The White House and congressional Republicans just released their long-anticipated framework for tax reform, and there are many significant changes for both corporations and individuals contained in the nine-page document. Here's a rundown of the major changes that Americans should know about as the tax reform process gets underway.
Corporations will get a big tax break
The cornerstone of President Trump's tax agenda has always been a massive tax cut for corporations. The logic behind this is that our corporate tax rate is not globally competitive -- the top rate of 35% is well above the 22.5% global average for the industrialized world. In fact, even many Democrats (including former President Obama) have said that the corporate tax structure in the U.S. needs to be reformed.
According to the GOP tax reform framework, the corporate tax rate will be reduced to 20%. This isn't quite as aggressive as the 15% rate the president has been pushing for, but it's still low enough to achieve the objective of boosting our global competitiveness. For many American companies, this could also mean billions more in profits. In addition, there will be incentives for companies to repatriate cash that is currently stashed overseas, although the framework didn't mention any specific rates.
The framework also allows corporations to immediately write off new investments in depreciable assets, but limits the deduction for interest expense and says that several other business exclusions and deductions will be repealed. Business credits for research and development, as well as for low-income housing, will be preserved.
As you might expect, corporations seem to be happy with the plan. For one example, "The National Restaurant Association applauds the tax reform framework released moments ago. We look forward to engaging with the President and Congress as the negotiations regarding tax reform continue," according to Cicely Simpson, the executive vice president of public affairs for the National Restaurant Association
Individual tax rates: From seven tax brackets to three (or maybe four)
On the individual side of the tax code, the current seven-bracket structure with rates from 10% to 39.6% will be consolidated into just three brackets with 12%, 25%, and 35% tax rates, which is mostly in line with previous GOP proposals.
The tax framework also provides for the creation of a fourth tax bracket with a higher rate, in order to ensure the tax system remains sufficiently progressive.
While the lowest tax rate would increase by 2 percentage points, the proposed higher standard deduction (more on this in a bit) should help to offset the change for most lower-income Americans.
Do you have "pass-through" income?
For small businesses conducted as sole proprietorships, partnerships, and S corporations, which have "pass-through" income, a newly created tax rate of 25% would apply. There is some concern that wealthy individuals would attempt to recharacterize their income to take advantage of this, but the framework says that measures should be put in place to prevent this from occurring.
A higher standard deduction
During the presidential campaign, then-candidate Trump's tax plan included a much higher standard deduction, and this is included in the GOP framework.
The plan would include a standard deduction of $12,000 for single filers and $24,000 for married taxpayers filing jointly -- nearly double the current amounts. However, it's important to mention that this amount includes the personal exemption, which is currently $4,050 per person. While this certainly simplifies the tax structure, it could actually result in some people getting a lower net deduction, especially larger families.
In addition, the deduction would likely mean that fewer middle-income families would be able to take advantage of the mortgage interest and charitable contribution deductions, since the threshold where itemizing would become worthwhile will be much higher.
Which deductions will stay, and which will go?
As I just mentioned, the mortgage and charitable deductions would remain, but would likely become less useful to many taxpayers.
Other than those, the framework calls for the elimination of many others. As it's written in the framework, "In order to simplify the tax code, the framework eliminates most itemized deductions, but retains tax incentives for home mortgage interest and charitable contributions."
While the framework doesn't specify exactly which deductions are on the chopping block, one that's widely expected to go is the deduction for state and local taxes, which could be worth roughly $1 trillion over the next decade, and is currently the most used deduction by high-income households.
Many people have been concerned that tax breaks for retirement savings or education might be going away, and while we don't know anything for sure, the plan calls for retaining tax benefits "that encourage work, higher education, and retirement security."
Expanded tax breaks for families
Since the higher standard deduction replaces the personal exemption, the framework proposes significantly increasing the Child Tax Credit and increasing the income limits for its phaseout, although it doesn't give any specific numbers.
In addition, the plan would also create a new nonrefundable $500 credit for non-child dependents, regardless of their age.
Two big tax breaks for the wealthy
Finally, there are two major tax breaks included in the GOP framework that could greatly benefit the wealthiest American households.
The first is the elimination of the estate tax, which is also known as the death tax. As of 2017, the estate tax is only imposed on estates valued at $5.49 million or more. Republicans have wanted to repeal this for a long time, so this shouldn't come as a surprise.
The second is the proposed repeal of the alternative minimum tax, or AMT. The AMT was created to ensure that high-income Americans paid their fair share of taxes, but as time went on, the tax has added unintended complexity, and has started to affect the middle class more and more. So, while this is certainly a tax break for the wealthy, it could actually be a welcome tax break for many middle-income households as well.
The bottom line on the GOP tax framework
To be clear, there weren't many big surprises in the GOP tax framework, although it did finally provide some much-needed specifics. Most of the framework was consistent with previous tax proposals by Republicans in Congress or with President Trump's tax agenda.
Also, there aren't nearly enough specifics to say whether the plan will actually result in a middle-class tax cut or if the wealthy will have to pay as much or more than they do now. The mentioned "fourth tax bracket" could be a rate of 40% or more on high earners, or it could be excluded from a final bill just as easily. We simply don't know yet.
Finally, it's important to point out that there are likely to be significant changes when a final tax reform bill is drafted, so take the framework with a grain of salt.
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