Donald Trump campaigned on promises to simplify the tax code for individuals and families, and now that he's won the White House, the way appears to be clear for significant tax reform. Trump's tax plan includes reducing the number of income-tax tiers and the maximum tax rate. However, not everyone will see his or her tax rate drop without some proper planning. Here's what you need to know about Donald Trump's tax proposals and how to make the most of them.
Managing your tax tiers
Donald Trump's tax plan includes reducing the number of tax tiers to three from seven. His plan eliminates the lowest 10% income-tax tier and it reduces the top tax tier to 33%. If Trump wins support for his tax plan on Capitol Hill, then income-tax rates under Trump could look like this:
And those brackets are significantly different from what they are currently:
If you look closely at those tables again, you'll notice there are winners, losers, and those who will break even under President-elect Trump's plan.
The biggest losers in this plan are low-income families, who will see a 2% tax increase. Those taxpayers don't have many tax planning options, but mid- and high-income earning individuals and families might be able to improve their tax situation with some careful planning.
For example, married tax filers with taxable earnings between $75,000 and $75,300 should consider contributing more to their retirement plan so that they can get their taxable income below $75,000. If they don't, they could see their income-tax rate jump from 15% to 25% under Trump. If they do, then they could drop down into Trump's 12% tax bracket, which would mean that they'd go from a 10% tax increase to a 2% tax decrease.
Couples with taxable income of more than $75,300 should consider their options, too. If they plan appropriately, they could go from breaking even under Trump's tax plan to getting a significant tax cut.
Currently, couples with taxable income of between $75,300 and $151,900 fall into the 25% income-tax bracket. Under Trump's plan, couples who make the maximum $18,000 contribution to an employer-sponsored retirement plan, such as a 401(k) plan, could have taxable income of up to $93,000 and still squeak into Trump's 12% tax tier. In that scenario, these taxpayers could net a 13% tax break under Trump.
Similar strategies could help couples with income that's above, but still near, the maximum $224,999 allowed in Trump's 25% income-tax bracket. If a couple's taxable income is between $225,000 and $231,450, then they'll see their income-tax rate increase from 28% to 33% under Trump. However, a little planning could get these couples below $225,000, netting them a 3% tax break instead.
Further, families with taxable income north of $231,450 who can get their taxable income below $225,000 could go from breaking even under Trump to an 8% tax cut.
Prep for changes to deductions
In addition to changing income-tax brackets, Trump proposes revamping how the IRS handles deductions.
Trump proposes increasing the standard deduction for individuals and couples to $15,000 and $30,000, respectively. That's more than double the current standard deduction of $6,300 for singles and $12,600 for most married couples.
To pay for that increase, Trump's plan would eliminate personal exemptions, which currently stand at $4,050 per individual and dependent. He'll also limit itemized deductions to $100,000 for individuals and $200,000 for couples. Taxpayers should also prepare for the integration of changes to deductions proposed by Republican leaders in the past. Those changes include eliminating itemized deductions, including property taxes, except mortgage interest and charitable giving. Because deductions for high-income earners could disappear, or be crimped significantly, those taxpayers might want to maximize their itemized deductions this year. Further, if deductions for state and local taxes end up eliminated, then it could be beneficial to pay any remaining state and local tax balances owed this year, rather than wait until 2017.
If you've got investments with capital gains that you're debating on selling, it may pay off to hang on to those investments a bit longer as well. Trump's proposing to eliminate the 3.8% Medicare net investment income tax, which is applied to taxpayers with modified adjusted gross income north of $200,000 if single, or $250,000 if married and filing jointly. That tax is based on investment income, including dividends and capital gains.
There's no telling how cost-conscious members of Congress will feel about passing significant tax reform that could increase the national debt. Therefore, it's uncertain if all of Trump's proposals will cross the regulatory finish line, or if they do, what tax year they'll begin to kick in. What taxpayers can assume, though, is that tax reform is coming, and that means it may be a good time to sit down with your tax professional sooner, rather than later.