Professor Fabio Ambrosio lectures at Course Hero’s headquarters on the impact of the most recent legislation on taxes.
Professor Fabio Ambrosio: Thank you, thank you. All right, so I’m typically loud, and I’m going to try to not speak loud, because when Rosie told me, “Do you need a microphone?”—I don’t need a microphone. I’m Italian. I don’t need a microphone. I’m going to try to not be loud. Today, I’m going to tell you about something that I love. Actually, let me premise that by saying, there are two loves in my life. One of them is a 6-year-old monkey. His name is Mateo. He’s so handsome that if I showed you a picture, you wouldn’t pay attention the rest of the lecture. He’s just like his dad.
Assistant Professor of Accounting, Central Washington University
LLM in Taxation, MBA in International Business, BA in German
So, Mateo. Then, my second love is tax. This will explain why I’m single, because I usually tell my dates that I hope to ever find in my life a woman that I love as much as tax, and that usually means no second date. No, truthfully, I love this subject. Hopefully, by the end of today, you’ll leave with more questions than answers, [which] probably is my measure of whether I did a good job or not.
Let’s start with this. We’re going to start by using your phones. The way you answer this … you could do it two ways. You can either go to the pollEV.com/my last name, and answer there, or you can test my last name to that number once you join, and then A, B, or C. Now, the question is, do you believe that exposure to styrene in drinking water at a concentration of 20 milligrams per liter for one day should be deemed safe? And no questions—just answer.
Now, the rule is answer yes if you believe or know the answer is yes. Answer no if you believe or know the answer is no. If you neither believe nor know that the answer is yes or no, then I ask that you answer “no opinion.” In other words, don’t guess. Just if you don’t know or believe, no opinion, that’s the rule. You ready for the next question? There is a point to this, I promise you. Do you believe that corporations should be subject to higher tax rates than individuals?
Same rules—if you know or believe the answer is yes. If you know or believe the answer is no. If you don’t know or believe in either, then you go for “no opinion.” The question here is: Do you believe that first-class seating on airplanes should be moved to the back of the airplane rather than the front? Same rule: know or believe, yes. Know or believe, no. Neither, you answer “no opinion.” OK. The point of this exercise was that I liked chemistry or logistics, safety.
Everybody has an opinion about tax. Almost everybody has an opinion about tax regardless. Probably, most of us really know just as much about economics and the impact of tax on economics as we do about the content of styrene in water and probably about the safety of the seats disposition on an airplane. But as you see here, you have an opinion.
And that’s what I love about taxes, because no matter who you talk to—it may be a person that really knows or understands nothing about it—they have sometimes a very strong opinion about tax. Which makes some very good conversation, [and] which makes it really difficult to actually come to an agreement. And I think you know that very well in terms of how politics go. All right. You all have an opinion about tax. I know that.
Now, let me tell you what my hope is for today. I would like you to, at the end of this lesson, learn how to define fiscal policy, fairness in fiscal policy, to relate recent tax law changes to your lives. And two, appraise the impact of these changes, not only to your lives but also to your work environment, to your city, state, country. Let’s start with the story. The story goes: We have 8 protagonists.
Can I have my protagonists come to the table here, please? We have John, Irving, Michael, Katie, Rachel, Justin, Connor, and Angie. All right. These are 8 folks. Eight protagonists. They share one love—that’s their love, beer. Can I have you reach out for a beer, please, and have a good time? Awesome. These guys get together for beer every week. They have so much fun. They love where they work. They’re best friends. They share every detail about their personal lives. Is that right?
You can drink for real. It’s not real beer, by the way, just for the record. It’s root beer. You can drink. It’s all paid. Right, it’s paid? It’s paid. It’s been paid. So you can drink. All right. But that’s the story, really. They get together all the time. They have a good time. I’m going to add one more fact about these guys. John. Where are you, John?
John: Right here.
Ambrosio: John, our friend here, is in the 39.6% tax bracket. Can I have you write it on your piece of paper, please? And same for the rest of you. Michael, you’re in a 35% tax bracket. Katie, 33. Rachel, you’re in the 28% tax bracket. Irving is in the 25% tax bracket. Justin is in the 15% tax bracket. Connor, 10%. Angie, you are the no-earner of the group. Where are you, Angie? This girl needs a raise. So, in the tax code as it was before the reform passed, we had 7 brackets and then, of course, the last non-bracket, which is you don’t pay anything.
So now, what happens is these guys drink every week and the bill comes. As you see, I even took the time and doctored a receipt. It’s the Tipsy Taxpayer at 1040 Socio Path Drive. The bill comes to $100. Now, if this bill was paid according to how taxes are paid, this is how much these guys would pay: John would pay $22. Can I have you write $22 on there, John? Underneath the 35%. Michael will pay $19. Katie would pay $18. Rachel will pay $15. Irving will pay $13. Justin would pay 8. Connor would pay 5, and Angie would drink for free.
