Samuel Taube: Joining us again today is Matthew Benjamin, The Oxford Club’s Editorial Director and a former consultant for the World Bank. Matt, thanks for joining us again.
Matthew Benjamin: Great to be back, Sam.
ST: So today we’re talking about the vast tax overhaul that was signed into law just before the end of 2017 by President Trump.
With a law this complex, it seems like many of our listeners could see their taxes go down due to across-the-board cuts in income tax rates and things like that. But on the other hand, some listeners could see their taxes go up due to modifications to some popular deductions, like state and local tax deductions.
So it seems like there’s some good news and bad news for different taxpayers in this bill. Can you list some of those good news and bad news items for us?
MB: Sure, Sam. This is a huge overhaul to the tax bill, the largest since 1986. There’s a ton of stuff in this bill. And for many taxpayers – and, I suspect, many of our listeners – there are some provisions that will increase their tax burden and some provisions that will lessen it, just as you mentioned.
So I looked at a lot of the provisions with regard to my own taxes and found that while I’ll pay more due to a lower state tax deduction, I’ll get a bigger cut on rates. So it’s not quite straightforward.
The new law, most importantly, maintains the existing seven individual tax brackets. And yet it reduces them and shifts around those brackets themselves. Not only is the highest marginal rate reduced from 39.6% to
37%, but rates on most of the other brackets are reduced a few percentage points as well.
For example, the second bracket used to be a 15% rate on income from about $19,000 to $76,000 – and I’m speaking about married couples here. Now that bracket has only a 12% rate and more income is subject to it: $19,000 to $77,000. So you see that more income will be subject to lower rates. And this is the case with every bracket.
But as you know, Sam, the mantra with tax reform is to broaden the base and lower the rates. So they lowered the rates, but broadening the base meant cutting out some loopholes: some deductions, reductions, exemptions, exclusions, etc.
So one of the biggest deductions that was cut in this bill, as you said in the beginning, is the state and local tax deduction. In the past, if you itemized your deductions, you would depend every year on a large deduction for state income taxes, property taxes or sales taxes.
ST: Particularly if you lived in a high-tax state, right? New York or California…
MB: That’s exactly right. Going forward, that deduction will be limited to $10,000, which could be significantly less than what you deducted before. For many taxpayers, as you said, in high-tax states like those – even like the state that we’re in, Maryland – it will hurt people.
Also, if you have a really big mortgage, you might get hurt. In the past, you could deduct mortgage interest on loans up to $1 million. Now that’s only $750,000. Conversely, if you have heavy medical expenses, the new law could help. In the past, you could deduct only expenses that exceeded 10% of your income. Now the new threshold for that is 7.5%.
And most importantly for many people, the law nearly doubles the standard deduction from about $13,000 to $24,000. I’m talking about joint filers.
ST: For a married couple, right. I see.
MB: Many people will decide to stop itemizing their deductions and just take this much larger standard deduction. I would say that if you’re interested in what it’ll do to your taxes this year, there are many calculators online. I use one on The New York Times’ website called the Tax Bill Calculator. It’s not perfect, but it may give you a good idea of how this law will affect you.
ST: So we just talked about the many complexities of this law for individuals… but how about for public companies? Obviously, I know one of the major provisions of this law was reducing the top corporate rate to 21%.
But I imagine that different public companies will be affected by this in different ways, just like individuals. So are there certain sectors of the market that will benefit especially from this law, and are there any that could actually be hurt by it?
MB: So the idea behind this whole law, Sam, as I think you alluded to, was to cut the corporate rate in the United States. Until now, it had basically the highest corporate rate in the world among advanced economies (not a good thing if you want to attract business). This law does that in a big way. As you said, it slashes that corporate rate from 35% to 21%.
That said, as you probably know very well, a lot of companies don’t pay that rate. Because of various loopholes, deductions and exemptions in the law, many companies pay quite a bit less percentagewise. And some pay close to that top rate. So as you said, it affects different companies in different ways.
