The Tax Cuts and Jobs Act (The Act) is a piece of legislation that was first passed by the House on November 16, 2017. Only one month later, both the House and the Senate have passed a unified version of tax reform that will modify tax policy for the next several years. These changes range from reducing both corporate and individual tax rates as well as international taxation. On December 22, 2017, President Trump officially signed it into law. Below is a brief analysis of the key points included in The Act.
Individual Tax Changes
New Income Tax Rates & Brackets
All of the ordinary income tax rates have been modified with the top rate changing from 39.6% to 37%. The Act maintains the "marriage penalty" as the top rate for married couples, beginning at $600,000 of taxable income and the single filer's top rate being $500,000 of taxable income.
Capital Gains Provisions Conformed
Capital gains rates (0%, 15%, and 20%) have no changes, and have been adjusted to match the current bracket structure.
One area that has been discussed thoroughly during the legislative process is carried interest. Effective Jan 1, 2018, The Act treats specific partnership interest transferred in connection with a trade or business as short term capital gain (ordinary income). If the partnership interest is held and transferred after the three years, the transaction qualifies for long term capital gain treatment (max capital gain rate of 20%).
The Act has retained the Alternative Minimum Tax (“AMT”) tax for individuals. However, the AMT exemption amounts for individuals will increase slightly in an attempt to exclude more taxpayers from the additional level of tax through December 31, 2025. Additionally, the phaseout limitation has been increased to $1,000,000 for married filing joint taxpayers and $500,000 for everyone else.
Standard Deduction & Personal Exemptions Increased
The standard deduction is increased to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers. These amount apply for tax years running through 2025. However, the deduction for personal exemptions has been suspended for the same time frame.
Deduction for Pass-Through Income
The Act adds a new section, Code Sec. 199A (not written yet). This code section defines a 20% deduction based on Qualified Business Income (“QBI”). This deduction will only be available to non-corporate taxpayers; including trusts/estates, who have QBI from a partnership, S corporation, or sole proprietorship. The deduction is computed based on the lesser of:
- the total QBI of the taxpayer, or
- 20% of the excess, if any, of the taxable income of the taxpayer for the tax year with regards to capital gains.
The deduction will not be allowed in several circumstances such as a W-2 limitation, applicability to the service industry, and taxable income thresholds. Once more data is available and the code section has been written, we will be able to provide a much clearer analysis of this new deduction.
Gambling Loss Limitation Modified
The Act will limit the amount of deductible gambling expense to the extent there is net gambling winnings (gross gambling winnings less gross gambling losses). Any excess gambling expenses not deductible will be lost.
Alimony Deduction/Income Suspended
The inclusion of alimony received, and deduction for alimony paid has been repealed for divorce and separation agreements executed after December 31, 2018. Included in the definition of alimony are separation payments.
Moving expenses deduction is rescinded through 2025. An exception applies for active members of the armed forces.
Medical Expense Deduction Threshold
The medical expense deduction threshold has been changed back to 7.5% of AGI for tax years through 2018 for all taxpayers. After 2018, the limit is increased back to the current 10% for all taxpayers.
Personal State and Local Tax Deduction Limited
The deductibility of personal taxes will be severely limited. The deduction for the combination of both state/local income taxes AND real estate taxes personally incurred is subject to a max deduction of $10,000. Any amounts in excess of $10,000 will not be carried forward. In essence, taxpayers will simply lose any remaining deduction. Taxes incurred in a trade or business (rental property, sole proprietorship, etc.) do not have a cap on the deductible amount.
Prepayment provision. Taxpayers cannot prepay taxes for a subsequent year and claim the deduction. Therefore, taxes incurred in a following year cannot be claimed as a deduction in the current year to maximize the threshold.