Cheers. Cheers to that. And they keep doing this for a long time, until the host realizes, “These are really good customers. Here’s what I’m going to do for them. I’m going to give you a $20 discount. Good news, guys. From now on, your bill’s gonna be $80.” What’s going to happen now? Who’s going to get the 20 bucks? So what I want you to do, all of you in the next couple of minutes, is brainstorm who you think should get the $20 discount.
In other words, how are they going to pay for an $80 bill? Now, who should get most of this $20 saving? The exercise for you here, what I have, is the Allocate the $20 Exercise. Here are their tax brackets. Here is how much they were paying before the discount. What I want you to do right now is talk among yourselves and think about how you would allocate the $20 discount. Go for it. Now.
Ambrosio: All right. So our test group here has come to an agreement. While they’re doing that and they’re writing it up…. I was a German literature undergraduate major. And I’m sure this has happened to you: How many times have your professors said, “Go and work in groups,” and you’re like, “Oh man, not again.” This is different. And the reason why is you can relate to it. And also, it really quickly shows you how difficult an exercise this is, because it impacts you but it also impacts those around you.
So while these people are working on writing down how much of their $20 each of them saved, let me take you to this. This is a poll; you answer it by going to pollEV.com/my last name. And the question is, who should get the most? Who should get most of this $20 discount? And it’s just basically a click on the image. You can click on Connor, you can click on Angie, you can click on John. All right. Try to watch where you’ll click, because the clicking on the heart is more of a hateful kind of click. Good thing you can’t click on the back.
This actually gives us quite a clue about your own instinct, I guess, or understanding of fairness. I think we can tell what the people that answered Connor and Angie were thinking. What are these people thinking? These people are thinking of tax as a tool of wealth and distribution of social welfare. These people are thinking of tax as a shared payment system. Maybe they also are thinking of the whole trickle-down economics, that if you give this guy a discount, it trickles down to the rest.
So let me flip that. Now, this question was: Who do you think should get the most? And I think overwhelmingly, it was either John or Connor and Angie, but you see, we really have no clicks on Michael, Katie, Rachel, Irving—the middle class. That’s our middle class. All of you screwed up the middle class, all of you. All of you so much talk about the middle class and none of you thought about the middle class. Fine. Same question, but now who should get the least out of this $20? I want to know who that person is. Angie should get it.
It’s really about the polls. Wonder why tax is such a polarizing topic? That’s why. You have interests at odds, with really most of the population stuck in between. All right. Now, let’s see how these guys decided to divide their $20. Can I have you stand up here and hold up your signs, please? Put yourselves in line. Just come here. Put yourselves in line. Or just stay like this. Hold up your signs, put yourselves in line. That’s fine if you’re not organized, it’s OK. All right. We have Michael.
Ambrosio: Irving. Close. Irving, he was paying $13 and $2.60 was allocated to him. He was in a 25% bracket, so 25% bracket would be Irving is right here. Let’s see, who do we have?
Ambrosio: Justin was in a 15% tax bracket. Justin got to save $6.40.
Justin: Sorry, save a—
Ambrosio: $1.60. So Justin saved $1.60, not $6.40. And …
Ambrosio: Connor was in the 10% tax bracket. He saves $1. And he’s still drinking his root beer. Saves $1, so now he pays 4. Angie paid zero, now pays zero, so she takes no money away. All right. She said something, but I didn’t get her. It sounds like a funny comment, but basically what she’s saying is, “I don’t need money. I just need social services.” What she just said is, “I don’t need money, just pay for my social services.” 28%, Rachel. She saves $3. How much were you paying before? 15. Okay, now she pays 12. Where did you get the orange sign? Angie. No. Angie is here. Katie, 33% tax bracket, was paying 18, now saves $3.60. Michael, 35%, will save $3.80. And …
Ambrosio: John. John’s the highest paid in the room. John’s the highest paid in the room?
John: I wish.
Ambrosio: He’s saving $4.40, so now he pays $17.60. So we basically have the top saving $4.40, and everybody’s saving something other than Angie. I don’t need you to comment on it, but they kind of come with their system. What’s interesting about this is that this design actually does not fit the answers that you gave at all, because in both answers, you told me the person who saves the most is John—which he is saving the most, I guess, $4.40, but not by an exorbitant amount. And the other pole was the person who saves the most is Angie, and Angie is getting nothing.
