Trumpy-The-Clown, The Stock Markets And Tax Policy
One of my advisors sent out a newsletter today-- from a money-Republican perspective basically-- about all the wonderful things Trumpism will bring to the greed and selfishness set. "President-elect Donald Trump," they drooled, "has made it clear that he wants tax reform, and he wants it as quickly as possible. To help him in this quest, he has a Republican House and Senate who also want tax reform.
There are two obstacles that will need to be overcome in order to enact tax reform. The first is the “Senate road bump.” The final count on the political distribution of the Senate is anticipated to be 52-48 in favor of the Republicans [after Louisiana elects a Republican]. In order to avoid the possibility of filibuster as a tool to prevent tax legislation from advancing, either: eight Democrats will need to get on board to attain the 60 vote Super Majority rule, or the Budget Reconciliation Process will need to be used which allows tax legislation to pass with a simple 51 vote majority.
The second obstacle is the resulting decrease in revenues. The 10-year cost of Trump’s proposal is estimated by experts to be between $4.4 and $5.9 trillion, with the GOP estimate half of that at $3.1 trillion.1 But where will offset replacement revenues or expense reductions be found? And how will the parallel proposal of massive works projects to improve infrastructure be paid for?
These two issues are likely the only potential “drag” on the march to tax reform. Many commentators believe the proposed changes to the tax laws will ultimately pass, probably with some compromises.
While Trump and the GOP's versions of tax reform have differences, they also share many similarities. It is safe to assume that whatever proposals we are seeing now will be “tweaked” before the cake is baked. Here is an overview of the changes proposed by Trump:
• Lower Individual Income Tax
As part of Trump’s proposal, individual income tax rates would go down. Currently we have seven income tax brackets. Trump’s plan has 3 brackets: 12, 25 and 33%. Capital gains rates stay the same-- 0, 15 and 20%. The GOP proposal for capital gains is to allow a 50% deduction of the gain before the tax is imposed.
As part of the calculation of taxable income, the Trump proposal changes three items: (1) personal exemptions are eliminated, (2) standard deduction is increased, and (3) itemized deductions are capped.
The new standard deduction: for single individuals from current $6,300 to $15,000; for married-joint filers from current $12,600 to $30,000. Itemized deductions will be capped at $100,000 for single filers, $200,000 for married-joint filers. We should note that the GOP plan does not contain these caps, rather it eliminates itemized deductions entirely, with the exception of mortgage interest, charitable donations and a few taxes (excluding state income tax). The elimination of personal exemptions may be bad for families with more than two dependent children (2016 personal exemption is $4,050). A family of five with 3 dependent children would see less deduction from the new system. Under the current rules, that family would have a $12,600 standard deduction plus 5 personal exemptions at $4,050 per person, for a total of $32,850. However, under the proposal, they are capped at $30,000.
The new standard deduction could negatively impact the benefits of the mortgage interest deduction for middle-class families with mortgage payments and few other itemized deductions. The first $30,000 a year in deductions will have no income tax benefit for a married couple because of the increased size of the standard deduction.
• Childcare and eldercare Deductions
An “above-the-line” deduction would be allowed for childcare costs for children under the age of 13, and would be capped based on a state average for a child of that age. The deduction would also apply for Eldercare expenses for a dependent of up to $5,000 a year. This deduction would not be allowed for married couples making over $500,000 a year and singles making over $250,000 a year. These benefits would be indexed for inflation.
• Eliminate tax loophole for "carried interest"
The average American may not know what “Carried Interest” is, but many have heard the stories of wealthy individuals avoiding millions in taxes by taking ownership in the company they work for in order to ultimately sell and pay capital gains instead of ordinary income. Ordinarily they would have received income and paid ordinary income tax. This is a huge paradigm shift on a contentious issue. Under the proposal, taxpayers who make money this way would have to pay ordinary income tax rates on their gains when the company is sold.
• Lower corporate income tax
The corporate income tax rate would be lowered from 35% to 15% with some limitations on deductions. The GOP proposal is 20%. There is uncertainty whether the 15% tax rate also applies to business income that flows through to individual tax returns, if the taxpayer has an active business structured as a “pass-through” (S corporations, LLCs, Partnerships and sole proprietorships). If this becomes part of the plan, it would create huge incentives for individuals to become independent contractors instead of employees. The proposal also provides for 100% expensing of capital expenditures in the year of acquisition instead of depreciation or amortization.
