The GOP Tax Plan: Breaking Down the Winners and Losers
This Tax Proposal Has Many Moving Parts
President Donald Trump dedicated a good portion of his campaign to promising sweeping changes to existing U.S. tax policy, but nothing particularly concrete happened for much of the first year of his term. That changed on November 2, 2017, when Republicans in the House of Representatives finally proposed a detailed bill: The Tax Cuts and Jobs Act.
Not surprisingly—because taxes are complicated, after all—the bill leaves many Americans scratching their heads, wondering what these changes will mean to them.
Will they end up paying more in taxes, or less?
It depends. Despite the name, the tax bill is not an across-the-board tax cut, and its impact on your own taxes is highly dependent on individual circumstances. Two individuals earning the same income dollar-for-dollar might find the Tax Cuts and Jobs Act impacts them differently, at least if it were to pass in its present form.
The Basics of the GOP Tax Plan
The House’s tax plan includes many changes, but these are the highlights for personal filers:
- Seven federal income tax brackets would be reduced to four, so the income ranges applying to each would necessarily change.
- The standard deduction would effectively double.
- Personal exemptions would be eliminated.
- The child tax credit would increase, and an additional family-related credit would be added for non-child dependents.
- Several tax exclusions and deductions would be eliminated, including the state income tax and local sales tax deductions, as well as those for medical expenses, alimony, and student loan interest. The plan imposes new limitations on the home mortgage interest deduction as well.
- The proposed plan would repeal the alternative minimum tax.
- It would repeal the federal estate tax… Eventually.
But some things remain the same:
- The bill does not make any changes to deductions for 401(k) plan contributions (as had been previously proposed).
- The earned income tax credit is unaffected.
- The terms of the Affordable Care Act would not be subject to change.
How Will This Affect Low-Income Taxpayers?
Yes, that’s a lot to take in. And the average low-income family probably doesn’t care too much about the alternative minimum tax provisions or the planned changes to the estate tax, both of which affect wealthier filers.
On the other hand, the changes to tax brackets, the standard deduction, and personal exemptions could all have a big impact on your tax situation. We'll use an example to show how those three big changes would impact a hypothetical tax filer.
Let’s say that John, a single taxpayer, earned $16,000 last year. As tax law currently stands, that would put him in a 15-percent tax bracket. He would pay 10 percent in tax on his income up to $9,325—the current 10-percent tax bracket, which would now be eliminated—and 15 percent on the balance up to his total income of $16,000. That’s a pretty significant tax bill of $1,933: $932 on the first $9,325, plus $1,001 of the $6,675 balance, for a total of $1,933.
The new tax plan provides for a 12-percent bracket for incomes up to $45,000 for single filers. This is now the lowest tax bracket, so it applies to all of John’s income. His tax bill would come out to $1,920 compared to $1,933, so there’s no significant change.
But this doesn’t take the standard deduction into consideration! Under the terms of the tax plan, John would not pay taxes on the first $12,000 (the proposed new standard deduction amount for single filers). After the standard deduction, his actual taxable income is just $4,000, meaning his actual tax would work out to just $480 (12 percent of $4,000). By comparison, John currently gets a standard deduction of $6,350, meaning he would pay tax on $9,650 ($16,000 less his standard deduction of $6,350). His total tax bill would therefore come out to $980: $932 or 10 percent of the first $9,325, plus $48 or 15 percent of the $325 balance.
The final result is that John comes out ahead under the terms of the new tax bill: Due largely to the change in the standard deduction, he would pay $480 under the new plan, compared to $980 under the existing tax structure.
But we’re still not done. Remember that personal exemption that the new bill would eliminate? Under existing tax law, John would be able to further reduce his taxable income by an additional $4,050 by claiming that exemption for himself. As it stands now, he would pay tax at the rate of 10 percent on $5,600 in income: $9,650 less the additional $4,050 for the exemption. His $980 tax debt drops to $560.
