News from Jerome E. Horton

Member, 3rd District State Board of Equalization

The Trump Tax Plan Trumps Californians!

The Republicans’ “Tax Cuts and Jobs Act” will be devastating to California’s poor to middle-income families because they pay the highest income and sales taxes in the nation (in proportion to their income), the second highest gas tax, and their property tax assessments have doubled – and none of these will be deductible.

The over eight million individuals who live below the poverty line in California, which has the highest poverty rate in the nation, will initially benefit from the Republican tax plan, which doubles the standard deduction, maintains the federal and state “Earned Income Tax Credits,” and reduces the tax rate from 15% to 12% for those who earn under $77,400.  However, if you take into consideration the Republicans’ proposed cuts in health care, the cost of living tax adjustments, and the fact that these proposed tax benefits are temporary (expiring in 2025), by 2027 most Californians earning $75,000 a year or less will pay more taxes.  On the other hand, California’s ultra-rich, who earn $480,050 to $1 million and over, will benefit from the plan because it lowers their tax rate and maintains the majority of their tax-reducing loopholes.

California’s middle-class taxpayers who itemize their deductions will continue to be the proverbial turnip from whom President Trump seeks to squeeze tax blood. This is especially troubling because the Republican tax plans proposed by the Senate and/or House would eliminate deductions for dependents, state and local taxes (including property taxes), medical expenses, unreimbursed employee expenses, and tax preparation fees, as well as California’s personal casualty losses, such as losses resulting from California’s wildfires.

Families considering purchasing a home or an equity loan should note that California is proposing an increase in home financing fees from $75 – $255 per transaction and the Senate Republicans’ tax plan limits mortgage interest deductions (MID) for interest paid on new home mortgages greater than $1 million and denies mortgage interest deductions on home equity loans.  Seniors looking to sell their homes and relocate out of California or downsize will face new limits on the capital gain tax exemption of $250,000 for single filers or $500,000 for married filers on the sale of their personal residence.  Given that inflation is out of control in California, with an average home listing price in Los Angeles of $745,000, these combined proposals will make affordable housing nearly unaffordable for middle-income families.

The benefits in the proposed tax plan include maintaining the earned income tax credits and deductions for medical expenses and interest on student loans, protecting 401(k) retirement investments, and increasing the child tax credit from $1,000 to $1,650.  It also provides for a $300 “Family Flexibility” credit allowed for each spouse and an increase on the income limits on Child Care Tax credits from $75,000 to $115,000 for single taxpayers and $110,000 to $230,000 for married taxpayers, and doubling the standard deduction to $24,000 for married couples and $12,000 for singles. However, the positive benefits are not enough to offset the negatives in this tax plan.

California has over 772,555 millionaires and more billionaires than any state in the nation, who will disproportionately benefit from the Republican tax plan.  President Trump’s surrogates and economists espouse that, based on “trickle-down economics,” helping the rich will increase salaries and create jobs, but history proves otherwise – profits that result from tax savings generally benefit the shareholders and do little to add new jobs or generate an increase in employee compensation.

If the president wants to help working families prosper and stimulate our economy, it’s simple: lower their taxes, eliminate unwarranted loopholes, and incentivize California’s millionaires and billionaires to invest in education, innovation, environmental justice, and affordable housing, and hire 1.5 people each at $50,000 a year. This plan would end unemployment in California and stimulate over $57.9 billion in new salaries and corresponding state and federal taxes.

Senate Passes “Wealth-Building Tax Plan” at Expense of the Middle Class

On December 2, the Senate Republicans passed their version of the Trump Tax Plan that will not only impact the amount of taxes you will pay; it will also impact your ability to build wealth, educate your children, preserve your health, plan your estate, and grow your business in California.

It provides a $10,000 special tax-free college savings credit to pay tuition for private and religious K-12 schools, disproportionately benefiting rich families who can afford private schools, tutors, personal trainers, and parental volunteering.  This incentivizes a decline in public school enrollment without any effort to equalize education for all children.  The bill would also bar school districts from using cost-effective, tax-free “advance refund bonds” to lower their debt by refinancing school bond debts.  The bill also exempts private colleges with large endowments from a 1.4% excise tax on investment income, including Michigan’s Hillsdale College, whose benefactors include President Trump’s education secretary, Betsy DeVos.  You would think education equalization would be a number one priority for Congress given that if we fail to dramatically improve student success in higher education, our nation will suffer from a shortage of skilled workers needed to ensure global competitiveness and national security – according to studies conducted by the Bill and Melinda Gates Foundation.  These measures will place even greater pressure on an already seriously underfunded California public school system.