In addition, Trump’s proposal would encourage U.S. corporations that keep money overseas (from profits made overseas) to repatriate those assets by having a repatriation “holiday” (fixed-time period) when those assets could be brought back to the U.S. at only a 10% tax rate (as compared to the current 35% tax rate). Capital Economics reports that, as of 2015, U.S. corporations had over $2.5 trillion parked overseas, including $110 billion by Microsoft alone.
• Eliminate 3 taxes
Details on Estate Tax repeal
The Trump proposal calls for full estate tax repeal. Stepped-up basis for transfers at death would be repealed as well, and instead carryover basis would apply. For example, assume Antonio purchased a rental property many years ago and had taken depreciation, and his basis was currently $100,000, and the fair market value of the property currently $1 million. If Antonio sold the property, he would have to pay capital gains on $900,000, the difference between his $100,000 basis and the $1 million sales price (plus recapture depreciation). Under current law, if Antonio passed away and left his home to daughter Gabrielle, and Gabrielle sold the property for $1 million, she would pay $0 capital gains taxes because she got stepped up basis. If instead she held the property for a couple more years and was then able to sell for $1.2 million, she would pay capital gains only on the $200,000 of appreciation that occurred since her father died. If instead the new law is passed and Gabrielle only gets carryover basis, she would pay the same amount of capital gains tax as her father if he had sold it.
However, there is also an argument that what Trump means is that he actually wants to trigger all capital gains taxes at death (similar to the Canadian system). Trump’s website vaguely references some break on the triggering of capital gains tax at death for owners of small businesses and farms, without any details. In addition, there would be an exemption taxpayers could use to allocate to specific assets that would allow those assets to get stepped-up basis at the death of the taxpayer: $10 million exemption for married taxpayers; $5 million for single. Presumably a taxpayer (or the representative of their estate) could pick and choose which assets to allocate this exemption to, with the preference being the most highly appreciated assets, while factoring in whether there are any assets never likely to be sold by the heirs. This in turn leads to the conclusion that there would still have to be some kind of Federal estate information return filed to show the allocation of this tax benefit among the assets owned by the deceased. With this system, it would be imperative that a client’s estate plan make clear either who benefits from the $10/$5 million and/or who gets to make the decision. The GOP proposal is full estate tax repeal while retaining stepped up basis at death on all assets.
What is unclear at this point is whether full “estate tax repeal” also means full gift tax repeal and generation skipping tax repeal. Trump’s proposals to date have been silent on whether “estate tax repeal” really means the entire system including gift taxes and generation skipping taxes, or literally just estate tax repeal. It is likely that it does include generation skipping tax repeal. There is a split of opinion on whether it also means gift tax repeal; more on this in a moment.
...If the gift tax is also being repealed as part of the proposal, there would be no more restrictions on transfers of assets to your family and friends. No more $14,000 limit on annual gifts. So, if you wanted to give your children money or real estate, you could just go ahead and give it to them – or to anybody else for that matter. See below for comments on the ability to transfer assets at will as a means to move taxable income into lower tax brackets of family members and whether there will need to be some “gift-tax-like” rules to prevent this. However, no one yet knows if the tax proposal will eliminate the gift tax or otherwise put restrictions on it such as limiting how much you can gift during lifetime.
Will the middle class see real benefits from income tax reform?
Trump's proposal is positioned to help the middle class. Some interesting observations were recently made about the potential tax savings for a sample “middle class” taxpayer.2 Households with an annual income between $143,100 and $292,100 will see an average annual savings of $4,300 under Trump's proposal, and an average annual savings of $300 under the GOP's plan.
Households with an annual income of $3.8 million or more will see an average annual savings of $1.07 million under Trump's proposal, and an average annual savings of $1.2 million under the GOP's plan.
We’ve been here before with George W. Bush in 2001 and a Republican House and Senate. Economic Growth and Tax Relief Reconciliation Act of 2001 (EGGTRA) was passed in August of that year. It included the phase out of the Federal estate tax, with full repeal by 2010. The thinking behind waiting until 2010 was that Congress would figure out the numbers before then so that estate tax repeal would be permanent. But they never did figure it out. Or, put another way, they chose not to deal with the issue.
So, what's different now? First, the repeal of estate tax has now been on the table for 15 years. Additionally, the public has been convinced it's an unfair tax, even if most people don't pay it. Finally, Trump wants it and he has incredible political capital at the moment.