This week the House and the Senate both passed what is largely being hailed - for better or worse - as the biggest change in tax law since Reagan was in office, the Tax Cuts and Jobs Act (TCJA). There is no shortage of analysis, articles, op-eds, etc. in regards to this bill, and for good reason, as it will literally and directly impact almost every single person and company in the country.
So rather than give you a regurgitated version, here's how I'm going to tackle this subject. Below you'll find:
- A brief summary of what happened and what's changing
- Some oddities/minor items that are significant but won't necessarily impact a lot of people
- Who wins
- Who loses
- Why you should or shouldn't like it if you're politically liberal
- Why you should or shouldn't like it if you're politically conservative
- What to yet do in 2017 for planning purposes
- What to do in 2018 for planning purposes
I have to warn you, this is a long post but deservedly so (again, considering how broad of an impact this bill will have).
How was it passed?
There have been more than a few articles of late that mention that this bill was pushed through with haste. That is at once true but not true. It's true from the sense that once the final bill was written, there wasn't a lot of time for those actually voting on it to read it, and in that sense it seems like the spirit of the process wasn't being respected much (though a cynic would say, not inaccurately, that there was close to 0% chance that any Democrat was going to vote for it anyway, regardless of how much time was given for review). On the other hand, the vast majority of the changes within this bill have been known for a very long time. Some of them (e.g. the general idea of lowering the corporate tax rate) have been talked about for as long as I remember; more specifically though, Paul Ryan - probably best described as the brains behind this measure - started talking about his Better Way plan in 2015 and delivered a written plan/outline in June of 2016. The Better Way agenda wasn't just about taxes but it did have tax reform, and many of the details that ultimately made up the TCJA, within it. Finally, many of President Trump's proposals for the tax bill have been publicly talked about since as early as December, 2016. So the long and short of it is that most of the TCJA provisions and changes have been publicly known for quite a long time now.
What major things are changing?
- The corporate rates are going down, with the top rate now at 21% from a previous 35%
- Household tax brackets have changed with most of them being decreased, with only the 10% and the 35% brackets remaining (though with different thresholds for the 35% bracket)
- The Standard Deduction is almost doubling to $12,000 for Individual and $24,000 for Married-Filing-Jointly (MFJ) - this is coupled with a removal of Personal Exemptions
- The State and Local Tax (SALT) deduction is changed to now only allow for an aggregate of $10,000 per year. Interestingly, this is $10,000 regardless of whether you file as an Individual or as MFJ (differing from the traditional approach of allowing for higher amounts for MFJ)
- The Child Tax Credit is both doubled to $2,000 and now partially refundable ($1,400); additionally, the income threshold to use it has been dramatically increased with a phaseout at $400,000 for MFJ from a previous phaseout at $110,000
*There are far more things changing than what is outlined above or below; for the sake of brevity though, only those I see as being relevant for most readers are outlined.
- Only interest on loans related to "Acquisition Indebtedness" is deductible going forward; this means no more deducting interest on HELOCs or 2nd Mortgages (that were taken after original purchase) and no more deducting interest on the amount of refinancing above the principal amount refinanced (more on this subject later)
- 529 assets can now be used for K-12 education (not including homeschooling expenses), limited at $10k per year
- Kiddie Tax rates have been altered to mirror Trust brackets
- Several changes combined together will result in far fewer people being impacted by the Alternative Minimum Tax
*The following is just a list of the "big" winners. In truth, it's estimated that around 95% of all taxpayers will have a reduction in taxes going forward. So in reality, most everyone could be included in this category, though to varying degrees and only from the perspective of how the bill impacts their cash-flow.
- Households with dependent children under the age of 17 with incomes below $200k for Individual and $400k for MFJ; *even more-so the lower income the household is, the more kids in the house, and if the household doesn't typically itemize taxes (e.g. family who rents instead of owns, or doesn't live in a high-tax state like California, New York, or Minnesota).
This group is such a huge winner that it's difficult to convey properly. Not only are the brackets themselves going down but the Child Tax Credit has been doubled. So even with losing out on Personal Exemptions (which were eliminated), the credit now equates to a deduction of between $6,250 and about $16,000 per child! It gets even better for those who otherwise don't pay taxes due to the refundability (which is effectively getting money from the government even when one doesn't owe taxes) of up to $1,400 per child. The Child Tax Credit was previously not refundable, making it basically a wasted benefit for those who otherwise didn't have a tax bill (usually families with low income). So if a family, for example, with 3 kids otherwise didn't have a tax bill in 2017, that same family (assuming nothing else changed with their situation) would now get a return of $4,200!
- Business Owners
Without getting into the mechanics of it I'll just say that this group makes out very well due to a deduction of 20% of the profits, effectively creating a set of lower brackets for those who have pass-through income. There is a LOT more nuance to this, so if this applies to you and you're interested in learning more you should reach out to your accountant.
