We woke up the morning of Nov. 9, 2016, with the news that Donald Trump will be the 45th president of the United States. Among other things, Trump has promised tax reform. I know we have heard that over and over again from presidents, but this time we have a Republican Congress, so we might finally get tax reform.
Before I get into my commentary, I want to hop onto my soapbox for just a second. Outside of the estate tax, we have an income tax in the United States. If you are wealthy, you don’t necessarily make income. For example, you could have inherited money that is just sitting in an interest-bearing account. The only income tax would be on the interest. If you invested the money in stocks and mutual funds, the only income you would have is dividend income and capital gains income, if investments are sold.
So, to say that the wealthiest Americans would benefit from President-elect Trump’s tax plan is disingenuous. They are already benefiting from the tax code because they are paying a favorable tax on dividends and capital gains.
Now that I am off my soapbox, let’s talk about what Trump’s tax plan would do. First of all, today we have the following seven tax brackets: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent. Our C corporation rates run 15 percent to 35 percent, which are the highest in the world.
Trump is proposing a plan that would reduce the number of individual income tax brackets from seven to three: 12 percent, 25 percent, and 33 percent. The special rate structure for capital gains and dividends would be retained, but the 3.8 percent net investment income tax rate that currently applies to capital gains and dividends would be repealed.
The plan also would add a new deduction for child and dependent care expenses, and increase the Earned Income Tax Credit for working parents, who would not benefit from the new deduction. Furthermore, the plan would provide a new form of tax-favored savings account related to child and dependent care expenses, and expand the credit for employer-provided child care. He would also lower the highest corporate tax bracket to 15 percent.
What does this mean to us? Earlier I mentioned the C corporation tax bracket. Think about this for a second: How many of us have S corporations or other flow-through entities as clients? Now, how many of them do you think, when the profit flows through, pay taxes at higher than 15 percent? That would be a majority of my clients. It would make more sense for us to nullify the S election and just have our clients pay 15 percent corporate tax.
Remember that C corporations don’t have all those special rules about reasonable compensation, fringe benefits, and health insurance, just to name a few. Even with the double taxation, the dividends they took would only be taxed at 15 percent. However, it would be best to have our clients zero out their retained earnings before conversion to a C corporation. We don’t want our clients to take retained earnings as dividends because, as S corporations, they were already taxed once.
This does not even take into account all the companies that have moved operations overseas because corporate tax brackets are too high. They would simply bring their companies back and create new jobs.
Next, let’s take a look at individuals. The 12 percent, 25 percent, and 33 percent tax brackets would simplify everything for us. Anyone making $15,000 or less wouldn’t pay any taxes. I advise my self-employed clients to pay their children. It diverts money from the client’s higher tax bracket to the children’s lower tax bracket. I usually advise them to pay their children $5,000 or less so they don’t even have to file a tax return. I also could tell them to shift up to $15,000 to their children and put it into a 529 plan for college.
For a married couple, they could make $30,000 a year without paying taxes. For single taxpayers making $15,001 to $52,500, they would be in the 12 percent tax bracket. For a married couple, the 12 percent tax bracket starts at $30,001 to $105,000. At $52,501, the 25 percent tax bracket starts for singles and ends at $127,500. For married couples, the 25 percent tax bracket starts at $105,001 to $255,000. For singles, the 33 percent tax bracket starts at $127,501 and above. For married persons, it begins at $255,001. And the net investment income tax would be repealed, as well as the additional Medicare tax for those high wage-earners.
In addition to all this, the estate tax would be repealed.
My hope is that tax reform is on the table as soon as Trump takes the oath. I can’t wait to sit with my clients and save them a ton of money with all the new opportunities for tax savings.
About Craig W. Smalley, EA
Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as representation before the IRS regarding negotiations, audits, and appeals. In his many years of practice, he has been exposed to a variety of businesses and has an excellent knowledge of most industries. He is the CEO and co-founder of CWSEAPA PLLC and Tax Crisis Center LLC; both business have locations in Florida, Delaware, and Nevada. Craig is the current Google small business accounting advisor for the Google Small Business Community. He is a contributor to AccountingWEB and Accounting Today, and has had 12 books published on various topics in taxation. His articles have also been featured in the Chicago Tribune, New York Times, Yahoo Finance, Nasdaq, and several other newspapers, periodicals, and magazines. He has been interviewed and been a featured guest on many radio shows and podcasts. Finally, he is the co-host of Tax Avoidance is Legal, which is a nationally broadcast weekly Internet radio show.