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The New Tax Reform Plans: Who Wins, Who Loses?

Tony Nitti, Tax Reform

With Tony Nitti, tax partner with WithumSmith+Brown’s National Tax Service Group, Contributor to Forbes

House vs. Senate Tax Reform Bills

Tony starts by acknowledging substantial similarities in versions passed by the House and the Senate, which will reduce individual tax rates, double the standard deduction, and eliminate many of the itemized deductions people love, such as medical expenses, and state and local income taxes.  This will create winners and losers and make taxes easier to manage for lower income payers.

Doubling The Standard Deduction

Tax reform proposes doubling the standard deduction from $12,000 to $24,000 (married, filing jointly), so that’s another $12,000 dollars that you won’t have to pay tax on.  If your state and local taxes add up to $12,000, the higher deductible washes out the loss of your itemized deduction, Steve notes.

Doubling the standard deduction reduces the number of lower-income taxpayers by raising the baseline for taxable income to $24,000, helps those with itemized deductions of less than $12,000, and hurts those with itemized deductions of more than $12,000, such as people with high mortgage interest or real estate taxes.  Estimates suggest that 94% of all Americans will opt for the higher standard deduction, making taxes easier to prepare.

Charitable Gifting

Both versions of tax reform raise the limit on charitable cash contributions from 50% to 60% of adjusted gross income.  Even so, charitable organizations are unhappy because fewer people might make donations if charitable contributions are no longer tax deductible.

Higher Estate Tax Exemption

The Estate Tax exemption increases from $5 million to $11 million.  The House version takes the added step of eliminating Estate taxes after six years, but the Senate version leaves out Estate Tax repeal, and its changes expire on December 31, 2025, and revert to current law.

Tax Bracket Changes

The current tax law has seven rate brackets that go from 10% to 39.6%.  The House bill simplifies this to four rates, going from 12% and keeping the 39.6% top rate but limiting it to a much higher level of income—over $500,000 if you’re single and over $1,000,000 if you’re married.  The Senate bill keeps the seven rates as is but reduces the top rate from 39.6% to 38.5%.

While there is no significant rate drop for middle-class taxpayers, a broad reduction in rate brackets should benefit most taxpayers who don’t live in a high tax state or city.

Simpler Or More Complex?

Steve wonders if tax reform fulfills its purported goal of simplifying the tax code.  Tony believes it will make things simpler for about 27 million low-income filers.  On the flip side, it adds complexity for higher-income payers and will keep tax lawyers busy for years to come.

Corporate Taxes

Steve shifts gears to corporate taxes.  Tony says C corporations will continue to see double-taxation—on profits and on shareholder distributions.  If a company elects to be taxed as an S Corporation, its income flows through to the owner, who pays tax at the individual rate and escapes double taxation.  Both bills also lower taxes on S-Corps, but in a manner that is replete with its own set of limitations, phase-outs, and complexities.

Real Estate Taxes

Rental real estate owners will get the 25% tax rate under the House bill and will benefit under the Senate version too, but the latter is more complicated.

In closing, Tony says he loves the complexity of tax reform because it’s going to keep him busy as a tax advisor, but he’s not particularly happy with the complexity as a taxpayer and leaves us wondering, at the end of the day, what happened to all the talk of simplifying the tax code!

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

Read The Entire Transcript Here

Steve Pomeranz: The new tax bill is coming at us like a freight train. So it’s time to get down to brass tracks and see how it affects us all. I told that to my production assistant, and she doesn’t think it’s very funny. All right, Tony Nitti joins me today.

He’s a tax partner with WithumSmith&Brown’s National Tax Service Group. He’s a CPA licensed in Colorado and New Jersey and holds a Master’s in taxation from the University of Denver. And lastly, and perhaps most notably, he once sang the National Anthem at the World Series baseball game, though he was not at the vicinity of the microphone at the time.

With that, I welcome, Tony Nitti. Hey, Tony, welcome to the show.

Tony Nitti: Steve, thank you so much for having me.

