As we move into the holiday season and spend quality time with our families, there is a lot to be thankful for on the economic front. (Let’s leave politics aside, please!) The economy of the United States is steadily growing. Halfway through the fourth quarter, monthly data shows real GDP (Gross Domestic Product) growing at greater than 3% annually, which makes three consecutive quarters of growth at 3% or higher. This has not happened since 2004. With continued technological advances and reductions in government regulations, things are moving in the right direction.
This sets the stage for the fight in Congress over the tax reform bill. As mentioned in my first blog post about what the tax bill hoped to accomplish, the bill was designed to raise the entire “economic pie” and get GDP growth to 3%. With the economy growing, that is a huge accomplishment, even before passage of the tax bill. With the momentum we are seeing in the House, Senate and most important, the economy, we do expect a bill to pass. But what will it look like?
As we know, the House passed their version of the bill last week and the Senate Finance Committee passed their version as well. The Senate will vote next week to move the bill to the reconciliation phase. The House and Senate bills have similar domestic themes, evidenced by:
- reducing individual rates,
- cutting the corporate rate to 20%,
- reducing the tax burden of individual owners of pass-through businesses, and
- moving to a territorial tax regime for multinationals
Yes, most of the tax savings are more beneficial to businesses than individuals. However, the differences between the House and Senate versions of the bill are where the real debate begins. Most of these differences are seen in individual tax changes, the biggest among them being the state and local tax write-offs and the home mortgage interest write-off. Both of these changes will have a profound impact for our clients on both coasts.
The state and local tax write-offs are mostly dead. Both the House and Senate proposals agree on that. However, the House has a compromise which caps the deduction for real property tax at $10,000. This compromise would appease some House members from high-tax states such as California, New York, and New Jersey. However, it also sells well in Texas, where high property taxes replace income tax to fund the state. We expect the Senate to agree to the deduction because the overall tax cost is small and it would make some “blue state” taxpayers happy.
The home mortgage interest deduction is also in dispute. The House version of the tax plan would eliminate the deduction for a second home and lower the $1,000,000 ceiling on home acquisition indebtedness to $500,000. The Senate version keeps things as they are. This is a larger issue than just taxes.
Lowering the ceiling to $500,000 may significantly lower home values at the top of the market and could have a significant impact for home buyers in those more affluent and desirable areas of real estate. According to a Forbes Magazine article, “The proposal to cut the cap to $500,000 goes farther than NAR’S (National Association of Realtors) model, which also estimated the blueprint would cause a 10% drop in home values—with a greater loss in value in high tax states. Other estimates for drops in home values have been more modest.” We feel the decrease in high-end home values may be much closer to 15-20%. The negative economic effect of this could outweigh any tax revenue the provision would generate. As a compromise, Congress could agree to eliminate the deduction for a second home but maintain the $1,000,000 deduction ceiling. The reasoning is most second homes are a luxury item and many can be funded using available cash as opposed to a tax-favored mortgage/home equity loan.
Next week we will look at some year-end tax planning ideas in light of the proposed legislation. Stay tuned right here as we assist you in your business, tax, and financial planning, especially as the tax bill moves through Congress.
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