Tax Reform and Your Retirement Account
The highly discussed and anticipated tax reform proposal has finally been released in the form of a 400-page long overhaul of the current Tax Code. Controversy and political debate has been swirling around the proposal for some time, likely resulting in specific provisions being revised. Below are some of the major provisions on the table and what impact might result from them:
Individual Retirement Accounts
The rules surrounding retirement accounts have been largely left alone with contribution limits, requirements, stretch IRAs and Net Unrealized Appreciation all maintaining current availability.
One major change for retirement age individuals in the repeal of Roth IRA characterizations, making Roth conversions a permanent decision upon implementation. This would be effective in tax years beginning after December 31, 2017. As current law stands, an individual could reverse a Roth conversion decision by October of the following year if desired. There are multiple reasons why one would exercise that right, one of which would be a drastic change to the tax brackets. Another reason would be if the value of the newly established Roth account declined after the conversion process in order to recoup tax paid on value that is no longer present. If this particular provision does go into effect, this “second chance” rule will no longer be an option.
The highly anticipated reduction on 401(K) contributions did not find its way into the new proposal. Employees were granted a friendlier rule-set regarding in-service and hardship distributions from qualified plans. This would allow for employees to potentially broaden investment selections by gaining the ability to look for outside management. It will also benefit those with outstanding loans on their plan when they separate from service by granting more time to roll over existing loan balances to an IRA to avoid it being taxed as a distribution.
Tax Rate Changes
The largest changed hands-down is the reduction of corporate rates from 35% down to 20%, while also creating a new 25% rate for business income that is received by owners through partnerships and S corporations.
The individual tax bracket would be reduced down from seven to four: 12%, 25%, 35% and 39.6%.
Due to lower tax rates, the proposed act would reduce and possibly even eliminate many of the currently available itemized deductions. One of these eliminations will come from the medical expense deduction as well as the waiver of the 10% early withdrawal penalty from retirement accounts if used to cover deductible medical expenses.
Mortgage interest deduction would apply only to interest of $5000,000 worth of borrowing, down from $1 million, while the deduction for state and local income taxes would be altogether eliminated.
However, the standard deduction would be doubled to $12,000 for individuals and $24,000 for married couples in addition to an increase for child tax credits to $1,600. In most cases, the net result might look to be beneficial for those filing a simple return using the standard deduction and likely not so beneficial for those itemizing returns with large deductions.
The proposed bill would double the exemptible amount from estate taxes beginning in 2018, currently at $5 million. The estate tax in addition to the generation skipping tax would altogether be eliminated after 2023 while maintaining the full step up in basis. Gift taxes would stay in play but would be at much lower rates than currently.
There are still many scenarios surrounding how the final bill will actually be passed, if it is at all. Many of the proposed provisions will be altered in some way, possibly some of those listed above. Stay tuned for important updates as we await the final outcome of this widely discusses event.
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