Just this week the House and Senate both voted on and passed the Tax Cuts and Job Act. With President Trump’s signature, expected in the next week, this tax bill will be enacted into law. Considered to be the largest tax reform in 30 years, this new tax law is filled with both “give” and “take” with regard to the impact on taxpayers. Most of the revisions will not be permanent, but in place for the tax years 2018 – 2025.
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Reduced tax rates for individuals. Under prior law we saw tax brackets of 10%, 15%, 25%, 28%, 33%, 35% and a top tax rate of 39.6%. Under the new law the lowered tax rates will be 10%, 12%, 22%, 24%, 32%, 35% and 37%.
Major changes to itemized deductions. The new law limits taxpayers’ deductions for state income tax and real estate tax payments. The aggregate amount of state income tax payments plus personal real estate and property tax payments allowed as a deduction will be capped at $10,000 in total per year. Miscellaneous itemized deductions will no longer be allowed, as well, under the new tax act. Typical expenses included as miscellaneous deductions are unreimbursed business expenses, tax prep fees, investment expenses, and fees for safe deposit boxes. And finally, mortgage interest will be capped to only allow a deduction for mortgage interest paid on up to $750,000 of underlying debt on your residence. The new lower debt limit does not apply to a mortgage on a home purchased prior to 2018. Finally, the limitation on itemized deductions based upon income will be suspended as well.
New thresholds for the standard deduction and personal exemptions. With the significant reduction of expenses that qualified as an itemized deduction before 2018, more taxpayers will be left taking the standard deduction on their tax return. The good news is that the new law has increased that amount. Beginning in 2018 the standard deduction for married taxpayers will be increased from $13,000 to $24,000, for single taxpayers from $6,500 to $12,000, and for head of household filers from $13,000 to $18,000. However, beginning in 2018 taxpayers will no longer be allowed personal exemptions for themselves and their dependents. The personal exemption for 2017 is $4,050 per person. The impact of these two changes on a family of four that qualifies to use the standard deduction is an increase in the standard deduction in the amount of $11,000 but a loss in deductions due to the disallowed exemptions of 4 people in the amount of $16,200. Net effect in this example is a loss of deductions in the amount of $5,200.
New deduction for pass-through income. Taxpayers who have Qualified Business Income (QBI) from a partnership, S-corporation, or sole proprietorship will be allowed a 20% deduction on pass-through income subject to limitations. With regard to healthcare personal services (doctors, dentists, psychologists) joint filers will not qualify if their income exceeds $415,000 and single filers will not qualify once their income exceeds $207,500.
AMT exemption increased. The new law will increase the alternative minimum tax (AMT) exemption from $86,200 to $109,400 for married filers and from $55,400 to $70,300 for single filers. However, AMT may become a “thing of the past” for many filers beginning in 2018. Some of the primary reasons that taxpayers fell into AMT were due to the payments of 1.) significant state income tax and real estate tax, 2.) significant miscellaneous deductions, and 3.) several exemptions claimed on the tax return. Going forward, all of these deductions will no longer allowed (except the real estate tax and state income tax deductions which will now be capped at $10,000 combined).
Updated rules for business deductions. The deductions for section 179 depreciation will now be increased to an annual deduction of $1,000,000. Additionally, the new law will increase the allowed deduction for bonus depreciation as well as the allowed depreciation deduction for automobiles used in business. No longer allowed as a business deduction will be entertainment expenses. Previously entertainment expenses were 50% deductible.
The Kiddie Tax has been modified. Under prior law, generally a child’s unearned income (investment income) was taxed at the parents’ tax rates. Beginning in 2018, children who have income will be taxed at two levels. First, a child’s earned income (wages) will be taxed at single filer rates. Second, unearned income for the child will be taxed at tax rates applicable to trusts and estates.
The corporate tax rate has been reduced. Prior to 2018 corporations were taxed at various tax brackets with the highest tax bracket being 35%. For tax years beginning after 2017, the corporate tax rate will be reduced to a flat tax rate of 21%. This new rate also applies to personal service corps, previously taxed at a flat rate of 35%.
Various changes for other items:
- The child tax credit will be increased to $2,000 with the phase out being increased to an income level of $400,000 for married filers.
- For divorce agreements executed after December 31, 2018, alimony will no longer be a deduction for the payor nor taxable income for the payee.
- The deduction for moving expenses will no longer be allowed.
- Recharacterizations will no longer be allowed to undo a Roth conversion.
- The gift tax exemption will be increased from $5,000,000 to $10,000,000
Unfortunately, with the final version of the tax bill being passed just this week, the government didn’t leave much time to prepare for any year-end planning with regard to the changes being enacted. However, there is time to make some year-end adjustments in anticipation of the sweeping changes coming in 2018.
- The primary loss to many taxpayers will be the reduction of aggregate real estate and state income taxes to only $10,000 annually. If a taxpayer is not subject to the alternative minimum tax (AMT) consider the following: Be sure to pay your 2017 quarter 4 estimated tax prior to January 1, 2018. If a taxpayer believes that he will owe state income taxes for 2017, make that additional payment as well prior to 2018. Finally, consider prepaying a portion of your real estate taxes before 2018.
- Employee business expenses should be paid before year end as well, if the taxpayer is not subject to AMT, as these deductions will be lost in 2018.
- Some taxpayers will no longer itemize their tax return in 2018 if they do not pay mortgage interest on their residence. Such taxpayers may consider prepaying any charitable contributions in 2017 that they may normally pay in 2018. Are you paying a large charitable gift to your school over a number of years – if so perhaps you would benefit more by paying the balance on the remaining years before 2018. Another option would be to establish a Donor Advised Fund where the taxpayer receives an immediate tax deduction but then grants the funds over later dates.
- Given that tax rates will decline beginning in 2018, taxpayers should consider accelerating tax deductions into 2017 and deferring income into 2018, as much as they have control over.
- Defer any last-minute taxable Roth conversion until 2018, when the tax rates will be lower. However, if you converted a traditional IRA to a Roth IRA and plan to recharacterize that conversion, be sure to recharacterize before 2018. Taxpayers are no longer allowed to recharacterize a Roth conversion back to a traditional IRA beginning in 2018