- C Corps
Rates are going down in general and there is a special, limited-time, low rate for repatriated cash held overseas.
- Very High Income Households
The highest income earners in general will do well due to both the lowering of the top bracket and the elimination of the Pease Limitation, which required a gradual phaseout of deductions as income increased.
- Those with certain kinds of non-qualified deferred compensation.
This group is typically senior-level employees of large companies. The taxable event for receipt of certain types of stock grants will now be upon vesting, instead of upon liquidation.
- Certain Individuals and Families
Namely, individuals with income between approximately $200,000 and $400,000 and Married-Filing-Jointly households with income over $400,000 - though the degree of "losing" phases out as that income goes up (due to various items). This is because the rate(s) at which taxes are paid is either the same or only slightly lower plus the limitation on certain deductions like property and state income taxes or mortgage interest. Finally, the Child Tax Credit phases out at these levels.
- Some Tax Payers in High-Tax States
Because the SALT deduction is so greatly limited, the negative impact gradually increases the more your state taxes you. So for those who live in New York, California, Minnesota, Iowa, and others, this tax bill may hurt. This is especially true the higher your income is and the less dependent children you have.
Why You Should or Shouldn't Like It if You're Politically Liberal
Why should you like it?
It is enormously helpful to families with low incomes
The Democratic party is generally regarded as being the more sympathetic party to the poor. This bill does more to help families with low incomes than arguably any tax bill ever passed. Interestingly, when Senator Marco Rubio (R-FL) attempted to broaden the Child Tax Credit even further via an amendment on the Senate Floor a couple weeks ago, he only received support from 9 of the 48 Democrats in the Senate, which kind of shows the lens through which many legislators view legislation (as a party thing first and an actual legislation thing second).
- The corporate tax rate was lowered
This idea was championed by most Democrats - including former President Obama - throughout election periods in recent cycles.
- The limitation of deductibility for some execution compensation
These changes are extremely progressive, punishing high-income earners to a much greater degree than lower income earners
Why should you dislike it?
Extremely high income earners do quite well. There is no way around it, from a nominal perspective, this group does better than everyone. The DFL has mostly championed a tax-the-rich approach and though this bill does increase taxes on some of the rich (high income employees, for example), it helps most.
From a process perspective, it sounds as though Democrats were not invited (outside of the Senate-floor amendment process) to have input.
Why You Should or Shouldn't Like It if You're Politically Conservative
Why you should like it
It is a generally conservatively-minded idea that the people who earn money should get to decide how to use it. This bill, mostly, bends the curve towards that by lowering taxes for the vast majority of people.
It is extremely pro-small business. Between the lower rates in general, coupled with the deduction for pass-through entities, it cannot be argued that this is pro-small business - which has long been a Republican base of support.
- It is pro-family. Much like the Democrat party is generally regarded as being sympathetic to the poor, the Republican party is generally regarded as being sympathetic to families. Between the Child Tax Credit and - to a lesser degree - the expanded use of 529 plans, this is a very pro-family bill.
Why you should dislike it
Most analysis of it suggests that it adds to the deficit (all other things being equal). The Republican party used to be (in the very recent past even) a pro-fiscally responsible party. The argument is that lower rates will lead to more growth, which most reasonable people agree will happen, but the problem is that most analysis suggests that even with substantial growth we are unlikely to break even.
This greatly increases the number of non-tax paying households. Although conservatives may find it laudable to be pro-family via lower rates, higher standard deduction, and the expanded Child Tax Credit, there is also this general conservative thought that most people should have some skin in the game (so, for example, they care about spending). This bill only increases the disparity of non-tax paying households vs. tax-paying households.
- The vast majority of Republicans complained to no end about how the Democrats didn't invite them to the table in regards to passing the Affordable Care Act (colloquially known as Obamacare). If this was truly a problem then perhaps the opposite should have been done here by reaching out for bipartisan support. Concessions would have to have been made but even if they could have gotten just 8 or 9 Democrats, they could have made this bill permanent instead of sun-setting.
- This bill absolutely does not simplify the tax code. Simplifying was a goal, and it's true that it does simplify filing for some, but on net this is just changing out one complex tax code for another.
What To Yet Do in 2017 for Planning Purposes
Rates are going down for most in 2018 plus some deductions are being limited or eliminated. So we all have a narrow window to take some action to capture some breaks at higher rates yet in 2017. There are likely more items than what is detailed below but here are a few that could help:
- If you are charitably inclined and will otherwise itemize deductions this year, you may want to consider front-loading some of your planned 2018 gifts to right now (December, 2017). This could be as easy as, for example, simply making your January tithe to church right now instead of actually doing it in January, or as big as setting up a Donor-Advised Fund and gifting a very large amount to be dispersed to your non-profit of choice over time.