In other words, their allocation was actually more in the middle, and your allocation was more of the poles. Very interesting. So can I have you take a seat? Thank you very much. Take your root beer if you want. My original idea was to do it with hard liquor because it would be more fun, but yes, that was voted down. All right, so hopefully now you’re in the groove. Now, if we were to allocate savings the way that the tax code was until the end of last year, this is how the savings would have been allocated. Keep in mind there are many ways to do this, so there are a few caveats here.
Seven dollars of that savings would go to John, $5 will go to Michael, $4 would go to Katie. $3 will go to Rachel, $1 will go to Irving and actually zero will go to Connor, Justin or Angie. That’s how the tax code was until December 30, 2017. All right, very good. Now, when it comes to the tax reform, it’s basically no different than the $20 exercise. What it is we’re saying, “We want to give American taxpayers a break.” Well, now that generates to a $20 problem, $20 allocation.
Who do you give this $20 to? That is, who’ll get the $20? In 2019, tax breaks are going to cost $239 billion. These are the incomes that are going to get the breaks. So John, our top earner, is going to get 33 billion of that. Angie is going to get a 418 million, and so on. This is basically the Tax Cuts and Jobs Act allocated in the $20. You can see where the $20 has gone. Who gets the most? Now, keep in mind that the brackets, the income category, it does not reflect the quantity of people. In other words, when I say one million and over, this could actually be few people. Because, I mean, if the average income is $40,000, the higher your income, the fewer the people.
You may say, well, $33 billion; but this may also be 1% of the population or 2% of the population, 3% of the population. There are many ways, as with everything, to look at things. One way you could look at it [is to] say, “Well, the rich are getting the most.” There’s some truth to it, depending on how you look at it. Another way to see it is, “Well, the middle class is getting the most,” which is true—but also this may be one of the largest segments of the population. So in terms of per capita savings, they could actually be much, much smaller than this.
Now, you see, the savings actually start to phase out by 2027. By 2027, everybody’s paying more, other than people with incomes above $75,000. So if your income is below $75,000, you’re actually going to start paying more than you pay now, in 2027. But those above will still be paying less. Hopefully, I’ll be able to tell you a little bit about what the Tax Cuts and Jobs Act does, how it works, and my hope is that you draw your own conclusion. And I actually considered putting in some data about what studies say will happen, and we’ll get to this at the end.
I’m going to stay away from telling you what happens, because I don’t know what’s going happen. I don’t think anyone really knows, and just like anything, studies go in all sorts of directions. But my hope is that you are able to reach your own conclusion, I guess, as to what might happen. All right. Let’s start first—before we talk about that—[about] why I love tax so much. I came to tax from law. My first education was—well, my second education was as a lawyer, so I took the bar exam and then I started working in tax almost by accident, and I became an accountant.
And then oftentimes, when you work with tax issues, what we are taxing is the value of things. So that pulled me into valuation—valuation of businesses, artwork, real estate, and all that. And then I became interested in the impact of that on behavior, social behavior, economic behavior, as well as business-making decisions. Oftentimes when you’re dealing with tax, you’re dealing with a person that comes with a predominant discipline—financier, an appraiser, an economist, a lawyer, an accountant. And typically, they present or approach the issue depending on what their mother discipline is, which is fairly normal. But tax is really the intersection of all these things.
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One more thing I want to tell you about any kind of tax system: Oftentimes the discussion is about the rates. We’re going to reduce the rates. And that matters, but what matters more is actually the base. In other words, what are we taxing? Suppose that we work to raise all of our revenue, United States federal revenue, by taxing sales of cigarette packs. Well, suddenly the base becomes this small. To get enough money, we need to bump up the rate. So there is an inversely proportional relationship between the base and the rate.
The larger the base, the less you need to tax its rates. So don’t fall in love with the rate; also look at who’s getting taxed. The moment that you say, “We’re going to tax all income by individual,” then maybe your base gets to here. If you say, “We’re going to tax all income by individuals and companies,” then it gets here. If you say, “We’re going to tax, say, all sales activities, that’s what sales taxes do,” then you’re really looking at a large sales and a large base. Unlike say, fuel taxes. Fuel taxes only tax those who drive, so your base shrinks, your rate has to be increased, and all that.
Well, after you have your base figured out and your rate, then you come up with a system of preferences. You know what, the system of preferences is the point where we decide which behaviors we want to encourage and discourage, which ones should be exempt from paying the tax. If we’re saying, “Well, here’s the system, but churches are exempt,” that’s a system of preferences. People who smoke less than 10 packs of cigarettes per year, they’re exempt. So you’re creating the system of preferences.
People that have three kids don’t pay as much. That’s your system of preferences, where you’re penalizing or rewarding a certain type of behavior or activity. And then finally, you need a system to make it all work. That’s one way the IRS comes in. All right. Last thing before we get into the Tax Cuts and Jobs Act, actually: planning. Tax policy objectives have to do with revenue. You need to raise revenue, things have to get paid. The economy—you want to stimulate or discourage certain kinds of behavior.
