While much can still change about the tax reform proposal that came out of the house a few days ago, it’s worth discussing the implications of what’s currently on the table. One of the most important things to remember when it comes to the Power of Zero worldview is this: to get to the 0% tax bracket, you have to be willing to pay a tax. Given this impending tax legislation, some prospects have been putting their POZ planning on hold until they have a little more certainty surrounding the actual amount of tax they’ll have to pay. So, all this begs the question, does this tax reform proposal truly decrease the cost of getting to the 0% tax bracket?
The answer is: it depends. First, let’s identify the primary changes to the tax code that will affect your clients. In the current proposal the number of tax brackets gets reduced from 7 to 4 (5 if you make more than $1M). See the table below on the differences:
In the current proposal, a portion of the 15% bracket gets absorbed into the 25% bracket (good) and the 25% bracket gets extended all the way to $260,000 (even better!), formerly the realm of the 28% and 33% brackets. So, on the surface, it looks like there’s no question that taxes will be saved. In fact, I did an actual calculation of tax savings were a client to realize enough taxable income to reach the top of the 25% ($260,000 of taxable income). According to my calculations, their effective tax rate would be 20.5%. Contrast that with an effective tax rate of 23.46% under the old tax rates. That’s a savings of $7,714! The cost of getting to the 0% tax bracket may have just gotten cheaper!
Worthy of note, however, is that this tax reform proposal does eliminate and simplify many deductions. In some cases, this serves to offset some of the tax savings mentioned above. For example, the proposal calls for the elimination of the deduction for state taxes. So, were you to normally pay 5% state tax on $260,000, that’s a $13,000 deduction that just went up in smoke. At 25% tax, that lost deduction will cost you an extra $3,250. That brings our total tax savings on the first $260,000 of income down to only $4,464. If you live in a state like California where your taxes can exceed 10%, then your total savings just plummeted to less than $1,500.
In conclusion, should this proposal go through in its current form, it will be easier and more cost effective for our clients to get to the 0% tax bracket, if only marginally in some cases. More importantly, this bill would create more certainty in the planning process so that clients can make asset-shifting decisions with confidence. Further, because this proposal would get approved under budget reconciliation, it would expire in 10 years. That means that our clients would experience historically low tax rates for 10 years and know the year and the day when those taxes will go back up again. Talk about a window of opportunity! Should this legislation go through, it will create a period of historic opportunity for clients and prospects looking to adopt the zero tax paradigm!
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