Recently, Congress passed the Tax Cuts and Jobs Act, an extensive piece of legislation signed into law by President Trump on December 20, 2017. This Act constitutes the most significant change to the tax code in over thirty years, and considerably alters how individuals and businesses will be taxed. As a result, it is vital that you take the time to understand what changes have been made, how you will be affected (both positively and negatively), and how you can take advantage of these new laws.
A summary of key provisions that our office believes will be the most important to you is set out below. Keep in mind that drafting and negotiations for the Act were done behind closed doors, so no information from hearings or floor discussions exists to assist in understanding how Congress and the President intend for this law to be interpreted and applied. It is the fervent hope of every tax professional that the Internal Revenue Service will seek to provide additional guidance in the coming months. Additionally, there are a number of different effective dates for the Act’s various provisions, most of which became effective as of January 1, 2018. Most of the provisions that benefit individuals will terminate in 2024 or shortly thereafter.
1. Modification to Individual Income Tax Brackets
The rates at which individual taxpayers will be required to pay income tax, beginning in 2018, have been amended as follows:
|Prior Law||New Law|
|39.60%||$426,700 and above||37%||$500,000 and above|
Married Filing Jointly
|Prior Law||New Law|
|39.60%||$480,050 and above||37%||$600,000 and above|
These new tax brackets will ultimately lower taxes at many income levels. However, determining the overall impact on any particular individual or family will depend on a variety of other changes made by the Act, including increases in the standard deduction, loss of exemptions, limits on itemized deductions, and other changes discussed below.
2. Modification of Corporate Tax Brackets
Previously, corporate tax rates were graduated, with a maximum rate of 35%. Beginning in 2018 and beyond, the corporate tax rate has been reduced to a flat 21%. This change is permanent, and will not sunset in 2026 like many of the individual income tax changes.
3. Standard Deduction Increased
For tax years beginning in 2018, the standard deduction has been increased to $24,000 for married taxpayers filing jointly, $18,000 for head of household filers, and $12,000 for individual taxpayers. This will benefit taxpayers by further reducing the amount of income that will be subject to income tax. This change will also reduce the number of taxpayers who choose to itemize on their tax returns and simplify tax reporting for those individuals.
4. Miscellaneous Itemized Deductions Suspended
Under prior law, individuals who itemized deductions could deduct certain miscellaneous itemized deductions to the extent that the total of those deductions exceeded 2% of adjusted gross income. These deductions included unreimbursed medical expenses, investment expenses, tax preparation fees, and unreimbursed employee business expenses. Under the new law, these deductions are limited or no longer allowed.
5. Personal Exemption Suspended
The previous personal exemption amount of $4,050 allowed for each taxpayer and most dependents claimed on income tax returns has now been eliminated. This has the effect of offsetting the increase to the standard deduction for most taxpayers.
6. Child Tax Credit Doubled
Under prior law, taxpayers were able to claim a tax credit of $1,000 for each child being supported by the taxpayer who is under the age of 17. The new law doubles this tax credit to $2,000 per child.
7. Capital Gains Tax Adjusted
Capital gains tax applies to the income realized on the sale of a capital asset (investment property, stocks and bonds, collectibles, motor vehicles, etc.). While the rates at which capital gains are taxed remain unchanged (0%, 15%, and 20%), the points at which each rate applies have been adjusted. Beginning in 2018, each rate kicks in as follows:
|Head of Household|
|Married Filing Jointly|
|Married Filing Jointly|
8. Estate, Gift, and Generation-Skipping Transfer Tax Amendments
The 40% estate and gift tax has been retained, but the federal exemption amount per taxpayer (i.e. Unified Credit) has been doubled. Under the old law, the first $5.6 million ($11.2 million for married couples electing portability) was exempt from federal estate and gift taxes under the Unified Credit. Under the new law, for gifts made and/or decedent’s dying between January 1, 2018 and December 31, 2025, an individual is allowed to exempt the first $11.2 million of the estate ($22.4 million for married couples electing portability) from federal estate and gift taxes. Prior to this change, only .004% of estates in the country were subject to estate taxes. That number will most certainly decrease even further in light of these changes, leaving estate tax a non-issue for most taxpayers. However, this does not mean that estate planning itself is no longer important. Planning for incapacity, creditor protection, guardianship for minor and disabled children, charitable giving, etc. will remain important objectives for most taxpayers.
