Explicitly Defining Trump's Tax Reform Plan

Every year on April 15, tax season comes to an end for the majority of people. Even if their financial conditions remained the same, many taxpayers were shocked to learn that they had to pay more taxes in 2019, while others got slightly lower refund checks from the Internal Revenue Service (IRS).

Many tax professionals and accountants advised their clients to amend their withholdings in order to prevent a large tax bill at the end of the year. (It's easy to do so by completing and sending IRS Form W-4 to your payroll department.)

But how did this come to be? Let's take a closer look at President Trump's tax-code changes—the most significant in 30 years—and how they affect taxpayers and business owners.

Changes to the Internal Revenue Code

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law, making significant reforms to the tax code. How people feel about the $1.5 trillion+ overhauls is essentially determined by how they feel about Trump's presidency. Individual reactions to the changes were influenced by factors such as wages, filing status, and deductions. In 2019, those who live in a high-tax state with increasing property prices could have paid more in taxes.

Given the major and permanent tax cuts to corporate profits, investment income, estate tax, and other sectors, the tax reform bill was perceived as a lopsided triumph by the rich, banks, and other businesses. The fresh, lower corporate rate (21 percent), as well as the more favorable tax treatment of pass-through firms, could result in significant benefits for financial services companies. Some banks have reported that their effective tax rate would fall below 21%.

There were debates around tax changes, given public criticism of the tax overhaul's inequalities, GOP defeats in the 2018 midterm elections, and Trump's possible trade war muting the benefits of the tax cuts for voters. Individual tax cuts may be made permanent as a result of the changes, which will stimulate retirement savings and business innovation. Later on, I'll expand on that...

The Results of the Election

Sen. John McCain (R-Ariz.) was absent for medical attention when the bill was approved on a party-line vote of 51 to 48 on Dec. 20, 2017. Later that day, the House passed the bill by a majority of 224 to 201. The bill received no Democratic support, and 12 Republicans voted against it, the majority of whom were from California, New York, and New Jersey. The legislation's cuts to the state and local tax deduction is likely to affect taxpayers who itemize in these high-tax jurisdictions.

It was the bill's second vote in the House in less than a week. They were forced to amend the bill after the Senate parliamentarian struck down three of its clauses after it was passed on Dec. 19, 2017. The fast-track compromise process Republicans used to stop a Democratic filibuster could not pass these, according to the parliamentarian.

Over the next decade, the overhaul was expected to increase the federal debt by hundreds of billions of dollars, perhaps as much as $2 trillion. Estimates differed based on assumptions about how much economic growth the overhaul would spur, but no independent estimates agreed with Treasury Secretary Steven Mnuchin that the overhaul would result in a net reduction in the national debt. (According to the Washington Post, the country's deficit in 2019 was $984 billion, up from $665 billion in 2017.)

The legislation permanently lowered corporate tax rates and temporarily reduced individual tax rates. It abolished the individual mandate, a central provision of the Affordable Care Act that was supposed to increase insurance rates and cut the number of people insured substantially. As most individual tax laws expire after 2025, the highest earners are expected to benefit the most from the legislation, while the lowest earners are expected to pay more in taxes.

Income Tax Rates for Individuals

The legislation kept the old system of seven individual income tax brackets, although it reduced the rates in most cases. The top rate declined from 39.6% to 37%, while the 33 percent bracket fell to 32%, the 28 percent bracket to 24%, the 25 percent bracket to 22%, and the 15 percent bracket to 12%. The lowest bracket remained at 10%, while the highest bracket remained at 35%. For the five highest wage brackets, the proposed thresholds apply to lower income bands than the 2018 brackets under current law.

As with most of the law's personal tax breaks, the changes are only temporary and will expire in 2025. The deadline required the Senate to follow "reconciliation" laws, which prevent a Democratic filibuster—which Republicans lacked the votes to overcome—if the legislation does not increase the deficit in any year outside of a 10-year window and remains under the $1.5 trillion budget constraint during that period. Individual tax cuts could be expanded at a later date, as indicated by Republican congressional leaders.