Here are a few more key provisions of the Senate Republican tax plan. Their plan repeals the mandate requiring Americans to either obtain health insurance or pay a fine, and thirteen million Americans are projected to choose not to obtain health care through the Affordable Care Act.  This means the government would no longer have to pay billions of dollars to subsidize their health care plans and, unfortunately, poor and middle-income Californians whose employers do not provide healthcare coverage would be forced to pay higher Covered California Health Care premiums or be pushed into local emergency medical care, shifting the burden to the counties and the state.  It continues to allow charitable deductions, but the deduction for casualty losses in the case of theft, floods, or even home damages sustained from California wildfires was eliminated.  However, people who don’t itemize deductions because they do not have itemized deductions in excess of the standard deduction would not have a tax benefit from their charitable deductions.  However, those who itemize their deductions would find it beneficial to actually increase their charitable deductions to offset for the other deductions eliminated.

Property taxes remain deductible up to $10,000.  If you live in Los Angeles County you should watch out for the 14 different property tax add-ons because they may push you over your limit.  Mortgage interest is still deductible if your debt is under $1 million and the interest is not the result of a home equity loan.  Purchasing a home with the equity from another property may not be wise and instead you may want to refinance depending on other factors.  The Senate plan preserves the Alternative Minimum Tax, which hurts filers making between $200,000 and $1 million.  The plan expands deductions for medical expenses by reducing the threshold limitation from 10% to 7.5%, allowing more people to claim medical expenses that exceed 7.5% of their adjusted gross income.  If you are planning an operation with high deductibles, consider getting it done before the end of 2018.  However, the House plan eliminates the medical expense deduction, so wait a few weeks before you incur major planned health expenses.  Other interesting features of the Senate plan include increasing teachers’ classroom expense deduction, which would go from $250 to $500 – a $250 benefit for teachers, and retaining the refundable earned income tax credit of up to $6,500.  In addition, the child tax credit would be expanded from $1,000 to $2,000, but the additional $1,000 would be nonrefundable.  In the past, if you owed zero taxes you would get a refund for the full credit, but under this plan the refund would apply only to the first $1,000.

Mostly wealthy Californians, who pay the highest state income and sales tax in the nation, will no longer be able to deduct these taxes.  However, if they own a business the tax plan cuts the corporate tax rate to 20% from 35%, which offsets the loss of the state and local tax deduction – but this rate reduction will not go into effect until 2019.  The Republicans are hoping to encourage businesses to support their re-election in 2018 in order to preserve the 15% reduction in their tax rate. The plan also allows businesses to immediately and fully expense new equipment for five years, then phases the provision out by 20 percentage points per year thereafter. The House tax plan lowers taxes on pass-through business income such as partnerships, who pay tax on them on their personal returns under ordinary income tax rates from 39.6% to 25%, and phases in a lower rate of 9% for businesses that earn less than $75,000, but the Senate plan allows a 23% deduction against the income if it is less than $500,000 for married couples and $250,000 for singles.  Additional provisions would subject salary draws to ordinary income tax rates and prevent the re-characterization of wage income as business profit to get the benefit of the pass-through deduction.   The Senate plan would also prohibit pass-through entities that provide professional services, such as lawyers and accountants, from taking advantage of the lower rate.

Both tax plans would require companies to pay a one-time low tax rate on their existing overseas profits.  Multinationals would no longer be able to defer or avoid U.S taxes by leaving profits overseas in switching to a “territorial” tax system.  Currently, California companies pay taxes on all of their income regardless of what country they are doing business in, but they are allowed to defer paying taxes on their profits until they bring the money home. This is commonly referred to as a “worldwide” tax system. This sounds like a good thing until you take a closer look.  As the old saying goes, “the devil is in the details,” because this provision could provide a huge windfall for rich multinational companies while hurting California employees in the long run.

The next step is for the Senate and Congress to reconcile their differences and present a final bill to the President, which he will undoubtedly sign.  Stay tuned, because the language is evolving –including proposals to exempt cruise ships from taxes while docking in Alaska, allowing deductions on credits related to expenditures in connection with legal marijuana sales, and exempting kombucha tea from alcoholic beverage excise tax.  I suggest that you consult a tax expert on wealth-building tax strategies such as estate planning; converting your salary income to investment income; avoiding California’s high gas tax by buying an electric or hybrid vehicle, which could provide you up to $7,500 in tax credits; and consider making a donation to your local public school – it is going to need it.

Building Wealth ABCs: Tax Money for College

People are asking, “What can I do to build wealth and help educate my children if I don’t make millions of dollars?”  One strategy to build wealth is to use public dollars to pay for your children’s college education and then apply the savings to pay down your debt.