Steve Pomeranz: So I understand you’re joining us from New York today. Weather cold enough for ya?

Tony Nitti: Yeah, I’m from Colorado so this is actually fairly balmy for me.

Steve Pomeranz: Okay, that’s cool. Hey, these tax plans are preliminary because as we record this, the bill has not really been passed, but two versions have been passed. What do they look like from an individual’s point of view?

Tony Nitti: Well, there is a lot of kind of big picture items that are very very similar.

There are a couple of key difference but what we’re after here, both the House and the Senate bills, is individual tax cuts. However, right, they’re going to be coupled with the elimination of a lot of deductions. And so what we’re really looking at is more of what they refer to as tax reform, so adding some simplicity to the law.

Steve Pomeranz: Okay.

Tony Nitti: An example would just be, we’re going to reduce individual tax rates. We’re going to double the standard deduction, and then we’re going to eliminate a bunch of the old tried and true itemized deductions people love, whether it’s medical expenses, state and local income taxes.

And that means you’re inherently going to create some winners and losers, where some people may have an immediate tax increase. A lot of people are going to have a cut but the idea is you’re not just lowering tax rates; you’re leaving the tax law a little bit more easy to manage than it has been in the past.

Steve Pomeranz: All right, let me ask you this question. So let’s take the standard deduction. If you’re married, it’s doubled from $12,000 to $24,000. So that’s another $12,000 of dollars that you don’t have to pay tax on. Am I incorrect in saying that if my tax estate and city taxes are $12,000 then that’s a wash? Because I won’t be able to deduct the state and city taxes, that’s what I meant.

Tony Nitti: That’s exactly right. The standard deduction being doubled really accomplishes two things. Number one, for low income taxpayers, it removes more people from the tax roles. Simply because, as you eluded to, they’re going to have to have $24,000 of income before they’re forced to pay any tax now as compared to a smaller amount under current law.

But for everybody else, it just means that whether or not you benefit from those standard deductions, it’s going to depend what the sum of your itemized deductions are. And if you’re someone that typically has a large amount of mortgage interest or real estate taxes, you’re not going to benefit from the doubling of the standard.

Now, other itemized deductions are going to be eliminated, so that it looks like about 94% of the population will actually take the standard next year under either of these bills, which there’s no arguing that creates some simplicity, right? If more people are taking the standard, they’ll feel like they can prepare their own return and that’s certainly a step in the right direction.

Steve Pomeranz: What about charitable gifting? Has that been changed at all?

Tony Nitti: It’s actually one of the only things that kind of emerges from both these bills unscathed. And so not only has it really not been changed, it’s actually been enhanced a little bit. Where we used to be limited, we can only give cash contributions to a charity up to 50% of what’s called our adjusted gross income, that threshold will actually be increased to 60%.

Steve Pomeranz: Okay.

Tony Nitti: So charitable organizations, charitable contributions, I should say, are really one of the few itemized deductions that kind of dodged a bullet here.

Steve Pomeranz: So, in a sense, charitable organizations to a small degree can be one of the winners in this process?

Tony Nitti: Yeah, that’s kind of the funny thing, Steve, is your tax reform, by its nature, creates winners and losers. But sometimes, people that think, or we would think, would be the winners, perceive themselves to be losers and charitable organizations are a great example of that. Because here you have donations coming out of this largely unscathed, but yet the charitable organizations are furious about these two bills because—what did I say right?—94% of people won’t itemize going forward and charitable contributions are itemized deductions. And so not to say that people only give to charity to gain a tax break, but it certainly doesn’t hurt. And, as year-end approaches, people who want a tax deduction, they start cutting checks to the church and wherever it may be.

Steve Pomeranz: Got your point.

Tony Nitti: And now, if there’s 94% of people who realize they’re not going to get any benefit for cutting those checks, maybe that checkbook goes right back into the drawer.

Steve Pomeranz: All right, let’s go onto other features. The estate tax exemption went from above $5 million, it got doubled to $11 million.

