(Note from PFS-this seems to be the best source of unbiased information from either side that I can currently find.)
As tends to happen this time of year, I awoke this morning to find that a friendly Elf had mysteriously manifested itself in my living room. Only this time, Oscar wasn’t alone. He was toting along something else that, like Oscar, wasn’t here when I went to bed, but that had miraculously became a reality as I dozed: 479-pages of brand new tax law.
That’s right…in the wee hours of the night, as visions of corporate cuts and repealed death taxes danced in Paul Ryan’s head, the Senate overcame the last big hurdle as it speeds towards the most significant tax reform in 31 years, passing its version of HR 1 by a 51-49 vote.
The work is not technically done, however, as the House and Senate must agree on a bill. And while there may be some sticking points — the treatment of pass-through businesses, education incentives, and medical expenses to name a few — the path is cleared for the President to achieve his signature legislative victory and sign a $1.5 trillion tax cut package into law, just in time for Christmas.
Here are a few highlights of the plan:
- The top individual rate is reduced from 39.6% to 38.5%, and the threshold at which the top rate kicks in is increased from $418,000 for a single/$480,000 for married filing jointly to $500,000/$1,000,000. Further down the brackets, rates are reduced as well, for full detail, see here.
- The top rate on the income earned by owners of “flow through” businesses — S corporations and partnerships — is reduced from 39.6% to a shade below 30%.
- The standard deduction is doubled from $6,350 for a single/ $12,700 if married to $12,000/$24,000.
- Deductions for personal exemptions are repealed, but the child tax credit is increased from $1,000 to $2,000.
- Many popular itemized deductions — state and local income taxes, casualty losses, and unreimbursed employee expenses, among others — are eliminated.
- The estate tax exemption is doubled, to $11 million for a single taxpayer and $22 million for married taxpayers.
- The alternative minimum tax remains intact, although with a higher exemption amount.
- The corporate rate is reduced from 35% to 20%.
- Businesses will be able to immediately expense many asset purchases; after five years of 100% expensing, the rate will phase out at 80%/60%/40%/20% rates over the ensuing four years.
- The international tax regime is completely revamped, shifting from a deferral system to a territorial system.
As we will discuss below, all of the individual changes listed above, as well as the change in the estate tax, will expire on December 31, 2025 and reset to current law. This budget gimmick was necessary to comply with the Byrd Rule (described below), and will have long-lasting impact.
Tax reform, of course, creates winners and losers. Let’s see if we can identify who they are…
Winner: the GOP
Tonight’s victory belonged solely to the Republicans. The Senate passed the bill without a single “yes” vote from one of its 48 Democrats, but then, this was the plan all along. Using the streamlined “budget reconciliation” process, the GOP needed only a simple majority in the Senate rather than the standard 60 votes, and because Republicans currently control 52 seats, victory was assured provided defections could be minimized.
The reconciliation process requires three steps:
Step #1: The House and Senate were required to pass a joint budget that fixed the total amount of revenue that could be lost to tax cuts over the 10-year budget window ending in 2027. This was done back in January, with the cap on cuts for the next decade set at $1.5 trillion.
Step #2: The final bill could not add more than the agreed-upon $1.5 trillion to the deficit over the next ten years. Last night’s bill came in at a total cost of $1.447 trillion, satisfying this requirement.
Step #3: The final bill could not add to the deficit beyond the 10-year budget window; the so-called Byrd Rule. After many late-night maneuverings, this requirement was also met, as the final version of HR 1 actually shows a $33 billion decrease to the deficit in year 10, though as described in more detail below, it took no shortage of budget gimmicks to make it work.
With all three boxes checked, Democratic Senators were shut out of the process. Republican leaders needed only 50 of their 52 Senators to support the bill, and while it was touch-and-go for a few days, they were able to wrangle 51 votes, with only Senator Corker voting against HR 1.
Loser: Regular Order. Again.
