On Wednesday, December 20, 2017, the U.S. Congress approved the biggest tax changes to the U.S. tax code in over 30 years. The Tax Cuts and Jobs Act provides temporary tax cuts to individuals along with a reduction in available deductions. For businesses it provides permanent reforms, a significantly lower top tax rate for C corporations and a 20% exclusion for certain “small businesses.” The president has committed to signing the act into law by the beginning of January.
With all new legislation, and especially with a tax reform bill this large, it will take time to fully digest both its intended and unintended impacts. Consequently, tax reform will be a popular topic for the next 18 months as the IRS provides additional guidance and states enact their own tax reforms in response to the new federal changes. Over the coming months we’ll help you understand how these changes may affect you and your unique situation.
For now, here’s a summary of the key provisions included in the Tax Cuts and Jobs Act:
For Individuals and Families
2017 Taxable Income Brackets
2018 Taxable Income Brackets
Taxes and Rates
- Income tax rates on ordinary income are lowered and tax brackets are expanded (as shown in the tables above). Ordinary income consists of wages, business income, social security, pensions, interest income, retirement account distributions, rental income and farm income.
- Most, but not all, taxpayers will experience lower taxes beginning in 2018 and with their 2018 income tax return (filed in April 2019). These lower rates will not apply to 2017 tax returns (filed in April 2018). These lower rates are set to expire starting on January 1, 2026 at which point they will revert to the 2017 laws.
- Tax rates on qualified dividends and long-term capital gains were not modified and remain at 0%, 15%, and 20%. The 3.8% net investment income tax continues to apply as well.
Capital Gains Rates
- The Alternative Minimum Tax (AMT) is modified to significantly reduce who it impacts. The AMT rates remain 26%/28%, but the AMT exemption and phase-out ranges are increased.
- The standard deduction is nearly doubled, from $6,350 for individuals to $12,000, and from $12,700 for married couples, filing jointly to $24,000. The additional deduction for being blind or over age 65 is still available, so for individuals over age 65, the standard deduction would total $13,550 and for married couples over age 65 the standard deduction would total $26,500.
- Personal exemptions are eliminated. Under current law this was $4,050 per person and dependent.
- The state and local taxes itemized deduction is capped at $10,000. This limit applies to the combination of income or sales tax plus property taxes and applies to both individuals and married couples filing jointly. Prepayments of 2018 state and local income tax made in 2017 are treated as paid as of the last day of 2018. Prepayments of 2018 property tax made in 2017 will be treated as paid in 2017 as long as they are assessed by the end of the year.
- The limit for cash charitable gifts to public charities is increased from 50% to 60% of your AGI. That said, you will only benefit financially from your charitable donations if you itemize your deductions. Given the increase in the standard deduction, the likelihood of itemizing will decrease, meaning that an extra effort will be required to get the most out of your giving.
- The mortgage interest deduction is reduced for new mortgages. Deductible mortgage interest will be limited to the first $750,000 of loan value (versus $1,000,000 under current law) for new mortgages established after December 15, 2017. Mortgages on both first and second homes count towards the $750,000 limit. Mortgages existing prior to December 15, 2017 will be grandfathered under the old loan limit of $1,000,000.
- Interest on home equity loans, both new and old, will no longer be deductible in 2018. Unlike preexisting mortgage loans, preexisting home equity loans are not grandfathered as part of the new law.
- The medical expense deduction is enhanced by reducing deduction threshold from 10% to 7.5% of AGI. This lower rate applies for 2018 and 2019 and is scheduled to increase to 10% in 2020.
- Miscellaneous deductions subject to a 2% of AGI limitation and casualty/theft loss deductions are eliminated.
- The Pease limitation is eliminated. This limitation applies to high income earners and reduces your itemized deductions by 3% of AGI.
- Alimony will no longer be deductible for divorces finalized after December 31, 2018. Alimony will continue to remain deductible for all divorces existing prior to that date.