I know, for example, in Denmark, they tried a fat tax, on consumption of fats. It didn’t go well. A few states in the United States tried a sugar tax on sugary drinks. Third, it could be … And another thing also, economic stimulus. Say, for example—for many years now, businesses have been able to depreciate assets much faster than it makes sense to from an accounting standpoint. And the reason is because we’re trying to basically use taxes as way to put more money in the pockets of businesses with the hope that they will reinvest. So we’re using a tax tool to actually generate some additional after-tax cash.
Social: to encourage or discourage behavior. For example, deduction for charitable contributions. You can just get a deduction for giving to your church, to a hospital; that’s supposed to be a good behavior. Political, it could be, let’s say, a tax change proposed or passed because, quite frankly, it benefits my constituents and no one else. Awesome. Times all of the above. For example, the Tax Cuts and Jobs Act—and I should say, the Tax Cuts and Jobs Act was initially passed, [it] repealed what’s called the Oil Spill Liability Trust Fund. What the Oil Spill Liability Trust Fund is, is any kind of refinery, before they put oil into the market, they have to pay into this trust fund.
What this trust fund does, it puts money away already to pay for cleanups that are to come, because the idea is we know spills are going to happen, [and] they’re going to cost money. Tax Cuts and Jobs Act repealed this tax. Who was this benefiting? Clearly, the oil companies. And actually, the Democrats wanted it back as part of the budget deal, so oil companies are not happy. But this could be something that you could say [that] maybe it was meant to stimulate the economy in terms of making it more profitable for oil companies, [so that] was maybe also the political.
Anyway, that’s just an example. Part of this gets to … I guess what’s really interesting after today [is] you’ll find out what happened with the Tax Cuts and Jobs Act—but also what didn’t happen. And what didn’t happen is really the most important part. Tax Cuts and Jobs Act was supposed to be the most sweeping overhaul of any alternative fuel incentive. It was supposed to be this unleashing of the oil companies and total devastation of electric, wind, and alternative fuel energy; and that part of it did not pass. So really the part of the Tax Cuts and Jobs Act that was supposed to be so changing did not pass.
All right. Here’s a slide about tax breaks. People get hooked on tax breaks, I don’t know if you know that. Starting in 1986 all the way to today, tax breaks have actually increased, [so it’s] not surprising that the federal deficit has increased. Not surprising that Social Security is struggling. And I’m sure you’ve heard about Social Security being a bad program. Social Security is just an annuity. You get to a certain age and the government buys an annuity for you, that pays until you die.
Well, guess what? When people start living longer, the annuity pays for longer, but people are still putting in the same amount of money. So what’s going to happen is, now you have to buy more expensive product with less money. When the population ages, more people start drawing and less people start paying. So it’s not really a systemic problem, Social Security; it’s more a matter of a soup. If you start putting less ingredients in the soup, it tastes less good. That’s just kind of how it is.
In terms of Social Security, the rate is fixed; we can’t change the rate. What’s going to happen is we either expand the base or the program’s going to fall. And expanding the base means we tax more people. How do we do that? We make people retire later, or we tax more of the income that people pay. For those of you in this room that are at a $130,000 a year or above, you know that when you get to $128,000, you stop paying into Social Security. That’s what’s called the Social Security Wage Base. In other words, you contribute until $128,000, then you don’t contribute anymore.
One of the ways to increase revenue for Social Security will be to expand the wage base. It’s actually one of, I think, Warren Buffet’s ideas about how to fix Social Security. Anyway, I’m getting on the side here, but this is a comparison of revenues and spending. You see, we’ve been overspending for quite a long time, and it looks like we will be much more. As a matter of fact—I’m getting ahead here—even the most conservative estimates, the most optimistic estimates, about the Tax Cuts and Jobs Act say that the Act will start paying for itself in year eight.
That means that until year eight, it’s going to add to the deficit, and after year eight, it will start paying for itself. And before it actually breaks even, in other words, before it actually pays for itself and then starts reducing the deficit, even in their best-case scenario it will be many more years after that. So this pattern is about to get bigger, the spending is about to increase, the revenue is about to drop, with the hope—we don’t know the future—that at some point, they’ll come back and merge.
The Tax Cuts and Jobs Act is 429 pages. Very fun to read, I highly recommend it. There is a nice summary—it’s only 86 pages. I recommend reading that as well. The changes that are targeting individuals, those expire in 2025. In other words, the message I’m to give you today is, you probably came here thinking that you were going to learn something about you and that I’m going to tell you what’s going to change for you, but really the biggest thing that is going to change is not you. The biggest things are: one, what the Tax Cuts and Jobs Act was trying to do, which was basically repeal all progress towards alternative fuels. And two, really improve permanently, not temporarily, the business tax system.
