If you don’t have “pass through” income, then you may be one of the big losers in the so-called 2017 tax reform passed by Congress and signed by President Trump. Put another way, if you DO have pass-through income, you are a big winner. So who has pass-through income? Take a wild guess. If your first guess is real estate investors then you win the gold ring.
Real estate moguls be reaping a windfall, according to Fortune Magazine. In fact, under the Trump tax plan, loopholes for real estate investors like him and his son-in-law Jared Kushner will be bigger than ever. All versions of the Trump tax plan have included some type of break for “pass-through” businesses, so-called because their profits are passed through to their owners and subject to the personal income tax rather than the corporate income tax.
The Big Winners In the Tax Sweepstakes
Recently, the Treasury Department effectively published a list of the big winners in the tax sweepstakes. Sure enough, real estate reigned supreme, unless you are a landlord with triple-net leases. Other big winners under the Trump regulations include assisted living facilities and employment staffing companies, which appear now to qualify for the full deduction without limitations. Not so lucky are radiologists and possibly chiropractors.
The Big Losers Are……..
In a word….anyone who works for a living. An analysis by a dozen tax professors and reported by Barron’s Magazine found that the pass-through deduction and the new lower corporate rate created multiple potential loopholes. And in an op-ed piece penned by two law professors for the LA Times, new tax deduction disproportionately benefits the wealthy, penalizes workers and will ultimately reward those who can afford the best tax advice. As they explain it, the new deduction allows people with pass-through income — profits from a partnership or sole proprietorship, for instance — to write off 20% of that income before calculating their taxes. They assert that President Trump, for one, stands to gain significantly. He reportedly owns more than 500 large, pass-through real estate firms — just the type of business that would qualify most easily.
It turns out that pass-through business income is concentrated among the country’s highest earners. The top 1% currently earns less than 12% of labor income, but more than 50% of all pass-through business income. By slashing taxes for pass-through businesses, the deduction will exacerbate our widening income gaps.
Upcoming Challenges In Applying the New Law
Here’s the tricky part of this new loophole: the law is so poorly drafted, and its objectives so unclear, that it isn’t entirely clear as to whether or how you can qualify for a pass-through deduction. So you’d need to pay a hefty fee to legal and accounting firms to figure it out. And guess who has the money to pay for this advice?
It will reportedly take the IRS and Treasury Department many years to clarify exactly how the pass-through loophole works. By then, the new deduction will be on the verge of expiring, creating further uncertainty and risks for regular employees. In the meantime, some of the richest Americans who can afford this professional guidance will most assuredly get richer.
The pass-through loophole is only one of an extensive list of new loopholes created in this hastily-drafted, back-room dealt law. Slate Magazine dives deep into the disturbing details about how the new law will benefit the few and cost the many. A group of 13 tax law professors and lawyers, many of whom have been vocal opponents of the Republican plan, published a 34-page paper offering a list of those unintended consequences. Some of the issues the professors found aren’t loopholes so much as unintentionally perverse incentives that could, for instance, encourage companies to shift employment and investment overseas (which is the exact opposite of what this bill is supposedly intended to do).
With no regulations, no form instructions, and most unfortunate of all, no one who helped craft the bill or vote on the thing who actually understands what it says, it may be a while before clarity is forthcoming……and only the wealthiest tax payers will have the ability to navigate this impossibly complicated new loophole. That’s just a taste of how ugly this new tax “reform” is going to be.
This means the biggest winners of all in this tax boondoggle will be tax lawyers and accountants who will be challenging the IRS’ interpretation of this legal morass for the next decade.
How to Tell If You Are A Tax-Law Winner
You may well have come out as a winner under new tax bill. The only way to tell is to compare your effective tax rate for 2018 with that same tax rate in pre-2018 tax filings.
The effective tax rate is a percentage that explains how much of your income was paid in taxes. In contrast, your marginal tax rate are the taxes paid on each dollar earned above a particular tax bracket. To do this particular comparison, you need to first calculate your effective tax rate for 2017. Just look at line 22 of your 2017 IRS Form 1040. Then look on on page 2, line 63, which provides your total tax. Divide your total tax amount by total income and you’ll determine your effective tax rate.
Second, you’ll want to look at your 2018 Form 1040. Your total income will be listed on line 6, and total tax is on line 15. Do the same calculation to determine your effective tax rate under the new law.
Once you’ve done your comparison, you can figure out whether you were a winner or loser in the tax reform. Our prediction: get ready to be a loser. Congress was not motivated to provide relief for middle or low-income taxpayers. So unless you have pass-through expenses, the revisions to the tax code are not going to be kind to you.