Earlier today, House Ways and Means Committee Chairman Dave Camp released his long-awaited and highly anticipated proposal for tax reform. The proposal promised to present the most thorough, sweeping changes to the law since the 1986 Act, and it didn’t disappoint.
Before we begin our analysis of the plan let me start by saying that while I clearly admire Chairman Camp for his tireless push to simplify the industry in which I ply my trade, I’d be remiss if I didn’t point out the irony that in the tax world, even a proposal for “simplification” stretches to nearly 1,000 pages.
Because there’s so much to take in, we’ll be separating our analysis into two parts
Part 1: Proposal for individual tax reform
Part II: Proposal for business tax reform
Let’s get to it with Part 1, Chairman Camp’s proposal for individual tax reform.
Streamlining of Individual Income Tax Rates
Effective January 1, 2013, we now have seven income tax rates that are applied against so-called “ordinary income,” (i.e. income from wages, business income, interest, etc…): 10%, 15%, 25%, 28%, 33%, 35%, and a top rate of 39.6%. If you’ve ever wondered how efficient this type of structure is, consider that in 2013, the 35% rate was only applied on single taxpayers with incomes in excess of $398,351 but less than $400,000. Yes, we had a tax bracket that was $1,649 wide.
Because our tax system is a progressive one, taxpayers don’t pay a flat rate of tax on all earned income; rather, as income increases, so does the tax rate applied to the income. Thus, when someone proclaims that they are in the “39.6% bracket,” that does not mean they paid 39.6% on all of their income; rather, it means they paid 39.6% on their last dollar of income. It also means that they are likely insufferable.
No matter how you slice it, a system with seven brackets – and a high of nearly 40% — is far from ideal.
Camp’s proposal would consolidate the current seven brackets into three, consisting of 10%, 25%, and 35% rates. Generally, the new 10% rate would replace the old 10% and 15% brackets, meaning it would cover all income earned up to approximately $73,800 if married, $36,900 if single (for simplicy’s sake, from this point on I will refer to married versus single thresholds or limitations like so: $73,800/$36,900).
The new 25% bracket would replace the former 25%, 28%, 33% and 35% brackets, meaning single taxpayers with taxable income between $36,900 and $400,000 would pay a 25% rate on that income, while married taxpayers with taxable income between $73,800 and $450,000 would pay a 25% rate on that income.
If you happen to earn taxable income in excess of $450,000/$400,000, then you will pay a rate of 35% on the excess, as opposed to 39.6% under current law.
Excluded from this top rate of 35% — meaning it would be taxed at a top rate of 25% — would be any income earned from “domestic manufacturing activities,” which is defined as “any lease, rental, license, sale, exchange, or other disposition of tangible personal property that is manufactured, produced, grown, or extracted by the taxpayer in whole or in significant part within the United States, or (2) construction of real property in the United States as part of the active conduct of a construction trade or business.”