The changes that you are going to get, those are only temporary. Let’s start with the changes for individuals. Now, the reason I’m showing you this—this I got off the Tax Foundation website. There are many think tanks that come up with all sorts of numbers. And you see, they have various scenarios in here. They say, “Well, Joy and Ethan are going to save only 0.04%. And these people are going to save 2.58%. And these guys are at $48,000, these guys are at $325,000.”
After you look at so many of those, you just stop looking at them. And without saying anything against the Tax Foundation, in a way, this is kind of just propaganda, demagoguery. There are so many things that go into your tax liability, it’s not as easy as: You make this much, you have two kids, bang, there goes your tax bill. You can easily change these numbers by making certain assumptions. Sometimes when you’re looking at forecasts, predictions, this is what’s going to happen, there are key assumptions that the public is not being informed about. Basically I’m showing you this only to disregard it.
All right. Let’s start with changes that the Act makes for individuals. The red is the new law; the black is the old law. And in the old law, we had the seven brackets. We still have seven brackets, but the brackets have in general counted down. Now, let’s start with Angie. Angie, right? Angie was really here, I guess, in the first tax bracket, I mean 0%, but let’s just say she was here in 10% bracket.
As a single person, before the tax reform was passed, she was paying 10% of the first $10,000, pretty much. After the reform, how much is she paying? 10% of 10,000. Nothing has changed for her. Who was in a 15% bracket? One of you was, whoever that was. You were paying 15% of any amounts between 10,000 and 38,700. How much are you going to pay afterwards? 12% of the same bracket. In other words, before you start seeing any savings, you have to go one bracket above the bottom bracket.
And then you see that not only the rates have changed, but once you get to the third layer here, the brackets have also changed. Suddenly, the 25% bracket doesn’t go from 38,700 to 93,000 but from 38,700 to 82,500. This gets to the base. Don’t just look at the rate, look at the base. In other words, you can say, “Well, look, the 39% bracket has been eliminated and it’s been reduced to 37%.” That’s already a saving of 2%, but also you look at the 37%, now it kicks in at 500,000.
So before you even paid at 37%, you need to make more money than what you were making before, before you start paying 39%. So that means you’re not really saving only the 2%, you’re saving that 2% on a larger amount. Make sense? And so that’s pretty much how the changes were, in terms of rates and brackets. You can say from taking a look at this, you can say pretty much anyone other than Angie is going to benefit from this change. Anyone other than Angie is going to benefit of this change to a different degree.
Think about it. If my income is $5 million, I’m the one that is going to benefit the most. Now I have more than 2% saving because all the brackets have gone down. You may say, “I may have, now, a 3% saving or 4% saving compared to what I had before.” If my income was about $80,000, then I’m going to save a fairly small amount. I’m going to save 3% on this bracket and 3% on this bracket. Does it make sense? This is for the rates. Let’s look at other changes.
First, individual exemption. What’s an exemption? An exemption is basically an allowance per breathing head. Every breathing head in the United States gets that exemption up to the year that they die. So if I have a breathing head in my household and that person dies, on that year’s tax return, the breathing head gets the exemption. This is basically $4,000 that you can earn tax free—now it’s gone. When you look at this, who is this basically going to cost the most?
It’s going to cost the most to the bigger households, because if I had a household of 10, before, I could make $40,000 before anyone taxes me. Well, now it’s all taxable, because I have no exemptions. Bigger households in general are penalized the most from this. There are other provisions in the code that try to make up for that, but we’ll get to that. Standard deduction: Standard deduction is pretty much like the exemption. It’s technically not the same thing, but it really does the same thing. For purposes of this lecture, I want you to think of the standard deduction and the exemption as being the same thing, although there is a technical difference between the two.
What that means is that, if I was single, Fabio, before and I have no kids, before I was allowed to take the exemption, $4,050, as well as my $6,350 standard deduction. That makes about $10,400. I’d have to make 10,400 before I even had to file a tax return, and then before I even have to pay any tax. Let’s change it to next year. Well, next year I get no exemption and I can make up to 12,000. So, have I benefited from it? As a single person, no dependents, yes. Now I can make an additional $1,600 tax free.
Now, what if instead I have my parents living with me, I take care of my parents. So I have two dependents that are my parents. Up until last year, I would get $4,050 times three plus 6,350. Well, now I don’t, I only get 12,000. So have I won? No, I haven’t. Again, who stands to lose? Typically, bigger households, and bigger households where the size of the household is not made up of kids. That’s important. There’s a reason why I said my parents are living with me and not my kids; we’re about to get to that.
