Donald Trump was elected the 45th President of the United States last night, and while I allow that to sink in for a bit, it’s also worth noting that Republicans retained control over the House and Senate. As a result, the GOP has unfettered control over the future of tax policy, meaning we may be in for some big changes. What can you expect?
Lower and Fewer Tax Rates; Goodbye Obamacare
Under current law, we pay tax on “ordinary income” — things like wages and interest income — at graduated rates, meaning as income increases, so does the tax rate. There are currently seven rates, stretching from 10% to 39.6%, with the top rate kicking in once income exceeds about $470,000 (if married, $418,000 if single)…
…Of course, the top rate isn’t really 39.6%, because as part of Obamacare, high-income taxpayers pay an additional 3.8% surtax on “net investment income” — things like interest, rents, royalties, and passive business income — bringing the real top rate to 43.4%.
We don’t pay these rates on all forms of income, however. Certain types of income — namely, qualified dividends and long-term capital gains (the sale of certain assets held longer than one year) — are taxed at preferential rates, which under current law are 15% for most taxpayers, but reach a maximum of 20% for taxpayers in the 39.6% brackets shown above, before tacking on an additional 3.8% for the Obamacare net investment income tax.
Donald Trump has proposed cutting the seven brackets down to three: with 12%, 25%, with 33% rates. He would then align the preferential rates afforded dividends and capital gains to the new brackets, while also eliminating the net investment income tax — along with the rest of Obamacare. As a result, the top rate would be a true 33%, with the top rate on capital gains and dividends a true 20%…
No More Estate Tax
Under current law, if you die with an estate valued in excess of $5.45 million, you pay a tax of 40% on the excess value. Any appreciation inherent in the assets that make up your estate, however, is untaxed at your death; rather, the beneficiaries of your estate take the assets with a tax-free, “stepped-up” basis.
Donald Trump’s proposal would eliminate the estate tax, making the next four years as good a time as any to die, and judging by my twitter feed, many people may not resist that notion. The opportunity to pass a valuable estate on to your heirs tax-free is a rare one; but understand, according to Trump’s proposal, it won’t be completely without tax. His plan would tax the appreciation inherent in the assets of an estate valued in excess of $10 million, but only when the beneficiary sells the assets; the assets won’t be taxed immediately upon death.
Huuuge Business Tax Cuts; Farewell Depreciation
Corporations currently pay tax at a rate of 35%, which President Trump likes to point out is the highest rate in the industrialized world (It’s not). His proposal would cut the rate to 15%, while eliminating most business deductions. Businesses would be permitted, however, to immediately deduct the cost of asset acquisitions, a monumental divergence from current law, under which businesses have to depreciate the cost of purchased assets over a number of years, greatly reducing the tax benefits. Those businesses that fully deduct asset costs will not be permitted to deduct interest expense on any borrowing, a provision that’s intended to reduce corporate dependence on debt.
The bigger changes under the Trump plan come in the treatment of so-called “pass through” taxation. Under current law, S corporations and partnerships do not pay entity-level tax; instead, the income is allocated to the owners, who pay the corresponding tax at the individual level, based on the applicable individual rates laid out above.
Trump, however, would provide a unified business rate of 15%, meaning not only would corporations pay tax at that rate, but all business income – even the income earned by an individual from an S corporation, partnership, or sole-proprietorship and reported on the individual’s tax return — will be subject to the same 15% rate. This means that a taxpayer earning business income would experience a drop in top tax rate from 39.6% to 15% under the Trump presidency.
It also means that under the Trump plan, the difference in top tax rate between paid as an employee (33%) and as an independent contractor (15%) is extremely significant. As a result, my employer may consider this column my resignation as an employee, as I will now be providing services only as a consultant so as to pocket the extra 18%…
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