With a Trump presidency on the way and Republican control of both the House and Senate, the prospects for tax reform just improved a bit. Make no mistake, comprehensive tax reform won’t be easy to push through even with the support of the new administration and Republicans in Congress. It’s been 30 years since President Reagan signed the last major piece of tax reform legislation, a testament to the difficulty of doing so. It will take a big commitment from the players at the table, so watch carefully in the first half of 2017 to see what traction it gets.
What might tax reform look like? The incoming President and the House Republicans have both shared plans for income and estate tax reform. It’s worth examining both plans to search for commonalities, as they offer some guidance on what a final compromise might look like for individual taxpayers and their estates.
Trump income and estate tax plan highlights
- Reduce the number of individual income tax brackets from seven to three (12%, 25% and 33%)
- Retain the existing rates on capital gains (0%, 15% and 20%) and align them to the new proposed income tax brackets
- Repeal the net investment income tax (3.8% tax on investment income)
- Increase the standard deduction from $12,600 to $30,000 for married couples filing jointly and from $6,300 to $15,000 for singles
- Eliminate personal exemptions and the head of household filing status
- Cap itemized deductions at $200,000 for married couples filing jointly and $100,000 for singles
- Repeal the alternative minimum tax
- Repeal the estate tax, “but capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms.” [sic]
House Republican blueprint highlights
- Reduce the number of income tax brackets from seven to three (12%, 25% and 33%)
- Provide for 50% exclusion of capital gains, dividends and interest income. This equates to taxing these items at half the rate of ordinary income (6%, 12.5% or 16.5%)
- Increase the standard deduction to $12,000 for singles or $24,000 for married couples filing jointly
- Eliminate personal exemptions
- Eliminate all itemized deductions except for mortgage interest and charitable contributions
- Repeal the alternative minimum tax
- Repeal the estate tax and keep the step-up in tax cost
What planning opportunities might exist if tax reform occurs? Despite the difficulty of Republicans agreeing on a uniform proposal and overcoming challenges from Democrats, these two plans offer preliminary insight into any potential deal. If the major components of the two plans listed above are implemented, individual taxpayers may want to consider whether some of the following techniques are appropriate or possible:
- Accelerate deductions that may be eliminated or capped. Furthermore, deductions are more valuable when they offset income taxed at higher current rates.
- Defer income where possible. For wage earners, this can be difficult; consider tax-deferred savings vehicles such as IRAs, 401(k) plans or deferred compensation plans, and consider delaying the exercise of employer stock options.
- Delay realization of capital gains. On the other hand, consider accelerating realization of capital losses to offset gains that may be taxed at higher current rates.
- Reconsider asset location planning strategies. In the House Republican blueprint, interest is taxed at the same preferential rate as capital gains and dividends. This may create more flexibility in where to hold certain asset classes in your portfolio.
Estate & other transfer taxes:
- Defer making taxable gifts. A gift that would generate gift or generation-skipping transfer tax under current law may not result in tax if transfer tax reform or repeal is enacted.
- If you anticipate that your estate is subject to federal estate tax (broadly speaking, if the value of your assets is greater than the federal estate tax threshold [$5.45M in 2016; $5.49M in 2017], subject to prior taxable gifts and various deductions), postpone the event that triggers it—your death.
- If the step-up in tax basis upon death is eliminated (for some or all estates), consider whether holding onto highly appreciated securities until death is still appropriate (e.g., utilize intergenerational gifting if the next generation has capital losses available or is taxed at a lower income tax rate). In this case, the income tax implications may drive the estate planning decision.
Tax reform may still be a long shot, but the recent election results suggest that taxpayers should be ready for anything.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.