Trump Tax Plan: Effect on Retirees

Trump Tax Plan: Effect on Retirees

I wasn’t going to comment on the Trump tax plan because the crucial details are still missing, but don’t worry; Congress is hashing those out now. When it finishes, it still may not matter because some of the proposals are unlikely to pass. Nevertheless, after receiving several questions from clients, I decided it is time to clarify what’s being proposed and which items would most directly affect retirees.

Main features of the Trump tax plan:

  • Reduce the number of individual income tax rates from seven to three (12%, 25%, and 35%). It is impossible for most people to know how this would affect them since the income brackets to which these rates would apply have not been determined.
  • Eliminate the Alternative Minimum Tax (AMT). See: What is the AMT?
  • Eliminate all itemized deductions except for mortgage interest and charitable contributions.
  • Increase the standard deduction (to $12,000 for individuals and $24,000 for married couples)
  • Eliminate personal exemptions. This is currently $4,050 per dependent.
  • Repeal the estate tax.
  • Reduce the top corporate tax rate from 35% to 20%. This would make it more attractive for businesses to be based in the U.S. and would increase corporate after-tax earnings.
  • Reduce the tax rate on pass-through business income to a max of 25% from its current ordinary income rate. This would be a big tax-cut for many small business owners (e.g., sole proprietors, partnerships, and S corporations).

Which provisions of the Trump tax plan most effect retirees?

The two that jump out at me are:

  1. Eliminating the itemized deduction for medical expenses. These are currently deductible to the extent they exceed 10% of your adjusted gross income. Some retirees spend 1/3 or more of their income on medical expenses, especially in the last few years of life or when a major medical event occurs. The tax deduction is a small consolation, but it does cushion the financial hit from those endless medical bills.
  2. Eliminating the deduction for State income and property taxes, both of which are currently itemized deductions. Suppose you pay $10,000 in state income taxes. Most taxpayers who itemize can deduct them. So the $10,000 paid to your State provides a $10,000 deduction on your federal tax return. This deduction would save you $2,500 in federal income taxes if you are in the 25% tax bracket. Eliminating that deduction would save the federal government about $100 billion, but it’s highly controversial and unlikely to pass. See which states have the highest state income taxes.

The bottom line on Trump’s tax plan:

The changes are expected to increase economic growth but also increase the Federal deficit. However, with so many changes, not everyone would be impacted evenly.

The primary “winners” in the reform proposal would include:

  • Filers who currently take the standard deduction.
  • High and ultra-high-net-worth households (top .2%) who would no longer have an estate tax.
  • Successful small businesses owners who would likely see at least a portion of their income taxed at 25% instead of the current maximum of 39.6%.
  • High income individuals since the top tax rate would fall from 39.6 to 35%.

The primary “losers” would be:

  • Residents of high income and/or property tax states (e.g., California, New Jersey, New York, Connecticut, Maryland, etc., who would no longer receive federal deductions for state and local taxes paid.
  • People who make modest charitable contributions and currently itemize since they may be better off taking the standard deduction.
  • High-wage employees, who won’t necessarily be harmed, but who will not be able to take advantage of the preferential tax rates for many business entities.
  • People with large medical bills, which would no longer be deductible.
  • Young families with kids because there will no longer be a personal exemption for each dependent.

That’s it in a nutshell. Have a great week.