Congress’ recent tax reform bill, the Tax Cut and Jobs Act, aims to lower taxes on corporations and companies. The GOP believes that lower taxes will help American companies to be more competitive and, in turn, will generate more jobs and more dividends for shareholders. Not all economists are sold on this argument. They note that many corporations are already cash-rich, and there are no guarantees that lessening their tax burden will result in employment gains or more generous dividends for their shareholders.
Senate Republicans agree with their Congressional colleagues on corporate tax reform, but they have additional proposals. These have been reviewed by the nonpartisan Congressional Budget Office, which has reported that the Senate’s reform package will leave lower-income and middle-class families worse off, and that proposed health insurance changes will further burden America’s poorest families. The bill overall would add some $1.4 trillion to the deficit over the next decade. Here’s an overview of the how the currently proposed reforms might affect business owners and households.
Big Business Scores Big
The top corporate tax rate would be cut from 35 percent to 20 percent (Senate version does not go into effect until 2019) – the largest one-time decrease in corporate taxes ever. Also, corporations would see additional tax breaks, including a lower rate of percent on money expatriated from low-tax countries, and a new system that, for the most part, would tax the profits created in the United States rather than worldwide income. The amended House version taxes cash repatriation at 14 percent and non-cash assets at 7 percent, while the Senate version taxes cash at 10 percent and non-cash assets at 5 percent.
Some Joy for Small Businesses via “Pass-Through” Taxation Reform
More than 90 percent of small businesses are organized for tax purposes as “pass-through” companies – either sole proprietorships, partnerships or Limited Liability Corporations. This means that income is only taxed once. If the business receives income, the money boosts the owner’s coffers, and the owner makes the appropriate tax payments based on his/her individual tax rate. The new House proposals call for cutting the top pass-through rate from 39.6 percent to 25 percent, but excludes service companies like consultants and lawyers. It also proposes a complicated formula so that the lowered rate may apply to only about 30 percent of total income. Business owners who make $150,000 or less would be allowed to pay a reduced rate of 9 percent on the first $75,000 of their earnings. This tax break would be phased in – the lowest rate would not be available until 2022. The Senate takes a different approach to lowering business owner income by proposing allowing pass-through entity members to deduct up to 17.4 percent of their ordinary business income. It also denies this deduction to anyone operating a service business with a taxable income of more than $500,000 or $250,000, married filing jointly versus single.
A Simpler Tax Code
Filing taxes will be simpler. The House bill reduces the current seven tax brackets to just four – 12 percent, 25 percent, 35 percent and 39.6 percent. The top rate applies to income of $1 million or more per year for couples and $500,000 or more for individuals. The Senate bill keeps seven brackets but alters the rates and bracket ranges instead. The bill also eliminates many credits and deductions; but it does provide a larger standard deduction ($12,000 for single taxpayers and $24,000 for couples), a larger deduction for a child – $1,600 per child as opposed to the current $1,000 per child – and a new Family Flexibility Credit of $300 per year for individuals and $600 for couples. Both versions of the bill call for the elimination of personal exemptions as well.
Fewer Deductions for Most of Us
It may be great to have fewer tax brackets to consider, but along with this streamlining comes a big reduction in itemized deductions. What remains under the House version are deductions for charitable donations, property taxes (up to $10,000 per year), and mortgage interest deductions. The Senate version of the bill completely eliminates the SALT (State and Local Tax) deduction.
The Rich Get Richer
Changes to estate taxation will help wealthy families keep more of their inheritances, until 2024 when estate taxation is eliminated entirely. Current estimates suggest that about half the benefits included in the reform proposals will accrue to the wealthiest top 2 percent. These individuals will no longer have to pay the alternative minimum tax (AMT), a measure first introduced in 1969 to inhibit tax-dodging strategies. The extremely wealthy segment of society will also be able to file charitable deductions to lower their tax bills.
What eventually becomes law remains up for debate. However, almost everyone can agree that the final passage of the Republican’s tax reform proposals faces a rough road ahead.