Watching The Tax Proposal Duel Unfold

When Susan Roman and I sit down with folks to help them design their retirement system, we usually discuss whether it makes sense to use investment vehicles that result in growth or income on which taxes are paid currently, or whether we kick the can down the street and pay taxes later. A question we always ask is, “Do you think taxes will go up or down in the future?”
In all the years that I have been in this profession, I estimate that 95 percent of the time people respond that in the long term, they expect taxes will go up.
Folks, it is crazy to look at where our original tax system started, in 1913. Back then, indexed for inflation today, the tax rates were 1 percent on earnings of up to $463,000, to just 7 percent on earnings over $11.5 million (for married filing jointly). This is very different from today’s progressive tax system where, for 2017, taxpayers start at 10 percent on earnings up to $18,650, and shoot up to 39.6 percent on income over $470,700. And, of course, that is without including that pesky little Obamacare tax of 3.8 percent. Kind of reminds me of a famous saying from Steve Forbes when he was running for president in 1996, “The politicians say ‘we’ can’t afford a tax cut. Maybe we can’t afford the politicians.”
Hmm. Uncle Sam seems to get hungrier and hungrier as time goes on.
You see, while in the long term we can almost surely count on taxes going up, but in the short term there is a lot that remains to be seen. Right now we have two different tax proposals battling for attention: President Trump’s and Speaker Paul Ryan’s (the House GOP’s). They have some similarities, but also some stark differences. And, don’t forget: we have the outnumbered House Democrats who will most definitely try all they can do to filibuster and delay both from being implemented.
A recent blog I read by Michael Kitces lays out the differences between the two proposed tax plans quite nicely. Both proposed plans are aimed to cut taxes and simplify the income brackets. Specifically, both want to cut the number of brackets down to three, which is less than half as many as the seven that are currently in place. Those three brackets would be 12 percent, 25 percent and 33 percent, with that last tier kicking in at $112,500 for individuals, and about double that for a married couple.
Both plans also include shedding the 3.8 percent Obamacare tax, as well as the federal gift and estate taxes that plague many more affluent taxpayers.
In both President Trump’s and Speaker Paul Ryan’s plans, the tax rate cuts are balanced (at least in theory) by limiting deductions, but each in their own way. Speaker Ryan proposes keeping the mortgage interest and charitable gifts deductions, but eliminating all others. President Trump, on the other hand, would keep the current itemized deductions, but would cap them at $200,000 if married filing jointly and $100,000 if not.
Capital gains taxes are another significant piece of these plans. President Trump’s plan would keep the current brackets for capital gains taxes; 10 percent, 15 percent and 20 percent, while the GOP aims to change these figures to represent half of its proposed tax brackets for ordinary income; 6 percent, 12.5 percent, and 16.5 percent.
President Trump’s plan also proposes some changes to “above the line” deductions. An “above the line” deduction, also known as an “adjustment to income” is a deduction taken from the taxpayer’s gross income to arrive at Adjusted Gross Income (AGI). These deductions tend to be more valuable than “below the line” deductions, since they are taken before adjusted gross income is calculated. Remember, Cutter Family Finance readers, that Modified Adjusted Gross Income (MAGI) is used determine certain things, such as Medicare premiums and eligibility for Roth IRA contributions. So, the more a taxpayer can lower his or her AGI or MAGI, the better. (Below the line deductions do not lower either.)
Some of the president’s proposed deductions would benefit parents of young children. For example, within his plan, parents would be able to deduct childcare expenses for up to four children under the age of 13. It would be limited to the average cost of childcare. This does not just include the use of outside childcare, like daycare centers or other third-party facilities, but does include the implied cost of childcare if children are cared for by stay-at-home parents or other family members. This perk could phase out when individuals have an income level of $250,000, or twice that for married couples.
Just as luck would have it for me, my twins turn 14 this month. No deduction for the Cutters.
There’s a similar deduction for those caring for an elderly parent or relative in their home, although this gets limited to $5,000 in qualified expenses.
The president’s plan also includes a new Depend Care Savings Account (DCSA), which is the rough equivalent of a Health Savings Account (HSA), but for the expenses of caring for a dependent. These accounts could be funded with up to $2,000 a year, and all contributions would be tax-deductible and would grow tax free. In order to encourage low income families to save, they would also receive a 50 percent match from Uncle Sam into this account if they deposit funds directly into the DCSA.
None of these deductions (or the match) are included in the GOP tax plan.
I will leave you with this. Then-President Reagan said during his presidency, “We don’t have a trillion-dollar debt because we have not taxed enough, we have a trillion-dollar debt because we spend too much.”
Whether either of these plans comes to fruition is anyone’s guess right now. However, it is important to understand that changes may be coming. Tax planning is essential to any retirement system and I don’t think anyone would argue that our tax system is a mess. Heck, even former president Jimmy Carter said, “The Federal income tax system is a disgrace to the human race.”
Something has to give.
Let’s be vigilant and let’s stay alert with our taxes, because we do deserve more.
http://tinyurl.com/l8vfbjm; 2 http://tinyurl.com/k5es9a9