Trump's Tax Plan and How It Affects You
On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act. It cuts individual income tax rates, doubles the standard deduction, and eliminates personal exemptions. The top individual tax rate drops to 37%.
The Act cut the corporate tax rate from 35% to 21% beginning in 2018. The corporate cuts are permanent, while the individual changes expire at the end of 2025.
Individual Income Tax Rate
The Act lowers tax rates but keeps the seven income tax brackets.
These rates revert in 2026.
The Act created the following chart. The highest tax bracket is $500,000 for single people and $600,000 for married couples. Beginning in 2018, they pay a 37% rate after exemptions and deductions. That's lower than the 2017 rate of 39.6%.
|Income Tax Rate||Income Tax Rate||Income for Those Filing As:||Income for Those Filing As:|
The income levels rise each year with inflation. As a result, more people are subject to the highest bracket than they would have been under the old method. By 2025, 8.9% of taxpayers will pay more than they would have under the previous tax law. In 2018, only 4.8% of households paid more.
Individual Income Tax Deductions and Exemptions
Trump's tax plan doubles the standard deduction. A single filer's deduction increases from $6,350 to $12,000. The deduction for married and joint filers increases from $12,700 to $24,000. It reverts back to the current level in 2026. It's estimated that 94% of taxpayers will take the standard deduction.
That will save them time in preparing their taxes. It can also hurt the tax preparation industry and decrease charitable contributions.
The National Association of Home Builders and the National Association of Realtors opposed this. As more taxpayers take a standard deduction, fewer would take advantage of the mortgage interest deduction. That could lower housing prices. But this could be a good time to do that. Many people are concerned that the real estate market is in a bubble that could lead to another collapse.
It eliminates personal exemptions. Before the Act, taxpayers subtracted $4,150 from income for each person claimed. As a result, some families with many children will pay higher taxes despite the Act's increased standard deductions.
The Act eliminates most itemized deductions. That includes moving expenses, except for active-duty members of the military. Those paying alimony can no longer deduct it while those receiving it can. This change is effective for divorces signed in 2018.
It keeps deductions for retirement savings, and student loan interest. It also allows those age 70½ or older to directly transfer up to $100,000 a year to qualified charities from their individual retirement account.
This transfer counts toward the taxpayer’s required minimum distribution for the year but isn’t included in the taxpayer’s adjusted gross income.
Taxpayers can deduct up to $10,000 in state and local taxes. They must choose between property taxes and income or sales taxes. This will harm taxpayers in high-tax states like New York and California.
The Act expanded the deduction for medical expenses for 2017 and 2018. It allowed taxpayers to deduct medical expenses that are 7.5% or more of income. Before the bill, the cutoff was 10%. Seniors already had the 7.5% cutoff. At least 8.8 million people used the deduction in 2015.
The Act doubles the estate tax exemption to $11.2 million for singles and $22.4 million for couples. That helps the top 1% of the population who pay it. These top 4,918 tax returns contribute $17 billion in taxes. The exemption reverts to pre-Act levels in 2026.
The Act increases the Child Tax Credit from $1,000 to $2,000. Even parents who don't earn enough to pay taxes can claim the credit up to $1,400. It increases the income level from $110,000 to $400,000 for married tax filers.
It allows parents to use 529 savings plans for tuition at private and religious K-12 schools. They can also use the funds for expenses for home-schooled students.
It allows a $500 credit for each non-child dependent. The credit helps families caring for elderly parents.
Other Changes to Income Taxes
The Act repeals the Obamacare tax on those without health insurance in 2019. Without the mandate, the Congressional Budget Office estimates 13 million fewer people would be insured. The government would save $338 billion by not having to pay their subsidies. But health care costs would rise because fewer people would get the preventive care needed to avoid expensive emergency room visits. Health insurance companies would lose money. Healthier people would drop coverage, leaving insurance firms with a higher proportion of sick enrollees.
The plan keeps the Alternative Minimum Tax. It increases the exemption from $54,300 to $70,300 for singles and from $84,500 to $109,400 for joint. The exemptions phase out at $500,000 for singles and $1 million for joint. The exemption reverts to pre-Act levels in 2026.
Business Tax Rate
The Act lowers the maximum corporate tax rate from 35% to 21%, the lowest since 1939. The United States has one of the highest rates in the world. But most corporations don't pay the top rate. On average, the effective rate is 18%. Large corporations have tax attorneys who help them avoid paying more.
It offers a 20% standard deduction on qualified income for pass-through businesses. This deduction ends after 2025. Pass-through businesses include sole proprietorships, partnerships, limited liability companies, and S corporations. They also include real estate companies, hedge funds, and private equity funds. The deductions phase out for service professionals once their income reaches $157,500 for singles and $315,000 for joint filers.
The Act limits corporations' ability to deduct interest expense to 30% of income. For the first four years, income is based on EBITDA. This acronym refers to earnings before interest, tax, depreciation, and amortization. Starting in the fifth year, it's based on earnings before interest and taxes. That makes it more expensive for financial firms to borrow. Companies would be less likely to issue bonds and buy back their stock. Stock prices could fall. But the limit generates revenue to pay for other tax breaks.
