Tax Reform: What You Need to Know

House Republicans revealed their long-awaited tax reform legislation on November 2nd. The clock is now ticking to approve the most sweeping overhaul of the tax code in 30 years – by the end of 2017.

The path ahead could be rocky, as lawmakers dig into the details of the 400-page bill over the coming weeks. We fully expect some changes to be made as there are many competing interests to appease. This is especially true in the narrowly-divided Senate, which is expected to release its own version of tax reform later this month.

In the bill’s current version, here are some highlights that may be of interest to you:

  • Fewer brackets, though the top rate for the wealthiest filers is unchanged. The bill reduces the number of brackets for most Americans to three: 12%, 25% and 35%. But it maintains the current top rate of 39.6% for individuals earning more than $500,000 and couples earning more than $1 million per year.
  • No changes to retirement savings incentives. One of the most discussed elements of the potential tax reform package in recent weeks was a proposal to lower the cap on contributions to tax-advantaged 401(k) accounts and instead require most retirement savings contributions to be made to Roth accounts, for which contributions are taxed up front. But after considerable public outcry, the bill’s authors dropped the provision.
  • No changes to taxation of investment income. The bill calls for the tax rates on capital gains and dividend income (currently 0%, 15% and 20%, depending on income) to remain unchanged. It also makes no changes to the Net Investment Income Tax, the 3.8% surtax on investment income for wealthier filers that is part of the Affordable Care Act. For the time being, at least, the surtax is here to stay.
  • Eliminates the estate tax – in 2024. The bill immediately doubles the exemption for estates (to $11.2 million for individuals, $22.4 million for couples in 2018) and then eliminates the estate tax entirely in 2024.
  • Preserves the “step-up in basis.” Heirs will continue to be able to pay capital gains taxes based on the value of the asset at the time of death of the previous owner, not at the time the previous owner acquired the asset.
  • Eliminates the Alternative Minimum Tax. Getting rid of the unpopular AMT was a key part of the Republican strategy from day one.
  • Nearly doubles the standard deduction. As expected, the bill increases the standard deduction from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for couples.
  • Reduces the deduction for home mortgage interest. Current law allows homeowners to deduct the interest on mortgages up to $1 million. The House bill caps interest deductions for mortgages at $500,000 for new purchases. Expect this to be a particular point of contention in the weeks ahead.
  • Eliminates most deductions and credits. This is where the heart of the debate will be, as the bill eliminates hundreds of popular tax incentives, including those for medical expenses, student-loan interest and adoption expenses. As expected, the bill eliminates the state and local tax deduction, providing only a deduction for state and local property tax that is capped at $10,000. For lawmakers representing constituents in high-tax states like California and New York, this will be hard to swallow.
  • No changes to treatment of tax-exempt municipal bonds. Investors had been keeping a wary eye on whether the tax plan would change the treatment of muni-bonds, but the bill contains no changes.

Where we go from here

First, the bill is being reviewed and considered by the House Ways and Means Committee this week, which is expected to be relatively smooth. Assuming the committee approves, the full House would then consider the bill next week. Final passage could come before Thanksgiving.

The path through the Senate is much more difficult, where Republicans hold a slight 52-48 majority. The Senate tax reform bill could look much different than the House version.

Once the Senate and House have each passed their version of tax reform, the two chambers will need to reconcile the differences and produce a single, identical bill. Then each chamber will need to pass that version before it can be sent to the president for his signature. Accomplishing all that before the end of the year is plausible, but it’s going to be tough!

Mike Minter

Mike develops investment portfolio allocations, handles trading and rebalancing, and conducts research and analysis as a Portfolio Manager and Financial Advisor for the firm. As a perpetual student of investing and the markets, Mike considers himself obsessed with the subject. Mike has earned the CERTIFIED FINANCIAL PLANNER™ (CFP®) and Certified Fund Specialist® designations. He is also an active member of the Houston chapter of the Financial Planning Association (FPA).

Read Mike's Profile HereRead More Articles by Mike