The exemption for the Generation-Skipping Tax, imposed on amounts that are transferred (by gift or at your death) to grandchildren and others who are more than 37.5 years younger than you, has also been doubled. Additionally, heirs will continue to receive a “step-up” in basis for property they receive as of the date of death of the decedent. The old income tax brackets and rates applicable to estates and trusts (originally 15%, 25%, 28%, 33%, and 39.6%) have been updated and simplified (10%, 24%, 35%, and 37%). Finally, the gift tax annual exclusion amount remains unchanged, although inflation has increased the amount to $15,000 per donee, per year.
9. Limits on Mortgage Interest Deductibility
Under prior law, a taxpayer could deduct interest on up to $1 million of mortgage debt incurred in acquiring a principal residence, as well as a second home. Additionally, taxpayers could deduct up to $100,000 of qualifying home equity debt, which could be used to acquire or improve a home, pay for educational expenses, travel, etc. Beginning in 2018, the overall limitation on the mortgage interest deduction has been decreased to $750,000 ($375,000 for married filing jointly) for all mortgage debt incurred after December 15, 2017. Additionally, the home equity debt deduction has been eliminated entirely, regardless of when such debt was incurred.
10. Charitable Deduction Increased
Under the new law regarding charitable contributions made by taxpayers, the original 50% limitation on deductions for cash contributions to public charities and certain private foundations has now been increased to 60% of the taxpayer’s adjusted gross income. Contributions exceeding this 60% limitation are generally allowed to be carried forward and deducted for up to 5 years. (However, a deduction will no longer be allowed for payments made in exchange for college athletic event seating rights).
11. Section 529 College Savings Plans Expanded
Section 529 Plans are state-sponsored, tax-advantaged savings plans designed to encourage saving for the future educational expenses of the plan beneficiary. Under prior law, these plans only applied to college expenses. Therefore, tuition for elementary or secondary schools was not a “qualified expense” under the plan. New law provides that up to $10,000 in distributions per year, per child, can be taken tax-free out of 529 Plans to pay for private elementary and secondary educational expenses, expanding the usefulness of this estate planning tool for many taxpayers.
12. ABLE Account Contributions Expanded
ABLE Accounts are savings plans established to meet the qualified disability expenses of the account beneficiary. These accounts are very similar to Section 529 Plans, ensuring that all funds within the account grow tax free as long as the funds are used for qualifying disability expenses, and that such funds will not affect the disabled person’s qualification for Medicaid, SSI, and other government benefits. Previously, total contributions to an ABLE account in a single year from all contributors could not exceed the annual exclusion amount ($15,000 in 2018). New law allows an ABLE account’s designated beneficiary to contribute an additional amount up to the lesser of (1) the federal poverty line for a one-person household, or (2) the individual’s total compensation for the year.
13. New Deduction for Pass Through Entities’ Income
An important provision created by the Act involves a new deduction on qualified business income produced by pass-through entities (partnerships, S corporations, LLCs, and sole proprietorships). For non-corporate taxpayers, a 20% deduction will be allowed for “qualified business income” subject to various calculations and wage limitations.
Qualified business income includes income from a partnership, S corporation, or sole proprietorship, which is taxed to an individual, trust, or estate. The business must be conducted within the United States, and certain investment-related sources of income are not included (e.g. capital gains or losses, dividends, etc.). Taxpayers with wages exceeding $157,000 ($315,000 for married couples filing jointly) are subject to certain limitations on the deduction along with a phase-out of the limits.
This deduction is a below the line deduction, and therefore it will not reduce a taxpayer’s adjusted gross income. While this new law will be very beneficial to business owners, it involves several complex limitations on its use, and it is advised that contact your tax professional to discuss the technicalities of this provision.
14. Net Operating Losses Limited
Previously, a net operating loss deduction was not subject to a limitation based on taxable income, and generally could be carried back two years, and carried forward 20 years. Under the new law, net operating loss deductions are limited to 80% of taxable income, determined without regard to the deduction itself. Additionally, the two year carryback rule has been repealed, but carry forwards are allowed indefinitely.
