As the year winds down, Congress has been feverishly working to pass its final tax bill, the “Tax Cut and Jobs Act.” With the passage of the bill in both the House and Senate this week, the signing of the bill by the President will enact into law the most significant reform of the individual and corporate tax structures since 1986. The changes will undoubtedly impact every individual taxpayer in 2018. So what are the major changes that taxpayers need to know? This blog outlines these changes to assist you in preparing for 2018, and, as important, highlights some year-end tax planning initiatives that may help you minimize your tax bill for 2017.
Individual Tax Reform
One of the primary objectives of the new tax bill is to reduce taxes for individuals and families. The reduction in taxes is driven primarily by lowering rates across the various individual tax brackets. At the same time, a number of tax revisions modify or eliminate various tax deductions, thus offsetting the favorable impact of lower rates. The net impact to taxpayers will vary and will depend on each taxpayer’s individual income and deduction situation.
While the new tax bill takes effective with the 2018 tax year, many of the individual tax changes are temporary. The new provisions will be effective for taxable years beginning after December 31, 2017 and will sunset at the end of 2025 barring further legislation to make the provisions permanent.
So let’s review the most notable changes to the tax bill that will impact individuals:
Reduction and Simplification of Individual Income Tax Rates
- Reduction in federal individual income tax rates: A common headline in reference to the new tax bill is the reduction of the individual income tax rates effective in 2018. Previously, there were seven tax brackets – 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. Under the new rate structure, seven tax brackets remain, but the tax rates have been reduced for most brackets from 1% to 4%, with the top rate lowered to 37%. The new rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The new rate structures for taxpayers filing as Single Individuals and as Married Individuals Filing Joint Returns and Surviving Spouses are outlined below.
| Federal Individual Income Tax Rates for 2018 | |
| Single Individuals | |
| If taxable income is: | Then income tax equals: |
| Not over $9,525 | 10% of the taxable income |
| Over $9,525 but not over $38,700 | $952.50 plus 12% of the excess over $9,525 |
| Over $38,700 but not over $82,500 | $4,453.5 plus 22% of the excess over $38,700 |
| Over $82,500 but not over $157,500 | $14,089.50 plus 24% of the excess over $82,500 |
| Over $157,500 but not over $200,000 | $32,089.50 plus 32% of the excess over $157,500 |
| Over $200,000 but not over $500,000 | $45,689.50 plus 35% of the excess over $200,000 |
| Over $500,000 | $150,689.50 plus 37% of the excess over $500,000 |
| Married Individuals Filing Joint Returns and Surviving Spouses | |
| If taxable income is: | Then income tax equals: |
| Not over $19,050 | 10% of the taxable income |
| Over $19,050 but not over $77,400 | $1,905 plus 12% of the excess over $19,050 |
| Over $77,400 but not over $165,000 | $8,907 plus 22% of the excess over $77,400 |
| Over $165,000 but not over $315,000 | $28,179 plus 24% of the excess over $165,000 |
| Over $315,000 but not over $400,000 | $64,179 plus 32% of the excess over $315,000 |
| Over $400,000 but not over $600,000 | $91,379 plus 35% of the excess over $400,000 |
| Over $600,000 | $161,379 plus 37% of the excess over $600,000 |
Capital Gains and Qualified Dividends tax rates maintained: The new tax bill maintains the maximum tax rates on net capital gains and qualified dividends. Specifically, the three tax rates of 0%, 15%, and 20% remain, and the taxable income breakpoints between 0 and 15% rates and the 15 and 20% are based upon the same taxable income amounts as under the previous tax code, except the amounts are increased for inflation. For 2018, the 15% breakpoint is $77,200 for joint returns and $38,600 for unmarried individuals. The 20% breakpoint is $479,000 for joint returns and $425,800 for unmarried individuals.
- Increase in standard deduction: The standard deduction has increased for individuals under all filing statuses. The amount of the standard deduction is increased from $12,700 to $24,000 for married individuals filing a joint return and from $6,300 to $12,000 for all individuals. The additional standard deduction for the elderly and the blind remains unchanged.
- Elimination of the deduction for personal exemptions: One item that offsets the higher standard deduction is the elimination of the personal exemption of $4,050 for each taxpayer, spouse and dependent. The removal of the personal exemption has been, in part, offset by an increase in the child tax credit and a new tax credit for qualifying dependents.
