Nobody in their right mind feels nostalgic about taxes, but this April 17, Americans will say goodbye to the old 2017 tax structure for good.
New tax laws passed by the Republican Congress and President Donald Trump went into effect at the start of the year, and many people have seen increases in their 2018 paychecks as part of that. But since the bill passed quickly and with less than usual oversight, a lot of mysteries remain as to how it will actually work.
For his part, Todd Pisarczyk, president of Sustainable Wealth Management, a Vancouver investment firm, says he thinks in general the changes will be good for local small business and industry, but they could also have some unforeseen consequences in the housing market and for businesses that offer retirement plans.
“The biggest impacts on the business side will come from the lowering of the corporate tax rate,” Pisarczyk said. “That was a maximum of 35 percent, and it’s gone to 21 percent flat.”
That’s a change that many large corporations had been eagerly anticipating – and the stock market seemed to reflect that through most of 2017 – but there are also a host of changes for small businesses that have gotten less attention, he said.
Some drawbacks to the new tax laws
“Most small businesses, including mine, are set up as pass-through entities,” Pisarczyk said. “In general the new law allows business to exclude 20 percent of their net income from taxation. But there’s a downside to that – certain businesses are excluded.”
Lawmakers excluded accountants, lawyers, doctors, financial advisers and a few other groups from that deduction. Which means Sustainable Wealth Management also can’t take advantage of the business savings.
“We don’t know why they did that,” Pisarczyk said with a laugh that could easily be mistaken for an eye-roll. “But other than that, it’s a major tax break for small business.”
Individuals also got a boost to the standard deduction, which has doubled in most cases. A married couple filing jointly had their deduction raised from $12,700 to $24,000. About 70 percent of taxpayers claim that deduction.
But those deductions could cause some problems in the construction industry – and that could impact local efforts to build more housing, Pisarczyk said.
“So, if you’re somebody who’s writing off your mortgage now, with the standard deduction getting raised so high, the mortgage deduction doesn’t matter anymore,” Pisarczyk said. “Part of the motivation to buy a house instead of rent is because of that tax deduction. But with a bigger deduction, there’s less motivation for that.”
The new law also reduced the deduction people can take for state and local property taxes. In the older code, $15,000 worth of property tax was deductible. In the 2018 code, that drops to $10,000.
“So, there’s an increase in the standard deduction, and a decrease in deductions for property tax,” Pisarczyk said.
All that could have an impact on consumers purchasing new homes, and also on charitable giving, because many people use giving as a tax write off against their mortgages, he said.
“With the standard deduction increase, that may not make sense anymore,” Pisarczyk said.
The changes could also impact which retirement plans are now ideal. Pisarczyk noted that there aren’t any big changes to the structure of retirement plans, but business owners should pay more attention to what sort of retirement plans are provided to employees as the new tax plan affects the overall economy.
“I think there has to be more thought now with regards to what you put in your retirement savings,”
Pisarczyk said. “It used to be that you’d max out your 401k and get a tax write off. But those accounts were tax deferred vehicles and not tax free. Under the old tax code, that was kind of a no-brainer. But financial planners are rethinking this stuff a lot now.”
There are concerns that the deficit will continue to grow under the new tax plan, and if that happens, income taxes will rise again, and 401ks may no longer be the smart option they once were.
“A lot of people think tax rates under this plan are the lowest we’ll see in the rest of our lifetimes,” Pisarczyk said. “It’s very likely that when you retire, your taxes will be much higher. So, businesses want to look at how they’re using tax deferred vehicles.”
Plans like Roth IRAs, which deal with taxes up front, and taxable investment accounts, may be a smarter way to plan for retirement, he said.
“I believe Roth IRAs are more attractive under the new tax code, if you’re eligible,” Pisarczyk said. “We’re advising diversification among 401ks, Roth IRAs and non-qualified taxable investment accounts.”
New tax laws could be easily overturned by Democrats
Politics will also play a major role in how the changes to the tax structure play out in the long term. While the changes in the corporate tax rate don’t have an expiration date, the changes for individuals will expire after 2025.
But the whole thing, which has been criticized as a tax giveaway to the rich by the Democratic Party, could also easily be overturned if Democrats retake Congress in 2018 and the presidency in 2020.
“Obviously if we get a Democratic coalition elected it could change these tax cuts,” Pisarczyk said. “In my opinion, if we had a Democratic majority, I wouldn’t be surprised if a lot of this gets changed, because there is a lot of concern about what this tax cut will do to the deficit.”
The Republicans justification for the plan is that by lowering taxes on corporations, corporations will be less likely to divert money overseas and more likely to expand locally. If it works, that means there will be a more broad array of companies paying taxes, even if they pay less individually, and that will make up for the difference.
“But the concern is that with the reduction in new tax revenue that the government is going to be getting, our budget situation is going to be worse than before,” Pisarczyk said. “And there has not been a reduction in spending by the government to go with this.”
Some economists think the plan will work, but deficit spending remains a major issue, he added.
“It’s really too soon to tell what will happen,” Pisarczyk said. “The economy has been doing well since Trump took over. But it was also doing well under Obama, and that’s continued under Trump. But the big question is will these tax cuts spur an increase in growth overall? And we don’t know the answer yet.”