The ScholarShare 529 account, which allows your college savings to grow free of federal and state taxes, can result in up to 25% more money for higher education that can be used for certain college expenses.  In addition, when filing your return, as an employee and the recipient of educational assistance payments from your employer, you can claim an exclusion from taxable income for up to $5,250 a year.  Then if you take these tax savings and pay down your debt, you save even more.  For example, if you have a 30 year mortgage of $100,000 at 4% interest and you pay an additional $100 a month on your mortgage over the life of the loan, you could save $33,975.

Much to my dismay, California does not allow a deduction for tuition and fees, and it does not have any credits similar to the federal education credits.  However, the following five tax strategies will allow qualified taxpayers to defer or reduce federal taxes on money paid or saved for college, regardless of your state(s) of residence or where your children are attending college.

1. The ScholarShare 529 College Savings Plan allows you to invest money for your children’s college education and avoid paying taxes on the interest and distribution of the money toward qualified education expenses.  Contributions to a ScholarShare account may help you reduce the taxable value of your estate and, together with all other gifts from the account owner to the beneficiary, may qualify you for an annual federal gift tax exclusion of up to $14,000 per donor ($28,000 for married contributors) per beneficiary.  If an account owner’s contribution to a Plan account for a beneficiary in a single year exceeds $14,000 ($28,000 for married contributors), the account owner may elect to treat up to $70,000 of the contributions ($140,000 for joint filers) as having been made over a period of up to five years for the federal gift tax exclusion.

1. The American Opportunity Tax Credit (AOTC) is worth as much as $2,500 a year per student for up to four years.  If you meet the low-to-middle income requirements, the AOTC is worth 100% of the first $2,000 of qualifying education expenses and 25% of the next $2,000.  Effectively, if you pay $4,000 or more in tuition and other qualifying expenses, the government will give $2,500 of it back to you as a credit.  If you claim the credit on your return, 40% of it – up to $1,000 – is refundable, meaning you get it even if you owe no taxes.  In order to take the credit, the student must be enrolled in a degree or certificate program, must be taking classes on at least a half-time basis, have no felony drug convictions, and must be in the first four years of postsecondary education.  If a student has already completed four years of college, he or she is no longer eligible, regardless of whether the credit was used for those four years.  The credit phases out above a modified adjusted gross income (MAGI) of $80,000 for single taxpayers ($160,000 married filing jointly), and disappears completely above MAGI of $90,000 and $180,000, respectively.

1. The Lifetime Learning Credit (LLC) is designed for low-to-middle income taxpayers who paid qualifying education expenses but cannot meet the requirements of the AOTC.  Unlike the AOTC, the LLC does not require the student to be pursuing a degree or attending classes at least half-time, or to be within the first four years of higher education.  In other words, the student can take a single college course and claim the LLC.  However, the MAGI phase-out thresholds are significantly lower, at $55,000-$65,000 (single) and $110,000-$130,000 (married filing jointly).  If you qualify, the credit is worth 20% of up to $10,000 in qualified tuition expenses per year.  Another important distinction is that this limit is per return, not per student.  The maximum credit of $2,000 isn’t that much different from the AOTC, but you’ll have to spend more to get the full amount.  You can use the credit to reduce the tax you owe, but it isn’t refundable if you owe no tax

1. The Tuition and Fees Deduction is generally used by taxpayers who would otherwise qualify for the LLC but whose incomes are too high.  This deduction has significantly higher phase-out thresholds than the LLC, at $65,000-$80,000 for single filers ($130,000-$160,000 married filing jointly), and allows you to exclude up to $4,000 in qualifying tuition and fee expenses from your income, depending on your tax bracket.  If you’re in the 25% marginal tax bracket, for example, this translates to up to $1,000 less in tax liability.  Keep in mind that this is an above-the-line tax deduction, meaning that you can take it even if you don’t itemize.

1. The student loan interest deduction allows you to deduct the actual amount of interest you paid on your qualified student loans, up to $2,500 annually.  Like the tuition and fees deduction, this is an above-the-line deduction, so you can take it regardless of whether you itemize or not.  For purposes of this deduction, your student loan qualifies if it was taken out for the sole reason of paying for qualified higher education expenses within a reasonable time frame after the loan was taken out.  The deduction has the same MAGI phase-out thresholds as the tuition and fees deduction, of $65,000-$80,000 for singles ($130,000-$160,000 for married joint filers).

It’s important to mention that in claiming these tax breaks, you should only use the amount you paid during the calendar year, not the amounts billed by the school.  Specifically, if your classes start during the first three months of 2018, but you pay the bill in 2017, you can apply the amount paid to calculate your 2017 tax benefits.  These strategies may be quite helpful in reducing your federal taxes, so be sure to discuss them with your tax advisor as the tax filing season begins.