The GOP recently released a “framework” for tax reform legislation. The document spells out the party’s top priorities for tax reform and offers several big clues about how the new tax system would work. Here are some of the highlights relating to individual (as opposed to business) tax reform.
Fewer tax brackets
These tax brackets are “marginal,” meaning that if you make enough income to hit a certain bracket, you aren’t charged that rate on all your income — just the part of it that falls withing that bracket.
For example, a single person making $30,000 per year would be in the 15% tax bracket, but he would charged a 10% tax rate on the first $9,325 that he made and a 15% tax rate on his remaining $20,675 in income.
The proposed tax system continues to use marginal brackets, but it cuts the number of brackets from seven to three: 12%, 25%, and 35%.
The document suggests there may be an “additional top rate” for the highest-income taxpayers, but it doesn’t give any further details. It also mentions using a “more accurate” means of tying the three tax brackets to inflation, but again it’s short on specifics.
A much bigger standard deduction
The existing tax system allows taxpayers to choose between itemizing their deductions and simply taking a standard deduction.
The standard deduction for 2017 is $6,350 for singles and $12,700 for married taxpayers filing jointly. Taxpayers can also claim a personal exemption of $4,050 for themselves and their spouses. This exemption works like a deduction, reducing the taxpayer’s taxable income for the year.
The proposed tax system gets rid of personal exemptions and nearly doubles the standard deduction to $12,000 for single filers and $24,000 for married filing jointly.
The document doesn’t mention the head-of-household filing status, but President Trump has said in previous tax reform discussions that he intends to eliminate head of household as a filing option, in which case these filers would use the single filing status and standard deduction.
A smaller itemized deduction
The existing tax system allows taxpayers to claim several different types of itemized deductions, including the mortgage interest deduction, the charitable contribution deduction, the medical expense deduction, a deduction for state and local taxes, and several others.
The proposed tax system only retains two of the current itemized deductions: the mortgage interest deduction and the charitable contribution deduction.
The framework document doesn’t say whether the other deductions will now be non-itemized deductions or whether they will disappear entirely. In either case, with a greatly expanded standard deduction and far fewer itemized deductions, it seems likely that nearly everyone would be better off taking standard deductions under the proposed system.
Increased child and dependent tax credits
The existing tax system allows parents to claim a $1,000 tax credit for each child under the age of 17 (this credit phases out over certain income levels). The Child Tax Credit is nonrefundable, meaning the credit you receive cannot exceed the amount you owe in taxes for the year.
However, the Additional Child Tax Credit allows qualifying taxpayers to convert the first $1,000 of the Child Tax Credit into a refundable credit. Taxpayers can also claim personal exemptions of $4,050 for each dependent.
The proposed tax system gets rid of personal exemptions for dependents and “significantly increases” the Child Tax Credit to make up the difference. The first $1,000 of the Child Tax Credit will continue to be refundable, and the income level at which the credit starts to phase out will be increased so that more taxpayers can claim this credit.
The framework document also mentions adding a nonrefundable credit of $500 for taxpayers with dependents who are too old to qualify for the Child Tax Credit.
Repealed tax provisions
In accord with President Trump’s stated goal of simplifying the tax code, the proposed tax system eliminates several existing tax measures. The alternative minimum tax (AMT), the estate tax, and the generation-skipping transfer tax would all be repealed.
The framework document also mentions eliminating “numerous other exemptions, deductions and credits” to further simplify the process and allow for lower tax rates.
The upcoming legislation
The framework document is intended to provide Congress with a basis for designing its tax reform legislation.
If the GOP uses budget reconciliation rules to expedite tax reform (and it almost certainly will), then the party must make this legislation “revenue-neutral,” meaning that the new tax system can’t cost the government more money than it brings in.
Passing tax reform legislation will undoubtedly require a great deal of debate and compromise in Congress, so it’s unlikely that this legislation will pass in time for it to apply to the 2017 tax year. But when it does pass, it seems likely that it will impose some major changes on the tax code.
— Wendy Connick[ad#fool]
Source: The Motley Fool