All right, so not really a clear cut, but the differences between exemption and standard deductions is that exemption is per head. The standard deduction is based on the filer. So if I’m married, then I’m filing jointly. I get $24,000, whether I have 50 kids or no kids whatsoever. Whereas the exemption is based on the number of kids, which means that the exemption benefits the bigger households, the standard deduction is just basically dependent on the filer.
Up until everything we’ve seen so far, we really like people that have no kids. We’re trying to reward people not to have kids, but it changes at some point. Mortgage interest. It used to be that you could deduct interest on the first $1 million of your mortgage. Now it’s been reduced to 750,000. Who is impacted by this? People basically that get into mortgages between $750,000 and one million. That’s who’s impacted by this. It’s very popular deduction. What that basically means is that up until last year, you could buy a house up to one million and get a deduction for the interest. Ironically, side topic, the code as it is currently written, promotes deduction on the indebtedness on your home.
There is no incentive to pay off your home. There is an incentive to stay in debt. In fact, if I go to a bank and I take a $100,000 home equity loan and buy a yacht with it, I can deduct the interest on that loan. So there’s an incentive to be in debt on my home, not to actually pay it off. What else? Property taxes. Maybe you know this already. You used to be able to deduct property taxes without limits. Now you can only deduct the first $10,000. This actually gets into a very interesting side topic, which is vertical tax competition.
Vertical tax competition basically means that if I am a county and whatever I charge you in property taxes is deductible or creditable on your federal tax return, I can basically steal revenue from the federal government. The more I charge you, the federal government is going to pay for it. That’s vertical competition. And we see it in many other areas, but now we’re going to cap the deduction to $10,000. And the reaction is, I don’t want to predict the future, but the reaction is, probably counties are going to try to stick within $10,000.
This is probably going to … what this really is getting at, it’s not about the deductibility of property taxes. This is, in my opinion, an attempt to use the tax code to actually influence local political decisions to try to curb the increase in property tax rates. Because now I think counties are going to have a harder time increasing property taxes where there is no sign of federal tax benefit to it. All right. What else? Child tax credit. Now this is where we basically try to make it up to the families where we took away their exemption amount.
It used to be that you could get a credit. A credit is different from a deduction. A credit is like a payment, so dollar-per-dollar value. Whereas a deduction is only good to the extent of your rate. If I give you a $1,000 deduction and your tax is at 25%, that’s only worth $250. A $1,000 credit is worth $1,000. So now you get $2,000 per child—before you got $1,000 only, so it’s been doubled. For the low-income households, a portion of that child tax credit can be refundable. In other words, it not only counts as a payment; you even get money back for having kids.
And that money back for having kids has basically been increased from up to $1,000 to $1,400. The other change is—and this is what we’re trying to make up for, for having your parents in the household and not kids—before there was no credit for having your parents in the household, or anyone else. Let’s say you’re taking care of a foster child or someone else, a neighbor or a kid. Now, you can get up to a $500 credit. This is trying to make up to the people that have larger homes but not made up of kids, not made up of their children.
Now, just like anything in the code, the benefit phases out. Phases out means that this is meant to basically give you some benefit, but once your income gets to a certain point, you don’t need it anymore. The old mentality was, once you have a married couple filing jointly an income of $110,000, you don’t need this anymore; we’re going to take it out. We’re going to take it out over $20,000. So if your income was between 110 and 130, we would slowly take out your child tax credit. And by the time you get to 130 you get no child tax credit.
Now the phaseout is $400,000 for a married couple filing jointly. That means that not only the credit is bigger but more people are going to get it, and the phase-out is going to be $40,000. So now we’re going to take it away slower, at a slower pace between 400 and 440. By the time you get to 440, you don’t get any benefit anymore. Again, whether it works and how it works, it’s up to you.
One thing that changed—it’s rather significant—is the AMT. AMT stands for Alternative Minimum Tax. And the AMT is basically the secret tax code that works underneath the tax code.
Any time you prepare a tax return—if you ever tried with TurboTax and those of you that are higher earners, you might have—the system might have printed some forms that looks just like the regular form, but they have AMT written at the top. Basically, the AMT system is an alternative system that kicks in if you’re paying too little. If you’ve been able to maximize your deductions, structure your affairs in a way that, based on your income, you’re making too much and you’re paying too little, then the AMT system kicks in and makes sure that you pay at least an alternative minimum tax to bring you up to a certain point.
