12/8/17 – Contrary to popular belief, according to our analysis, for those that live in a high income tax state, the proposed tax bills will likely BENEFIT lower-income and middle-class individuals and families while driving higher tax rates for the upper-class. The primary reasons why? The child tax credit is increased in both the house ($1,000 to $1,600) and the senate ($1,000 to $2,000), the standard deduction is increased ($6,350 to $12,000/$12,200), the tax brackets have been lowered, and the personal exemptions have been eliminated. All of these favor the lower and middle classes while negatively impacting the upper-class.
As a recap, the Republican House of Representatives and the Senate have each put together their own version of a new tax bill.
Republicans hope to merge the two bills into a unified version and to present it to the President by the end of the year. The question of, “Will I pay more taxes?” or “Does this bill tax the lower-income and middle-class more and give a tax break to the rich?” is one that many, including myself, have asked.
This is a very complicated question as its answer depends upon a number of specific circumstances. As a number of my clients are high-income married individuals that reside in a high-income tax state (California and New York). I wanted to see how each tax bill would affect them.
Our Tax Scenarios
Brody Rosenfeld, CPA, a financial planner for Bull Oak Capital, has put together a fantastic model comparing 1. the current tax code, 2. the House proposed tax bill, and 3. the Senate proposed tax bill. (As a side note, this analysis was performed on 12/7/17 and I’m sure many changes to these bills will occur in the near future). Keep in mind that the current tax code is a very complex one and we were not able to completely build it out. For example, we did not account for AMT as it is highly complex and scenario dependent. Likewise, we had make a few assumptions when building out these scenarios. Does the tax filer own a home and do they have a mortgage? If so, what is their mortgage rate and their subsequent payment? Where are they currently on the amortization schedule? That being said, the point of this exercise was to give us a broad-based view of the current proposals based on today’s environment (current mortgage rates, tax rates, etc.). To compare apples-to-apples, we analyzed what effect these tax bills would have on a California married couple with 2 children. We ran 4 scenarios:
1. Married with 2 Dependent Kids – $70k income in California
2. Married with 2 Dependent Kids – $150k income in California
3. Married with 2 Dependent Kids – $300k income in California
4. Married with 2 Dependent Kids – $600k income in California
To create a scenario that would benefit a high-income earner, we ran an additional scenario:
5. Married with 0 Dependent Kids – $600k income in a Tax-Free State (e.g. Wyoming, Florida, etc.)
Here are the results.
Married, 2 Kids – $70k Income in CA
Both the House and Senate bill clearly favor this client. This scenario analyzes the potential effect of tax law changes on a couple with two dependent children earning $70,000/year in California. The client takes the standard deduction as the $3,115 California state tax does not exceed the standard deduction under current laws. Additionally, the client qualifies for the child tax credit. As this credit is increased in both the house ($1,000 to $1,600) and senate ($1,000 to $2,000) bills the client will see a substantial tax reduction.
Married, 2 Kids – $150k Income in CA
The scale of this chart may be misleading as there is a very small change between the current tax law and both proposed bills. This scenario analyzes the potential effect of tax law changes on a couple with two dependent children earning $150,000/year in California. The client currently itemizes deductions totaling $20,555. This is less than the increased standard deduction on the proposed bills. The client also does not qualify for the child tax credit due to income. Taxes are almost flat with the House bill while they increase slightly with the Senate bill. This is due to higher taxable income driven by the proposed bills elimination of the personal exemption.
Married, 2 Kids – $300k Income in CA
Under this scenario, the client begins to feel the impact of the lack of itemized deductions and child tax credits. This scenario analyzes the potential effect of tax law changes on a couple with two dependent children earning $300,000/year in California. The client currently itemizes deductions totaling $59,521. Itemized deductions for Taxes Paid are reduced in the proposed bills leading to higher taxable income. The client also does not qualify for the child tax credit due to income. Taxes increase for both bills driven by the limitations on itemized deductions related to California Income Tax & Property Taxes. As the client’s assumed mortgage was $500,000 they were still able to deduct the interest on it.
Married, 2 Kids – $600k Income in CA
This scenario analyzes the potential effect of tax law changes on a couple with two dependent children earning $600,000/year in California. The client currently itemizes deductions totaling $128,323. Itemized deductions for Taxes Paid are reduced in the proposed bills leading to higher taxable income. The client also does not qualify for the child tax credit due to income. Taxes increase for both bills driven by the limitations on itemized deductions related to California Income Tax & Property Taxes. As the client’s assumed mortgage was $1,000,000 so deductibility of interest was capped on the proposed bills.
Married with No Kids – $600k Income in Tax-Free State
For this scenario, we wanted to see which high-income earners would benefit under the proposed tax plans. This scenario analyzes the potential effect of tax law changes on a couple with no dependent children earning $600,000/year in a tax-free state. To accomplish this, we had to assume that the client currently takes the standard deduction, they are renters with no children, and they live in a state that has no income tax. Taxes decrease for both bills driven by the increase of the standard deduction and reduction of bracket rates.
In short, the proposed tax bills benefits those with lower incomes as the standard deduction and the child tax credit limits are higher. Likewise, the removal of a number of different deductions, including student loan interest, medical and dental expenses, and personal exemptions (a big deal for Californians) drive a higher overall federal tax bill for higher-income earners. Of course, no bill has yet to pass so these issues may well very change before they are placed in front of the President.
Bull Oak Capital
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