Earlier today, the US House of Representatives passed the tax reform bill we’d been hearing about for several months in the news and heralded by our President as something that would stimulate massive investment and create all kinds of new jobs. I’m skeptical on that and cannot say I am happy with what I’ve seen, but this isn’t a political commentary blog. Still, I feel the need to mention that the currently proposed tax reform will result in considerably decreased revenue, and will be largely devastating to the field of higher education, cause the real estate market to soften considerably in some parts of the country (for both new and existing houses) and result in wealthier taxpayers enjoying lower taxes at the expense of the middle and poorer classes of taxpayers (those with incomes under $ 24,000 remain largely unaffected and will continue to pay little or no tax). The bill passed without a single vote from any Democratic representatives (2 did not vote at all, the rest voted against), and 13 Republican representatives voting against the bill, hardly the wonderful “bi-partisan effort” on lawmaking that every President or House Speaker loves to cheer about. All but one of the Republican representatives that voted against this tax reform bill came from California, New Jersey and New York, where state and local taxes are generally the highest in the country (more on that below). Walter Jones, a Republican from North Carolina, also voted against this bill.
Here are some of the key parts of the House’s successfully passed tax reform bill that affect most taxpayers:
- Four new tax rates, ranging from 12% for married couples with taxable income under $ 90,000 and individuals with taxable income under $ 45,000, to 39.6 % for married couples with taxable income over $ 1 million and individuals over $ 500,000.
- For the approximate 30% of taxpayers who itemize their tax deductions, they would no longer be able to deduct the state and local income taxes they pay on the state returns they file. They would also be limited to deducting no more than $ 10,000 of real estate taxes. This would largely explain the group of Republicans’ vote, whose constituencies pay among the highest state income and real estate taxes in the country, choosing to dissent from the party line.
- The state and local tax deductions being repealed or severely curtailed may not matter to many wealthier families, because they often lose these deductions when the Alternative Minimum Tax (AMT) is calculated on their income. The AMT would be repealed under the recently passed bill. However, many people forget that the AMT is actually an acceleration of one’s lifetime income tax liability; in the years when regular income tax is computed as higher than the AMT, the taxpayer receives a credit for the AMT they paid in prior years; essentially the government is paying back the interest free loan the taxpayer was forced to give them. But if the AMT is repealed, it is not clear as to what would happen to prior years’ tax credits built up from paying the AMT over the years if their is no separate tax to compare the regular income tax to.
- Taxpayers who own a home and itemize their deductions would also only be able to deduct the mortgage interest on the first $ 500,000 of their mortgage balance. The National Association of Realtors and National Association of Home Builders will be putting forth heavy efforts to prevent this bill from becoming law for obvious reasons and it would make acquiring a home more difficult in the more expensive coastal states, ultimately causing a softening in the real estate market. Admittedly, the average homeowner carries a mortgage balance that is far less than $ 500,000, so most homeowners would not be affected by this change; proponents of this change will also claim that taxes are not the main driving reason behind the purchase of a home.
- Charitable donations would still be deductible; however with a higher standard deduction of $ 24,400 for married couples and $ 12,200 for individuals, the number of Americans who itemize their deductions will likely decrease and thus fewer people will have a tax incentive to make charitable donations.
- Although the standard deduction would be increased, a typical family of four takes the standard deduction would see more of their income taxed, as the personal exemption of $ 4050 per person we enjoyed on the 2016 return would be repealed. Under the old law, a family of four with the standard deduction would deduct a total of $ 28,900 from their income before it was taxed ($ 12,700 for the standard deduction, $ 16,200 for the exemptions), while under the new law, they would deduct only $ 24,000, resulting in $ 4900 additional income being taxed.
- Whether they itemize deductions or not, taxpayers who move more than 50 miles to take a new job are allowed to deduct up to $ 5000 of moving expenses, but under the recently passed bill, only members of the armed forces who move pursuant to military orders will be able to do so. Moving long distance can be a costly expense, and I believe this deduction helped ease that burden as well as helped encourage people to make the effort to find more fulfilling and better paying jobs.
- Another deduction that taxpayers below certain levels of income can take under the current law, whether they itemize or not, is up to $ 2500 in student loan interest paid. The House bill eliminates this deduction entirely. I know that for my first few years out of graduate school, when I began my career and was getting started in the workforce, this deduction helped ease the burden of my student loans on my government salary. Recent graduates with student debt would no longer have such a benefit, no matter what their income.
- In another blow to the educational field, graduate students who receive teaching stipends and tuition funding from the university they attend (as well as typically do research and teach undergrads for the university) would be taxed on both the teaching stipends and the value of the free tuition. For example, a graduate student who receives an annual stipend of $ 20,000 for teaching undergrad students and $ 40,000 in tuition funding for doing research at the university they attend for their masters or PhD program would now be required to include a total of $ 60,000 of income on their returns, instead of just the $ 20,000 in teaching stipends they are required to include today.
- The American Opportunity, Hope Scholarship and Lifetime Learning Credits are unchanged, saving students who pay tuition up to $ 2500 in federal taxes, but have been combined into the same program for the sake of simplicity.
- Perhaps to make up for the repeal of the personal exemptions, the Child Tax Credit has been increased from $ 1000 to $ 1600, but is phased out for married couples with more than $ 230,000 of income and individuals with income of more than $ 115,000.
- Individuals who receive self-employment income from their own business or a partnership in which they are actively involved would pay income tax at a special 25% rate instead of the regular tax rates. I am unclear as to how this part of the proposed new law would work and it appears that any person receiving self-employment or partnership income of less than $ 90,000 would pay a higher tax rate, but as always, the devil is in the details and I will reserve any judgment on this part of the bill until I better understand it. It is clear, however, that this tax rate would not apply to licensed professional businesses like my own and others such as doctors, dentists or architects.
- For those who are able to accumulate significant wealth in the course of their lifetime but risk the unfortunate problem of only being able to pass on $ 5 million of it without suffering the estate tax, the exemption would be doubled to $ 10 million and then fully repealed after 2023. Whether our government deserves to have a share of the wealth built up by a hardworking and successful family over their lifetime is not something I want to debate, but I do believe the estate tax helps prevent all our country’s wealth from being concentrated in the hands of a few super rich families (our President being among them). Let’s not forget our history; such a scenario was at least a partially driving force behind some extremely violent and unpleasant revolutions in numerous countries.
Other areas have been affected by the recently passed tax reform but at some point I had to end this post. Do not make any plans around what I have just written; the Senate version of the proposed changes to our tax laws is somewhat different and will probably stall most of these changes from being formally written into law before Congress adjourns for the year. Furthermore, the Senate has a smaller Republican majority than the House and has a greater chance of deadlock, potentially further stalling these changes.
As I’ve said before, I try to avoid political commentary, but this has been the most shocking set of proposed changes to our system of taxation. Many people, potentially even myself, could benefit from these changes, but of course it is more than being just about me. Our country’s future is at stake here. It is at a time like this that contacting your Representatives and Senators to express your opinion about these proposed changes is more important than ever, as I do not see the positive aspects being touted under this proposed tax reform (increased investment and job creation) materializing so easily, while the negative aspects of it (decreased tax revenue, softening real estate values, reduced support for higher education and wealth being concentrated in a smaller portion of the population) are of greater certainty.