It's been a whirlwind first two months in office for President Donald Trump, yet the reality is he's only managed to tackle a small amount of the pledges he laid out during his campaign. Assuming he and Congress can pass the American Health Care Act, which is the replacement plan for Obamacare, the next most logical step will be for Trump and Congress to tackle tax reform.
Trump's three-pronged approach to tax reform
Arguably one of his most touched-on topics during his presidential campaign, tax reform is something Trump plans to tackle three ways.
Image source: U.S. Department of Homeland Security, Flickr.
First, he has a vision of dropping the corporate income-tax rate from 35%, which is among the highest in the world, to 15%, which would put the U.S. among the lowest in the world for developed countries. Trump believes that enabling corporations to keep more of their income should translate into more innovation, hiring, and expansion.
Second, and sticking with the corporate side of the equation, Trump wants to offer U.S. multinationals an opportunity to repatriate what amounts to roughly $2.5 trillion in overseas capital. Instead of paying the full corporate income-tax rate, Trump would allow for a special repatriation holiday tax rate of 10%. The belief is that this added income could spur business reinvestment and hiring.
Lastly, but most directly, Trump wants to completely reform the individual income-tax brackets. Trump's promise to lower taxes for all Americans involves narrowing down the current seven-tier ordinary income-tax brackets (ranging from a low of 10% to a high of 39.6%) to just three ordinary income brackets (12%, 25%, and 33%). If this three-bracket proposal looks familiar, it's because House Republicans were proposing it before President Trump adopted it during his campaign.
In addition to cutting ordinary income-tax rates, Trump's individual income tax reforms would simplify the tax-preparation process by removing nearly all deductions and credits (the mortgage interest deduction and charitable-giving deductions would stay) and replacing them with a considerably higher standard deduction of $15,000 for single filers and $30,000 for joint filers. For added context, the corresponding standard deductions in 2016 for single filers and couples was $6,300 and $12,600, respectively.
Image source: Getty Images.
Trump just hinted at two potentially big changes to his tax plan
However, based on a recent interview Trump had with Fox News contributor Jesse Watters, two pretty sizable changes could be in the cards for his individual income-tax proposal.
First, as pointed out by CNN Money, Trump suggested that the current number of individual tax brackets be reduced "from seven to three or four." The addition of "four" is a bit intriguing, given Trump's staunchness in following the lead of the House Republican plan, which has three brackets.
Trump later commented, "I'd like to see 0% if you don't make much, like 0%. That's what it's going to be, it's going to be 0% up to a level." Previous iterations of Trump's tax plan have not included a 0% tax bracket, although a 0% bracket is somewhat implied, given his call for beefed-up standard deductions.
In theory, $15,000 in income for individual filers and $30,000 in income for married couples will be wiped out by the standard deduction, relegating that income to a 0% federal income-tax rate to begin with. However, Trump's implication could mean that his idea of more than doubling the standard deduction may not be possible, thus creating a 0% tax rate in place of a standard deduction for low-income individuals and couples. Again, this is all speculation at this point.
Image source: Getty Images.
The second major change might be the initial 12% tax level after the aforementioned 0% rate. Remember, the House Republican proposal that Trump adopted during his campaign listed a 12%, 25%, and 33% tax rate. Trump commented to Watters that "it's going to be 12.5%, 15%, it's going to be 10%. We're working on the different numbers." In other words, it looks like there's some fluidity to the tax rates that Trump touted during his campaign.
While it's far too early to know right now, the ordinary income-tax rates could depend on how much of a deficit reduction the passage of the American Health Care Act yields. Initial reports from the Congressional Budget Office estimated a $337 billion reduction over the course of 10 years. Yet a separate analysis of Trump's income-tax proposal from the Tax Foundation called for a substantial static and dynamic decline in revenue collected by the federal government over the next decade. Thus, Trump will need to find ways to cut costs elsewhere to pass along lower tax rates to corporations and the American public.
Don't hold your breath
Perhaps the only certainty for the time being is that taxpayers shouldn't be holding their breath and waiting for tax reform. If there's anything close to a constant on Capitol Hill, it's that tax reform timelines almost always take longer than expected, and that certainly appears to be the case once again with the Trump administration,
So what should you be doing? Chances are, not much of anything different in terms of tax planning than you've been doing for the past couple of years. I'd suggest approaching 2017 with the expectation that the seven ordinary income tax brackets will remain in place throughout much, if not all, of the year. It simply wouldn't be prudent to try to jump the gun on tax reform when even the president isn't exactly sure what the final bill might look like.