So the first $11 million of your estate is not subject to tax. I know the Republicans seem to want to eliminate the estate tax, and they’ve done something with this over the years. What happens?

Tony Nitti: So the House and Senate kind of take a different tack here. The House, as you said, would certainly double the exemption right off the bat to 11 million to 22 million if you’re married, but then the house will take the added step in year 6 of completely eliminating the estate tax. Whereas the Senate will double the estate tax exemption as the house did but never take that second step of completely repealing it. And, in fact, you talk about a twist here—for the Senate bill to comply with these budget rules, every single individual change, whether it’s tax cuts or change deductions or even the estate tax under the Senate bill, will expire on December 31st 2025. And so the estate tax, if nothing would have changed between now and the end of 2025, would actually…the exemptions would kick back to where they are under current law which is half of what they are moving to.

Steve Pomeranz: Okay, so well, let’s not get too complicated because not too many people are going to be worrying about that for now. I want to get to the tax rates or levels themselves. There’s the highest tax bracket is 39.6. I think that gets slightly lower. Take us through the two versions as simply as possible; one version has seven, one version has four, where do they kind of overlap, and what does this mean to the middle-class person?

Tony Nitti: Sure, well, first, current law, just establishing a baseline, we’ve got seven rates, and they go from 10% to 39.6% The House bill will kind of embrace a long health Republican ethos that fewer brackets are better. And so they will leave us with four rates going from 12% and keeping that 39.6% top rate but really limiting it to a much higher level of income.

So you would have to make more than half a million dollars if you’re single and a million dollars if you’re married. And then the Senate bill would keep seven rates like we have under current law but reduce that top rate and some of the lower rates too, but the top rate from 39.6% to 38.5%.

And so when you ask about the middle class, there’s no huge marginal drop in rates for middle class taxpayers, but because all of the rates along the way are being lowered, there will be some immediate benefit given out to most taxpayers.

Steve Pomeranz: According to this chart I’m looking at, if you make between $60,000 and $93,700, the current tax rate is 25, the House tax rate is 25, and the Senate tax rate is 25.

Tony Nitti: Yeah, I’m sorry, go ahead.

Steve Pomeranz: Well, so I guess if you add in the standard deduction and you don’t live in a high tax state or city, you’re probably going to see a benefit.

Tony Nitti: Well, sure, particularly because your lower brackets will be reduced as well, so 15% bracket becomes a 12% bracket and things like that.

Steve Pomeranz: There is some money, again, for those people that are not in high tax states. There is some money that they’re going to get back or some amount of reduced tax.

Tony Nitti: Yes, particularly in year one. Tax law can get a little tricky because, to use the process the Republican tax writers used here, they had to comply with again kind of a complicated process, but that’s why we see things expire over the ten-year period. And so the people who get cuts in year one, what we’re finding is that a lot of those people may not still be getting cuts in year ten.

Steve Pomeranz: So, has this plan become simpler or more complex?

Tony Nitti: That’s a great question, and I think it depends on who you really zero in on. On the lower income side of things, you absolutely get some much needed simplicity in the form of the double-standard deduction, without question, all right?

That’s 27 million more taxpayers that won’t have to go through shoeboxes full of charitable contribution receipts or medical expense deductions. So that’s nice simplicity. For the more sophisticated higher income tax clients, I think we’ve got a great deal of complexity layered on top of what has already be a complex body of laws.

And so I think that the people who really become excited about these two proposals are the tax lawyers and the tax accountants who are going to be working on this law for the next ten years.

Steve Pomeranz: Yeah, so much for the flat tax idea and to eliminate all the complexity.

All right, let’s move to corporations. Now, a lot of small businesses form a corporation as an S corporation and can you just take a moment to explain what an S corporation is?

Tony Nitti: Yeah, sure. In very simple terms, a C corporation, or what we call regular corporation, is subject to tax twice.

When the C corporation earns the income, it’s taxed, and then when the C corporation distributes the income, the shareholder pays taxes the second time. If you make this election to be taxed as an S corporation then you’re only going to be subject to one level of tax, which is surely advantageous.

