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Major tax reform enactment is a rare event, with the last occurring back in 1986 under President Ronald Reagan. As a result, current discussions could pan out to be much ado about nothing; however, with the solid majorities that Trump and the Republicans hold in both houses of Congress, there is real potential for unprecedented tax reform.
The Trump administration’s goal is to get the tax changes passed and signed into law by the end of 2017. So, what should you expect from a tax bill that will likely be more than 1,000 pages long by the time it’s all over? Let’s take a look at some of the most notable changes widely impacting taxpayers and see.
- Simplify the tax bracket structure by replacing the current seven individual tax brackets (10, 15, 25, 28, 33, 35 and 39.6 % with three tax brackets (12, 25 and 35%)
- Lower the corporate tax rate by about half from the current 35% to 20%
- Create a 25% business tax rate for certain pass-through entities’ (S Corporations, LLCs, etc.)
- Create a territorial tax system for companies conducting business internationally
- Enacting a one-time mandatory repatriation tax
- Estate tax repeal or expansion
- Eliminate most itemized deductions and personal exemptions
- Repeal the alternative minimum tax (AMT)
401(k) Tax Deductibility Changes
In addition to these proposals, there is one particularly contentious change on the docket that impacts the tax deduction related to 401(k) plans. Essentially your current 401(k) into a Roth 401(k) by limiting pre-tax contributions to $2,400 versus the current limits of $18,000 ($24,000 if you are 50 and older). Plan participants are still allowed to save on an after tax basis up to the old limits. The significance of this change is that taxpayers would be paying tax based on current tax rates on the excess amount resulting in potentially higher taxes being paid on retirement income.
For example, many taxpayers expect that their taxable income will be lower in their years of retirement since they will no longer be collecting a salary. If the taxable income of retired taxpayers is lower in their retirement years, then their withdrawals from traditional 401K or IRA plans would be taxed at a lower tax rate; thus, reducing overall their tax liability and improving the after tax returns of their retirement accounts. Taxing the retirement contributions at current higher tax rates, which is what effectively is occurring by reducing the pre-tax allowable amount, would result in higher taxes paid for taxpayers in higher tax brackets today but expecting to be in a lower tax bracket in retirement.