With the proposed tax reform comes a lot of analysis. Sorting through these reviews to find a nonbiased viewpoint is difficult. I've read several different reports including from the Tax Foundation, and the Tax Policy Center.
One is considered more conservative (Foundation) and the other more liberal (Policy Center). Both accurately report on what the proposed tax reform contains. The differences come in how each analyzes the impact of the tax changes on various groups.
My last article, What We Know About the New Tax Reform Bill, reviews many of the changes in the proposal (personal and corporate rates, deductions, personal exemptions, etc.). Most of the controversy comes from taxes on the wealthy. There is a case to be made that this bill benefits the wealthy more than the middle and lower classes of income. Looking more closely, that is true for some wealthy and not for others.
In this post, we will dive a little deeper into some of the more controversial provisions of the bill. I'll let you decide whether this is good or bad.
Taxes on the wealthy
To determine the impact of taxes on the wealthy, we must start with a definition of who the wealthy are. Measuring by who is in the 39.6% tax bracket (the highest), it's singles and heads of households making $500,000 and married couples making $1,000,000 or more. Comparing that to the current income levels for that bracket (singles – $418,400, married – $470,700, heads of household – 444,550) the wealthy have a net gain with higher income levels.
Taxes paid by the wealthy depend on the type of income they receive. If the income is passive income from an S-Corp, LLC or other entity, the maximum tax rate on that money is $25%. That is a significant tax cut from the current rates, which could be as high as 39.6%.However, if the income is from salary, the 39.6% level stays in place.
The Tax Foundation estimates that 70% of revenue generated from passive entities is subject to ordinary income, while 30% is subject to the maximum 25% rate for active owners. So, if an employee of the pass-through business entity makes over $500,000 a year, he/she would be in the 39.6% tax bracket. The owner, making the same or higher income, would pay the lower 25% rate. That disparity is troubling to some.
The other side of that argument is that the business owners are taking the risk of ownership and providing the jobs for his/her employees. Because of that risk, they should benefit with lower taxes.
Some wealthy will pay more
One provision we don't hear much about is the elimination of the 12% bracket for those with the highest incomes.
Remember, the tax system is progressive. We pay the marginal tax rates on the next dollar of income. In the new proposal, that means we pay 12% tax on the first $90,000 of income, 25% on the next $170,000, and so on. For singles making $1,000,000 or more, and couples making $1,200,000 and up, that 12% bracket is phased out. Those taxpayers would pay the 39.6% bracket on their first dollar of income. According to a Wall Street Journal analysis, that adds six percentage points to the highest rate bringing the top tax rate to 45.6%.
The GOP tax proposal kept the 3.8% surcharge on investment income. Again, this impacts the highest earners and applies to the lesser of net investment income or the excess of modified adjusted gross income (MAGI) above $200,000 for individuals, $250,000 for couples filing jointly, and $125,000 for spouses filing separately.
One thing I think we can all agree on is that the proposed tax reform is anything but simple. Like most bills Congress writes these days, this law is complicated and full of hyperbole. How one looks at the benefits of tax reform is subjective. And the devil is in the details.
I'll be honest with you; I haven't read the Tax Cuts and Jobs Act in its entirety. Frankly, it's too painful. They wrote this bill as an amendment to the current tax law. Unless you an expert in the current law, trying to discern the amendments that pass as the Tax Cuts and Jobs Act is a tedious and laborious process. The Ways and Means Committee have written a Section by Section Summary. It is a bit more digestible. Stil, interpreting how it affects various groups is difficult.
The public will have its say on the final product. Those members up for reelection in 2018 will want to make sure they satisfy their constituents. That means we can expect lots of changes before the final product is in place.
What do you think? Is this a fair tax bill? Do you think your taxes will go up? Down? Unsure? Do you agree with the argument that business owners in pass-through entities should pay lower taxes? Let me know in the comments below.
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