By now, you are aware of the sweeping Tax Cuts and Jobs Act (“TCJA”) and the fact that it will have a major impact on individual and business tax planning. The changes are quite extensive and will impact each individual and business differently.
The following is a brief overview of the major changes included in the TCJA. Many of the changes expire in 2025 presenting some unique planning opportunities as well as challenges in determining the appropriate strategies to implement to take maximum advantage of the new law. Unless otherwise noted, most changes are effective for tax years beginning in 2018 through 2025.
Changes for Individuals
· Tax rates.
Seven new tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The top rate was reduced from 39.6% to 37% and applies to taxable income above $500,000 for single taxpayers, and $600,000 for married couples filing jointly. In most instances, the new brackets will result in a lower marginal rate compared to 2017.
Capital gains rates remained the same.
The “kiddie tax” was simplified. The income of a child subject to the rules will be taxed at the same rates that apply to trusts and estates. Thus, the child's tax is unaffected by the parent's tax situation or the unearned income of any siblings.
· Standard deduction. The standard deduction is increased to $24,000 for joint filers, $18,000 for heads of household, and $12,000 for singles and married taxpayers filing separately. Given these increases, many taxpayers will no longer be itemizing deductions. These figures will be indexed for inflation after 2018.
· Exemptions. The deduction for personal exemptions has been suspended. Thus, starting in 2018, taxpayers can no longer claim personal or dependency exemptions. The rules for withholding income tax on wages will be adjusted to reflect this change, but IRS was given the discretion to leave the withholding unchanged for 2018.
· Child and family tax credit.
The new law increases the credit for qualifying children (i.e., children under 17) to $2,000 from $1,000, and increases to $1,400 the refundable portion of the credit.
The TCJA adds a new (nonrefundable) $500 credit for a taxpayer's dependents who are not qualifying children. The adjusted gross income level at which the credits begin to be phased out has been increased to $200,000 ($400,000 for joint filers).
· State and local taxes. The itemized deduction for state and local income and property taxes is limited to a total of $10,000 starting in 2018.
· Mortgage interest. The deduction for mortgage interest on loans used to acquire a principal residence and a second home is limited to interest on debt up to $750,000 (down from $1 million), starting with loans taken out in 2018. The new tax law suspends the deduction for interest on home equity loans from 2018 to 2026 - unless the loan is used to buy, build or substantially improve the home that secures the loan.
· Miscellaneous itemized deductions. There is no longer a deduction for miscellaneous itemized deductions which were formerly deductible to the extent they exceeded 2 percent of adjusted gross income. This category included items such as tax preparation costs, investment expenses, union dues, and unreimbursed employee expenses.
· Medical expenses. Under the new law, for 2017 and 2018, medical expenses are deductible to the extent they exceed 7.5 percent of adjusted gross income for all taxpayers. Previously, the AGI “floor” was 10% for most taxpayers.
· Casualty and theft losses. The itemized deduction for casualty and theft losses has been suspended except for losses incurred in a federally declared disaster.
· Overall limitation on itemized deductions. The new law suspends the overall limitation on itemized deductions that formerly applied to higher earning taxpayers.
· Moving expenses. The deduction for job-related moving expenses has been eliminated, except for certain military personnel. The exclusion for moving expense reimbursements has also been suspended.
· Alimony. Generally for post-2018 divorce decrees and separation agreements, alimony will not be deductible by the paying spouse and will not be taxable to the receiving spouse.
· Health care “individual mandate.” Starting in 2019, there is no longer a penalty for individuals who fail to obtain minimum essential health coverage.
· Alternative minimum tax (AMT) exemption. The AMT has been retained for individuals by the new law but the exemption has been increased to $109,400 for joint filers ($54,700 for married taxpayers filing separately), and $70,300 for unmarried taxpayers. The exemption is phased out for taxpayers with alternative minimum taxable income over $1 million for joint filers, and over $500,000 for all others.
· Code Sec. 529 Plans. Qualified higher education expenses now include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school. The amount of cash distributions from all 529 plans per single beneficiary during any tax year can't, when combined, include more than $10,000 for elementary school and secondary school tuition incurred during the tax year.
