Tax Reform Proposals and the Art of the Possible

USA map with stethoscope

The markets are focused on the progress tax reform bills are making on Capitol Hill. Most significant to the markets is the proposed reduction in corporate tax rates, as this would have a positive impact on corporate earnings. Some experts predict a comprehensive bill will pass before year-end. However, at this point, it is difficult to ascertain what, if any provisions, Congress will ultimately enact.

Both the Senate and House bills contain provisions that will result in significant reductions in tax revenues. This is a concern for retirement plans which are viewed as a giant tax loophole by those at the Treasury Department responsible for tax policy. For this reason, retirement plans are often a target when the Treasury is looking for ways to make up for lost revenues. In the past, major tax bills have often included significant paring of tax benefits for retirement plans.

A proposal was introduced in the context of tax reform that would reduce the annual limit for employee deferrals from $18,000 to $2,400. President Trump tweeted against this and it does not appear to be going anywhere.

The most significant tax proposal is in the Senate bill. It reduces the corporate tax rate to 20 percent. While there is a consensus that a reduction in corporate tax rates is needed, this provision will result in a major reduction in revenue. For this reason, it will likely be subject to negotiation.

Some items seem fairly likely to pass as they appear in both the Senate and House bills. These include:

  • IRA Re-Characterization: Repeal the rule that currently allows individuals to reverse a Roth IRA re-characterization before the due date, including extensions, for filing the individual’s tax return.
  • Standard Deduction: Increase the standard deduction, which 70 percent of taxpayers take in lieu of itemizing. It will increase from $6,500 to $12,000 for singles and twice that for married couples filing jointly. It is predicted that this would reduce the number of tax payers who itemize to 10 percent. This appeals to the IRS as it simplifies enforcement.
  • Deduction for State and Local Taxes: Repeal the deduction for state and local income taxes. This will be a tough sell for members from blue states where the deduction is most valuable. Currently, the House version of the bill keeps the deduction for property taxes with a cap of $10,000.
  • Estate Tax: Increase the exemption from $5 million per individual to $11 million.
  • Alternative Minimum Tax: This is a complex surtax that rescinds or postpones the value of many tax breaks in order to guarantee that all taxpayers pay a certain minimum amount of tax. Enacted in 1982, it was aimed at only the wealthiest tax payers, but with inflation now impacts many taxpayers and for this reason has become controversial.

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