Heirs, Some Business Owners Are Winners in Tax Plan

The heirs of wealthy people and business owners in low-tax states are among those most likely to benefit from the tax overhaul proposed Thursday by Republicans in the House of Representatives.

Families who have children and few deductions are also expected to benefit.

Who loses? Highly paid employees in high-tax states; future buyers of large homes or second homes; high-earning home sellers; people who take medical deductions; and future alimony payers, among others.

The plan fills in crucial blanks missing from earlier proposals, such as brackets and rates. The top rate would remain 39.6%, although the threshold rises to $1 million for married couples from $470,700 now. The bottom rate would move up to 12% from 10%.

The proposals outlined in the current bill could change significantly during the legislative process, but here is a rundown of changes that explains why certain groups would -- and wouldn't -- benefit.

Many owners of partnerships, limited-liability companies and S Corporations -- who currently pay tax on income at the owner's personal rate -- would get a tax cut as a result of the Republican plan. The top tax rate on a portion of that income, known as "pass-through income," would drop to 25% from 39.6%.

The very wealthy get a tax break on their estates. The bill would double an estate-tax exemption to $10 million from $5 million per person, plus inflation adjustments. This change wouldn't take effect until Jan. 1, 2018.

Roberton Williams, an economist with the Tax Policy Center, estimates that the number of taxable estates could fall from about 5,000 a year to fewer than 2,000. The bill also ends the estate tax completely, starting in 2024.

Residents of some states are hurt by the loss of deductions. The plan eliminates virtually all itemized deductions other than for mortgage interest, some property taxes, and charitable gifts. It also eliminates other write-offs, such as for moving expenses and alimony for divorce decrees after 2017.

The loss of the deduction for state and local income or sales taxes would hit hardest in the six states that account for half the value of these deductions: California, New York, New Jersey, Maryland, Massachusetts, and Illinois, according to the Tax Foundation.

The deduction for property taxes would be capped at $10,000. Six states also get more than half the value of this deduction: California, New York, New Jersey, Texas, Illinois, and Florida, according to the Tax Foundation.

The deduction for medical expenses would also be repealed. Medical-expense write-offs are currently allowed only if they exceed 10% of annual income, so it is most useful to taxpayers with large unreimbursed costs -- such as for a nursing home or home health aides.

In the weeks before Thursday's announcement, many users of this break who are concerned about losing it contacted journalists and lawmakers with concern over the loss of this provision.

Home buyers and sellers face new restrictions. Under current law, taxpayers can deduct interest on up to $1 million mortgage debt for a first and second home.

For mortgages taken out after Nov. 2, other than refinancings, interest would only be deductible on $500,000 of debt, and only for a first home. The $1 million limit would continue to apply to existing mortgages, but only for a first home.

The bill would also restrict an exemption useful to many home sellers. Under current law, sellers who have lived in a home for two of the last five years don't owe capital-gains tax on $250,000 of profit if they are single or $500,000 for married couples. For example, if a married couple buys a home for $200,000 and sells it for $500,000, the $300,000 gain isn't taxable.

Families with few deductions could be in better shape. The "standard" deduction for filers who don't break out their deductions would roughly double, to $12,200 for single filers and $24,400 for married couples in 2018.

But the exemption of about $4,000 that every person gets under the current law would be repealed. The loss of the personal exemption would be a blow, but expanded credits could turn some losers into winners. The credit for children under 17 would increase from $1,000 to $1,600 for many. And a "family flexibility credit" of $300 for each family member who isn't a child would be in effect until 2023.

Some owners of partnerships, limited-liability companies, S corporations, and sole proprietorships, stand to benefit under the new plan. Such entities currently bypass corporate taxes and pay tax on income at the owner's personal rate, which is why they are called "pass-throughs."

These pass-through entities have surged in popularity in recent decades and now account for more than 40% of all business income. They include some very large private companies as well as smaller firms like car dealerships, manufacturers, and professional-service firms.

The top tax rate on a portion of pass-through income -- typically 30% -- would drop from 39.6% to 25%. That won't help business owners earning less than $200,000 (singles) or $260,000 (married couples). But it would reduce the effective top tax rate for many pass-through owners earning more.

"Service" providers such as doctors, lawyers, accountants or architects are generally excluded from getting the lower rate.

Following the change, many pass-through owners will weigh which is more beneficial to their bottom line: stay a pass-through business or convert into a traditional "C"-corporation. It is likely one of these options would give them a lower tax rate than currently.

Should an owner convert to a C-corporation, the firm would owe corporate tax. The plan would drop the top corporate rate to 20% from 35%.

"This bill could encourage pass-through owners to switch into corporate form to get a lower tax rate on current earnings and defer taxes on dividend payouts," says Steven Rosenthal, an attorney with the Tax Policy Center.

Write to Laura Saunders at laura.saunders@wsj.com

(END) Dow Jones Newswires

November 02, 2017 20:48 ET (00:48 GMT)