Treatment of Business Income of Individuals
- Deduction for qualified business income: Beginning in 2018, an individual with income from a pass-through entity such as a partnership, S-corporation, or sole proprietorship may deduct 20 percent of the qualified business income. This deduction is subject to a limitation based upon W-2 wages paid, which is phased in above a threshold amount of taxable income. The deduction is also phased out for specified service trades or businesses involving performance of services in such fields of health, law, consulting, athletics, financial services, and brokerage services above the threshold amount of taxable income.
Simplification and Reform of Family and Individual Tax Credits
- Enhancement of child tax credit and new family credit: The child tax credit has been increased from $1,000 to $2,000 for each qualifying child. The determination of a qualifying child as an individual who has not attained age 17 by the end of the tax year remains unchanged. In addition, the tax bill provides for a new $500 tax credit for qualifying dependents other than children. Two additional favorable changes related to the child tax credit include an increase in the maximum refundable amount and an increase in the income level before the credit phases out. Beginning in 2018, if your tax liability is zero, you can be refunded up to $1,400 in tax credits per qualifying child compared to the previous limit of $1,000. The child tax credit now begins to phase out once adjusted gross income exceeds $400,000 for married filing jointly and $200,000 for all other taxpayers.
- Modification of education savings rules: 529 education plans can now be used to distribute up to $10,000 in expenses per student for tuition incurred during the tax year at a public, private, or religious elementary or secondary school. Under the prior tax law, a 529 plan could be used only for any college, university, or community college.
- Repeal of overall limitation on itemized deductions: Under the previous tax bill, itemized deductions excluding medical expenses, investment interest, and casualty, theft, or gambling losses were limited for certain taxpayers. Itemized deductions started to phase out at a threshold of $313,800 of adjusted gross income for married filing jointly and $261,500 for single taxpayers. Beginning in 2018, the overall limitation on itemized deductions is eliminated.
Simplification and Reform of Deductions and Exclusions
- Change to deduction for home mortgage interest: A common itemized deduction for many homeowners is interest expense on a home mortgage. With the new tax bill, interest expense continues to be deductible on all mortgages existing as of December 15, 2017 up to $1 million of indebtedness. However, for any new mortgages initiated after December 15, 2017, interest expense is deductible only up to $750,000 of indebtedness. Keep in mind that home mortgage interest will be a deduction only if your total itemized deductions exceed the new higher standard deduction amounts.
- Elimination of deduction for interest on home equity loans: Beginning in 2018, interest paid on a home equity loan will no longer be deductible. Looking ahead to 2018, you may want consider paying down your home equity loan since the effective borrowing cost is higher with the loss of the tax deduction.
- Modification of deduction for state and local taxes: The new tax bill now caps the deductions for state and local real and personal property taxes, and state and local income taxes (or state sales tax, if higher than income taxes). Whereas previously 100% of such taxes were deductible in the year they were paid, beginning in 2018 you can claim an itemized deduction of up to $10,000 ($5,000 for a married filing separate return) in total for state and local property taxes and income taxes (or sales tax in lieu of income taxes).
- Modification of deduction for personal casualty and theft losses: Beginning in 2018, you may now claim a deduction for personal casualty loss only if the loss was related to a disaster declared by the President.
- Modification to the deduction for charitable contributions: The new tax bill increases the limit for contributions of cash to public charities from 50% to 60% of the taxpayer’s adjusted gross income.
- Elimination of miscellaneous itemized deductions subject to the 2% floor: Miscellaneous expenses including investment advisor fees, tax preparer fees, and unreimbursed business expenses incurred by an employee, are no longer deductible.
- Deduction of medical expenses: Prior to the new tax bill, the threshold for deducting medical expenses in 2017 was 10% of adjusted gross income for all taxpayers. Under the new tax bill, the threshold for 2017 and for 2018 is 7.5% for all taxpayers, and the threshold applies to the AMT calculation. Beginning in 2019, the threshold reverts back to 10% of adjusted gross income.
