Later this week, we will find out whether federal tax reform has any real chance of happening in time for 2018. Compared to most Americans, people in Washington, D.C. and Montgomery County, Maryland—and other highly taxed jurisdictions—have a lot more to lose or gain, depending on the final contents of the new legislation.
Almost half of my clients have expressed their concerns that tax reform might cause their federal taxes to go up; the main culprit is the inability to deduct state and local taxes. Several popular deductions may disappear depending on last-minute negotiations. For example, the House proposed to cap the property tax deduction at $10,000, whereas the Senate’s latest proposal eliminates deduction completely. Also, we could lose the mortgage interest deduction for newly purchased properties worth more than $500,000. People with existing mortgages need not worry, however, unless they are planning on buying a new home, as their current deductions would be grandfathered in under the proposed law.
Of course, it is by no means clear the tax reform bill will garner support from a minimum of 50 senators. Even if the Senate can push through reform without significant defections from the House GOP rank and file, it remains to be seen whether the House and Senate versions of the bill can be reconciled.
Since the details of tax reform are still being hammered out, I cannot opine on whether I think it is a boon for the American public as a whole or to D.C. and Maryland residents specifically. But there are at least three provisions (in both versions of the bill) that I think most of my clients would be happy about:
1. Federal estate tax exemption increased to over $11 million for individuals (over $22 million for couples). One of the big reasons to hire an attorney who is experienced with estate planning is to minimize or avoid this tax. It has often been the case that well-to-do people avoid the tax entirely, whereas someone whose estate barely qualifies for taxation (and whose family could really use a tax break) passes unexpectedly in some kind of accident, and the law punishes his or her heirs. Not surprisingly, most Americans consider the tax unfair—including people who are usually supportive of taxes on the wealthy. Many people feel the estate tax amounts to double taxation and should be repealed for that reason. Moreover, the tax can discourage potentially hardworking individuals from being productive, since they cannot give their earnings directly to loved ones. The House version of the bill would eventually repeal the estate tax entirely.
2. 1031 exchanges would still be allowed. Also known as a “Like Kind Exchange” or “Starker Exchange”, Section 1031 of the Internal Revenue Code allows a taxpayer to defer capital gains and related federal taxes when swapping certain properties. By doing this, you can more easily finance a new investment because the IRS realizes you are not yet cashing out, so all of your gains are merely paper profit. This was an item of concern for the real estate industry. Indeed, two separate clients told me that if these exchanges were repealed it would cause significant burdens for their businesses. For smaller investors, a 1031 exchange can be the difference between growing their business and being economically stationary.
3. Businesses would continue deducting state and local taxes. Although state and local deductions would be eliminated for individuals under the proposed reform, the good news for businesses owners and entrepreneurs is that businesses would still be able to deduct state and local taxes, including property taxes.
I wish to emphasize that all of this analysis may be void in a few days. The reason I waited so long to comment on issues of tax reform is that I know how quickly legislation can change at the last moment due to deal making and compromise. I will be prepared to discuss the latest developments in detail with my clients as more information arises later this week.
Paul Oliver Eisler, J.D. writes about legal issues that affect people and businesses in the District of Columbia and Maryland.