So here's the final analysis: Under current tax law, John pays $560 in federal income taxes. Under the House’s proposed tax plan, he pays $480. So the bill saves him $80 a year. That's not a huge windfall, but for someone who only earns $16,000 on the year, it's nothing to sniff at.
This is the new tax plan’s calling card—supporters say that many low-income taxpayers will come out ahead. And those who earn less than the new standard deduction amount of $12,000 would fall into a zero tax bracket, and wouldn’t owe any taxes at all.
What About Families?
Of course, this all assumes that John isn’t eligible for any tax credits. What if he has a child dependent so he can claim the child tax credit?
The child tax credit is currently $1,000 per child under age 17. The GOP tax plan pushes this up to $1,600 per child, an increase of $600. The first $1,000 remains refundable just as it has always been. This means that a parent with zero tax liability would receive a refund from the IRS for $1,000 for each dependent child he can claim. If John’s tax bill was $480 and he could claim the credit for one child, the $1,000 refundable portion would wipe out that debt and lucky John would end up not owing the IRS anything at all. He would actually receive a $520 refund.
The additional $600 is nonrefundable, however, so John wouldn’t be receiving a check for $1,120—the original $520 balance of the credit plus the additional credit. The IRS gets to keep that portion of the refund under the proposed Tax Cuts and Jobs Act.
About Those Personal Exemptions…
Now let’s say that John is married and he has four kids. He earns $50,000 in this scenario and his spouse earns $25,000 for a total joint income of $75,000. This still puts them in a 12-percent tax bracket under the proposed bill because this bracket stretches up to $90,000 in joint incomes. Under current law, they’d pay 15 percent in tax.
But they’re losing those four personal exemptions under the new law, one for each of their children, for a walloping total of $16,200. So John and his spouse would end up paying taxes on $16,200 more in income, which neutralizes that 3-percent break they’d get on their tax rate. Of course, they’d potentially get $6,400 back—$1,600 per child—thanks to the revamped child tax credit. So John’s overall tax situation might still be expected to improve, marginally, under the terms of the new House bill.
The Bill's Effect on the Middle Class
Middle-class taxpayers shouldn’t fare too badly under the proposed House changes, either. But once again, it depends on personal circumstances.
The math on the new tax brackets pretty much works out the same way as it does for low-income taxpayers. The new income parameters reduce the tax percentage for many middle-class filers. The 25-percent tax bracket currently begins for single filers with incomes of $37,951. Under the new law, they could earn up to $45,001 before finding themselves in this tax bracket.
But a higher percentage of these taxpayers have historically chosen to itemize their deductions rather than claim the standard deduction for their filing status, and the Tax Cuts and Jobs Act could end up hurting them in this respect.
Under existing tax law, their total itemized deductible expenses could well exceed their standard deduction, making it more advantageous for them to itemize. This might well change because the proposed standard deduction almost doubles over what it is under the existing tax plan. A single taxpayer who previously had about $12,000 in itemized deductions would find himself in pretty much the same tax situation under the new plan.
But one who has historically claimed $15,000 in itemized deductions would find himself paying tax on an additional $3,000 if he chose to claim the standard deduction rather than itemize. And itemizing probably wouldn't reap the same tax savings under the new plan because the increased standard deduction also interacts with all those lost itemized tax deductions. Remember, the House tax bill takes away itemized deductions for state and some local taxes, as well as the deductions for medical expenses, alimony, and student loan interest among others.
These taxpayers might well end up having less in the way of itemized deductions. The theory is that the increased standard deduction is supposed to balance that, but will it really?
Originally, the deduction for property taxes was to be negated, too, as part of the elimination of deductions for state and local taxes. But this met with a lot of resistance from legislators. The property tax deduction stays, although it would now cap out at $10,000. The deductions for state income taxes and local sales taxes are gone under the GOP plan, however, and this doesn't sit well with some legislators either, particularly those representing states where these taxes are typically high. They provide significant deductions for residents of states such as New York and New Jersey, and even Republicans argue that residents of these areas would be unfairly prejudiced by the new GOP plan. Their itemized deductions would be impacted and reduced the most.