The AMT is basically hitting higher earners. And the AMT threshold had been increased. Those that are going to benefit from this are basically people … well, before we were hitting singles making more than $54,000. Now we’re going to hit singles making more than $70,300. So we’re basically taxing less people: not a reduction in rate, a reduction in base. A big one: wealth transfer. Any of you heard of the Gift and Estate Tax? Gift and Estate Tax is a tax on the transfer of wealth.
I have $10 million under my pillow, I give it to my son. Up until last year, $5,500,000 was exempt. Which means that the gift or estate tax would only apply on the excess $4,500,000. Starting 2018, you can actually give $11,200,000. Now, if I’m a couple, married couple, that means $22,400,000 free of estate or gift tax. Pretty big increase.
Other changes? Let me just go through some of my impact. The repeal of the penalty for failure to have insurance under the Affordable Care Act.
The code, the Tax Cuts and Jobs Act, did not amend the Affordable Care Act, but it did basically reduce the penalty to zero, which is pretty much the same thing. If you don’t have insurance, your penalty is zero. That’s what happened. It reduced the requirement to deduct medical expenses. Without boring you with details, now, basically, anyone will be able to deduct more medical expenses than they were able to before. People can also gift more to charity. It used to be that you could gift only half of your income to charity; now you can gift 60% of your income to charity.
Other things that had been eliminated: We have eliminated deductions for job-related expenses, union dues. Let’s say that you’re a CEO; we required you to drive somewhere and did not reimburse you for it. You used to be able to deduct it; now you can’t. Moving expenses. If you moved for a job, you used to be able to deduct [those costs]; now you can’t, only military people can. And personal losses. So if you get into, say, if a tornado destroys your house and it’s underinsured or uninsured, you used to be able to deduct that, and now you can’t unless the President declares that a disaster area.
Anyway, this is what the code was trying to do, which did not pass. Repeal of any sort of alternative energy incentive as well as the repeal of the oil spill recovery fund—that was part of the agenda and it didn’t pass. A simplification of the tax code as a whole? This is not simplified tax code. I’m not saying it makes it more complicated, but it’s just as complicated as it was before. So this idea that it simplified things—it didn’t. It’s just as complicated as it was before.
All right. Let’s start with the businesses. This is where really the stuff is getting hot. A few changes, very meaningful changes. Corporations used to be subject to a progressive tax rate between 15 and 35%, 15 and 35%. Now it’s been changed to a flat 21, flat 21%. Alternative Minimum Tax, remember what that is? An alternative system that kicks in when you’re paying too little—gone. So now you can arrange your affairs to a point where you pay zero and we’re happy about it. I don’t need to pay a minimum amount; we’re good.
We take that 35 down to 21, arrange your affairs and the way you pay zero, we’re happy—go. The other thing, dividends received deduction was meant to basically help stacked corporations. So let’s say that your company has another company underneath and that company pays dividends to the parent company. If the bottom company’s paying tax and the parent company’s paying tax and then the shareholder pays tax, that’s creating this three-tax system. We used to have this dividends-received deduction, where the parent company would only basically be taxed on 20% of the money that comes from a subsidiary.
Well, now we have reduced that.
Now the parent company is going to be taxed on 35% or sometimes as much as 50% of the money that comes from a subsidiary. What’s the result of this going to be? Well, the result is going to be a disincentive to have subsidiaries in the first place, but this is where it gets hot—or actually, as you’re about to see, an incentive to making the subsidiary abroad, to putting it abroad. That’s where we’re getting at. Other things that have changed: Accelerated depreciation has been used as economic stimulus for a long time and now we’re basically beefing that up.
We’re allowing businesses that buy assets of two and a half million or less to immediately depreciate $1 million of that. If you buy a coffee machine, well, a coffee machine would be an expensive coffee machine for two and a half million, but let’s assume you were to buy a two and a half million coffee machine. A coffee machine certainly does not depreciate a million in the first year, but now it can. And guess what, if you take that million dollars, you’re still left with one and a half million.
Bonus depreciation says you can deduct it all in year one. So if you actually buy a two and a half million dollar coffee machine, you can deduct all of it in year one, all of it in one year. You’re at a 21% tax bracket, two and half million times 20%, that gives you an additional $500,000 in your pocket as a business.
We did repeal the domestic production activity deduction. That basically was a deduction for businesses that employ local workers and make products in the United States. It’s gone.
Now, pass-through entities. Pass-through entities are partnerships […] corporations. To give you an example, most types of pass-through entities are either professional services firms, accountants, lawyers, doctors, or—typically—real estate investment firms. Those tend to be most of the pass-through entities. The pass-through entities don’t pay tax. So if I am a lawyer in a partnership of lawyers and the law firm makes $5 million, the law firm does not pay tax. That money comes to us and we pay tax on our individual rates.
