We began discussing the proposed changes to personal tax filings yesterday.  We’ll finish with the changes to the individual tax system today-and then go on to the changes to the business tax filings.

Deductions (Schedule A)

The biggest change for itemized deductions is the removal of limitation on itemized deductions for those making more money.  Right now (before the change), there was a throttling of allowable itemized deductions when one made $ 261,500 (or $313,800 for marrieds).  Under HR-1, that totally disappears.  (But, there are changes to the various components of the deductions, as we’ll see below.)

We can also deduct mortgage interest now for total indebtedness of $ 1KK.  That will continue to be allowed*, but any interest on NEW debt (assuming there is no other mortgage debt) will be subjected to a $ 500K mortgage indebtedness limit.   (Guess what?  Only one home mortgage interest will be deductible, now.  No second homes or vacation homes  Which is why I used an asterisk (allowed*)  about the current situation that may be maintainable.)

Oh, and property taxes?   They’ll only be deductible up to $ 10K a year.  Sorry Californians and New Yorkers (among other high property tax locales).  Moreover, while only 2.5% of Americans have (or may need) mortgages in excess of $500K, the bulk of those folks live in California, New Jersey, and New York- and the cities of Boston (MA) and Washington (DC).   You know- the places that don’t generally vote for the GOP.

State and local taxes would also no longer be deductible, either.  Only sales taxes would now be allowed to be deducted from one’s income.  (Both of these are deducted via the Schedule A, itemized deductions.)

Theft and personal casualty- unless one lives in a certified disaster zone- would no longer be deductible from one’s income, either.

Deductions for charity would no longer be limited to 50% of one’s adjusted gross income- that limit would now be 60%.  And, the gimmick about buying college athletic tickets and deducting the cost as a charitable donation- poof!  It’s gone.

Nor will we be able to deduct the cost of tax preparation.  That’s really not a big loss, since it had already been limited by the fact that there is a 2% threshold.  (Only the costs that exceed 2% of one’s income were deductible.)  The same rule – the loss of deductions- will also apply for expenses one incurs (and that are not reimbursed) due to one’s employment.   These were also deductible above the 2% threshold.  (Actually, the tax prep AND non-reimbursed employee expenses were added together before the 2% threshold was computed.)

Medical expenses that exceed 10% of your income would also no longer be deductible.  Oh, another thing.  The deduction for Medical Savings Accounts would no longer be deductible.   And, employer contributions to such accounts (MSA) would now be considered taxable income. (It was deductible to the employer, but not taxable to the recipient; the MSA’s let employers provide high deductible health insurance and use the MSA to cover the out-of-pocket expenses.)  Only Health Savings Accounts be allowed.  (Existing balances on an MSA are allowed to be rolled over into an HSA.)

As I stated Thursday, these provisions covering medical deductions and costs are going to hurt seniors big time.  The costs of nursing homes, assisted living, and long-term in-patient hospital stays will no longer be deductible.  Considering that almost 1/2 of those deducting medical expenses have family incomes under $ 50K (69% earn $ 75K or less), this is a big hit to the lower middle class and senior citizens of the US.

Alimony and Moving

This specific provision is going to make divorce settlements a lot harder to achieve.  Because anyone getting divorced after CY 2017 will no longer be able to deduct the cost of alimony from one’s income nor will those funds be taxable income to the recipient.

And, moving expenses will no longer reduce one’s income.  These costs will no longer be deductible. Worse yet- if the employer pays for the move to a new location (where they want you to be working), it is now taxable income to the employee!

Homes and Housing

Excluding the costs for employer provided housing would now be limited to $ 50K a year- but only if your earned income is $120K or less.  The benefit will be phased out at the rate of 50 cents on the dollar for each dollar of earned income that exceeds $ 120K. Assuming one’s income were $220K or more, the deduction would be totally disallowed and taxable to the recipient.

Selling our homes will become more expensive, too.  Right now, we can exclude $ 500K (married; half that for singles) of the gains on the sale of ours home from our income- as long as this house was our primary residence for 2 of the past 5 years.  The rule would become 5 of the past 8 years- and the capital gains exclusion would be limited in use to once every 5 years!  Oh, it gets worse.  That capital gains exclusion would be limited by $1 for every dollar of taxable income above $ 500K.  (Singles currently get $ 250K- and the benefit will be erased as their income exceeds $ 250K, dollar for dollar.)