The bottom line is that all these lost deductions could add up to a lot of no-longer-deductible money, possibly more than the new standard deduction for each filing status. This could leave some upper- and middle-income filers paying more, particularly those living in areas that impose high state and local taxes.
As for that revamped child tax credit, more middle-income earners will qualify for it under the terms of the House tax bill. Currently, the credit begins phasing out or reducing at incomes of $75,000 or more. John and his spouse would have just made it in under the wire for claiming the full credit. The new bill increases this limit to $115,000, allowing more middle-income families take full advantage of the credit.
So does a middle-income taxpayer win or lose under these proposed changes? It depends. Does he have children? How many? Was he claiming a lot of itemized deductions that would now be eliminated?
The Bill’s Effect on High Earners
Opponents of the Tax Cuts and Jobs Act argue that it unfairly favors the wealthy. And in some cases, that would appear to be true.
Many of these taxpayers will still fall into the 39.6 tax bracket reserved for the highest earners. That bracket would still exist. It currently begins with incomes of $418,401 for single filers. The new tax bill increases that threshold to $500,000, or $1 million for taxpayers who are married and filing joint returns. So, yes, some wealthy taxpayers will get a break there.
The Tax Cuts and Jobs Act also does away with the highly unpopular alternative minimum tax, which currently hits many taxpayers who earn $200,000 or more a year. The AMT was first implemented back in 1970 to prevent high-income earners from claiming a multitude of tax deductions and credits to significantly whittle down their tax obligations. They earned more, so they correspondingly spent more on tax-deductible expenses. This “mini tax,” as it’s not-so-affectionately been called, effectively takes away a lot of those deductions and credits and adds them back to taxable income for those who are subject to it because they’re high earners. But the House bill repeals the mini tax, so high earners can go back to grabbing all those lucrative deductions.
The wealthy should soon be able to pass their largess to their heirs tax-free as well. The GOP tax bill would eventually do away with the federal estate tax, which heretofore affected only the wealthiest of Americans. As of 2017, only estates worth in excess of $5.49 million must pay a federal estate tax on their values over this threshold. Statistically, this comes out to about just 0.2 percent of all estates. Low- and middle-income taxpayers have always dodged this tax so there’s no big change for them here. But now wealthy individuals might be able to stop concerning themselves with the estate tax, too.
The estate tax wouldn’t go away immediately, however. Its demise isn’t scheduled until 2024, but in the meantime, that exemption amount of $5.49 million would increase to $10 million, saving really large estates a lot of money in taxes.
It’s Not All Sunny Skies for the Wealthy
The GOP tax bill also eliminates the exclusion for dependent care assistance accounts. This is a tax perk that has been advantageous for many wealthy taxpayers. Statistically, more upper-income filers claim this exclusion than any other income group, but they won’t be able to do it anymore if the House bill passes.
And the home interest mortgage deduction is slated for tweaking under the new bill as well. As it stands now, mortgage debts of up to $1 million qualify for this deduction. The new law slashes that in half to $500,000. One can presume that anyone with a $1 million dollar or more mortgage is very well off, but he’s going to be paying taxes on more of his income because he can only claim mortgage interest on the first $500,000 of that debt now.
What Happens Next?
None of these changes are a done deal by any stretch of the imagination. The new tax act could result in a lot of economic fallout, so it can be expected to meet with a good deal of resistance. Detractors say that it will cost the U.S. a staggering $440 billion in revenues in the first 10 years alone. This could be disastrous if there aren’t also significant cutbacks in government spending. And if there are cutbacks in spending, key programs for the poor might be negatively affected or even eliminated entirely.
The bill next goes to the Senate, and to really complicate things, the Senate is expected to release its own new tax plan in the coming weeks. President Trump has said that he’d like to see the Tax Cuts and Jobs Act passed into law by Christmas, but there’s no guarantee that this will happen in its current form or even at all.
The bottom line? Don’t start your 2018 tax planning quite yet, and don't make any major financial decisions based on these changes.