- Moving expenses lose their tax preferred status. If paid out of pocket, moving expenses will no longer be deductible. If paid by an employer, the benefit will no longer be excluded and instead will be treated as income to you.
- The Child Tax Credit is expanded meaningfully to benefit more families. The credit will increase from $1,000 to $2,000 for each child. Additionally, the Adjusted Gross Income (AGI) for which these credits begin to phase-out increased from $75,000 to $200,000 for single taxpayers and increased from $110,000 to $400,000 for married couples, filing jointly.
- A new $500 Family Flexibility Credit is created. This credit applies to non-child dependents in a household and is subject to the same AGI phase-outs as the Child Tax Credit.
- The Adoption Tax Credit and the Elderly and Dependent Care Tax Credit remain. In response to feedback, these provisions were not repealed in the new act.
- No major changes were made to existing education credit and deduction benefits. The American Opportunity, Lifetime Learning, and Hope Scholarship credits as well as the student loan interest deduction, tuition and expense deduction continue to apply under the new law.
- 529 plans are expanded to allow distributions for elementary or secondary schooling expenses. Up to $10,000 per year per student instead of only post-secondary education expenses.
Retirement & Estate
- No major changes were made to the primary retirement savings options (401k, 403b, Traditional and Roth IRAs). Despite rumors that significant changes were being considered, no major changes were included in the final act.
- Roth IRA recharacterizations were repealed. The ability to perform a recharacterization of a Roth conversion is eliminated beginning in the 2018 tax year.
- Non-qualified deferred compensation plans. Changes were made to potentially make deferrals taxable when there is “no substantial risk of forfeiture”. This means that deferrals in this type of plan may become taxable when they vest, not when they are paid. Additionally, these rules apply to a wider range of equity grants, including stock options and appreciation rights.
- The federal estate tax exemption will double from $5.6 million to $11.2 million per person beginning on January, 1 2018. This change is not permanent as it ends on December 21, 2025 at which point it will revert back to the $5.6 million.
For Business Owners
- The C corporation tax rate will be lowered to 21%, down from the current 35% beginning in 2018. Additionally, the corporate AMT is eliminated effective in 2018.
- Pass-through businesses will continue to be subject to individual tax rates. The new rates discussed above will apply to taxable earnings from pass through businesses such as S corporations, partnerships, LLCs, and sole-proprietorships.
- A new 20% deduction of income is allowed for non-service based businesses (i.e. manufacturers). This deduction is only available to owners of S corporations, partnerships, LLC, and sole-proprietorships. The 20% deduction will also be available to service based businesses when the owner’s taxable income is below $157,500/$315,000 single/married.
- 100% immediate expensing for new and used property. This provision is effective for property purchased after September 27, 2017 through December 21, 2022, and then reduces by 20% each subsequent year until it is fully phased out in 2027.
- Interest expense deductibility may be limited. Limitations do not apply if you are a
“small business”, whose gross revenue for the last three years is less than $25 million. If over this amount, the deduction is limited to interest income plus 30% of your adjusted taxable income.
- Entertainment expenses will no longer be deductible beginning in 2018. However, the deduction for 50% of meals is retained.
- Depreciation for business automobiles is expanded. Depreciation limits for the first four years increase from $3,160/$5,100/$3,050/$1,875 to $10,000/$16,000/$9,600/$5,760, which may make purchasing vs. leasing automobiles more advantageous.
- 1031 like-kind exchanges are limited to real estate. Under current law, like kind exchanges could be used for a wide variety of property (collectibles, art, depreciable property, etc.). The new law eliminates this, and only permits like-kind exchanges for real estate.
The Tax Cuts and Jobs Act is the first big win for Republicans under the Trump administration. While we know what many of these changes are, it will take time for tax professionals to get a firm grasp on what it all means for you and your financial future.
Stay with us as we maneuver this new tax landscape over the coming months.
Brian Vnak has been helping clients create intricate financial, tax and estate strategies that are in line with their goals and values for more than 10 years. His popular column for Kiplinger.com is published monthly.