President-elect Donald Trump’s agenda places tax changes as a high priority item. Some of the proposed changes are a radical departure from where the tax code stands now and will significantly impact both individuals and businesses. Keep in mind that the proposals outlined below are just that – proposals. They will probably change in substance and scope as they make their way through Congress.
Simple and Low – Tax Brackets and Rates
Right now, everyone pays taxes on their ordinary income under a tiered tax bracket system. The tax brackets are scaled on a graduated basis, meaning that as income increases so does the tax rate. Currently there are seven rate brackets ranging from a low of 10 percent to a maximum of 39.6 percent. And the top tax rate is actually higher than 39.6 percent because the Obamacare 3.8 percent surtax kicks in on certain kinds of income at certain levels. But for the sake of examining the proposals, let’s put that aside.
Trump’s proposal includes eliminating four of the seven brackets, leaving only three at 12 percent, 25 percent and 33 percent. His plan would also eliminate the net investment income tax (the Obamacare tax), resulting in a true top rate of 33 percent.
Death to the Estate Tax
If you were to die right now, there would be good news and bad news. First, the bad news: the portion of your estate valued over $5.45 million would be taxed at a 40 percent rate. The good news is that any unrealized appreciation on your estate assets is “stepped-up” in basis. For example, if you bought a stock at $10 per share and when you died it was worth $50 per share, your heirs would have a basis of $50 per share. This means that no one will have to pay the capital gains tax on the $40 of appreciation. Not such a bad deal.
Trump’s proposal would eliminate the estate tax, but that doesn’t mean your estate would pass 100 percent tax free. Under his plan, estate assets valued over $10 million would not receive a set-up in basis, so the unrealized appreciation would eventually have taxes paid on those gains. But not until they are sold.
Business Tax Cuts & Undoing Deductions
Corporate tax rates would be cut from their current rate of 35 percent down to 15 percent under Trump’s plan. This is not as radical as it seems when you add in the fact that many business deductions would also be eliminated.
One of the more dramatic changes would impact depreciation. There would no longer be a depreciation deduction; instead, you could deduct the entire cost of the asset purchased. This greatly accelerates the tax advantages of acquiring capital assets; however, there is yet another twist. Assets with cost fully deducted in the year of acquisition but acquired through debt financing would not be allowed to deduct the interest expense associated with the debt. The idea is to discourage corporate dependence on debt.
Under, Over or In the Middle
Another major change under the president-elect’s tax plan is the alterations to the treatment of “pass through” taxation. Currently, partnerships and S corporations do not pay taxes at the entity level. The activity instead passes through to the partners or shareholders, who include the activity on their individual income taxes.
Trump’s change would provide a unified business tax rate of 15 percent. This means that ordinary income that passed through would only be taxed at the 15 percent rate even as it reaches the individual level instead of being taxed at the individual tax brackets. This means that a taxpayer earning business income could benefit from a drop in their top tax rate from 39.6 percent to 15 percent.
As you can see, President-elect Trump’s tax plan consists of a number of simple but significant changes to business as usual. Regardless of how you feel about the election results, it is important to understand where tax law may be heading and prepare accordingly.