Tax Reform Framework for Individuals October 10, 2017

Tax reform was part of President Trump’s campaign promises. We each know personally of the complexities in a tax code with 4,029 pages and year-after-year changes. Individuals want tax reform. Is this the year?

Although short on details, leadership from the House, Senate, and administration has proposed a TaxReform Framework to the House Ways and Means Committee, charged with writing the tax reform legislation. The individual proposals include:

1. Reduce tax rates from seven to three—12%, 25%, and 35%. The increase from the current 10% to 12% could cost some taxpayers more but the larger standard deduction is intended to offset the rate increase. The income tax brackets are not specified.

2. Double the standard deduction to $12,000 for single taxpayers and $24,000 for MFJ
taxpayers. (The standard deduction for head of household filing status is not mentioned.) This will reduce the number of our clients claiming itemized deductions.

3. Eliminate personal exemptions. According to Framework document, “To simplify the tax rules, the additional standard deduction and personal exemptions for the taxpayer and spouse are consolidated into this larger standard deduction.” In addition to the elimination of the personal
exemption for the taxpayer and spouse, the exemption for a qualifying child and a qualifying relative is also eliminated. Under the current system, a family of six has a deduction for exemptions of $24,300 ($4,050 times 6) and a standard deduction of $12,700 ($37,000 total). Unless the tax rates are significantly reduced for this family, the increased standard deduction won’t make up for the loss of the current deductions for exemptions and the standard deduction. Maybe the next proposal will help.

4. Increase the child tax credit—amount to be announced. Currently, the child tax credit is $1,000 for a qualifying child up to age 17. AGI limits apply. The Framework proposes to increase the income levels at which the child tax credit begins to phase out so that more middle-income families will benefit. If the child tax credit is increased to $1,500 or $2,000, our family of six might have a tax reduction, unless of course they have a child in college (older than 17) or include in their family an elderly parent (qualifying relative.) To help, the Framework proposes a non-refundable credit of $500 for non-child dependents.

5. Eliminate most itemized deductions—retain only mortgage interest and charitable contributions.

• This proposal could mean the elimination of the medical expense deduction when health insurance premiums and out of pocket costs are sky rocketing and many more clients might have been able to finally deduct medical expense over 10% of their AGI. The FSA and the HSA will be more valuable.
• The repeal of state and local taxes will particularly annoy our clients that live in high tax states but some clients won’t notice the repeal as AMT nixed their tax benefit.
• Mortgage interest deduction is protected in the “Framework” but there have been discussions by some tax writers of reducing the home mortgage debt limit to $500,000 and removing second homes as a “qualified residence.” A reduction in home mortgage interest may be on the table if an increase in the deficit due to other aspects of tax reform is unpalatable and more revenue is needed to get an agreement.
• The charitable contribution deduction seems to be safe, but remember that the doubling of the standard deduction will mean all itemized deductions may go away for some clients, particularly those who are retired. The IRA transfer to charity may be even more attractive.
• Many clients don’t get a benefit from miscellaneous itemized deductions because of the 2% of AGI limitations. But those that do get a benefit will be hurt by this change. Employee business expenses and the employee home office deduction would be gone. Investment adviser fees and tax preparation fees would be gone. Personal casualty losses would disappear (but most likely, the casualty loss in a federally declared disaster area would remain due mostly to Harvey, Irma and their sisters and brothers.) What would happen to gambling losses or the deduction for income in respect of a decedent?

6. Repeal AMT. What more can you say other than “yeah”? But note that the proposed repeal of exemptions, state and local taxes, and miscellaneous itemized deductions — the bulk of AMT preferences—would mean that many of our clients would not be impacted by AMT anyway. Note. The repeal of the 3.8% tax on net investment income was originally included in President Trump’s tax reform and simplification proposals. The high price tag of that
repeal has seen it hit the cutting room floor. And, it didn’t help the cause that the repeal’s benefit was to high-income taxpayers.

7. Retain tax benefits for education and retirement.

8. Repeal estate taxes and generation-skipping tax.

What, When, and How? The path to tax reform is arduous. We don’t know what the final changes will be. We don’t know when the changes will be effective. And, we don’t know how the changes will be implemented. In other words, we are looking at the first steps toward individual tax reform.