Regardless of your political affiliation or opinion of the proposed tax plan, you should be mortified by what took place over the past two weeks in the Senate. First, Senate Finance Committee Leader Orin Hatch neglected to publish legislative text of his proposal until November 21st. At 515 pages, this was no light read, but yet the Finance Committee was somehow familiar enough with its contents to vote to move the bill forward a mere seven days later.
On the Senate floor, things went from shady to sham rather quickly. First, a list of possible amendments was handed out around Capitol Hill, but only to lobbyists, rather than journalists. Then, after a flurry of 11th-hour bargains were made to nail down the final few wavering Republican Senators, the final version of the bill — now reduced to a lithe 479 pages — was made available in the dead of night, and was voted on before you awoke. Even more embarrassing was the state the text of a bill that will shape our economy for the next decade was in, as it was complete with — and I’m not making this up — key amendments and alterations hand-written into the margins of the page, with large swaths of text simply crossed out. One enterprising twitter personality offered a $25 gift card to anyone who could decipher a critical piece of chicken scratch located on page 187.
If you’re wondering how 51 Republican Senators can confidently vote for a piece of text so lengthy it would make Tolkien blush, well, they simply can’t. Call me a cynic, but there is no chance any of the Senators fully grasp the impact of the sweeping tax changes they passed last night. I make my living in the Code, and 12 hours later, I’m still grappling with the intent and impact of certain provisions in the bill, as are other tax wonks.
But make no mistake; these isolation politics are not unique to Republicans; for every person on the left who wakes up this morning wistfully recalling “regular order,” there is one on the right fully prepared to remind them of the Obamacare roll-out in 2010. Perhaps Senate Majority Leader Mitch McConnell best summed up the new environment of winner-take-all politics by responding to Democratic complaints about the bill thusly: “You complain about process when you’re losing, and that’s what you heard on the floor tonight.” I’m unclear how we got here, but it appears certain that we have entered an era where it is simply inconceivable that both parties could work together to ensure that no one is a loser.
Winner: Cognitive Dissonance
As discussed above, the Senate bill will add $1.5 trillion to the deficit over the next ten years. This is not up for debate. What is up for debate, however, is what the plan will cost after accounting for economic growth, or what is called the plan’s “dynamic score.” For months, deficit hawks within the GOP have been able to justify their vote for debt-financed tax cuts because Treasury Secretary Steven Mnuchin and Chief Economic Advisor Gary Cohn have continuously pushed the belief that the tax cuts will so dramatically boost the economy, that when it is all said and done, the bill will fully pay for itself. In other words, so much economic growth will be created by the plan that after ten years, there won’t be an additional $1.5 trillion deficit; rather, there will be no additional deficit at all.
Mnuchin, Cohn and the like have remained steadfast in this belief, despite the presence of absolutely no empirical or anecdotal evidence to support such a claim. This refusal to accept battle-tested economic theory has, however, provided one fantastic moment of levity in this otherwise morbid process, as this article explains that of the 137 economists who reportedly signed a letter supporting the GOP’s tax plan, many are retired, others may have never been employed as economists, and one may not even exist, the elusive Gil Sylvia, who I can only assume is a distant cousin of the equally-elusive Pepe Silvia of It’s Always Sunny fame.
As the ensuing paragraph describes, by the time the vote came around last night, ample evidence was available to disprove any hope that the plan would pay for itself. But that did nothing to dissuade a normally “fiscally conservative” party from choosing to add over $1 trillion to the debt over the next decade.
Loser: The Country’s Credit Card Balance
If you read the paragraphs above and asked — “Well, where is your evidence that the tax plan WON’T pay for itself?” — I kindly direct you to the official scorekeepers of Congressional tax plans, the Joint Committee of Taxation. In this report, the JCT concluded that even after accounting for economic growth, the plan will add over $1 trillion to the deficit over the next decade. And that was the good news. The report from the nonpartisan Tax Policy Center wasn’t nearly as rosy, concluding that the bill will add $1.3 trillion to the deficit after factoring in economic growth.
