3 Game-Changers for Investors in House Tax Plan

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published 3 November 2017

Nobody likes paying taxes. Our current tax code has been called burdensome, unfair and overly complex. Yet, the thought of doing your tax return on a postcard — as touted by House Ways & Means Committee Chairman Kevin Brady, R-Texas — may sound appealing to some taxpayers, especially investors.

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But let’s take a closer look at three changes proposed by House tax writers that could be very beneficial for certain investors.

Repeal of the Alternative Minimum Tax

The current form of AMT was enacted in 1969. It was originally designed to ensure wealthy taxpayers paid their fair share of taxes. The IRS did not want them to take excessive tax breaks and avoid paying tax.

When enacted, AMT only affected a few hundred thousand taxpayers. But today, because incomes have increased for many, it has blossomed to ensnaring upwards of 5 million. Many of these folks are high-income taxpayers (most often filers making between $200,000 and $1 million), but not necessarily the wealthy people that the IRS intended to hit. They certainly aren’t using “tax loopholes” to avoid paying tax.

AMT is essentially a separate tax system. Each taxpayer’s numbers are run through the calculations for “regular” tax and for AMT. The taxpayer then ends up paying the higher of the two.

But AMT can especially hit taxpayers who have significant investment income. A situation where I often see AMT is when a taxpayer has a large capital gain (called a preference item).

For example, assume someone has a $1 million long-term capital gain on the sale of stock. I have to explain to them that the tax will be 20%, plus net investment income tax, plus possibly an adjustment for AMT. You also have to consider state income taxes. When you bundle all this together, the rate can be in excess of 30% (depending on the state). But each client’s situation is unique.

Repealing AMT will almost certainly benefit taxpayers who incur significant long-term capital gains. I’d score it a victory for investors if repeal makes it into law.

Changes to the Estate Tax

This is a significant change for a small number of very wealthy Americans. Since 1916, the United States has taxed the estates of the nation’s wealthiest deceased taxpayers. Currently, less than 0.2% of the U.S. population pay estate taxes. Under the new proposal, the exemption is doubled, and the estate tax would be repealed after six years.

The estate tax currently applies to the “gross estate.” This typically includes all the decedent’s assets, including investments (stocks, bonds, etc.), real estate and other tangible property. It also consists of the value of the decedent’s business interests.

Estates can deduct specific items like debts, funeral expenses, legal costs, accounting fees and estate taxes paid to states. The taxable estate is equal to the gross estate less any allowable deductions.

A credit is then applied that exempts a significant portion of the estate. For 2017, the effective exemption is $5.49 million for individuals. Any value of the estate over $5.49 million is taxed at the top rate of 40%. Under the new proposal, the exemption would be doubled to approximately $11 million for individuals and then be phased out after six years.

Because of the significant exemption applied, any decedent subject to the estate tax would likely have investments. For people with large estates, they often were able to get around the rules through quality estate planning. In either case, the revised exemption and ultimate repeal of the estate tax could result in a windfall for beneficiaries of large estates. Another win for wealthy investors with very large estates.

Pass-through entities

Many taxpayers invest in so-called pass-through entities, such as partnerships, limited liability companies (LLCs) or S corporations. These entities do not pay income tax as any income, losses, deductions and credits “pass-through” to the individual owners and are taxed at their tax rate.

S corporations have become more popular in recent years and are a favorite of many business owners. Under the proposal, owners who conduct business as sole proprietorships, partnerships and S corporations would get a big cut in the top tax rate, from 39.6% under current law to 25% under the House plan. However, this favorable rate would not apply to wages paid on form W-2. Those wages would be subject to the owner’s marginal tax rate.

Still, this change could stimulate the investment in pass-through entities. With the preferred rate, we may see more investors making passive investments in operating businesses. This could stimulate economic development, but we will have to wait and see.

Summary

The U.S. tax code hasn’t had a major overhaul since the 1980s. Many believe that our tax code is broken. Even if President Trump and congressional Republicans can enact a new tax overhaul, the contours of the final plan have yet to be drawn. What we do know is that tax law is very complex. I think we need more transparency in the tax code. Taxpayers need to understand how the tax law affects them.

You may not be able anytime soon to file your tax return on a postcard, as Kevin Brady would like. But if congressional tax writers have their way, you may find a few new opportunities that can reduce your tax bill.