Trump on Taxes! The Outcome of the Elections.
The President promised a massive “across-the-board reduction of taxes for working and middle-income Americans.” The Trump Plan proposes to revamp and simplify the tax code with the expectation to boost the economy, create jobs and reduce the tax burden on taxpayers. We have highlighted some of the most relevant changes that affect the average American family.
Personal Exemption & Standard Deduction
The President plans to repeal the personal exemption and replace it with a higher standard deduction. Trump suggested increasing the standard deduction to $15000 for single and $30000 for married filing joint taxpayers. The head-of-household filing status will be eliminated. Finally, the itemized deductions will be capped at $100,000 for single and $200,000 for married filing joint taxpayers.
The higher standard deduction aims at reduction of the tax compliance burden and return preparation costs for low and middle-class families. More households will favor the standard deduction in exchange for a decrease in the number of taxpayers who will itemize deductions. The expected outcome is an improvement in the tax compliance rate and a decrease in administrative costs for the IRS who will audit fewer returns. Simultaneously, high-income taxpayers are expected to bear a fair share of the tax burden because of the cap on itemized deductions.
Tax Rates & Brackets
Under current law, the federal income tax rates gradually increase from 0 to 39.6% of taxable income separated into seven brackets. On top, there is an additional 3.8% Net Investment Income Tax (NIIT) that applies to certain income from investments of individuals, estates, and trusts that have income above a statutory threshold.
The President planned a reduction of the tax brackets to three starting at 12 % for low-income taxpayers and topped at 33 % of taxable income for high-income taxpayers. The additional 3.8% NIIT which was introduced by the Obama’s administration to subsidize the Affordable Care Act (Obamacare) will be eliminated. The long-term capital gain tax rates remain unchanged with a maximum of 20% for individuals in the highest tax bracket. The proposed federal and long-term capital gain tax rates and brackets are summarized in the table below.
|Income Tax||Capital Gains||Single||Married Filing Joint|
Taxable income under $32500
Taxable income under $75000
Taxable income between $32500 and $112500
Taxable income between $75000 and $225000
Taxable income over $112500
Taxable Income over $225000
Alternative Minimum Tax (AMT)
The Alternative Minimum Tax (AMT) applies to taxpayers who have certain types of income that receive favorable treatment or who qualify for certain itemized deductions, under the tax law. Supposedly, the AMT eliminates the tax benefits that reduce the regular tax of some high-income taxpayers by setting a limit on the deductibility of tax preference items.
However, because of the lower capital gain tax rates and sophisticated tax planning, many high-income taxpayers manage to escape the AMT in exchange for a growing number of middle-class families who are negatively affected by the tax. Trump proposed to eliminate the Alternative Minimum Tax for both individuals and business taxpayers.
Child & Dependent Care Reforms
The Trump Plan made it clear that the “current federal policies regarding child and dependent care do not reflect the needs of American families.” Under current law child and dependent care stimuli are driven by the nonrefundable Child & Dependent Care Credit and Child Tax Credit and the refundable Additional Child Tax Credit. Complexity arises because each of the credits has different rules and various limitations.
The President plans to replace the current childcare tax credit system by an above-the-line Child and Dependent Credit deduction. The deduction will encompass the average childcare costs incurred by a household for up to 4 children from birth to age 13. Thus the childcare costs will be directly written off by the family to arrive at adjusted gross income.
Similarly, the Trump Plan would also extend the above-the-line deductions to include eldercare costs. The new eldercare deduction would apply to costs like home care or adult day care for elderly dependents when those expenses are necessary to keeping family members gainfully employed. The deduction would be limited to $5,000 per year.
Earned Income Tax Credit
Of course, the extended above-the-line deductions will not benefit the lowest-earning taxpayers. Instead, low-income taxpayers will be compensated by a boost in the Earned Income Tax Credit (EIC). This EIC increase will equal half of the payroll taxes paid by the lower earning parent, subject to an income limitation of $31,200.
Affordable Care Act (Obamacare)Another change in course affects the Affordable Care Act. The Trump Plan proposed to annul the Obamacare and replace it with a universal Health Savings Account (HSA). The individual mandate will be eliminated, and the purchase of healthcare insurance will become voluntary again. Furthermore, taxpayers will be allowed to deduct the cost of insurance premiums from their gross income. Contributions to the new HSA will be tax deductible, and the HSA gains will accumulate tax-free.
FATCA & Expatriation Taxes
The Trump Plan does not specifically address any of the issues that concern expatriates and Americans abroad, including the controversial FATCA legislation. However, based on the vast changes proposed by the President, it is expected that relief will be granted in one form or another. Still, we won’t see significant changes in the current expatriation tax provision, regardless of the forecasted growth of expatriates who will turn their back to the States in disagreement with the views of the President.
Current Law vs. The Trump Plan
The following comparison illustrates the application of the Trump Plan to a middle-class family with two dependent children under age of 13. Assume that both parents are employed, and the average cost of childcare is $5000 per child. The 2016 gross income of the household is $120000, and a joint return is filed. For simplicity, the family has no investment income and takes the standard deduction.
|The Trump Plan|
Deductible Childcare Expenses
Tax before credits
Child Tax Credit
Child & Dependent Care Credit
|Final Income Tax|
Apparently, the Trump Plan leads to tax cuts that would be even more compelling for a household with 3 or 4 children and dependents. But the tax cuts will widen the deficit and the tax gap. So will we witness some unexpected twists and turns when the proposed legislation hits the Ways and Means and the Finance Committees?