- Make your January mortgage payment early. Interest is still deductible going forward but again, rates themselves are lower starting in 2018, so perhaps capture the break at a higher rate now; also, you may not be itemizing next year due to a higher standard deduction.
- If you have time to still alter your withholding on your last paycheck in December, you may want to increase your state tax withholding amount. This is because there isn't a limitation (for most) on SALT deductions in 2017 but is limited to $10k in 2018. If you get a state return in 2018 it will be considered income next year but again, the rates are generally lower. So even if you increased your state withholding by, for example, $400 on your last paycheck this month and are in the 25% federal tax bracket that'd be $100 back in your pocket as a result of lower taxes now (though, again, if you get a state return it will be income next year).
- *(Read edit at bottom of page) Make your 2018 property tax payment in December, 2017. Same concept as the state income tax item and the January mortgage item just this time in regards to property taxes.* (Credit to Taylor Ripka of Delta Capital Advisors for this tip. Also, congrats to Taylor, who is now a CFP®!)
What To Do In 2018 for Planning Purposes
Are you a low or middle income earning household with dependents? If so, odds are pretty good you shouldn't be saving in a pre-tax retirement account going foward. Due to both the high level of and the refundability of the Child Tax Credit, you may actually not benefit at all from saving pre-tax (what's the point of lowering your income if your tax bill will be eliminated by the credit anyway). As such, saving in a Roth becomes a near no-brainer for the vast majority of middle-income and low-income tax-payers with multiple children.
On the topic of Roth, due to both the sun-setting of these rates and likelihood of at least some increase in the national deficit, it's not hard to imagine a scenario of increased rates in the future. This reform makes saving in a Roth all the more attractive, even if you aren't a low or middle income household.
- Remember the "Acquisition Indebtedness" piece related to mortgage interest deduction? Well, keep in mind that for future refinances - if you do a cash-out refinance - the proportion of interest on the debt above the prior loan balance is no longer deductible. So what does this mean? Well, it makes paying off your mortgage early slightly less attractive, as accessing the equity of the home now is slightly less attractive. Not saying this makes paying off your mortgage early a bad financial move, just more unattractive than it previously seemed.
So where does that get us?
To recap, most people win from the perspective of whether they have more money in their pockets going forward. Some "win" more-so than others. Some "lose" in that their tax bill will be going up.
We probably all lost in how this bill came to fruition. The Democrats could have easily reached out to Republican leadership this past spring when the tax bill was first being talked about as a policy item for 2017; however, it seems that many/most/all of them preferred to just be anti-Trump/Republican than trying to impact how this bill was written. Additionally, many Democrats come across as highly-hypocritical as it relates both to the deficit and "stimulus." There was hardly ever an ounce of concern from Democrats on the deficit when there were annual budget deficits as a result of near-continuous increases in spending during the Obama administration and Democrats were all for "stimulus" when they got to decide how the money was spent. On a related note, Republicans come across as extremely hypocritical on both being fiscally-conservative as well as in regards to their prior complaints on the legislative-process being one-sided when one party controls everything. There have been repeated calls for budgets to be balanced going forward from Republicans in recent election cycles and that the federal government should operate like a household in terms of how they handle finances, yet this bill likely will increase the deficit (all things being equal). Additionally, they could have easily reached out to at least some of the Democrats (moderates specifically, like West Virginia's Joe Manchin) to try to make this bipartisan and get to the 60 votes necessary to make the bill permanent.
Unfortunately, both parties preferred to go party-first.
None-the-less, enjoy your likely windfall (assuming you're part of the 95% benefiting)!
Edit 12/28 10:00am
*For those looking to prepay 2018 property taxes to deduct in 2017 and wondering about the legality of the action (in light of the IRS statement late yesterday):
Just got off the phone with a Carver County property tax employee. Her statement to me is that the IRS' notice does not provide a conclusive answer as to whether pre-payment will be deductible (at least as it pertains to Carver County residents, though I'd guess it's true for most other MN counties as well), as property values have been assessed but payment amounts are just estimated.
As such, there is some risk to pre-paying.
1.) I am of the opinion that these pre-payments will not be deductible. This is because, as the Carver County rep stated, the property values have been assessed but the property taxes based on those assessments are at this point estimates. I could be wrong and I am not a CPA, so take this with a grain of salt.
2.) Regardless of whether the pre-payment ends up being tax deductible, if you otherwise pay property taxes via escrow you may be increasing your odds of an audit. This is because your mortgage company will send a statement to the IRS reporting how much you paid through them for property taxes; this amount would obviously differ from what you'll report (which would be 2017 + 2018). This is not a guarantee that you will for sure be audited, just would increase the likelihood.