December 2017 update: As I predicted, the final tax bill looks nothing like the preliminary proposals from Congress. Most of this blog post’s content has become IRRELEVANT. I kept it here just for historical reference. Again, information below is no longer accurate!
With the Obamacare fight finally over, the next frontier is the much anticipated (back in 2016) Trump tax plan.
Some make a big deal out of it. The reasons why I just roll my eyes:
- There is no plan as of October 2017. The current version is “work in progress.”
- The plan has changed more than once since Trump’s 2016 campaign version. It will keep changing.
- Every single idea in the plan is heavily attacked by one group or another, with huge money at stake.
- Given this administration’s track record, I don’t believe in a major tax reform happening.
- Whatever will be done, if anything, is likely to be minor and add more complexity and chaos.
Why worry about something that has no shape yet and is unlikely to become a reality?
What are we trying to accomplish?
Nobody knows, and it’s a scary thought. Three goals are mentioned by politicians:
- Stimulating the economy. Well, it means tax breaks for businesses. Tax breaks mean less revenue and more deficit. At the time of major natural disasters and the need to increase military spending.
- Balancing the budget. Well, that means getting someone to pay more. Any volunteers? Too bad, because many congressmen indicated they would not support a tax reform if it increases deficit. Not to mention this minor thing: keeping their voters happy.
- Simplifying the mess. Excellent idea, I’m all for it! Except that it obviously contradicts the other two goals. The two goals that also happen to contradict each other.
Basically, we have no defined destination.
“Always watch where you are going. Otherwise, you may step on a piece of the forest that was left out by mistake.” – Winnie the Pooh
But did not Trump have a good-sounding tax plan during his campaign?
He did. One year to date, in September 2016, Trump said the tax plan will have four “very crucial principles”:
- making the tax code more fair and simple;
- middle-class tax cuts;
- lowering tax rates for businesses;
- and creating incentives to bring offshore investments back into the country.
Unfortunately, the current concept of the proposed tax plan is much farther from these principles than what was promised in 2016. Let’s look at what’s being discussed today.
Middle-class tax cuts. Pardon, what cuts?
I struggled with Trump’s early promises to “massively cut taxes for the middle class, the forgotten people.” Even in his initial plan, it was hard to find this elusive middle class relief. Supposedly, it was to come from lower tax brackets and doubling the standard deduction.
Today, a married couple living on a $50k salary pays about $3,500 in federal income taxes. The current Trump plan will save them less than $400. Hardly qualifies as a massive cut, don’t you think? That was without itemized deductions: mortgage interest, state or sales taxes, property taxes and donations. If our couple tithes and pays a mortgage – they may actually pay more taxes under the Trump plan. Ouch.
It gets more unsettling when we insert couple kids in the picture. Personal exemptions of $4k per person are rolled into the standard deduction under the Trump plan. It means no taxable income reduction for kids, in stark contrast with the current system which affords a $8k write-off for 2 kids. Unless the new system increases child tax credit, this family is looking to pay at least $1,000 more in taxes, compared to their current tax bill.
As I said earlier, we do not know what the final proposal will look like, but so far the forecast for the working middle class is gloomy.
But at least it is simpler than today’s multi-page forms?
On the surface – yes. It will not stay simple, however. Not only because the Congress and the IRS will surely find a way to complicate even the simplest things. It is because we, the American people, will not allow taxes to get simple. Let me explain.
Under Trump proposal, we will have twice the standard deduction – instead of the tedious itemized deductions and personal exemptions. This simplicity will remove (or at least dramatically reduce) the tax benefits of
- paying high state taxes – which cannot go well in New York or California
- paying high mortgage interest – which will infuriate homeowners and disrupt the super-powerful real estate industry
- donating generously – which threatens countless charities, from churches to hospitals to universities
- having kids – do I need to explain why it may create a problem?
- being a single parent – because the Head of Household status is on the chopping block
Trying to simplify the system that favors some and disfavors others requires redistribution of favors – taxes in this case. You tell me what happens when you try to take major money away from powerful groups – who just happen to be voters and campaign contributors! Exactly.
Now, if your optimism about changing our nightmare tax system is still alive – throw in the social justice angle.
If there is some tax reform – it will end up anything but simple, in order to please the numerous stakeholders, for political reasons.
Business owners, however, should save a bundle under Trump! Yes?
Sure sounded that way in 2016. We were promised 15% tax rates on business income – ALL kinds of business income! Sorry, folks. Borrowing the title from a quirky TV show – Curb your enthusiasm!
First, even the White House insiders concede that 15% corporate rate is unrealistic. The new number thrown around is 20%. Compared to the current 35%, that is a big win, no? Not for small businesses that currently pay well below 35%. But this is not where the real trouble is.
Second, and far more important, issue is: what business structures will be eligible. The encouraging promise of “all of them” is history. Most small and medium businesses are not corporations. Half are what is known as “pass-through” entities: partnerships and S-corporations. The other half are sole proprietorships – no formal entity at all. What happens to all of them?
The recent troubling comments made by Trump administration officials indicate that they intend to treat pass-through entities differently from corporations. Worse, their comments are inconsistent and very confusing. Treasury Secretary Steven Mnuchin hinted at differentiating between two types of pass-through income: service businesses and manufacturing businesses. Oh Lord, please do not go there!
Those of you familiar with S-corporations know what a nightmare it is to establish “reasonable compensation” under today’s rules. It sounds like this insane complexity is about to get 50 times worse. If the tax reform goes in this direction – structuring small businesses will become pure hell.
The only good part I can see is lifetime job security for accountants and business lawyers.
Then what do we do now to prepare?
Prepare for what?
This is like preparing for Atlantic hurricanes. Yes, you have an advance warning, sort of. Still, until the day of landfall, you are not sure where it hits and how strong. It may pass you completely – or it may wreck havoc. Who knows? I don’t.
Stay tuned but stay calm.