Our Take on Tax Reform [Part 2] – The Senate Takes Center Stage

A close look at individual tax rate changes proposed by both houses of Congress, how it will affect taxpayers, and our thoughts on the tax reform proposals.

---

Well, quite a bit has happened since last week’s post. The House of Representatives passed its version of tax reform and has passed the baton to the Senate to push its own plan over the finish line.

Truth is, the path to a new law is a much more difficult one in the Senate because of its complicated rules and procedures. The House requires a simple majority vote on all legislation.

In its regular rules of order, the Senate effectively requires a 60% majority to pass legislation due to the filibuster rules. Getting 60 out of 100 Senators to agree on where the sun will rise tomorrow is impossible, let alone an agreement on a new law.

However, there is another rule called reconciliation, which under a very narrow set of guidelines, allows for passage of legislation with a simple majority. This is the path chosen by Senate Majority Leader McConnell.

To go this route, the tax reform plan cannot impact the federal budget deficit beyond 10 years, which severely restricts the level of tax relief that the Senate plan can offer. There are other limitations precipitated by the reconciliation rule, and they could be the undoing of the whole process, but today we want to cover the individual tax rate changes proposed by both houses of Congress.

We recognize the speed at which things are changing on this issue, but we feel it is important enough to weigh in on what we now know to maintain perspective on the process as it continues to unfold.

Individual Marginal Tax Rates

Senate Plan	House Plan
Maintains the seven-bracket structure, but changes the rates to 10%, 12%, 22%, 24%, 32%, 35%, 38.5%. Individual rate reductions sunset by 2025. More details needed here.	Reduces the number of marginal tax brackets from seven to four: 12%, 25%, 35% and 39.6%.

Standard Deduction/Personal Exemptions

Senate Plan	House Plan
Standard deduction increases to $12,000 for individual filers and $24,000 for joint filers. Also, eliminates personal exemptions.	Doubles the standard deduction to $12, 200 for individual filers and $24,400 for joint filers. Eliminates personal exemptions.

Child Tax Credit

Senate Plan	House Plan
Raises credit to $2,000.	Raises credit to $1,600 from current $1,000.

Mortgage Interest Deduction for Primary Residence

Senate Plan	House Plan
Leaves current threshold of $1,000,000 for primary residence mortgages, but eliminates interest deduction on home equity loans. Unclear if existing mortgages are grandfathered. No change on deductibility of interest expense on commercial property mortgages.	Lowers mortgages eligible for interest deduction to $500,000 from $1,000,000. Interest on second homes and home equity loans will no longer be deductible. Existing mortgages on primary residences are grandfathered in under current law. No change on deductibility of interest expense on commercial property mortgages remain.

State/Local/Property Taxes

Senate Plan	House Plan
Eliminates deduction for state and local income taxes as well as property taxes on principal residence. Property taxes on investment property will still be deductible as an operating expense.	Eliminates deduction for state and local income taxes and limits deductibility of property taxes on principal residence to $10,000. Property taxes on investment property will still be deductible as an operating expense.

Depreciation Rules for Investment Property

Senate Plan	House Plan
Reduces economic life from 39 years to 25 years.	Unclear.

Alternative Minimum Tax

Senate and House Plans
Eliminates AMT.

Estate Tax

Senate Plan	House Plan
Doubles current exemption and leaves the tax in place.	Raises exemption to $10 million for individuals and eliminates the tax altogether in six years.

Of course, there are other provisions that have been outlined and there’s probably a whole lot more that we don’t yet know about. Bottom line, we think both plans just pick another set of winners and losers and offer little in the way of significant tax relief to individuals.

In fact, a big chunk of taxpayers may pay even more than they do under current law, especially Californians who have state tax burdens that will no longer be deductible for federal tax calculations. Add the limitations on mortgage interest and it looks like the tax checks for a lot of us are going to get bigger, not smaller.

At this point, Republican lawmakers have backed themselves into a political corner. They have to get something done to save face, but

neither plan helps the average taxpayer to any significant degree. Click To Tweet

Corporations, on the other hand, may see major tax relief, but there’s no guarantee that those savings will result in a significant increase in economic activity. Big companies may use simply use the extra cash to buy back stock or not spend it at all.

The politicians all tout the simplicity of the new proposals, but only the most naïve of us truly believe that the tax code is going to be less complex under any new law. The K Street lobbyists are burning the midnight oil on behalf of their special interest groups and the final law will probably contain a variety of exceptions that we will discover after the fact.

If it were up to us, we would leave the tax code alone until something truly beneficial to all is front and center. More to come as the drama unfolds…