So now if an S corp generates income, there is no tax at the S corp level, instead the income quote unquote flows through to the owner and the owner pays the tax at the individual level. So you escape double taxation; so it’s very very appealing.

Steve Pomeranz: All right, so if I owned a small business, let’s say I owned a clothing store or some kind of small manufacturing company, and I was an S-Corp. I had maybe ten employees, relatively small, and all of the excess earnings would flow through to me at the end of the day and then my current tax bracket then would apply. Now, what is the change in the tax bracket now for these pass-through or these S corporations.

Tony Nitti: Well, that’s a question that could take anywhere from four to eight hours to answer based on what we’re seeing here in the House and Senate Bills. But the idea is because the regular corporate tax rate is being reduced, they had to do something for owners of S corporations and partnerships as well to keep them kind of on equal footing. But they went about it in different ways. The House would effectively say the highest tax rate you could pay on your income from a S corp or partnership would be 25%, but there are a lot of exceptions to that which make it very, very difficult, in fact, to get that 25% rating.

Steve Pomeranz: Okay.

Tony Nitti: And then the Senate bill would say we’re not going to give you a flat rate. Instead, whatever income you get from your S corporate partnership, you can take a deduction equal to 23% of that income. Again, and that’s replete with its own set of limitations and phase-out, and complexities, so.

Steve Pomeranz: Okay, alright, look, you sang the National Anthem at a World Series baseball game. Give me a number because I didn’t really, it’s too complex what you just told me.

Tony Nitti: Yeah.

Steve Pomeranz: So what are we talking about, 30% maybe? Is there a number we can hang a hat on?

Tony Nitti: Yeah, let’s do it this way. Under the House bill most business owners, you’ll be paying around 35% at a top rate, I should say, a top rate of 35%. And then under the Senate bill, you’d pay a top rate of under 30% about 29% so.

Steve Pomeranz: Okay, good, so are there any S corp, like service industries, lawyers, and the like, that are excluded from this bill or does this apply to everybody?

Tony Nitti: Yeah, you hit the nail on the head. I mean the only universal loser as far as industry goes between the House and Senate bills and the treatment of this S corp partnership type income are people in personal service businesses. So if you’re an accountant, a lawyer, consultant, etc. you are not eligible for either the 25% rate under the House bill or the deduction under the Senate bill. So you’re just paying tax at normal rates the way you always did.

Steve Pomeranz: So, the tax lawyers will have more business, but they’re not going to get a benefit from lower taxes, that’s kind of one thing to say, right?

Tony Nitti: Isn’t that the beauty of it, right?

Steve Pomeranz: [LAUGH]

Tony Nitti: As a tax accountant, I am thrilled by these changes, I love the complexity because I know it’s going to keep me busy but as a taxpayer, I’m not particularly happy.

Steve Pomeranz: We are running out of time, but I did want to go over one of the winners and that was the rental real estate owners.

I didn’t know this and I saw this in your material. Why do people who own rental real estate benefit from this new law?

Tony Nitti: Well, under the House bill, remember when I said it’s going to be hard for flow-through owners to get that 25% top rate? The easiest way to get it is on your rental income.

So under the House bill, most rental income will be absolutely favored and get this 25% rate. Under the Senate bill, while you may not get that particular advantage, depreciation lives are going to come down. The ability to deduct all your interest expenses will come down, while it’s going to be limited for other taxpayers.

There’s going to be additional changes where you can do additional light kind of changes of real property, where everyone else is going to be shut out. So in both bills, owning real estate is a great position to be in going forward.

Steve Pomeranz: Thank you, my guest Tony Nitti is a tax partner with Withum Smith & Brown National Tax Group Service, and he joins me today from New York.

And to hear this discussion again, to read it, to weigh in with your opinion and to share with your friends, don’t forget to join the conversation at stevepomeranz.com. Hey Tony, that’s so much.

Tony Nitti: Thanks for having me, Steve.

Steve Pomeranz: Wow, we could have done an hour on this.

Tony Nitti: We could have done eight hours