Chairman of the House Ways and Means Committee Kevin Brady revealed details of the Republican tax reform bill last week. The package, now being debated in the House of Representatives contains expected and unexpected overhaul to the existing tax law.
Not surprisingly, the plan calls for a repeal of the Alternative Minimum Tax (AMT). It also calls for a repeal of the estate tax while keeping the step-up in basis.
The bill redefines like-kind exchanges. The proposal includes language that would amend code section 1031 from exchanges of like-kind property, to exchanges of like-kind real property. This ensures real estate investors maintain the benefit of deferring capital gains realized on the sale of property.
Also favoring real estate activities, the proposal limits the deductions that businesses can claim for interest, with the exception of real estate businesses, where no limit would apply.
According to the nonpartisan Tax Policy Center, the richest 1 percent of Americans would reap 48 percent of the benefits of the Republican tax reform legislation.
Using the theme of “simplification” the reform reduces the current seven tax brackets with a proposed use of five ranging from 0 percent to 39.6 percent.
At the core of the bill is a dramatic reduction in business income tax, cutting corporate tax rates to a flat 20 percent from 35 percent. Likewise, the plan also calls for tax cuts on pass-through business income, taxing this income at a flat rate of just 25 percent.
For someone like President Trump, this cut represents millions of dollars in savings each year. It is reported that Trump owns interests in more than 500 pass-through businesses. His personal benefit alone from the tax reduction on pass-through business income is estimated to be $23 million. Millionaires and billionaires who currently pay the highest tax rate of 39.6 percent on their flow-through income will see a savings of close to 15 percent.
Calling for reform to itemized deductions, the plan eliminates all itemized deductions with the exception of charitable contributions and mortgage interest on principal residence mortgages up to $500,000 in balance.
Opponents doubt the plan will have support from high income-tax states such as New York, New Jersey, and California where the ability to deduct state income taxes eliminates some of the impact of double taxation from state and federal tax mandates.
‘Foul’ on Mortgage Limit
Representatives of the real estate industry — including developers, brokers, and agents — are “crying foul” over the proposed limitation on mortgages to just $500,000.
While the overhaul is designed to create a simpler tax system for average Americans, this is primarily being accomplished through limiting itemized deductions while luring more taxpayers into an increased standard deduction equal to double the current deduction amounts.
However, the bill also calls for the elimination of personal and dependency exemptions, leaving families that have children with fewer deductions than under current law.
Coverdell ESA vs. 529
Also included in the reform is a provision cutting deductions for deposits to Coverdell ESAs, thus ending the benefit of the college savings mechanism. Instead, authors of the bill call for rolling existing Coverdell Education Savings Accounts to 529 plans that are run by the states.
As is typical with legislation, the 419 page proposal includes changes to seemingly nontax-related items. For example, under current 529 plan rules, it is possible for parents to create these accounts for unborn children. However, the bill calls for a clearer definition of the term homo sapien to include life beginning in the womb. Additionally the bill calls for a defined number of hours art museums must remain open to the public in order to qualify for current tax incentives.
According to top Democratic leaders who oppose the bill, the estimated increase to the federal deficit would be $2.3 trillion over the first five years. Yet supporters respond by pointing out that opponents are not calculating the impact of an improved economy related to the reform. The plan also calls for a one-time 5 percent excise tax on US businesses with foreign assets, a strategy to raise much needed revenue to pay for the plan.
While the reform for businesses appears to lower taxes, the plan calls for a repeal of the Domestic Production Activities Deduction which incentivizes businesses who produce within the United States. However, tax credits like the Research and Development Credit would remain under the plan.
American Institute of Certified Tax Planners
Dominique Molina is the President and Founder of the American Institute of Certified Tax Planners.With over 15 years of experience as a CPA, Molina has worked with many top business owners and investors using proactive tax planning to help them keep more of what they earn.