· Charitable Deduction Expanded. The charitable deduction for cash contributions to public charities was increased from 50% to 60 % of adjusted gross income.
· No More Deduction for College sports seating priority donations.
· Estate Tax Exemption Doubled. Prior to the TCJA, the limit that someone could pass to future generations at death, or during lifetime as a gift, without paying an estate tax (the “tax free” amount) was $5,490,000. The "tax free amount" in 2018 is $11,180,000 per person and $22,360,000 for a married couple. But in 2026, the "tax free amount" per person returns to $5,490,000 plus the applicable cost-of-living adjustment since 2017.
Changes C Corporations, S-Corporations, Partnerships, and Pass-Through Entities
Here's a look at some of the more important elements of the new tax law that have an impact on C corporations, S corporations, partnerships, and entities with pass-through income. In general, they are effective starting in 2018.
· Corporate income tax rate drop. Previously, C corporations were subject to graduated tax rates of 15% to 35%. Beginning with the 2018 tax year, the TCJA makes the corporate tax rate a flat 21%, significantly reducing the income tax on most C corporations.
· Corporate Alternative Minimum Tax repeal. The Tax Cuts and Jobs Act repealed the AMT on corporations.
S Corporations, Partnerships, and Pass-Through Entities
· New deduction for pass-through income. The new law provides a 20% deduction for “qualified business income,” generally defined as income from a trade or business conducted within the U.S. by a partnership, S corporation, or sole proprietorship. The deduction reduces taxable income but has some major limitations. For taxpayers with taxable income above $157,500 ($315,000 for joint filers), the deduction will be phased out unless sufficient W-2 wages are paid by the business and/or sufficient depreciable assets are used in the business. In addition, for service related businesses (health, law, consulting, athletics, financial or brokerage services), the phase out occurs without regard to W-2 wages or depreciable assets.
· Partnership “technical termination” rule repealed. Before the new law, partnerships (and most limited liability companies) experienced a “technical termination” if, within year, 50% of the ownership changed hands. This often resulted in unintended burdens and costs on the parties. The new law repeals this rule allowing for much more flexibility in planning the entry and exit of partners and members.
· Partnership loss limitation rule. A partner can generally only deduct his share of partnership loss to the extent of his basis in his partnership interest. IRS has ruled, however, that this loss limitation rule should not apply to limit a partner's deduction for his share of partnership charitable contributions. The new law codifies the IRS position.
Changes to Expensing
· Bonus depreciation. Before the TCJA, taxpayers were allowed to deduct 50% of the cost of most new tangible property (other than buildings and some building improvements) and most new computer software in the year placed in service. The TCJA raised the 50% rate to 100%. In addition, the 100% deduction is now allowed for used qualifying property. (Appropriately, 100% bonus depreciation is also called “full expensing” or “100% expensing”.)
· Code Sec. 179 expensing. Before the TCJA, smaller taxpayers could immediately deduct the entire cost of section 179 property up to an annual limit of $500,000 adjusted for inflation. The annual limit was reduced by one dollar for every dollar that the cost of all section 179 property placed in service by the taxpayer during the tax year exceeded a $2 million threshold adjusted for inflation. For tax years beginning after 2017, the TCJA substitutes as the annual dollar limit $1 million (inflation-adjusted for tax years beginning after 2018) and $2.5 million as the phase down threshold (similarly inflation adjusted).
· Like-Kind Exchanges. Generally, upon the sale of any depreciable business or investment asset, a gain would result in taxable income subject to either ordinary or capital gains tax in the year of the sale. Section 1031 allowed for the deferral of that gain if other property of a “like-kind” were purchased within 180 days. Prior to the TCJA, both real property (land and buildings) and personal property (equipment, vehicles, etc.) would qualify for like-kind exchange treatment. Now, only real property qualifies.
Over the coming months, we will provide a “deeper dive” into some of the more important aspects of the Tax Cuts and Jobs Act with some practical analysis and suggestions. The new law’s impact on each client is extremely fact specific. Therefore, it is important to contact us with questions. We would be happy to discuss how these changes will impact your specific tax situation, and what kind of strategies we can adopt to ensure that you get the best possible outcomes under the new rules.