Financial Planning Friday: How the Republican Tax Bill Affects Your Financial PlanDecember 1st, 2017 by Anchor Bay Capital's Investment Team
As I write this, it appears that Senate Republicans are gaining momentum to pass their highly debated tax bill. So far this year none of this administration’s main agenda has made it through Congress so the fate of this bill could have an impact on how the markets and economy respond in 2018. If the bill does pass, it is important to understand how changes to our tax system will affect your financial plan. Here are key areas that you will want to stay informed on:
Your individual tax rate and deductions:
Two big questions with this new plan are: “What rate will I be taxed at?” and “Can I still take my deductions?” While the final results are still to be determined, you may not have exemptions next year and your deductions could be quite a bit different.
Your current tax rate is a progressive system. This means that you pay a higher rate as your income increases. We currently have 7 tax brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. To calculate the tax rate for a married couple filing jointly with $90,000 of annual income, it would look like this:
10% of income up to $18,650 = $1,865
15% of income from $18,650 to $75,900 = $8,587.50
25% of income above $75,900
The result would be: $13,977.50 which is a 15.5% tax rate.
Under the proposed Senate plan, there will still be 7 brackets, but the rates have been lowered to 10%, 12%, 22%, 24%, 32%, 35% and 39.6%.
As far as deductions, the proposed plan caters to the 70% of Americans who take the standard deduction versus itemizing deductions. For those who itemize, the deductions for local and state taxes will be capped at $10,000, and personal property tax and some miscellaneous deductions are proposed to be eliminated, while charitable deductions and mortgage interest deductions will remain.
The standard deduction is being changed significantly under the new plan. Right now a married couple can take a standard deduction of $12,700 and under the new plan the proposed deduction is $24,000. However, for families, this may not result in significant savings. Currently, you are exempt from taxes on $4,050 for each qualifying individual in your family. This means that a family of 4 can subtract $16,200 ($4,050 x 4) from their adjusted gross income and then claim the standard deduction of $12,700. Under the new plan, the exemption is going away.
Your Business Income:
If you are a business owner, the debate has not been settled on how this tax plan will affect your income. All the news has been about cutting corporate taxes from 35% to 20%. However, this leaves out the majority of business owners that are considered “Pass-through Entities.” Sole-proprietors, partnerships, LLCs and S-Corps all are companies that pass their income through to the business owner to be taxed at individual rates. This means that while the corporate tax is cut from 35% to 20%, a successful S-Corp could still pay taxes at the highest individual rate of 39.6%. This isn’t the only problem. If Congress decided to cut rates on pass-through companies, this creates an incentive for a wealthy individual to set up a business entity just to move to a lower tax rate. The solution right now is to keep pass-through companies taxed at individual rates and offer a deduction to these business owners of up to 23%. Effectively, this could lower the highest earning pass-through companies to a rate of under 30%.
A major overhaul in the new plan is the elimination of the Alternative Minimum Tax and the Estate Tax. The Alternative Minimum Tax is an alternative tax calculation designed to prevent tax payers from reducing their complete tax liability. It typically affects the highest earners. However, last minute changes by the Republicans now indicate that this will remain in order to pay for other tax cuts. The elimination of the estate tax will allow families with over $11 million in assets to pass their wealth to their family estate tax free.
Right now we have to maintain the status quo. While debates continue and we wait to see how much of these changes will actually result in a law, it is inevitable that any changes will benefit some people differently than others. Keep these topics in mind as you watch the news and make sure to contact us if you have questions about your specific circumstances.