Also importantly, the law largely shifts the business tax code from a worldwide system, in which U.S. multinationals pay taxes on any income they earned anywhere in the world, to a so-called territorial system, which taxes only domestic profits.
So for years, U.S. multinationals have been deferring the repatriation of foreign profits to avoid paying taxes on them. They’ve kept profits abroad because as soon as they bring them home, they have to pay this high corporate tax. This law deems all those profits immediately repatriated and taxes them one time at rates ranging from about 8% to about 15.5%.
ST: I see.
MB: So those cuts should help many companies across the board, especially U.S. multinationals. Of course, it depends on the sector they’re in… what the company does.
You asked about which companies might benefit the most. My reading, and the analysis of many tax experts, is that healthcare companies (especially drugmakers that have lots of profits offshore) will benefit because they can now repatriate those profits – or they’re going to have to, actually, at a very low rate. And those profits can go into share buybacks and dividends, etc.
Banks will also benefit. They tend to have high tax burdens. So this much lower rate will help them enormously.
The energy sector, which has a high effective tax rate – something in the top 35% – will get a big rate cut here, and that sector will also benefit because it’s very capital intensive. And this new law has provisions in it that allow companies to very quickly deduct capital investments.
ST: Because previously they had to do it over a certain period of time through amortization, right?
MB: That’s exactly right. Now they can do it all the first year. This is going to be a huge boost to their bottom lines.
So lastly, you asked about sectors that might not benefit that much – tech stocks. Many tech companies already enjoyed, for various reasons, relatively low tax burdens. So they will not benefit. Of course, it depends on the company. Overall, the tech sector will not benefit nearly as much from this law as some other sectors.
ST: Interesting. Is that because they tended to participate in a lot of tax credit programs, green energy things – stuff like that?
MB: Yeah, the code was full of incentives for such companies. This law removes some of those incentives and just lowers everybody’s tax rate by a little.
ST: I see. So in your view, how much should our listeners be changing the way that they conduct their personal finances in response to this law? For example, if you have a bit of extra income, is creating an LLC to get this new pass-through corporate income deduction a practical move?
MB: Well, let me get to that in a second. That’s a very good point. There are a couple of things that you might consider. Some people might actually consider moving out of a high-tax state into a lower-tax state because they no longer get a huge deduction for their taxes. That’s a dramatic change, of course.
It may change the way people look at housing. Interest paid on vacation homes is no longer deductible, so you might consider that if you have a vacation home or are thinking of buying one. It’s not as tax-advantaged as it once was. You might consider renting out your beach house because some of the costs involved in doing so are still deductible.
And also importantly – and this is something I just learned – the interest on home equity loans is no longer deductible. So you might want to plan accordingly about where you borrow your money.
But as you said, if you’re a freelance worker or independent contractor and not a full-time employee, you might look into incorporating your business in order to take advantage of a new 20% business income deduction.
This could help a lot of people who get income or have a very small business and have so-called pass-through income into that business. They get a bit of a deduction, which could come in quite handy.
That said, it all depends on the business, and the IRS is very aware that some people will try to game the system. You have to be very careful with this. You can’t just quit your job and start going back to business with the same company as an independent contractor. The IRS knows this trick, and they’re on the lookout for it.
I’m not a tax professional, but this is worth looking into for people who do own small businesses or are sole proprietors.
ST: I see. And finally, do you think our listeners should be changing their investment habits in any way in response to this law?
MB: The easy answer is “not necessarily.” There was some hope that the law would change the taxes on capital gains and dividends. It did not do that. They remain almost exactly the same.
There were some very subtle changes in the code with respect to capital gains and dividends and investment income overall. But it’s not significant. It’s worth looking into if you have a lot of that… but still, it’s not significant.
ST: And certainly if listeners want to learn more about how to reduce their taxes, they should check out The Oxford Communiqué. Alex Green and his team are always working on providing effective ways to reduce your personal tax burden.
Matt, thanks so much for joining us again.
MB: Absolutely, Sam. Thanks for having me.