And you have to understand something very, very important: EVERY. SINGLE. INDIVIDUAL. TAX CUT. in the Senate bill is slated to expire on December 31, 2025. If these cuts are extended — which as discussed below, is clearly the intent — then the true cost of this plan goes well beyond $1 trillion over the next decade.
Even in the face of the JCT’s tally, however, Mitch McConnell remained unfazed, choosing to double down by not only promising that the plan will pay for itself, but that it will actually further reduce deficits, stating, “I’m totally confident this is a revenue neutral bill. Actually a revenue producer.”
You can decide for yourself who or what to believe: 100 years of sound economic theory and two independent analysis, or the promises of Paul Ryan, Mitch McConnell, and the elusive Gil Sylvia.
Winner: Big CPA Firms and Tax Lawyers
As an American taxpayer, I’m saddened by the way the process played out. A tax bill needs to be carefully considered, available to the public for review and contemplation well in advance of a vote, and — in a perfect world — bipartisan. That way, we can reap the benefit of the most valuable product of tax reform: permanence. Certainty of where the tax law will be in years 3 and 5 and 7 and 10, so that we can plan accordingly. With a Republican-led bill, however, the tax law is only as certain as Republican control; should things flip in 2020, the Code will be revamped again, and it will be taxpayers left struggling to respond to the changes.
As a tax adviser, however, I’m downright giddy. Four weeks. The GOP thinks it can enact a dramatic overhaul of the law, adding substantial new legislation governing pass-through businesses and multi-national corporations, in only four weeks without leaving behind glaring loopholes and opportunities for (legal) manipulation. The hubris is both startling and appetizing.
The eventual signing of the Senate bill into law, regardless of how it is ultimately married with the House bill, will signal the start of hunting season for tax professionals, who upon opening the pages of the new legislation (presumably, now minus the handwritten amendments) will find ample opportunity to game the system and minimize their clients’ tax liability. The irony, of course, is this is precisely what tax reform is supposed to avoid; but then, this was no ordinary tax reform process. After all, during the last meaningful overhaul of the Code — the bipartisan Tax Reform Act of 1986 — it took more than 14 months to go from proposed legislation to enactment; a full year longer than will be the case in 2017.
Loser: Small Tax Preparation Shops
Don’t get me wrong; the Senate bill also adds some much-needed simplicity to the tax law; it just happens to be centered on those who already had fairly simple returns. By doubling the standard deduction from $6,350 for single taxpayers/ $12,700 for married filing jointly to $12,400/$24,800, while simultaneously gutting the majority of itemized deductions, it is estimated that roughly 94% of taxpayers will claim the standard deduction in 2018. Thus, while high-income taxpayers will be pillaging the opportunity left behind by the revamped Code, many lower-income “W-2” filers will be basking in its newfound simplicity, confident enough to prepare their own returns now that it doesn’t require totaling itemized deductions on Schedule A. This could well cause a slow-down in business for those tax preparation shops that cater to pure compliance, rather than consulting. But on the other hand, it’s a great time to buy stock in Turbo Tax!
Loser: Real Estate Brokers
No more deduction for interest on home equity debt. A $10,000 cap on the deduction for real estate taxes. A new requirement that you own your home for 5 years — rather than 2 — before you can sell it tax-free. It’s not a great time to sell houses for a living.
Winner: Rental Real Estate Owners
It is a great time, however, to be a landlord. For starters, the life over which you can depreciate your property has been reduced — from 27.5 years to 25 years for residential property and from 39 years to 25 years for nonresidential property. In addition, while most other businesses will find their interest deduction limited under the Senate bill, that limitation doesn’t apply to landlords, who can continue to deduct their mortgage interest in full.