15. Alternative Minimum Tax (AMT) Exemption Increased
Prior law applied the alternative minimum tax (AMT) to both corporate and non-corporate taxpayers, designed to reduce a taxpayer’s ability to avoid taxes by using certain deductions and other tax benefits. The taxpayer’s liability for the year was equal to its regular tax liability plus the AMT liability for that year. New law retains the AMT, but increases the exemption amounts to $70,300 for individuals
($109,400 for married filing jointly). This exemption is phased out as income exceeds $1 million for joint taxpayers and $500,000 for all others. Additionally, the AMT for corporate taxpayers has been repealed completely. These changes greatly reduce AMT exposure for most taxpayers.
16. Limits on Deduction of Business Interest
Starting in 2018, every business, regardless of its form, is subject to a disallowance of the deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. This disallowance is determined at the tax filer level. However, a special rules applies to pass through entities, requiring the determination to be made at the entity level. Adjusted taxable income must be computed without regard to deductions allowed for depreciation, amortization, or depletion. An exemption from these new rules applies for taxpayers with average annual gross receipts of $25 million or less (for the prior three-year period).
17. Employer Deduction for Fringe Benefits Restricted
Under the new law, beginning in 2018, deductions on entertainment expenses incurred by an employer are disallowed (e.g. client meals, tickets to events, etc.), eliminating the subjective determination of whether such expenses are sufficiently “business-related”.
Additionally, the existing 50% limit on the deductibility of meal expenses incurred while traveling on business has been expanded to apply to meals provided through an in-house cafeteria or otherwise on the premises of the employer. However, beginning in 2026, this “in-house” meal deduction will also be disallowed.
Furthermore, deductions for employee transportation (e.g. parking and mass transit) are disallowed, but the exclusion from income for such benefits received by an employee is retained. Finally, no deduction is allowed for employee commuting expenses.
18. State and Local Tax (SALT) Deduction Limited
Previously, individual taxpayers were permitted to claim state and local real property taxes, personal property taxes, and income taxes as itemized deductions on their federal income tax returns, regardless of whether such taxes were business related. The new law requires that state, local and foreign property taxes, and state and local sales taxes, are deductible only when paid or accrued in carrying on a trade or business, or an activity generally intended to produce income. Additionally, state and local income, war profits, and excess profits are not allowable as a deduction at all. However, a taxpayer may claim an itemized deduction of up to $10,000 for the aggregate of (1) state and local property taxes not paid or accrued in a trade or business and (2) state and local income, war profits, and excess profits taxes paid or accrued in the tax year. Foreign real property taxes are not deductible.
19. Alimony Deduction Eliminated
Previously, all alimony or separate maintenance payments were deductible as an above the line deduction. Under the new law, beginning after December 31, 2018, no deduction will be allowed for alimony or separate maintenance payments. As a result, such payments received by the payee are not includible in income. Therefore, any pending divorce settlement or separation agreement must be signed in 2018 in order to take advantage of this deduction.
20. Medical Expense Deduction Reduced
Beginning after December 31, 2016, and ending before January 1, 2019, the threshold on medical expense deductions is reduced from 10% of adjusted gross income to 7.5% for all taxpayers.
21. Repeal of Obamacare Individual Mandate
The new Act permanently repealed the individual penalty for failing to acquire minimum essential health insurance coverage under the Affordable Care Act (i.e. Obamacare). This repeal essentially guts the Affordable Care Act, effective after December 31, 2018.
How to Respond Now:
Many of these changes to the tax code require your immediate attention. It is therefore important that you call and schedule an appointment with your team of trusted advisors to discuss how this Act affects you, and the personal and business planning opportunities that may now be available. Because tax calculations will be made at the end of this year looking back, planning should begin as soon as possible.
As always, if you would like to discuss how these changes and many other provisions of the Act might impact you, your family, or your business, do not hesitate to contact an attorney at Carnahan, Evans, Cantwell, and Brown at 417-447-4400. We look forward to assisting you.