The news outlets are abuzz with reactions to President Donald Trump’s tax proposal. The opinions are as divided as the country, of course.
It is “wonderful, amazing, even stupendous,” according to Club for Growth President David McIntosh. “The Trump administration’s tax reform proposal is massively pro-growth. Cutting rates and eliminating deductions will put the U.S. squarely on the path of sustained economic growth, and allowing small and midsize businesses to use a new 15% business tax rate is crucial to that growth. This is the tax plan that the American people supported when they elected President Trump, so House Republicans would do well to give it their full support.”
By contrast, those who think all money is made in and doled out from Washington, D.C., see the plan as disastrous. “Trump will outline major tax cuts for Americans … that could take trillions of dollars away from the federal government over the next decade and lump it on to the national debt,” writes Newsweek.
You may have your own opinions about the pros and cons of the proposal. Before we get too excited, however, understand that this proposal is not in the form of legislation or a new law even under consideration. Trump’s April proposal is more of a statement of objectives. What are the chances that the proposal will become law?
A Wall Street Journal editorial hints, “If anything close to this reform can survive the political maelstrom, it will go a long way toward returning to the abundance of the 1980s and 1990s.” Other sources are more blunt, like “Donald Trump made tax reform less likely” from Forbes, or “Chances the Trump tax proposal gets through Congress? ‘Slim-to-none’” from CNN.
Impact on agriculture
So, this may be much ado about nothing. But for those interested, what exactly is proposed, and how would enactment affect Illinois farmers? Here are the key points, from least to most significant:
• Repeal the federal death tax.
• Replace the seven individual tax brackets with three brackets of 10%, 25% and 35%, double the standard deduction, and eliminate most itemized deductions (except charitable and mortgage interest).
• Repeal the 3.8% Obamacare “Net Investment Income” surtax.
• Enact a new 15% business tax rate.
Repealing the federal estate tax would have no impact on most Illinois farm families, and may do more harm than good. The current federal estate tax is completely avoidable for couples with a relatively simple estate plan and basic professional assistance at each death, unless the net value of their estate exceeds $10,980,000. With more sophisticated planning, they can avoid the federal estate tax on much larger estates.
The downside of the elimination of the estate tax is this: Will we lose the step up in basis? This was not addressed in Trump’s April proposal, but is widely believed to be the necessary trade-off to death tax repeal, as a way to replace the lost revenue. One idea has been floated to allow a step up for a limited amount of assets. It didn’t appear in the April proposal. But beware: Eliminating an estate tax you would not have paid and having the capital gain tax applied to inherited assets will be a net loss for most farm families.
Also, keep in mind that repeal of the federal estate tax will do nothing to help you avoid the Illinois estate tax. That is a “real and present danger” to many more farm families. If your estate exceeds $4 million, you will pay Illinois a significant tax on the excess. A married couple, with proper planning, can avoid taxes on $8 million. This challenge will persist even if the federal tax is repealed. If step up in basis is eliminated, your family will be worse off.
Simplification of the income tax code starts with reducing the number of income tax brackets from seven to three, with the tax rates lowered. Couple that with doubling the standard deduction to help people who don’t itemize or who lose some of their itemized deductions, and Trump would reduce ordinary income taxes for nearly everyone. What’s not to like about that?
Elimination of the Obamacare 3.8% surtax will be a real benefit to what were called “high-income taxpayers” (HIT). You are HIT if you are single with income exceeding the $200,000 mark, or a married couple with income exceeding $250,000 (notice the built-in marriage penalty). Active farming income in excess of the HIT mark was already subject to 2.9% Medicare tax, but Obamacare tacks on another 0.9%. On rental income over the HIT mark, Obamacare adds 3.8%. So elimination of this tax would save high-income taxpayers 0.9% on earned income and 3.8% on passive income like rent.
The biggest news, without doubt, in the April proposal is the 15% business tax. We have all heard that with a tax rate of 35%, U.S. corporations “face the highest statutory tax rate in the developed world.” This applies to C corporations. The owners of C corporations pay taxes twice on the same profits: the company pays tax first; then owners pay individual tax on any of the net earnings that are distributed (dividends). Reducing the corporate tax rate aims to bring C corporations nearer a level playing field with other forms of business.
But few family farms use a C corporation. Family farms are usually operated in a pass-through form: sole proprietorship (reported on individual tax return, schedule F), S corporations or partnerships (limited liability companies might be taxed as any of these). The profits of these businesses are taxed only once, by the owners, but under the seven individual tax brackets topping out at 39.6%. The earth-shaking part of Trump’s April proposal is to reduce the taxes on your business income from a top rate of 39.6% to 15%.
Finally, you may be wondering about self-employment (Social Security and Medicare) taxes. The April proposal doesn’t include any changes to these. However, with the cap of 15% on business income, your overall tax burden would be dramatically reduced.
Will any of Trump’s April proposal get into the tax code? I hope so. But the following from National Taxpayers Union provides excellent perspective: “The relatively easy part of the reform process is bringing these ideas to the table. The challenge will be crafting legislation and bringing members on board with fundamental change. That’s when we might learn who is actually serious about reforming the code, and not just talking about it.”
Ferguson owns The Estate Planning Center in Salem. Learn more at thefarmersestateplanningattorneys.com.