Real estate owners will really enjoy a windfall, however, if the final bill adopts the House version of “pass-through” taxation. Under the House bill, all rental income will be subject to a top rate of 25%, as opposed to 39.6% under current law. Under the Senate bill, however, it appears that for those large landlords earning more than $700,000 annually, unless the rental properties or a management company pays out significant W-2 wages, the owners would be stuck paying a top rate of 38.5% on the income, a rate 13.5% higher than under the House bill.
Winner: the Current President
On a day when President Trump desperately needed some good news (see: Flynn, Michael), a major step towards his first legislative victory was achieved. And then, of course, there’s the little matter of how much money the President will save under the plan; as discussed above, it is a great time to own a real estate empire.
Loser: the Future President
It bears repeating: in the Senate bill, EVERY. SINGLE. INDIVIDUAL. TAX CUT. will expire on December 31, 2025. Why? Because as discussed earlier, the bill needed to comply with the Byrd Rule, and couldn’t add to the deficit beyond the ten-year budget window. Unfortunately, the Senate’s first run at legislation did just that, sending the writers back to the drawing board. The quick fix? Simply make all of the individual cuts being offered turn back into a pumpkin when the clock strikes midnight on New Year’s Eve of 2025. The corporate cuts in the bill, however, are all permanent.
Why would Republican leaders, keenly aware of a distrusting public’s view that these cuts were truly earmarked for big corporations rather than the middle class, fuel these concerns by making individual cuts temporary and corporate cuts permanent? Because Republicans are also keenly aware that should things swing, and a Democrat win the White House in 2024, the future President will face tremendous pressure — even by a Dem-controlled Congress — to extend any expiring individual cuts. Should the corporate cuts have been made temporary, however, a future Democratic President would have had a much easier time allowing those cuts to expire. Thus, by structuring the bill in the manner in which it did, Republican leaders ensure that both the individual and corporate cuts will survive.
Whoever takes office in 2024 will have no easy task, as they will be greeted soon after by Fiscal Cliff 2, Republican Bugaloo. If the expected deficits caused by the plan come to fruition, our future leader will be tasked with balancing the need for additional revenue with the hugely unpopular decision to allow individual cuts to expire. I look forward to seeing President Kanye’s handling of the situation.
Winner: Corporations, the Richest 1%, and the Middle Class (for now)
Make no mistake, corporations are the big winner under both the House and Senate bills. The drop in tax rate from 35% to 20% is monumental, and even after accounting for some base-broadening tax increases on the corporate side, these businesses will enjoy half of the total cuts provided for in the plan.
And while it’s never a bad time to be rich, things just got a whole lot better. Under the Senate bill, the richest 1% — those earning more than $700,000 — will enjoy an increase in after-tax income in 2018 of 2.2%, and an average savings of $34,000 (by comparison, the middle class will see an increase of 1% – 1.5% in after-tax income in 2018).
Ah…that middle class…the very group of taxpayers for whom this plan was designed, according to those who built it. While the majority of middle-income taxpayers will enjoy a tax cut right away, some won’t be so lucky, with the Tax Policy Center estimating that 15% – 20% of those earning between $86,000 and $300,000 will experience an immediate tax increase, resulting from the confluence of lost itemized deductions, eliminated personal exemptions, and slower indexing of the individual tax brackets.
By the time the budget gimmicks prevalent throughout the plan run their course in 2027, however, things are much different for the middle class. If the individual cuts are not extended at the end of 2025, the middle class will not only be left with nothing by 2027, nearly 60% of those earning between $86,000 and $300,000 will pay more than if these cuts were never enacted. Oddly enough, even IF the individual cuts expire, by virtue of the steep corporate cuts, the richest 1% do just fine, with only 16% experiencing an increase relative to current law.
Loser: The Poor
The poor technically aren’t losers under this bill; in truth, they’re not really impacted at all. That’s because the bill never intended to provide additional benefits to the poorest taxpayers. To illustrate: to soften the blow of lost personal exemptions, the child tax credit increases from $1,000 to $2,000. In addition, the income limits where the credit phases out are increased as well, from $75,000 (if single, $110,000 if married filing jointly) to $250,000/$500,000. Oddly enough, however, the additional credit is in no part refundable, meaning that if you have no tax liability at all, it’s not going to help. This gives rise to a strange result: someone making minimum wage with two kids won’t benefit at all from the additional $1,000 child tax credit, but someone making $495,000 with two kids will. What a world.
