GOP Tax Plan Spares 401(k)s, Targets IRAs

While retirement savings provisions look to be unaltered, the bill eliminates the recharacterization of IRA contributions

Rep. Kevin Brady, R-Texas. (Photo: AP) Rep. Kevin Brady, R-Texas. (Photo: AP)

The House Ways and Means Committee unveiled Thursday its sweeping tax legislation, the Tax Cuts and Jobs Act, which, despite rumors to the contrary, retains the current tax advantaged status of 401(k)s.

In releasing the tax bill, House Ways and Means Committee Chairman Kevin Brady, R-Texas, said the package “marks the beginning of the end of our nation’s broken tax code,” as the bill will deliver “real tax relief to Americans across the country — especially low- and middle-income Americans who have been struggling for far too long to earn a raise and get ahead.”

While retirement savings provisions look to be unaltered, the legislation eliminates the provision that allows recharacterization of traditional and Roth IRA contributions, Nicole Kaeding, an economist at the Tax Foundation in Washington, told ThinkAdvisor in a Thursday interview. “For instance, when an individual contributing to a Roth or traditional IRA had a spike in their income during the year, they could recharacterize the contribution to either a Roth or traditional IRA. That has been eliminated” under the GOP bill.  

With retirement savings plans largely intact, “that’s good news overall for savers, although with lower marginal tax rates for most taxpayers, the current tax benefit of those savings has been reduced,” said Baird Director of Advanced Planning Tim Steffen. “This makes Roth-style plans marginally more attractive.”

Dale Brown, president and CEO of the Financial Services Institute, stated that FSI is "very encouraged that this draft protects the tax incentives for retirement accounts."

The GOP tax bill eliminates the individual as well as the corporate Alternative Minimum Tax, which Brady says “punishes hardworking families.”

The bill also doubles the exemption for the estate tax and repeals it after six years. “Family-owned farms and businesses will no longer have to worry about double or triple taxation from Washington when they pass down their life’s work to the next generation,” Brady said.

The estate tax provisions are “likely to be lost during the final negotiations,” opined Steffen. “Estate taxes are viewed as a tax only on the rich, and that’s not exactly a sympathetic group. It's hard to see that one lasting.”

Tax Foundation analysts noted that changes are likely in committee markup, which Brady has said will start Monday, and the Senate “will certainly bring its own priorities to the process.”

Indeed, Steffen added that the GOP bill is “a long way from complete, and we could see many changes, from small tweaks to large rewrites, in the coming weeks.”

The wrangling will continue, as the Senate plan should be out in a few days, which is “expected to be quite a bit different,” Steffen said.

Here’s a breakdown of the major changes in the GOP bill:

It consolidates the individual tax brackets to 12%, 25%, 35% and 39.6%.

  • Roughly doubles the standard deduction to $6,350 to $12,000 for individuals and $12,700 to $24,000 for married couples.
  • Establishes a new Family Credit – which includes expanding the Child Tax Credit from $1,000 to $1,600 and provides a credit of $300 for each parent and non-child dependent 
  • Preserves the Earned Income Tax Credit
  • Consolidates three similar higher education benefits into one expanded American Opportunity Tax Credit.
  • Ends the Coverdell savings program, which helps families cover primary and secondary education expenses. Instead, elementary and secondary school expenses would be qualified under 529 college savings plans, which would also be expanded to allow unborn children as beneficiaries.
  • Continues the deduction for charitable contributions 
  • Preserves the home mortgage interest deduction for existing mortgages; for newly purchased homes, maintains the deduction for mortgages up to to $500,000. (The current limit is $1 million.)
  • Continues to allow write-offs the cost of state and local property taxes up to $10,000.
  • Repeals the deduction for state and local income taxes and sales taxes.
  • Repeals the deduction for medical expenses and tax preparation expenses
  • Repeals the overall limitation on itemized deductions.

The plan lowers the corporate tax rate to 20% from 35% and establishes a controversial 25% rate for “pass-through” business income.

Hunter Blair, an analyst at the Economic Policy Institute, said in a Thursday statement that the use of pass-through entities "has exploded in recent decades, but most of this increase is not attributable to mom-and-pop stores but to hedge funds, law firms, and private equity partners."

In fact, 49% of all pass-through income goes to just the top 1% of households, he said, "thus the new pass-through rate would disproportionately help the wealthiest Americans, including President Trump, who owns more than 500 pass-through businesses." (The Trump Organization is one of them.)

For his part, Brown says that “FSI has long supported tax reform that safeguards the important role of independent contractors in our economy, and provides equitable treatment of pass-through entities operated by financial advisors.” He added that FSI would work with members of Congress and the administration “throughout this process” to make sure the final bill includes this provision and preserves the retirement tax incentives.

While the deduction for property taxes would be capped at $10,000 under the GOP plan, “the state income tax deduction would go away. This is another one that will be strongly debated, and I'd expect this to change,” Baird’s Steffen added.

Also, the bill includes “good incentives for businesses - the lower corporate tax rate, a new immediate deduction for the cost of new equipment, and the deduction for interest remains in place,” however, “the application of the new corporate rate will be complicated,” Steffen said. 

The new rate is 25%, “but only on income not attributed to ‘labor,’” Steffen continued. “The default assumption is 70% of the income would be exempt from the lower rate. For service firms, like lawyers and accountants, the assumption is 100%. They may be able to fight that, but it appears by default those business won’t benefit from the lower rate.”

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