President Trump’s Individual Income Tax Plan
Before we go too far down the rabbit hole of what would happen if Trump’s one-page tax plan becomes law, it’s important to remember that the plan isn’t law. There is no sign currently that Trump’s plan will become law. And the great deal of historical legislative evidence suggests that if tax reform is passed, Congress will make sure it will be very different from what the President proposed. To paraphrase the military: “No Presidential plan survives contact with Congress.”
What You Should Do
Nothing. Absolutely nothing. Considering the tax reform is nothing more than the intentions of the President, there is nothing you should do, and absolutely nothing you can do based on his tax plan. You should, however, practice good tax planning strategies based on the code we have now.
Assuming the President is able to pass some form of tax reform, whatever it might look like – and assuming you will experience lower taxes next year – you should familiarize yourself with the currently available tax planning strategies such as the timing of deductions, managing your withholdings, and maximizing your tax deductions.
Even better, use this opportunity to talk with a tax advisor or financial planner about how you can better manage your taxes in the future. If tax reform does come, once you know the details, you can use these same planning strategies to take the best advantage for yourself.
What if?
But for the fun of it, let’s say Trumps plan is implemented exactly as proposed. The following is what I like and what I don’t like, and what elements of the plan may mean for you. Why “may mean for you”? Because taxes are extremely complex, and how things impact you will depend on a host of factors which are unique and specific to your personal situation. Do not take anything on the internet as tax advice. This article is intended as general educational for understanding the possible impacts of the proposed tax reform.
The Devil in the Details
The truth is, even if the plan is implemented as written, there isn’t a lot of detail in the plan. The true impact of any tax plan is in the details. On the plus side, the President’s plan is presented in a simple format which anyone can understand. Too often, legislative proposals are made in a complicated manner so as to be incomprehensible to the average person.
At the same time, the simplicity of the plan means we can understand the broad direction the President wants to go in, but we can’t actually do anything with it due to the lack of details. The good news, by the time Congress is done with it, whatever is made law will likely be hundreds of pages of confusing detail.
Overview of the Plan
Trump is proposing to massively overhaul the personal income tax code down to four tax brackets. He keeps the progressive tax structure we currently have, where the more money you make the higher percentage tax you pay. The highest tax bracket drops from over $400,000 to around $150,000 per person. At the same time, the top tax rate drops from 39.6% all the way down to 25%.
The plan is said to be ‘revenue neutral,’ which means whatever tax deductions are given have to be made up by raising taxes elsewhere. In order to accomplish this, the President says he will take away deductions from the wealthy (single filers making $150,000+ and married filers making $300,000+) except for the charitable deduction and the mortgage deduction. In order for the plan to be truly revenue neutral, though, all deductions will have to be taken away from the wealthy. A significant number of deductions will also need to be removed from those in the proposed 20% tax bracket, which make up the middle class.
What I Like:
The simplification will make it easier for people to do their taxes, and eliminates all tax deductions for very high-income individuals. The proposal also takes away the marriage penalty where moderate- and high-income earners actually pay more taxes when they get married.
Eliminating Income Taxes For Low and Middle Income
The plan will also likely mean lower-income and middle class earners will pay no taxes, as the bottom tax bracket is now 0%. With the standard deduction and personal exemptions, a family of four earning $100,000 or less would likely pay no taxes. This is because the higher proposed standard deduction and personal exemptions will lower their Adjusted Gross Income to the $50,000 range identified in the proposed 0% tax bracket.
Doing Away with AMT
The elimination of the Alternative Minimum Tax (AMT) is also a welcome change. Originally, the AMT was targeted at a couple hundred ultra-high income earners who legally avoided paying taxes. But since it was never indexed to inflation, nearly 50 years later the AMT now catches millions of mainly middle-class Americans. Eliminating deductions for the wealthy is a much better system, as the tax brackets are indexed for inflation.
What I Don’t Like:
Using the IRS statistics for 2014, we can calculate the current average tax rates for people in every income bracket based on the taxes they actually pay. The President’s plan greatly decreases taxes for everyone making less than $100,000, but those making between $100,000 and $500,000 per year would see their taxes increase. Families between $100k and $200k would see an increase in taxes from 17% to 20% under the President’s plan. And those earning between $200k and $500k would see taxes go from 22% to 25%.
Those making above $500k would also see their taxes cut, even with the removal of all deductions. Currently, after all their deductions, those making more than $500,000 per year pay between 28% and 33% of their income in taxes. Dropping to 25% will be a significant tax benefit for this group.
Although I like some elements of the plan, if the plan is tax neutral, as the President says, it is because it represents a major tax break for lower income and ultra-wealthy on the backs of the moderately wealthy and wealthy. Adding in another 30% tax bracket for the highest wage earners and adjusting the President’s top two brackets would be a much more palatable plan in my opinion.
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Joshua Escalante Troesh is a tenured professor of Business at El Camino College and the founder of Purposeful Finance. His career provides him with a unique insight on personal financial, having been a VP at a financial institution leading up to 2008, and involved with technology and internet stock research leading up to 2000. He can be reached for comment at info@purposefulfinance.org