Mortgage & Home Equity Debt Deduction
For personal home mortgages entered into after Jan 1, 2018, the maximum principal amount of home indebtedness will be decrease to $750,000 ($375,000 for married taxpayers filing separately). Once the debt is in excess of the threshold, a portion of the interest paid during the year will not be deductible. The $1 million/$500,000 limitations still apply for home indebtedness prior to January 1, 2018. The Act has also suspended the deductible of home equity interest effective January 1, 2018. Only home indebtedness (initial debt and refinanced debt qualify). Debt on business property, most commonly rental property, retain a no deduction limit.
Charitable Contribution Deduction Limitation Increased
Charitable contribution deductibility thresholds will be increased to 60% of a taxpayers AGI. This amount increased from the previous 50% AGI threshold. Any amounts that aren't deductible due to the AGI threshold will be carried forward for five years.
Deductions for Amounts Paid In Connection with Athletic Seating Rights
No charitable deduction is allowed for any payment to an institution of higher education (primarily colleges) where the taxpayer receives the option to purchase tickets or seating at an athletic event. This rules applies to tax years beginning January 1, 2018.
Deduction for Personal Casualty & Theft Losses
The Act suspends personal casualty and theft loss deduction unless it is a personal casualty losses incurred in a Federally-declared disaster area.
Miscellaneous Itemized Deductions Suspended
The deduction for miscellaneous itemized deductions that are subject to the 2% floor is repealed through 2025. Common deductions include:
- Investment fees
- Tax preparation fees
- Estate planning fees
- Unreimbursed employee expenses
- Bank fees.
Overall Limitation ("Pease Limitation") on Itemized Deduction
The Act suspends the "Pease limitation" on itemized deductions through 2025. Therefore, to the extent deductible by any other section (medical expense/charitable AGI limit, deductible interest and deductible taxes), taxpayers will not have a second limitation placed on their deductions.
Child Tax Credit Changes
The Act increases the child tax credit to $2,000, and implements changes to phase-outs and refundability through 2025. A limited credit is also available to non-child dependents (siblings, parents, grandparents, etc.)
- Phase-out. The income levels drastically increased to $400,000 for married taxpayers filing jointly ($200,000 for all other taxpayers). These amounts are not indexed for inflation.
- Refundability. The refundable portion of the credit is increased to $1,400 per qualifying child. The refundable portion IS indexed for inflation.
- Non-child dependents. A new component of the credit, a $500 nonrefundable portion is provided for certain non-child dependents.
Repeal of Individual Insurance Mandate
The amount of the individual shared responsibility payment is reduced to zero. This repeal is permanent and will be in effect for the months beginning January 1, 2019. However, The Act does not remove the 3.8% net investment income tax and the 0.9% additional Medicare tax.
Kiddie Tax Changes
The Act retains the Kiddie Tax, but modifies the application drastically. In the past, a child would be required to use the same tax brackets as their parents. Taxpayer's income that qualifies for this tax will now utilize the estate and trust brackets. These rates would be applied against the child's applicable ordinary income and his income taxed at preferential rates (long term capital gains and qualified dividends).
Expanded Use of 529 Account Funds
The Act expands the definition of "qualified higher education expenses" to include tuition at an elementary or secondary public, private, or religious school, up to a $10,000 limit per tax year. All other features of 529 plans, including transferability, are retained.
Rule Changes Allowing Recharacterization of IRA Contributions
Under prior law, traditional IRAs could be recharacterized as Roth IRAs by a taxpayer in any year provided the taxpayer pays the tax on the conversion in the subsequent year. If, in the next year, it was determined the recharacterization wasn't beneficial, taxpayers could convert back to a traditional IRA and not incur any tax. Going forward, once a Traditional IRA has been converted to a Roth IRA, the taxpayer must pay the tax on the conversion, and NO recharacterization back to a Traditional IRA is allowed.
Estate and Gift Tax Retained, with Increased Exemption Amount
For estates of decedents dying and gifts made after Dec. 31, 2017 and before Jan. 1, 2026, the Act doubles the base estate and gift tax exemption amount from $5 million to $10 million.