It allows businesses to deduct the cost of depreciable assets in one year instead of amortizing them over several years. It does not apply to structures. To qualify, the equipment must be purchased after September 27, 2017, and before January 1, 2023.
The Act stiffens the requirements on carried interest profits. Carried interest is taxed at 23.8% instead of the top 39.6% income rate. Firms must hold assets for a year to qualify for the lower rate. The Act extends that requirement to three years. That might hurt hedge funds that tend to trade frequently. It would not affect private equity funds that hold on to assets for around five years. The change would raise $1.2 billion in revenue.
It retains tax credits for electric vehicles and wind farms.
It cuts deductions for client entertainment from 50% to zero. It retained the 50% deduction for client meals.
Other Changes to Corporate Taxes
The Act eliminates the corporate AMT. The corporate alternative minimum tax had a 20% tax rate that kicked in if tax credits pushed a firm's effective tax rate below 20%. Under the AMT, companies could not deduct research and development spending or investments in a low-income neighborhood. Elimination of the corporate AMT adds $40 billion to the deficit.
Trump's tax plan advocates a change from the current "worldwide" tax system to a "territorial" system. Under the worldwide system, multinationals are taxed on foreign income earned. They don't pay the tax until they bring the profits home. As a result, many corporations leave it parked overseas. Under the territorial system, they aren't taxed on that foreign profit. They would be more likely to reinvest it in the United States. This will benefit pharmaceutical and high tech companies the most.
The Act allows companies to repatriate the $2.6 trillion they hold in foreign cash stockpiles. They pay a one-time tax rate of 15.5% on cash and 8% on equipment. The Congressional Research Service found that a similar 2004 tax holiday didn't do much to boost the economy. Companies distributed repatriated cash to shareholders, not employees.
It allows oil drilling in the Arctic National Wildlife Refuge. That's estimated to add $1.1 billion in revenues over 10 years. But drilling in the refuge won't be profitable until oil prices are at least $70 a barrel.
Seven Ways It Affects You
The Tax Act is so complex it affects each family differently depending on their personal situation. Here is a broad description of how it might affect the following seven groups:
- High Income: If you have a very high income, the tax plan helps you the most. The Tax Foundation said those who earn more than 95% of the population would receive a 2.2% increase in after-tax income. Those in the 20% to 80% range would receive a 1.7% increase. The Tax Policy Center said those in bottom 20% would only receive a 0.4% increase.
- Heirs to Wealth: If you inherit a lot of money, the larger exemption for the estate tax will benefit you.
- Few Deductions: If your itemized deductions are less than the new standard deduction, you win on two levels. First, the larger standard deduction will reduce your taxes. Second, you can skip the complicated process of itemizing. That not only saves you time but also money if you no longer need to pay a tax advisor.
- Large Families: You may be hurt by the elimination of personal exemptions. The higher credits for children and elderly dependents may not be enough to offset that loss.
- Homeowners: If take out a new home equity line of credit, you can only deduct the mortgage interest if you use it to buy or improve a home. If you take out a new mortgage or refinance an existing one, you can only deduct the interest up to the limit. If you live in a state with high property taxes, you can only deduct the first $10,000.
- Young People: Since young people are generally healthier, they are more likely to benefit from the elimination of the Obamacare tax.
- Self-employed: If you are a 1099 contractor, own your own business, or are self-employed, you may benefit from the 20% deduction on qualified income.
To see how Trump's tax plan affects you personally, use this federal income tax calculator.
How It Affects Businesses
The tax plan helps businesses more than individuals. Business tax cuts are permanent, while the individual cuts expire in 2025. But the nation's largest private employer, Walmart, said it will raise wages. It will also use the money saved by the tax cuts to give $1,000 bonuses and increase benefits.
As of March 2018, the tax cut spurred a record number of mergers. Corporations are using the cash windfalls to award dividends and buy back their own stock. In the first quarter, they spent $305 billion on share buybacks and cash mergers. They only spent $131 billion to increase wages, according to TrimTabs. That's just slightly above the pace over the last five years.
Apple agreed to pay $38 billion to bring home as much as $252 billion in overseas cash. It will invest $30 billion in capital spending, creating 20,000 jobs. The repatriation could also raise Treasury note yields. Corporations hold most of the cash in 10-year Treasury notes. When they sell them, the excess supply would send yields higher.
JPMorgan announced a $20 billion, five-year investment across its businesses. It would increase charity donations by 40% to $1.75 billion over five years.
Impact on the Economy
The increase in the standard deduction would benefit 6 million taxpayers. That's 47.5% of all tax filers, according to Evercore ISI. But for many income brackets, that won't offset lost deductions.
The Trump tax cuts cost the government even more. The Act increases the deficit by $1 trillion over the next 10 years according to the Joint Committee on Taxation. It says the Act will increase growth by 0.7% annually, reducing some of the revenue loss from the $1.5 trillion in tax cuts.