Pensions and Estates

No longer can one recharacterize payment to a traditional IRA or a Roth IRA.  Once a conversion has been done, it’s done.  No more gaming the system.  (Yes, that’s a good thing- from a policy point of view.)

There are few arcane changes for the deductibility of hardship withdrawals and repayment plans.   I’m guessing those may actually stay, since only a few people are so affected.

The Estate Tax exclusion will at least double from $ 5 million to $ 10 million (and be indexed for inflation, a system that used to obtain, but hasn’t been used lately).

The alternative minimum tax would be repealed completely, under this new plan.

It’s that simple.  Nothing else needs to be added to this tax provision that was supposed to apply to the rich, but hit the upper middle class more than any other group.

How the very rich will fare

By now, you’ve seen who are the gainers and the losers.   But,  as I said earlier, how one makes money is the real change behind this tax plan.

Let’s consider four examples.  Tom, who is the CEO of Myco.  Ruth, who is the owner-operator of WidgetsRUs.  Andy, the semi-retired investor.  And, Sam, who owns RentMyFarms.    Each of these folks are earning $ 2 million in taxable income.

Recognize that I have had to make more than a few assumptions (owning a home, how many kids, what age, etc.  I kept those the same for all, to minimize any special changes)  But, here’s how much taxes they’ll pay.

Now you can see that this tax program – assuming lobbyists (and taxpayers) don’t convince anyone otherwise- means HOW we make our money is going to be a lot more critical than HOW MUCH money we make.  As a W-2 employee, Tom sees virtually no change.  Ruth and Sam benefit because their businesses are favored under this tax plan.  And, Andy gains most because the restrictions on itemized deductions have evanesced.   (It’s not the first time that our tax system is arranged to render certain situations more politically acceptable.)

It is critical to note that very few econometric models are able to provide accurate tax analysis.  The Tax Foundation and the  Penn Wharton Model are two of the few non-partisan, non-biased systems.  They are upon whose analyses I rely.

It is inane to seek out hacks to bolster one’s arguments, which some employ to justify the mistruths one desires to expound. Such entities would include the American Action Forum (a conservative-funded entity that develops data based upon conclusions drawn before effecting analyses) or Dr. Laurence Kotikoff (Boston University) (who uses sleight of hand to  equate dissimilar systems as congruent or omits whole sections of the economy (such as personal taxes) to discern overall economic results of fiscal plans).

What about those folks with high mortgage interest and pass-through businesses, that aren’t among the ultra-rich?

I’ve tried to consider the effects for those who live in those high state tax states with high mortgages.  I’ve created four scenarios to further demonstrate that this plan really affects  how one makes a living.  Each of my fictional taxpayers are married with no children and an adjusted gross income (AGI) of $ 200K.

Joe simply gets paid a salary, whose home mortgage started at $ 500K.  Sam’s mortgage loan is at $ 750K, as are the Wanda’s, but Sam only gets a salary.  Ms. Entrepreneur has a professional firm (which means her K-1 income doesn’t get the 25% pass-through tax rate), with a high mortgage.  And, Ms. Manufacturer is identical to the other Wanda, except her business is a favored one-  she gets the capped pass-through rate.   (Both Wanda’s had to recalculate the wages the firms paid, since the new law implies that the reasonable compensation must be at least 30% of the corporate profits.)

As you can see, up to now, each of  these folks paid the same amount of taxes.  Unfortunately,  all of them will now see an increase under the proposed tax.  Wanda Entrepreneur (she’s got a thriving accounting practice) gets socked for an additional 10K (restated pass-through earnings, no capped pass-through rate, and a mortgage limitation), which is the same increase McMansion will have to pay.  Meanwhile, Wanda Manufacturer gets hit with the smallest increase, because she has that capped 25% pass-through rate, even though she loses about 1/3 of her mortgage interest deduction.  And, poor working Joe won’t be getting that promised tax increase- he  will have $ 6K less spending money due to this program.

Tomorrow, we’ll start discussing the business changes effected under HR-1.

Don’t forget.  You only have a few days left to get your personal health insurance (PPACA) or obtain Medigap or Medicare Advantage improvements to Medicare. Here’s some help in navigating the systems.  Open Season Primer: Obamacare (PPACA) & Medicare

 

The Entire 7 Part Series on the “Tax Reform & Jobs Act”
Preamble 
Personal Taxes, part 1 
Personal Taxes, part 2 
Grad Students, private colleges
Biz Taxes, part 1
Biz Taxes, part 2 
Senate’s version changes