Well, now, basically from now on, only 80% of that money from the law firm is going to be taxable to us. So if a law firm makes five million, we take the five million, multiply it by 80%, that gives us 4.2 million, we divide it across the partners, and the partners pay tax. Well, the partners are saving two ways. One, they’re shaving 20% off from the get-go. And two, their individual rates have gone down, so they’re also going to save. Biggest benefiters are professional services firms, real estate investment firms.
OK. The hottest part, international. This is probably the hottest part of the changes. The change is, we moved from a worldwide tax system to a territorial tax system, and I don’t have enough words to tell you how major that is. Worldwide tax system basically means, if you are a US citizen today, even on an individual level, you go and earn money in Switzerland, you’re taxed on that money. The way the system works is that your income is taxable regardless of where you earn it.
So you could say, “I moved to Qatar. The United States did absolutely nothing for me other than give me a passport.” And the United States is going to get tax from you for the rest of your life, even if they contributed zero to your fortune. That’s how a worldwide system works. A territorial system works that you only pay tax there, where the money is earned. So if you go to Qatar and you earn money there, the United States keeps their hands off.
Now, in the United States, basically, the worldwide system was creating this phenomenon—and I’m not trying to pick on companies, but I’m going to show you some. Apple, Microsoft, Cisco, Alphabet, Oracle, etc. Basically, the money that is being earned abroad as a company is going to be taxed only when it’s brought home. So one way that I can defeat the tax is I can just keep it abroad until what happens? Until I can bring it home on better terms. This is the list of companies with the biggest amount of profits overseas, in millions, I think so. 256 billions by Apple and if you go down, Microsoft, Cisco, and so on.
This is money that up until 2017, if the company brought it home, it would be taxed at 15 to 35%. Well, now, we’re saying two things to these companies: We are saying, “Well, bring it home at 15.5%. If you reinvest it, we’ll allow you to bring it home as little as 8%. You can pay that amount in the course of eight years. If you paid any dime to a foreign country, you can use that to offset your liability. And guess what, here’s the best part. We are never going to tax you on the money that you earned abroad ever again. This is your last tax on foreign profits in the history. This change is permanent, not temporary.”
Is this going to stimulate the economy? This was part of the biggest push. Probably. You bring back two and a half trillion dollars, potentially, into the economy—will it stimulate the economy? You bet, one time only and then you’re going to keep paying for the rest of your life. Basically, we’re eliminating the domestic production activity deduction; we’re making it more difficult to have domestic stacked corporations. We’re given an incentive to have subsidiaries abroad. That’s the biggest change. And for the companies that stay in the US, if you’re a pass-through entity, only 80% of income is taxable.
If you’re a corporation, now your rate goes as from as high as 35 to as [low] as 21. So you draw your own conclusions as to the effect. The effect will be positive in the short term. I’m just afraid that the benefits in the long term may not outweigh the effects. But there is no question that the effects will be positive; it’s just the nature of the biz.
Let’s see. I think that pretty much brings me to the last slide, which is, many projections have been presented and I was tempted to show you some. [Then] I decided it was really pointless, because we don’t know how the future is going to go. But even the most conservative optimistic forecasts that I’ve seen, will all agree that it will be a short-term benefit, which is not surprising.
Everybody at a people’s level is getting some tax incentives. Some people are getting more, some people are getting less, but pretty much everybody’s getting into a tax incentive at the individual level that’s going to expire in 10 years. Corporations are basically having the tax rate reduce as much as 14%, and potentially two and a half trillion dollars could be brought back in the United States. Professional partnerships are only going to be taxed at 80% of the base that is being taxed now. The rates go down for almost everyone.
Short-term effect, probably booming effect. But before it actually starts paying, how’s it going to start paying? Basically, the moment that we reduce the rate, reduce the base. Remember: Reduce the base, reduce the rate? What’s going to reduce is the revenue. So what you need is the base that increases on its own, and that’s what the plan is trying to do here. It’s trying to say, “We don’t want to increase the base by saying we’re going to tax more people. We want to increase the base on its own by having the economy grow.”
The success of this is really dependent on the economy growing, not in the short term but in the long term. And even in the best-case scenario, that the economy grows at what is expected, we’re only going to start being in the positive in year eight. Now, let me tell you this, this has come from Tax Foundation I think. By 2027, the Tax Cuts and Jobs Act will have added two trillion to the federal deficit. The good news is that by year eight, it will be in the positive by 32 billion.
So two trillion down, 32 billion up. So that’s the good news. Unless the economy really starts picking up, it’s going to take so many years for these two trillions to get paid and then for the current deficit that we already have to start getting paid. So I don’t know what’s going to happen, but I hope this helped. That’s me at the end of all of this, and I’m happy to take any questions. I hope you enjoyed it.