Deductions that are normal

In 2018, the law expanded the statutory deduction to $24,000 (from $12,700) for married couples filing jointly, $12,000 for single filers (from $6,350), and $18,000 for heads of household (from $9,350). These modifications will be phased out after 2025. The extra standard deduction, which would have been eliminated under the House bill, is unaffected. The inflation index used to index the standard deduction adjusted in 2019 in a way that is likely to hasten bracket creep.

Healthcare Mandate and Personal Exemption

The personal exemption, which was $4,150, was placed on hold until 2025. In 2019, the bill also repealed the individual mandate, which was a clause of the Affordable Care Act (ACA) or "Obamacare" that imposed tax fines on those who did not have health insurance. (While the mandate is legally still in force, the penalty for tax years 2019 and beyond is zero.) If a taxpayer files a previous year tax return (i.e., 2018 or 2017), the penalty for not having health insurance for the whole year will also apply.)

According to the Congressional Budget Office (CBO), repealing the measure will result in a $338 billion reduction in federal deficits from 2018 to 2027, but it would also result in 13 million more people living without insurance at the end of that period, driving premiums up by an average of 10%. The repeal will not be repealed in 2025, unlike other individual tax reforms.

On March 19, 2018, Senators Lamar Alexander (R-Tenn.) and Patty Murray (D-Washington) introduced the Bipartisan Health Care Stabilization Act to alleviate the consequences of the repeal of the individual mandate. After a decade, the CBO predicted that this law will still leave 13 million people uninsured. The bill was not included in the $1.3 trillion spending bill approved by Congress on March 23, 2018. As a result, states and health insurers will bear the responsibility of offering quality health care.

Inflation Meter

The legislation modifies the inflation calculation used for tax indexing. The IRS currently uses the consumer price index for all urban consumers (CPI-U), which will be replaced by the chain-weighted CPI-U in the near future. The latter is considered to be more rigorous than normal CPI because it takes into account changes in consumers' purchasing patterns as a result of price changes. It also rises more slowly than standard CPI, so using it instead of standard CPI would possibly speed up bracket creep. The standard deduction's worth, as well as other inflation-linked aspects of the tax code, would erode over time, increasingly increasing tax burdens. The modification isn't scheduled to expire.

Credits and Deductions for Families

The legislation increases the child tax credit to $2,000 for a limited time, with the first $1,400 refundable, and adds a non-refundable $500 credit for non-child dependents. Only if the taxpayer presents the child's Social Security number will the child credit be claimed. (The $500 credit is exempt from this requirement.) Children must be under the age of 17 to be qualified. When your adjusted gross income (AGI) reaches $400,000, the child credit starts to phase out (for married couples filing jointly, not indexed to inflation). These updates will be phased out in 2025.

Head of the Family

According to a Tax Policy Center study, Trump's revised campaign plan, published in 2016, would have removed the head of household filing status, eventually raising taxes on millions of single-parent households (TPC). The legislation maintains the filing status of the head of household.

Deductions for Itemized Deductions

Deduction on Mortgage Interest

The mortgage interest deduction is now limited to $750,000 for married couples filing jointly, down from $1,000,000 under the previous law but up from $500,000 under the House bill. The new limit only applies to mortgages taken out before December 15, 2017. The transition will be phased out after 2025.

Deduction for State and Local Taxes

In 2025, the current legislation limits the deduction for state and local taxes at $10,000. A number of Republican members of Congress from high-tax states spoke out against efforts to abolish the deduction, as the Senate bill proposed.

Deductions for Other Itemized Deductions

With slight changes, the statute maintains the charitable contributions deduction. A contribution made in return for tickets to a college sporting event, for example, cannot be deducted. The interest deduction for student loans is unchanged (see "Student Loans and Tuition" below).

Both taxpayers, not just those 65 and older, could subtract medical costs that exceeded 7.5 percent of their adjusted gross income.