Should you continue to defer income in 2017 or will it be better, in the long run, to pay taxes as you go? There are high expectations that President Trump and Congress will reform income taxes this year. The President has expressed several ideas concerning what changes he thinks should be made to the tax code. House Republicans have their own ideas, which have been presented under the “Better Way for Tax Reform” proposal. There are similarities but also some notable differences. Let’s start with a look at some of the similarities.
Similarities between President Trump’s and Congress’ income tax reformation plans
Both proposals would like to reduce the current seven tiers of tax brackets down to just three: 12%, 25%, and 33%. They would each keep preferential tax rates for long-term capital gains and qualified dividends. The Obamacare 3.8% Medicare surtax on net investment income would be repealed along with the Alternative Minimum Tax. Finally, both proposals would make changes to the deductions—the standard deduction, what can be itemized as a deduction, and the personal exemption.
How the plans differ
The differences are found in the details of how to accomplish these changes. Our tax code has been growing in complexity ever since the Tax Reform Act of 1986 was passed to eliminate the years of complexity that had built up since the previous tax reform in 1954. The Tax Foundation says it takes the country 8.9 billion hours and costs $409 billion to prepare and file their taxes.
The President’s proposals are not actually tax reform in the classic definition of simplification. The reduction of tax brackets down to three and alignment of capital gains rates with the three income brackets is a step towards true tax reform. It’s his treatment of deductions that moves his position away from simplification.
The House GOP plan would keep only the mortgage and charitable deductions on Schedule A. Their plan would also keep the incentives for retirement accounts and college savings found on the adjusted gross income section on the front of Form 1040. Virtually all other deductions would be eliminated altogether. They would like to combine the standard deduction and personal exemptions into a larger standard deduction.
The proposal calls for standard deductions of $12,000 for individuals, $18,000 for individuals with a child, and $24,000 for married couples. Only taxpayers with a significant mortgage and/or sizeable charitable gifts would qualify to itemize and claim those two deductions in excess of the standard deduction. Most taxpayers would be able to just claim the standard deduction. The goal of the GOP reform proposal is to simplify the tax code so that most tax returns could be filed on a postcard.
A tax reform with more complexity
The President’s proposal would keep the current complexity of itemized deductions, add new above-the-line deductions, and create new tax-preferenced accounts. He suggests adding a more aggressive phase out of deductions at higher income levels. He wants to consolidate the standard deduction and personal exemptions into a single, larger standard deduction of $15,000 for individuals, and $30,000 for married couples. The President has also proposed several new tax breaks that would apply specifically to families supporting dependents—either children or adult parents.
- An above-the-line deduction for child care expenses.
- A similar above-the-line deduction for “elder care” expenses.
- A new Dependent Care Savings Account (DCSA).
- Low-income households eligible for the EITC would get up to a 50% match.
If the President’s plan was adopted as proposed, it would, at a minimum, maintain complexity while simultaneously adding to the complexity of the tax code.
Once the details of the tax proposals are worked out, the new plan will still need to get passed. It’s important to remember the 1986 tax reform act took two years to become law. Republicans control both houses of Congress but tax reform is a long way from being a “done deal.”
The President’s tax proposals are projected to create a substantial increase in the Federal deficit. Even if you consider the potential for positive economic growth that might occur as the President suggests, it would still only partially offset the deficit. House Republicans have stated repeatedly their goal of keeping tax reform revenue neutral.
The President’s own party may not be willing to vote in favor of his proposals as they currently stand. The Republicans have a majority in the Senate but not the 60 votes required to avoid a filibuster. Senate Democrats have the potential to block legislation unless a compromise can be reached that would satisfy their vision for tax reform.
Tax planning in 2017 should avoid aggressive changes that cannot be reversed. Roth conversions should proceed because they can be undone through recharacterization. Recharacterizing makes the entire event go away for tax purposes. Recharacterizations do not have to be done in the same year as the conversion. You actually have until your filing deadline, including extensions, to complete the transaction. That means conversions done during 2017 could have until October 15, 2018 to be recharacterized.
Tax law changes could alter your tax bracket, increasing the tax cost of converting in 2017. If tax reform lowers tax brackets but not until 2018, recharacterizing would undo the conversion.
We generally consider recharacterizations in our tax projections during the fourth quarter. It is helpful to know where the breakeven point is for taxes and market value. It is our objective to have a plan in place by December so we know what circumstances would trigger a recharacterization for the client.
- Both the President and the GOP want to reduce the current seven tiers of tax brackets down to just three.
- The goal of the GOP reform proposal is to simplify the tax code so that most tax returns could be filed on a postcard.
- Tax planning in 2017 should avoid aggressive changes that cannot be reversed.