With new tax laws likely coming, here's what advisors need to know.
Planning for potential tax changes can be difficult and often futile. Yet clients rely on their advisors to be informed and ready for any shifts that might or might not occur. Come 2017, we are looking at a new government controlled by a Republican president and Congress. It seems likely that new tax laws will become a reality.
As of this writing, we only know what has been said in the campaign as clarified by preinaugural speculation. What is clear is that some taxpayers can expect tax reduction, while others could be facing tax increases. I will address the expected changes, based on available information, and then discuss potential planning strategies.
President-elect Donald Trump has vowed to lower tax rates. However, his proposals are not as simple as that. Currently, there are seven tax brackets. Under Trump’s plan, these will be reduced to three. Depending on where each bracket kicks in, the new rates could hurt those in the lowest current bracket, while higher earners would experience no change or a reduction in tax rates.
It is a bit more complicated than just tax brackets, however. The new tax rates also eliminate an entire filing status: head of household. Single parents would be required to file as single taxpayers, effectively increasing their tax rates. Additionally, the married-filing-jointly brackets will be exactly double the single brackets, meaning there would no longer be a “marriage penalty tax.”
Capital-gains tax rates might be changing as well. Currently, long-term capital gains are taxed at either 0%, 15%, or 20%. For certain high-income taxpayers, there is an additional Medicare surtax of 3.8%, meaning the top capital-gains rate is 23.8% now. Trump would eliminate the surtax and subject all long-term gains to 20% tax. House Republicans, however, are considering a maximum 16.5% rate on capital gains.
Finally, corporate tax rates would decline significantly under the Trump proposals. The current corporate tax rate is 35%, with some variability based on income levels.
Trump proposes to lower the rate to 15%. At this point, it is uncertain whether the 15% tax rate would apply to other business entities with pass-through tax treatment, such as limited liability companies, partnerships, S corporations, and sole proprietorships.
The new tax proposals include many changes to deductions, and there are differences between the House GOP proposals and Trump’s plans. Under the House proposals, itemized deductions would be allowed only for mortgage interest and charitable contributions. Trump would continue to allow all of the current itemized deductions, but would cap them at $100,000 for single taxpayers and $200,000 for married couples. Because of the substantial negative impact this limit could impose on charitable organizations, there is a possibility that these expenditures could be carved out from the cap.