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With last night's Senate passage of the Tax Reform and Jobs Act, Americans woke up this morning faced with the reality of a brand new income tax code for 2018. There is plenty to dislike about this bill. And judging by the latest polls on its popularity, the majority of Americans do, in fact, dislike it. There is no rational argument that says this bill doesn't increase our Country's already large deficit. No rational argument that the vast majority of the tax relief proposed in the Tax Reform and Jobs Act is headed somewhere other than the corporate sector and the wealthiest Americans. That said, there is also no rational argument that our tax reform was not in need of reform after more than three decades without major legislation.
Think about that for a second...when it comes to how much money we are giving the government, we are operating an Apple 2G computer; a rotary phone; a cassette tape. Choose any 1980s technology analogy you want. Bottom line is, we are working off of an old system that needs to be updated. Now we can argue all day about whether or not this bill is the right way to change it. Whether the proposed tax cuts are paid for in a way that responds to the needs of the majority of Americans. Frankly, that depends largely on where you live. However, the fact remains that with the stroke of a pen, this Tax Reform and Jobs Act will become law, so we must educate ourselves on what is and what is not in the bill.
First, let's face facts. This is a corporate tax cut. And frankly, we needed one. I am not saying that we needed to reduce corporate tax rates from 35% all the way down to 21% as this bill does, but there was significant reform needed. Fact is that the worldwide average is 22.9% and in the industrialized world, our rate is higher than virtually all competitors. Naysayers will point out that corporations like Walmart, Apple, and other large companies pay nowhere near the current 35%. They pay millions to lawyers and accountants to shelter that money from our tax code. And yes, that is true. But it is important to remember than the 35% rate is not only for large multi-national US companies, but for small businesses, c-corporations, some LLCs, S-corporations and others who are subject to the highest rate. Add the rising costs of healthcare and other employee benefits, as well as the sheer cost of doing business, and small businesses needed some relief. Plus, let's be honest, those large companies still have their lawyers and accountants, and will still find ways to pay less than others...why should we penalize all other businesses, especially when they employ more people (in aggregate) than large corporations do?
On the individual side, the overwhelming majority of Americans will see their marginal tax rates reduced in 2018. Typically by three or four percent. Why? Well, when you couple lower marginal rates with a doubled standard deduction ($12,000 for a single; $24,000 for a married couple) and a doubled child tax credit (from $1,000 to $2,000) that doesn't faze out until your combined income reaches $400,000 you have a whole lot of people getting some relief next year. EXCEPTION: If you do not itemize and have more than three children, some of the benefit you derive from the decreased marginal rate will be negated by the lack of personal exemptions, which have been repealed.
If you itemize deductions, like many of us who live here in New Jersey or in other high-tax states like New York, Connecticut, California or Maryland, then you might not feel the same relief as those who I mentioned above. This has to do with changes and/or elimination of many deductions that you may have become used to taking. To be fair, the final package is nowhere near as catastrophic to those who rely on personal deductions as this process started with. If you recall, the Trump Administration initially put forward a plan that called for the elimination of all personal deductions (minus the charitable deduction)—a message that was echoed loudly by the original plans put forward by the House of Representatives and Senate. While the new tax bill may sting, it is not nearly as bad as it could have been in that regard.
Below is a chart that illustrates exactly which popular deductions made it into the final bill, which were changed and which were eliminated entirely. If you have specific questions about your deductions, you should contact your accountant.
| Remains the Same | Changed | Eliminated |
Student Loan Deduction
Graduate Student Tuition Waiver
Charitable Deduction
Retirement Plan Contribution Deduction |
State and Local Tax Deduction: Limited to $10,000 which is NOT indexed for inflation. That includes real estate taxes, state and local income and general sales tax.
Medical Expense Deduction: Threshold is reduced from 10% of AGI (adjusted gross income) to 7.5% for 2017 and 2018 ONLY. Reverts to current law in 2019. Mortgage Interest Deduction: Loan cap reduced from $1,000,000 to $750,000. Educator Expense Deduction: Raised from $250 to $500. |
Moving Expense Deduction (except active duty military)
Alimony Deduction (beginning in 2019)
Tax Preparation Services Deduction
Financial Advisory Fee Deduction
All other itemized deductions |
Speaking of taxes that appeared to be headed for total repeal but did not make it, I present you with the estate tax. I have spoken to many people who were seemingly unaware that there was an estate tax before this came into the mainstream. That is probably because up until now, that tax has only impacted those with estates of $5.6 million dollars or more ($11.2M for a married couple). But yes, it is true. Current law has a top estate tax rate of 40% for estates over the exemption amount. While there has been much talk about the repeal of estate tax in total, it is not what made it into the final package. Beginning in 2018, the exemption amounts will increase to $11.2M and $22.4M respectively, which reduces the number of estates that will fall victim to paying estate tax. It will relieve some of the pressure on the estate of people like farmers, who are land-rich and cash-poor by nature, but keep the pressure on people like, well, Donald Trump, who would still pay a hefty estate tax bill under the new law.
Over these past weeks, I have heard one question more than any other...why now. Well, it is not a secret that Republicans believe in smaller government and lower taxes. It was also widely accepted, in bipartisan manor, that corporate tax cuts needed to take place. While the impact on the middle class remains to be seen, Republicans are betting that corporate growth will lead to higher GDP (gross domestic product) numbers which lead to more jobs, more consumer spending, and a livelier, more vibrant economy.
History would tell us that this sort of trickle-down strategy does not spur the kind of middle-class growth that it is intended to spur. History would also tell us that corporations, which are sitting on larger pots of gold than at any time in American history, do not use increased profits to raise wages and create jobs. But history also tells us something needs to give. We need to upgrade that Apple 2G. We cannot expect to make this economy work with stagnant low GDP, which is where we have been for most of the recovery cycle, despite market growth.
Is this the upgrade? No matter what the experts, think tanks, politicians and political pundits tell us, we just don't know. And we won't know until this plan has taken effect and has had time to work its way through the economy.
As I said at the outset, there are going to be winners and losers in this bill. 2018 will see more winners than losers. That is for sure. But when you couple nearly a decade of stock market growth and historic economic recovery, with the sunset provision in this bill, the Tax Reform and Jobs Act could be a recipe for some pretty short-lived victory. Remember, the tax reductions that you or I might see next year are temporary. They sunset after about ten years, reverting back to current rates without action by a future Congress. Only the corporate tax cuts in this bill are permanent.
You're not really surprised, are you? The truth is that barring spending cuts, the federal government needs the revenue they are giving up. Without it, all the growth in the world won't make a dent in the 20 TRILLION dollar debt we are currently saddled with. They know that. Basically, Congress just did what Congress does better than anything else—take the short-term win and kick the long-term can down the road.
Sources
https://taxfoundation.org/conference-report-tax-cuts-and-jobs-act/
https://taxfoundation.org/final-tax-cuts-and-jobs-act-details-analysis/
http://www.nj.com/politics/index.ssf/2017/12/heres_what_you_need_to_know_about_the_republican_t.html
https://www.bloomberg.com/news/articles/2017-12-18/everything-you-need-to-know-about-the-gop-tax-overhaul-plan