- Elimination of deduction for alimony payments and inclusion of alimony in gross income: Alimony payments are no longer deductible by the payor spouse and alimony payments received are no longer included in income. The new tax bill delays the effective date of this provision by one year. As such, this new provision is effective for any divorce or separation agreement executed after December 31, 2018.
- Elimination of deduction for moving expenses and exclusion for qualified moving expense reimbursement: Moving expenses related to starting work as an employee or as a self-employed individual at a new place of work was previously an “above the line” deduction to determine adjusted gross income. This deduction has been eliminated for all taxpayers with the exception of active duty members of the Armed Forces. Additionally, reimbursements for qualified moving expenses by an employer to an employee are no longer excluded from gross income and wages except for active duty members of the Armed Forces.
Simplification and Reform of Savings, Pensions, Retirement
- Repeal of special rule permitting recharacterization of IRA contributions: Beginning in 2018, the special rule that allows a contribution to one type of IRA to be recharacterized as a contribution to another type of IRA does not apply to a conversion contribution to a Roth IRA. As such, recharacterization cannot be used to unwind a Roth conversion.
Other Provisions
- Modifications to Estate, Gift, and Generation-Skipping Transfers Taxes: The new tax bill doubles the estate and gift tax exemption by increasing the basic exclusion amount from $5.6 million to $11.2 million for individuals, and to $22.4 million for married couples with portability. This increase in the exemption amount applies to estates of decedents dying and gifts made after December 31, 2017.
- Alternative Minimum Tax (AMT): In calculating the AMT under the previous tax bill, a taxpayer was entitled to an exemption amount that reduces the AMT income. Additionally, the utilization of this exemption began to be phased out once a threshold income was reached. Under the new tax bill, the AMT exemption amount has been increased to $109,400 for married individuals filing a joint return (was $84,500), to $54,700 for married individuals filing a separate return (was $42,250), and to $70,300 (was $54,300) for unmarried individuals. Additionally, the phaseout income thresholds have been increased to $1 million for married filing jointly and $500,000 for all other taxpayers. This change means that very few people will be subject to the AMT going forward.
- Elimination of Shared Responsibility Payment for Individuals Failing to Maintain Minimal Essential Coverage: Under the Affordable Care Act (ACA), individuals who did not maintain an ACA-compliant health insurance plan were required to pay a penalty. Beginning in 2018, this penalty is eliminated.
Tax Planning Moves for 2017
While the reduction in tax rates and the changes to deductions and exclusions take effect in 2018, in view of these changes some 2017 year-end tax planning strategies can minimize your overall tax liability. In general, you should look to defer income to 2018, when tax bracket rates are lower, and accelerate deductions in 2017 as they will generate a larger tax benefit based upon the higher 2017 tax rates.
Looking ahead, itemizing deductions may be less of an opportunity for many since the standard deduction has been increased and certain itemized deductions have been capped or even eliminated. As a result, there are several strategies to consider in 2017 and beyond.
Given the cap on state and local tax deductions beginning in 2018, taxpayers should consider paying before year-end any remaining amount owed of their 2017 property taxes as well as their 4th-quarter estimated state income tax for 2017. However, those subject to the AMT in 2017 need to remember that property tax and state income tax payments are AMT adjustments, which may result in these payments having minimal or no tax benefit. It is important to note that a specific provision was added to the new tax bill prohibiting a 2017 deduction for the prepayment of any 2018 state and local income taxes.
Since the miscellaneous itemized deductions are eliminated after 2017, prepaying investment advisory fees this year will provide a deduction if you meet the 2% of adjusted gross income threshold.
Beginning in 2018, many people may find it difficult to claim a deduction for charitable contributions given the higher standard deduction amounts. As such, you may want to consider aggregating several years of charitable contributions into a donor-advised fund either this year or in a future year to increase itemized deductions over the standard deduction amount thus creating a tax benefit for the charitable deduction. With a donor-advised fund, you contribute an amount to the fund and take an immediate tax deduction for the full amount in the year the amount is funded. You then direct donations to be made from the fund in future years to the charitable organizations of your choice.
While most people will see a benefit from the lower tax rates beginning in 2018, there are many other changes for the average taxpayer to consider and to understand. If we can assist with your tax planning related to the changes taking place with the new Tax Cuts and Jobs Act, please reach out to us to discuss.