Tax Reform Updates Key Changes and Implications for Taxpayers
The TCJA cuts taxes for individuals and businesses, but it also reduces revenues. In particular, the expanded standard deduction and repeal of the Net Investment Income Tax (NIIT) reduce revenue by $4.0 trillion over 10 years.
Moreover, the reopening of the code in 2025 necessitates important fiscal trade-offs. Policymakers should pursue true reform that avoids the regressivity of this law and accords more favorable treatment to working families.
Taxes on Pass-Through Income
The 2017 tax law created a 20% deduction for certain income from pass-through entities (partnerships, S corporations, and sole proprietorships) that owners report on their individual returns. Previously, this income was taxed at the same rates as wages and salaries. This new deduction is skewed in favor of higher-income individuals, and research suggests that it does not encourage real economic activity. On a conventional basis, it will reduce federal tax collections by $700 billion over the next ten years.
The framework also adjusts many of the tax rules to help Americans avoid “bracket creep” – when they find themselves paying higher taxes in future years as their inflation-adjusted incomes rise, even though their actual standard of living has not changed. It also doubles the standard deduction, helping families keep more of their paycheck. The tax code would be fairer and simpler, putting more money in the pockets of middle-class families. It would also help businesses invest in their local communities and grow their paychecks.
Capital Gains and Dividends
Investors realize capital gains when they sell investments held for more than a year. The amount of the gain is the difference between the original cost of the investment (plus adjustments) and the selling price. Investors also receive dividend income when companies distribute earnings to shareholders. These are usually considered ordinary income or qualified dividends and taxed at preferential rates compared to other types of income.
Under current law in 2020, long-term and short-term capital gains are taxed at 0 percent or 15 percent depending on a taxpayer’s filing status and taxable income level. Taxpayers with modified adjusted gross income above certain levels owe an additional 3.8 percent net investment income tax (NIIT) on long- and short-term capital gains and qualified dividends.
Investors who primarily seek dividend income may want to work with a financial advisor to weigh the pluses and minuses of focusing on dividends or capital gains. Investors with a mix of both can take advantage of a strategy known as “tax-loss harvesting,” which involves selling stocks that have lost value to offset the gains realized by other stocks in their portfolio.
Taxes on Interest Expenses
The tax code is a patchwork of deductions, credits and other preferences that imposes an inherent bias against saving and investment. This bias is exacerbated by an income tax that taxes both the returns on savings and the benefits of delayed consumption.
While major reform proposals have failed to pass Congress, many changes were included in the Inflation Reduction Act that gained Congressional approval in August 2022 and the SECURE 2.0 Act approved in December 2022. Consequently, taxpayers should be aware of the potential impact on their tax bills and financial decisions from these new provisions.
Taxpayers should also remain mindful of the fact that several tax benefits put into place in 2017 are closing in on their sunset dates, and that inflation adjustments for 2024 will affect some items including the standard deduction and tax brackets. With so much uncertainty in Washington, it is difficult to predict how Congress and the Administration will handle future attempts at tax reform.
Taxes on Investment Income
With taxes as a major factor in investment decisions, many individuals and investors want to understand how the new tax law impacts their investments. This page aims to provide a summary of key changes and implications for taxpayers under the new tax code.
The reform increases the standard deduction and expands the child tax credit, making it more likely that families will receive significant after-tax savings. The reform also reduces marginal income tax rates moderately for most middle-class taxpayers and by half for many high-income taxpayers, which will encourage work, savings, and investment.
It reduces the maximum corporate tax rate to 20%, below the average in the industrialized world. It also eliminates most individual tax expenditures and replaces the book minimum tax with a distributed profits tax similar to Estonia’s, which will help businesses compete globally.
In addition, it establishes a comprehensive market state tax sourcing regime that will facilitate the relocation of companies to New York and encourage companies to locate here to capitalize on our skilled workforce and robust technology infrastructure. These provisions will be effective beginning in 2024.