3 Myths About Tax Cuts

On Friday, I touched on the proposed “tax cut/reform” bill introduced by the House Ways and Means committee which is chaired by Congressman Kevin Brady. Some of the key highlights of the “House plan” are as follows (courtesy of Zacks Research):

No change to 401(k) contribution caps

Repeal the Alternative Minimum Tax (AMT)

Corporate tax rate at 20% (aims to be a permanent cut)

Top individual tax rate 39.6% threshold at $1 million

Cut the current 7 individual tax brackets down to 4:

12% for $45,000 ($90,000 married) and lower
25% for $45,001 – $200,000 ($90,000 – $260,000 married)
35% for $200,000 – $500,000 ($260,000 – $1,000,000 married)
39.6% for $500,000+ ($1,000,000+)

Estate tax threshold doubles and gets repealed starting in 2024

Deductions limited to $10,000 on property tax and 500,000 on “new mortgages”.

Pass-throughs

Passive owners of pass-through get 25% rate
Active owners have different standard
Presumes 70% of pass-through income is attributable to labor and would be taxable at higher individual income tax rates
For professional service firms default rate would be 100% of labor – no benefit from 25% rate

Repeals itemized deduction for medical expenses

Repeals credit for adoption

Child tax credit at $1600 and creates $300 credit for each parent – $300 credits expire after 2022

Repeals deduction for student loan interest

No expansion of charitable giving limits

For corporations, 10% tax on US companies’ high-profit foreign subsidiaries calculated on global basis

Foreign companies operating in US face up to 20% tax on payments made abroad from US operations to prevent deduction load-up

Tax rate could be lowered by companies agreeing to increase US operations

Interest deductions capped at 30% of EBITDA – exemption for real estate firms and small businesses

While on the surface this tax proposal looks promising, when you dig into the details the outcome looks less robust.

Many of the proposed changes may sit wrong with the public as some of today’s more popular deductions will be reduced or repealed. Furthermore, when lumping individuals into fewer income brackets, combined with deduction eliminations, the result may actually create a “tax increase” on the bottom 40% of earners. As I noted on Friday the bottom 80% of taxpayers currently pay only about 18% of the total individual tax liability with top 20% paying the rest. But the bottom 40% currently have a NEGATIVE tax liability and the elimination, or reduction, of many of the deductions could increase taxes for many.