tax brackets to the child credits and childless filers doubling the EITC as well as the elimination of the Pease limitations and the AMT. This plan however would enact a 30% maximum tax rate for pass-through businesses.

These plans do not consider that law makers sometimes use temporary laws as work around, so who can say what the tax reform changes will lead to?  Treasury Secretary Steve Mnuchin says that tax reform should absolutely be retroactive to January 1, 2017. He also believes "permanent is better than temporary and temporary is better than nothing."

In our current era of partisan deal making - everything is negotiable.

Money Script Wealth Management, LLC does not provide specific tax advice. Please consult your CPA or tax attorney for specific tax questions.

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