The Tax Foundation made a slightly different estimate. It said the Act will add almost $448 billion to the deficit over the next 10 years. The tax cuts themselves would cost $1.47 billion. But that's offset by $700 billion in growth and savings from eliminating the ACA mandate. The plan would boost gross domestic product by 1.7% a year. It would create 339,000 jobs and add 1.5% to wages.
The U.S. Treasury reported that the bill would bring in $1.8 trillion in new revenue. It projected economic growth of 2.9% a year on average. The Treasury report is so optimistic because it assumes the rest of Trump's plans will be implemented. These include infrastructure spending, deregulation, and welfare reform.
The JCT analysis is probably the most accurate since it only analyzes the cost of the tax cuts themselves. The tax cuts' increase to the debt means that budget-conscious Republicans have done an about-face. The party fought hard to pass sequestration. In 2011, some members even threatened to default on the debt rather than add to it. Now they say that the tax cuts would boost the economy so much that the additional revenues would offset the tax cuts. They ignore the reasons why Reaganomics would not work today.
The impact on the $21 trillion national debt will eventually be higher than projected. A future Congress will probably extend the tax cuts that expire in 2025.
Increase in sovereign debt dampens economic growth in the long run. Investors see it as a tax increase on future generations. That's especially true if the ratio of debt-to-GDP is near 77%. That's the tipping point, according to a study by the World Bank. It found that every percentage point of debt above this level costs the country 1.7% in growth. The U.S. debt-to-GDP ratio was 104% before the tax cuts.
Supply-side economics is the theory that says tax cuts increase growth. The U.S. Treasury Department analyzed the impact of the Bush tax cuts. It found that they provided a short-term boost in an economy that was already weak.
Also, supply-side economics worked during the Reagan administration because the highest tax rate was 70%. According to the Laffer Curve, that's in the prohibitive range. The range occurs at tax levels so high that cuts boost growth enough to offset any revenue loss. But trickle-down economics no longer works because the 2017 tax rates are half of what they were in the 1980s.
Many large corporations confirmed they won't use the tax cuts to create jobs. Corporations are sitting on a record $2.3 trillion in cash reserves, double the level in 2001. The CEOs of Cisco, Pfizer, and Coca-Cola would instead use the extra cash to pay dividends to shareholders. The CEO of Amgen will use the proceeds to buy back shares of stock. In effect, the corporate tax cuts will boost stock prices but won't create jobs.
The most significant tax cuts should go to the middle class who are more likely to spend every dollar they get. The wealthy use tax cuts to save or invest. It helps the stock market but doesn't drive demand. Once demand is there, then businesses create jobs to meet it. Middle-class tax cuts create more jobs. But the best unemployment solution is government spending to build infrastructure and directly create jobs.
Trump Versus Bush and Obama Tax Cuts
President Obama cut taxes in the 2009 economic stimulus package. Between that and the government spending, the recession ended in July. The 2010 Obama cuts occurred only two years after the 2008 financial crisis. Ending the cuts might have thrown the economy back into recession.
All three cuts increased the deficit and debt.
Trump's Promises That Aren't in the Plan
Trump's 2016 proposal allowed up to $2,000 to be deposited tax-free into a Dependent Care Savings Account. The account would grow tax-free to pay for a child's education. Taxpayers could also receive a rebate for the Earned Income Tax Credit and deposit it in the DCSA.
Trump promised to end the AMT for individuals.
Trump promised to increase taxes on carried interest profits, not just stiffen requirements. But lobbyists for those industries convinced Congress to ignore Trump's pledge.
Trump promised to end the Affordable Care Act tax on investment income.
The Bottom Line
The Tax Cut and Jobs Act significantly changed personal and corporate taxes. Corporations benefit more since their cuts are permanent while the individual cuts expire in 2025.
Individual tax rates have been lowered, the standard deduction raised, and personal exemptions were eliminated. Many itemized deductions are removed while the medical expense deduction is expanded. Families with several children and elderly dependents may pay more taxes. with the elimination of exemptions. Healthy, young citizens would pay less with the elimination of Obamacare tax. Those who earn more than 95% of the population will see an increase of over 2% in after-tax income while the bottom 20% will enjoy only a 0.4% increase.
The maximum corporate tax rate has been lowered from 35% to 21%. Passthrough companies receive a 20% deduction on qualified income. The corporate AMT has been eliminated. The plan encourages corporations to repatriate foreign earnings.
The Tax Act may curtail economic growth in the long run. According to the Joint Committee on Taxation, the Act will add $1 trillion to the debt over the next 10 years. Since tax rates weren't prohibitive to start with, their benefits won't “trickle down” to boost consumerism and economic growth. Since they occurred during the expansion phase, they won't generate many new jobs.
This article provides an overall summary. The Act is so complex that it affects each taxpayer differently. Consult a tax expert to determine the Act's impact on your personal situation. If you would like Congress to change the Act, then contact your U.S. Representatives and Senators and tell them.