So if the poor are breaking even, why do I have them listed as a loser? Because the Senate bill repeals the individual insurance mandate, which requires a taxpayer to pay a penalty to the IRS if he or she doesn’t obtain “minimum essential healthcare coverage.” And while not paying a penalty sounds like a good thing, by eliminating the financial penalty for not carrying insurance, millions of young, healthy individuals are expected to flee the insurance markets, raising premiums on those who remain behind. Thus, while the tax bill may not directly harm the poorest part of the population, rising premium costs will likely more than offset any minimal cuts they receive as part of HR 1.
Winner: Fans of Complexity
Do me this one small favor — the next time you hear any politician — Republican or Democrat — decry the complexity of the current tax law and promise to overhaul the Code in a way that leaves it simple, just ignore them. They don’t mean it. Simplicity will ALWAYS take a backseat to backroom deals and partisan politics.
For example, as discussed above, the ONLY reason the individual cuts all expire at the end of 2025 is because they had to for the bill to become Byrd Rule compliant. To put it another way, simplicity only mattered until it threatened to cost Republicans unilateral control; once that was at stake, simplicity was thrown out the window and instead, we get a fiscal time bomb waiting for us in eight years.
Or consider the dreaded alternative minimum tax. Republicans have long pointed to this parallel tax system as the embodiment of all that is wrong with the current law, creating confusion without adding value. Every Republican plan since the AMT’s inception would immediately and irreversibly eliminate the tax from the law, and this one was no different.
Until, that is, late yesterday, when it looked like a few Republican Senators were wavering, jeopardizing vital votes. To placate those with concerns, GOP tax leaders made some last minute concessions, offering additional breaks on pass-through income. Of course, when the bill can’t exceed $1.5 trillion and remain compliant with the reconciliation process, when you add more cuts, you have to offset that with more revenue, and McConnell and Senate Finance Committee leader Orin Hatch found that revenue by….you guessed it…reinstating both the corporate and individual alternative minimum tax computations.
And make no mistake, much of the new law brings its own complexity to the Code. The 23% deduction for pass-through income is rife with limitations and phase-outs. The corporate add-back for excess interest expense will require considerable thought. And the new territorial international tax regime will challenge even the most astute tax attorney.
The end, of course, justifies the means. The Senate got its tax bill, even if it does little to clean up the Code, and in many ways, makes it more clumsy to wield.
Loser: Fans of Consistency
What a strange vote this was. Senators Collins and McCain voted FOR the tax bill — which largely declaws Obamacare by repealing the individual mandate — after refusing to vote for Obamacare repeal.
Senator Flake — who voiced significant concerns over the debt-financed nature of the bill, going so far as to attempt to add a “trigger mechanism” that would have raised taxes if economic growth did not conform to expectations (it failed) — ending up voting for the bill anyway, AFTER the JCT and Tax Policy Center issued reports showing the bill’s detrimental fiscal impact.
And Senator Corker, the lone Republican to vote against the bill, did so after playing an instrumental role in setting the bill’s $1.5 trillion price tag as part of the budget negotiation process.
Perhaps the DJ 3000 said it best:
So here we are. The Senate has done its job, and now all that is left is to merge the House and Senate bills and forward it on to the President for signature just in time for Christmas. But if it’s just the same to you, I think I’ll be sending this Senate bill back to the North Pole with Oscar the Elf, with hopes that he comes back in a few weeks with something a little less reminiscent of a stocking full of coal.
curity Administration, is January 31. The January 31 filing deadline also applies to certain forms 1099-MISC reporting non-employee compensation such as payments to independent contractors.