The Good, Bad and Ugly of the New Tax Proposal

Marc Lichtenfeld By Marc Lichtenfeld
Chief Income Strategist, Wealthy Retirement

Market Trends

In the 1966 film The Good, the Bad and the Ugly, starring Clint Eastwood, the three main characters are on the hunt for easy money – $200,000 in buried Confederate gold.

While presenting the Republican tax proposal last week, House Speaker Paul Ryan made it seem like every American would wind up with some easy money from the proposed lowered rates.

But as Eastwood’s character Blondie discovered, easy money is never easy.

Here’s a look at some important facets of the new tax reform and what they could mean for you.

The Good

Most Americans will see a three-percentage-point decrease in their tax rate. That said, the lowest income group will see a two-point increase in their tax rate, as will a small group of people who earn between $416,700 and $470,700. Americans earning more than $470,700 will pay the same rate.

The standard deduction that most taxpayers use will nearly double from $12,700 to $24,400 for a married family filing jointly. That lowers taxable income by an additional $11,700, which would save another $2,925 per family in the 25% tax bracket.

The rich get a big break in the form of estate taxes. The exemption on the inheritance tax will rise from $5.49 million per person to $11.2 million and will be phased out in 2024.

The plan also gets rid of the alternative minimum tax, which was used to ensure that wealthy Americans didn’t use massive deductions to get out of paying taxes.

The corporate tax rate will fall to 20% from 35%. That seems like a good sound bite, but on average companies pay less than 19% already.

Additionally, companies with overseas funds will be allowed to repatriate the cash by paying a 12% tax. That should lead to greater dividends and stock buybacks.

I’ll get into how the new plan will affect your investments next week.

The Bad

On the surface, the lower rates sound good. But when you look at what the plan does in regards to deductions, it gets a little trickier.

For those who itemize, rather than take the standard deduction, it could be a problem.

In what appears to be a big middle finger to high-tax blue states like New York and California, taxpayers will no longer be allowed to deduct state and local income taxes. That’s a big deal in states where some people are taxed at rates as high as 13.3%.

So if you pay $10,000 in state and local taxes, you can kiss that $10,000 deduction goodbye.

It also limits property tax deductions to $10,000, an issue in states with either high taxes or high real estate prices. In California, for instance, property taxes are a reasonable 1.25%. But in Los Angeles and San Francisco, you typically can’t buy a decent house for less than $1 million. If you bought a $1 million fixer-upper, you’d pay $12,500 in property taxes, but would only be able to deduct $10,000 according to the new proposal.

Another unpopular rule is that the mortgage interest deduction will be capped at $500,000 of mortgage debt. The National Association of Realtors is going ballistic. The group says the new plan would “nullify the homeownership incentive for all but the top 5% of tax filers.”

And what seems to be an unnecessarily cruel part of the proposal is the elimination of the student loan interest and medical expense deductions. That’s going to hurt a lot of young people who are not earning big incomes and older people who are in difficult circumstances.

Currently, taxpayers can deduct up to $2,500 in student loan interest, which would save most people $625. It may not sound like much, but to a 20- or 30-something trying to make ends meet, an extra $625 can be meaningful.

Under current law, if you spend 10% or more of your income on medical expenses, you can take the deduction off your income. That includes insurance premiums for self-employed individuals.

And it hurts more people than you’d think… 8.8 million Americans, many of them with low incomes, use the medical expenses deduction. The deduction has been part of the tax code since 1942.

The Ugly

So much for fiscal responsibility. For eight years, we heard about how out of control our national debt was. Surely any new plan would address that, right?

The tax plan will add $1 trillion to $3.5 trillion in debt in the first decade and as much as $10.6 trillion by 2040. But I guess that’s something for our children to worry about.

Should the proposal be signed into law the way it stands now, the wealthy will be helped a lot, while the middle class and the poor will be helped a little.

What do you think of the new tax plan? Leave your comments below.

Good investing,