By Ryan Ellis
The U.S. House of Representatives is out with their draft version of tax reform today. If you want to get into the weeds, the bill, the detailed summary, and a bunch of one-pagers are all available here.
The plan basically gets done what it needs to: it enacts permanent, pro-growth tax reforms in combination with tax cuts and simplification for the middle class. That was the mission, and the mission has been accomplished.
Let’s dive in.
The good folks at the Tax Foundation have produced a useful graph looking at various types of families to see what kind of tax relief they can expect.
For families, the bill creates a new tax rate structure that looks like this (all numbers taxable income)
Married/Joint Head/Household Single Married/Sep.
12% $0-$90,000 $0-$67,500 $0-$45,000 $0-$45,000
25% $90,000-$260,000 $67,500-$200,000 $45k-$200k $45,000-$130k
35% $260,000-$1 mil $200,000-$500,000 $200k-$500k $130,000-$500k
39.6% $1 mil-$1.2 mil $500,000-$1 mil $500k-$1 mil $500,000-$1 mil
45.6% $1.2 mil-$1.614 mil $1 mil-$1.3 mil $1 mil-$1.2 mil $1 mil-$1.2 mil
39.6% $1,614,000- $1,310,500- $1,207,000- $1,207,000-
You’ll notice there is a “bubble rate” in there. The only purpose of that rate (which is really a 6 percent surtax on incomes exceeding $1.2 million for married couples and $1 million for everyone else) is to deny high income taxpayers the benefits of the 12 percent bracket. It really shouldn’t be considered a tax rate per se, but more like the clawing back of a tax rate. The 1986 Tax Reform Act had a similar structure. Tax writers really ought to consider making that bubble tax cancel out not only the 12 percent bracket, but also the 25 and 35 percent brackets, for truly high income folks. The money could be used on more pro-growth tax policy elsewhere in the plan.
These brackets eliminate the marriage penalty up to $260,000 of taxable income, far higher than today.
One other important note: most Americans (conservatively speaking, the lower four-fifths of us) do not make enough to worry about any tax bracket above the 12 percent level, especially when the “zero bracket” (discussed below) is factored in. For most of our fellow citizens, today was all about the unveiling of a 12 percent federal flat tax with generous provisions for standard of living and children. That’s a big simplification for everyday folks.
Standard Deduction (“Zero Bracket”) or Itemized Deductions
Before arriving at taxable income, families are allowed to either claim the standard deduction, or they can instead add up their itemized deductions. The standard deduction, which House policymakers think about 90 percent of families will elect to use (see the postcard being held above by President Trump), is as follows:
Standard Deduction or “Zero Bracket”
Married Filing Jointly/Surviving Spouse $24,400
Head of Household $18,100
Single/Married Filing Separately $12,200
For the other one out of ten families, totaling up their itemized deductions will make more sense. There are three itemized deductions which remain:
Mortgage interest. Mortgage interest will be deductible for primary residences only. For homes bought before today, up to $1 million of mortgage indebtedness is permitted. For homes bought starting today, this number is reduced to $500,000.
Property tax. Up to $10,000 in property tax on homes will be deductible.
Charitable contributions. Similar rules to today, but taxpayers will be able to deduct more in contributions without having to roll deductions into future years.
Once tax is actually calculated, most families with children will be able to take a credit (that is, a direct reduction against tax) for being parents.
This credit will be:
$1600 for every child dependent under the age of 17, plus
$300 for every parent, so $600 for a married couple, plus
$300 for every child dependent over the age of 17, as well as other non-child dependents
This credit phases out starting at $230,000 for married couples (half that for for all others). That is a much higher level than today–double, in fact.
Other Personal Tax Notes
The AMT is repealed. The dreaded “alternative minimum tax” or “AMT” is totally and finally repealed
The death tax is repealed. I’ve written a lot about the death tax and why repealing it is so important. The plan immediately doubles the death tax
exemption level to $11 million ($22 million surviving spouse), and repeals the tax entirely in 2024.
Education tax credits are consolidated into one. The confusing hodgepodge of education tax benefits is simply and easily put into one unified tax credit.
No major changes to IRAs and 401(k) plans. One neat element, though–if you have left a job and you have an outstanding 401(k) loan, you have until tax time to repay it (as opposed to the 60 days under current law).
529 plans made easier. 529 College Savings Plans are made easier in two ways: first, you can now open one for your unborn baby; second, you can distribute up to $10,000 per year per beneficiary for grade school and high school tuition. Apprenticeship programs are also now kosher.
Business Tax Reforms
Corporate Income Tax. Rate is reduced from 35 percent today all the way down to 20 percent, close to the developed nation (OECD) average.
“Flow through” or “pass through” businesses. This includes sole proprietorships, partnerships, Subchapter-S corporations, and limited liability companies. Their rate is more complicated. Professional service firms (think white collar companies) are taxed at the personal rates above. Pure investors in other types of flow through firms are taxed at 25 percent. Active owners of non-white collar firms are taxed at a blended rate of seven-tenths the brackets above and three-tenths the 25 percent rate of non-white collar investors, for a blended rate equivalent of 35 percent.
Top Tax Rate on Business Activity
Professional Service Companies Ordinary income, see brackets above
Investors in non-PSCs 25%
Active Owners in non-PSCs 70/30 split between ordinary brackets and
investor rate, or 35%
Interest deduction. Flow through firms earning less than $25 million can deduct interest in full. Corporations and large flow through firms are limited to an interest deduction equal to roughly 30 percent of profits.
Capital investments. Flow thorough firms can use small business expensing, which rises from $1 million to $5 million annually. All other firms can immediately expense all business investments (except buildings, land, and intangibles) for the next five years. This is known as “full business expensing.”
Territoriality replaces worldwide taxation. U.S. firms doing business overseas would owe no tax to the IRS on overseas operations, provided the average/blended income tax they have paid overseas is at least 12.5 percent. It’s unclear to me whether firms operating overseas and selling into the United States would owe a tax.
The “bridge” to get to a territorial system is a “deemed repatriation” tax of 12 percent on all prior deferred foreign cash earnings, and 5 percent on all prior deferred foreign earnings which have been invested.
Read more here.