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Tax Reform: The Good, the Bad and the Ugly

by on November 12, 2017 5:00 AM

The “Tax Cuts and Jobs Act,” the one almost known as the “Cut Cut Cut Act,” is the biggest tax reform bill in decades.

What’s the good, the bad and the ugly?

Trump promised tax reform in his campaign and while the House proposal doesn’t put forth all his ideas, it does make significant changes to the tax code. This past Thursday, the Senate Finance Committee released highlights of their tax reform bill.

One of the main components is lowering the tax rates for corporations, which is important to keep the United States competitive with other countries. The United States currently has the third highest top marginal general corporate income tax rate in the world, behind only Puerto Rico (Puerto Rico’s corporations are currently treated as foreign corporations under U.S. tax law) and the United Arab Emirates. By lowering the tax rate our companies will stay competitive and more companies may choose to headquarter in the United States. In both the House and the Senate Finance plan the top rate is reduced to 20 percent; however, the Senate’s plan starts the tax reduction in 2019, much to the disappointment of the stock market.

A repatriation tax reduction is a popular part of the bill for multi-national corporations. Repatriation tax is levied on foreign earnings brought back into the United States. A temporary reduction in our repatriation tax is built into both bills in the hope that it would prompt firms to bring more money into the States. This could help pay for itself by prompting companies to bring money back into the U.S. that is currently parked overseas and spend it on research, hiring and stock buybacks. The House bill temporarily reduces the repatriation rate to 12 percent on cash and 5 percent on non-cash. The Senate Finance plan ups the repatriation tax to 14 percent, which is still a reduction but not as nice an incentive. This would assist many companies who hold large cash reserves overseas, such as Apple (AAPL).

One of the biggest benefits to the middle class would be the repeal of the Alternative Minimum Tax (AMT). The alternative minimum tax was created to hit high-income earners but was never adjusted for inflation. Therefore, it eventually hit many middle-class American families and would affect more and more as time goes by. Both plans feature a repeal of the AMT.

Another huge help to individuals is that both plans would double the standard deduction for individuals and married couples.

The Senate plan offers a benefit to small business owners that typically have ‘pass-through’ entities, such as S Corporations. In S Corporations and other pass-throughs, business income is passed through to the owners and not separate from the business owner’s personal taxes. Their plan offers a deduction for pass-through entities, which would help many small business owners.

In both plans, the individual tax rates were changed. CNBC noted that the Senate plan would keep seven individual income tax brackets and the House plan would reduce the number of brackets to four. Both plans reduce the top tax bracket and extend the rate ranges so that less people hit the top rate.

Finally, the federal estate tax, which doesn’t hit anyone but the very wealthy, is gradually eliminated over six years in the House bill and the Senate proposal doubles the already high exemption.

The biggest roadblock: how will we pay for the tax cuts? Experts estimate that the House bill would reduce tax revenue by $1.5 trillion over the next decade and we are already carrying a huge deficit.

To pay for the cuts, the plans include eliminations of some popular tax breaks. In particular, much is being made of the elimination of the “SALT” deduction. Currently, state and local taxes are deducted from federal taxes. This is particularly advantageous in high-tax states like California, New Jersey and New York, so this change will hurt residents of those states the most.

One item that had been batted around to pay for the tax cuts was to further limit or eliminate the tax deduction for employer retirement plans, such as 401k plans. It could still be added back in to help pay for the cuts due to negotiations, but I sincerely hope not. Many workers find contributions to a 401k attractive because of the very tax deductions the government now suggests taking away. They already helped lead to the downfall of defined benefit plans, so hurting 401ks would make saving for retirement less attractive to a hardworking person. Plus, it just moves tax revenue from later (when you retire, anything you pull from your 401k is taxable if all contributions were deducted). Luckily, both plans kept 401k contributions intact. Another worry was charitable contributions might be cut but the Senate and House plans happily kept them intact as well.

While I love the idea of lowering taxes, helping families and businesses stay strong, I am concerned about the cost of these changes without the reduction of government costs in some form. Our federal deficit is large and this would certainly make it larger, even with the eventual economic benefits from companies using their money to grow and families having more money to spend. The government needs to look in the mirror and cut some of their benefits to pave the way to greater prosperity.


 

 



Judy Loy, ChFCâ, is a Registered Investment Advisor and CEO at Nestlerode & Loy Investment Advisors, State College, Pa. A graduate of Penn State University, Loy has been with the firm since 1992, assisting clients with retirement planning, brokerage services and investment advice. She can be reached at jloy@nestlerode.com.
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