Charles Schwab Corp.’s (SCHW) Michael Townsend, vice president of legislative and regulatory affairs, waded into the tax reform debate, saying in a blog post this week that the proposal on the table leaves a lot of unanswered questions from tax credits and deductions to how investments will be treated from a taxable perspective. (Compare brokers with Investopedia's broker reviews.)
Take the tax credits and deductions for starters. Under President Donald Trump’s plan, most itemized deductions go away, but tax incentives for home mortgage interest and charitable contributions remain. It is that part of the reform that Townsend argues will likely garner the most outcry. “How credits and deductions are handled will likely be one of the most controversial elements of the debate,” he wrote. “Virtually every credit and deduction has a constituency that wants to preserve it.”
Then there is the question of how investment income will be handled. Without any guidance on what the tax rate will be for capital gains and dividend income, Townsend said it creates a lot of unanswered questions and uncertainty. What’s more, he said it doesn’t mention what will happen with the Net Investment Income Tax, which is a 3.8% tax on investment income for taxpayers in the higher tax brackets and is part of the Affordable Care Act. He said there are also questions about whether there will be changes to retirement savings incentives that could hurt savers. “The framework says only that it ‘retains tax benefits that encourage work, higher education and retirement security.’ But there have been reports in Washington for months that changes may be coming to retirement savings incentives, including the idea that some or all contributions might be taxed up front, as happens today in Roth accounts,” he wrote. With a traditional IRA, contributions are tax deductible on state and federal tax returns for the year the investor makes the contribution while withdrawals in retirement face the ordinary income tax rates.
Roth IRAs are not tax-advantaged upfront, but earnings and withdrawals are largely tax free.
Charles Schwab’s Townsend said a major question, and one that has yet to be answered, is how the tax reform, which calls for around $5 trillion in tax cuts, will be paid for. After all, he said it would “blow an enormous hole” in the federal budget and “dramatically” increase the federal deficit. “At least some of the tax cuts would have to be offset with provisions that raise revenue for the Treasury, but the plan is vague on those details. Those trade-offs will create winners and losers and are likely to be fiercely debated,” wrote the executive.
As for the timing of a overhaul in the tax code, Townsend said legislation will likely be introduced in mid-to-late October, with both chambers working on it during November. With a current agreement to keep the government up and running that ends on Dec. 8, Congress will have to turn their attention to passing an extension. That could hurt the progress on tax reform and raises doubts that something on the tax front will happen this year. “A more realistic expectation is that this issue will be the top priority for Congress in early 2018, as Republicans will want to push to get a signature accomplishment on the books as they head into the mid-term elections next fall,” wrote Townsend.