Understanding Tax

2017 Tax Reform: We Hate Employees

Current tax law is moderately unfriendly to employees, more friendly to folks who can structure their businesses as sole proprietorship or partnerships. Sole proprietor expenses are deductible above-the-line, reduce adjusted gross income, and are deductible for AMT purposes. Employee expenses are only deductible below-the-line, are subject to the 2-percent floor and the overall limitation on itemized deductions, and are not deductible at all for AMT purposes.

Under the House Republican bill, things are about to get much worse.

If House Republicans get their way, you, as an employee, will still be taxed at a top rate of 39.6%. With an exception for service providers (like lawyers), however, “business income” derived through partnerships or LLCs will now be taxed at a top rate of 25%. Even service providers, however, will be eligible for that 25% rate if they incorporate, and business income derived by run-of-the-mill corporations will be taxed at a top rate of 20%.

Nor are changes to the rate structure the bill’s only problem for employees.

If your company forces you to incur job expenses, you will no longer be able to deduct them at all. If your employer pays for daycare for your young children so you can afford to work, you will be taxed on that payment. The credits that employers used to get for making day care available to working employee-parents will also be repealed. And if your employer pays part of your tuition for continuing education, you will be taxed on that payment.

Be comforted. The revenues generated by these tax increases on employees will go to fund a good cause – the tax cuts I’ve summarized above for large corporations and unincorporated businesses. The theory is that the benefits of tax cuts for employers will eventually trickle back down to the employees who are funding them. This was, of course, the argument made to support tax cuts for the rich back in the 1980s. Unfortunately, that trickle down never happened. Median income has been stagnant in the US for the three decades since. Perhaps this time trickle down will work better.

2017 Tax Reform: Divorce Slavery Returns

When a couple divorces, the working member of the couple is often required to pay alimony to the nonworking member. Although in theory men have equal rights to alimony, in fact only 3% of alimony recipients are male. 97% are female. In my examples below, therefore, recognizing that I’m only 97% correct, I’m going to use “he” to refer to the payor and “she” to refer to the recipient. For the remaining 3%, flip the pronouns.

Under current tax law, alimony is both deductible and includible. The effect is to require each member of the divorced couple to pay income tax on his or her share. If, for example, he makes $100,000 per year and pays her $40,000 in alimony, he can deduct that $40,000 and ends up paying income tax only on the $60,000 he keeps. She, in turn, pays income tax on her share – the $40,000 she received.

This, say House Republicans, subsidizes divorce. By moving that $40,000 out of his return and into hers, they point out, the rule allows the couple as a whole to pay less tax – because that $40,000 will be taxed at the lower rates applicable to individuals making $40,000, not at the higher rates applicable to those making $100,000.

The House Republican bill therefore propose to tax the entire $100,000 to him. In addition to paying alimony, child support, and the taxes on his share of the couple’s income, under the new bill he will now be required to pay the taxes on her share as well. Back in the bad old days, before the current rule fixed the problem, this was sometimes called “divorce slavery.” Well, it’s back.

Even the argument that the current rule subsidizes divorce is now largely inaccurate. It’s true only where the rate structure still imposes a so-called “marriage penalty.” Under the House bill, this would only be true for individuals making $200,000 per year or more. The vast majority of divorced couples are not so lucky.

But don’t panic. The new rules will only apply to divorces taking effect after 2017. Donald Trump will continue to be able deduct alimony to all of his prior wives. If you’re thinking about getting divorced, however, and you’re likely to be at the paying end of the stick, get it done before midnight Dec. 31, 2017. If you’re going to be at the receiving end, delay, delay, delay.

Tax Reform 2017: The Donald Trump Provision

Hidden in the many hundreds of pages of dense tax text in the House Republican bill is one really great proposal: to get rid of the “like-kind exchange” rules. For decades, these rules have allowed qualifying taxpayers to avoid reporting gains from qualifying exchanges. There has never been any sound policy justification for what is an incredibly generous give-away: it was bought and paid for by campaign contributions. Finally, if the House Republicans get their way, it’s going to bite the dust.

With one exception. Donald Trump and other real estate developers will continue to be given the benefit of the rule. As a result, with a bit of planning Donald Trump will never have to pay US income tax on any of the gains from his investments. You will have to. I will have to. He won’t.

Again, there is no sound policy justification for not repealing the provision altogether. The reason real estate is exempted from the repeal is simple. Donald Trump is President. He would undoubtedly veto a full repeal. You and I have no such power.