Deferring income into next year is likely going to be a smart play. If the Trump Plan is enacted, individual and corporate tax rates will be significantly lower next year.
Under current law, individuals pay tax on ordinary income at graduated rates from 10 % to 39.6 %. In addition, high-income taxpayers pay an additional 3.8% surtax on net investment income. Qualified dividends and long-term capital gains are taxed at 15% or 20% depending on your income. But such dividends and capital gains are also subject to the additional 3.8 % surcharge tax.
Individual Tax Rates
Under the Trump Plan, there would be only three tax brackets: 12, 25, and 33%, and the tax rate on qualified dividends and long term capital gains would be fixed at 20%. The Trump Plan would also eliminate the 3.8% surcharge on net investment income. The top personal income tax rate would then 33%, compared with the current 43.4 rate, and qualified dividends and long term capital gains would be taxed at a 20% rate rather than a 23.8% rate.
The Trump Plan does calls for eliminating or restricting some itemized deductions. Under Trump’s Plan, personal exemptions are eliminated entirely, and itemized deductions are capped at $200,000 for married filing jointly taxpayers.
Business Tax Rates
Corporations currently pay tax at various rates from 15% to 39% rate. Under the Trump Plan, corporations would pay tax at a 15% rate. The Trump Plan would eliminate most business deductions including interest on debt. But the Trump Plan allows up-front deduction of depreciation expenses rather than taking depreciation deductions over many years.
Pass-thru entities like “S” corporations, partnerships and LLCs don’t generally pay any tax. But the owners of pass-thru entities pay tax at the individual income tax rate. Under the Trump Plan, the owners of pass-thru entities would be subject to tax at a 15% rate on their business income. This is huge. A business owner who currently pays tax at the highest rate of 39.6% (or 43.4% rate including the net investment income surcharge) could end up being taxed at a 15% rate. Wow.
This disparity in the rates that would apply to business owners versus employees may lead more employees to start their own business and seek to be taxed as independent contractors. This is not all bad. But the new business owner, former employee, must do it right and actually create and operate a new business. Becoming an owner versus an employee involves more than just sending out an invoice and receiving a Form 1099 rather than a W-2. The IRS has been involved in worker classification audits for years and applies a 20-factor test to determine which classification is appropriate.
Repatriation Tax on Overseas Profits
The Trump Plan includes another change that could affect many international companies based in the United States. Under the current system, international companies park billions of dollars off shore to escape taxation in the United States. Under the Trump Plan, a repatriation tax of up to 10% would be imposed on the accumulated profits of foreign subsidiaries of United States companies. This repatriation tax on accumulated overseas profits would be payable over 10 years. In the future, the profits of the foreign subsidiaries would be taxable as the profits are earned. But until the Trump Plan is enacted into law, it is unlikely, however, that United States with foreign subsidiaries are going to bring any money back.
Repeal Estate Tax
Currently, each individual is allowed an estate tax exemption of $5.45 million. If this exemption is not entirely used at death, the balance can be used by the decedent’s spouse. But the portion of a decedent’s estate in excess of the exemption amount (that is not otherwise eligible for the spousal or charitable deduction) is subject to estate tax at the rate of 40%. Under the Trump Plan, the federal estate tax would be entirely repealed.
If the estate tax is repealed under the Trump Plan, then the current step-up in basis at death will also be eliminated. Under current law, a beneficiary’s basis in inherited assets is stepped-up to the fair market value of the assets at the date of the decedent’s death. The beneficiary can then sell the inherited assets and realize no taxable gain since the sale price would be equal to the stepped-up basis. In this way, asset appreciation that occurs during the life of the decedent can escape forever both the income tax and the estate tax (if the estate tax exemption was sufficient to cover the assets).
Under the Trump Plan, the appreciation in the value of the assets in an estate in excess of $10 million would eventually be subject to income tax (not estate tax). But this income tax would only be paid when the beneficiary sells the inherited assets.
The devil is always in the details. The final version of the Trump Plan may be dramatically different from what has been proposed to date. If you have any questions about the Trump Plan or any other aspect of federal or state tax law, please contact one of our tax attornies at 937-223-1130 or Jsenney@pselaw.com