Congress passed the “Tax Cuts and Jobs Act” on Dec. 21, 2017. Many of the provisions in the Act begin after Dec. 31, 2017, and expire by Jan. 1, 2026. There is a lot to digest and we will have continuing communication with you to more fully explain these changes to the tax law, how they may impact you and your business, and planning recommendations for you to consider as a result of the tax reform.
Due to the complexity of tax law and the number of changes included in the Act, many tax planning opportunities will need to be tailored to your specific situation to be most effective and avoid unintended side-effects or issues. We also anticipate Treasury will issue regulations to give further clarity to some of the provisions in the Tax Cuts and Jobs Act. We have attempted here to summarize some key provisions that we believe are applicable to most business and individual taxpayers.
Individuals
New income tax rates and brackets: The tax reform bill provides for seven individual tax brackets, but lowers the rates on five of those, including for the highest income earners. For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the individual tax brackets are: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent.
For an example, see this chart:
MARRIED INDIVIDUALS FILING JOINTLY
If taxable income is: The tax is:
Not over $19,050 10 percent of taxable income
$19,051 – $77,400 $1,905 plus 12 percent of excess over $19,050
$77,401-$165,000 $8,907 plus 22 percent of the excess over $77,400
$165,001-$315,000 $28,179 plus 24 percent of the excess over $165,000
$315,001-$400,000 $64,179 plus 32 percent of the excess over $315,000
$400,001-$600,000 $91,379 plus 35 percent of the excess over $400,000
Over $600,000 $161,379 plus 37 percent of the excess over $600,000
Standard deduction increased: The standard deduction is nearly doubled for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026. Under the new law the standard deduction, adjusted for inflation in tax years beginning after 2018, is increased to:
- $24,000 for married filing jointly;
- $18,000 for head of household;
- $12,000 for all other taxpayers
Personal exemptions suspended: Beginning after Dec. 31, 2017, and before Jan. 1, 2026, the deduction for personal exemptions is reduced to zero.
State and local tax deduction limited: For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, itemized deductions for state and local income taxes, state and local property taxes, foreign property taxes, and sales taxes would be limited to $10,000 in the aggregate ($5,000 for married filing separate). This cap would not apply if the taxes are incurred in carrying on a trade or business or for the production of income.
Home mortgage interest deduction limited: The deduction for interest on home equity indebtedness is suspended. Further, for mortgage indebtedness incurred on or after Dec. 15, 2017, the deduction for mortgage interest is limited to underlying indebtedness of $750,000 (or $375,000 for married taxpayers filing separately) beginning after Dec. 31, 2017. For tax years after Dec. 31, 2025, the prior limits are restored and a taxpayer may claim these amounts of indebtedness no matter when the debt was incurred. The suspension for the home equity indebtedness also ends for tax years beginning after Dec. 31, 2025.
Child tax credit increased: The child tax credit is increased to $2,000 beginning after Dec. 31, 2017 through December 31, 2025. The phase-out income level is increased to $400,000 for married filing jointly or $200,000 for all other taxpayers. The amount that is refundable is increased to $1,400 per qualifying child. A $500 nonrefundable credit is also provided for certain non-child dependents.
Estate and gift tax exemption doubled: The current lifetime estate and gift tax exemption amounts are doubled for tax years 2018-2025, subject to inflation-indexing. This projects to approximately $11.2 million per person in 2018 ($22.4 million per married couple, with the portability provision remaining).
Repeal of Obamacare individual mandate: The shared responsibility payment under the Affordable Care Act, also known as the individual mandate penalty, will be reduced to zero after Dec. 31, 2018. Note: The employer mandate is still in effect.
AMT (Alternative Minimum Tax) for individuals: The Alternative Minimum Tax for individuals was not repealed. Rather, the Act increases the AMT exemption amounts and the phase out thresholds for individuals through December 31, 2025. The exemption amounts were increased slightly as follows:
- $109,400 for joint returns and surviving spouses;
- $70,300 for single taxpayers;
- $54,700 for marrieds filing separately.
In addition, the above exemption amounts are reduced to an amount equal to 25 percent of the amount by which the alternative minimum taxable income of the taxpayer exceeds the phase-out amounts, increased as follows:
- For joint returns and surviving spouses, $1 million
- For all other taxpayers (other than estates and trusts) $500,000.
‘Pease limitation’ on itemized deductions suspended: Limits on itemized deductions for higher-income earners, also known as the “Pease limitation” is suspended after Dec. 31, 2017, until Jan. 1, 2026.
Medical expense deduction threshold reduced: The new law provides a temporary reduction (for tax years beginning after 31, 2016, and ending before Jan. 1, 2019) on the threshold on medical expense deduction to 7.5 percent.
Alimony deduction/income suspended: For any divorce or separation agreement executed after Dec. 31, 2018 (or entered into prior to that date but modified after it), alimony and separate maintenance payments are not deductible by the payor spouse and are not included into the income of the payee spouse.
Rule allowing recharacterization of IRA contributions repealed: For tax years beginning after December 31, 2017, the rule that allows a contribution to one type of IRA to be recharacterized as a contribution to the other type of IRA does not apply to a conversion contribution to a Roth IRA. Thus, the recharacterization cannot be used to unwind a Roth conversion.
New deduction for pass-through income: For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, a new section, “Qualified Business Income,” will apply. Under this, a non-corporate taxpayer, including a trust or estate, who has qualified business income from a partnership, S corporation or sole proprietorship is allowed to deduct:
- The lesser of:
- The “combined qualified business income amount” of the taxpayer, or
- 20 percent of the excess of any taxable income of the taxpayer for the tax year over the sum of net capital gain and the aggregate amount of the qualified cooperative dividends for the taxpayer for the tax year, plus
- The lesser of:
- 20 percent of the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year, or
- Taxable income (reduced by net capital gain) of the taxpayer for the tax year.
The “combined qualified business income amount” means, for any tax year, an amount equal to:
- The deductible amount for each qualified trade or business of the taxpayer (defined as 20 percent of the taxpayer’s QBI subject to W-2 wage limitation); plus
- 20 percent of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of the taxpayer for the tax year.
QBI is defined as the net amount of qualified items of income, gain, deduction and loss related to any qualified trade or business of the taxpayer. If the net amount of QBI is less than zero, the amount is treated as a loss from a qualified trade or business in the succeeding tax year. QBI does not include certain investment items, reasonable compensation paid to the taxpayer from the business, any guaranteed payment to a partner for services to the business, or a payment to a partner for services rendered to the business. The 20 percent deduction is not allowed in computer the adjusted gross income (AGI), but is allowed as a deduction reducing taxable income.
There are some limitations to the deduction. The deduction cannot exceed the greater of:
- 50 percent of the W-2 wages with respect to the qualified business; or
- The sum of 25 percent of the W-2 wages plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property. Qualified property is tangible, depreciable property that is held by and available for use in the qualified business at the end of the tax year, that is used at any point during the tax year by the business to produce income, and for which the depreciable period has not ended before the close of the tax year.
**This provision will impact the majority of our clients, therefore expect more communication to come from us on this as we learn more about this provision. Again, we anticipate Treasury will issue further Regulations on this, providing more clarity.
Business
Flat corporate tax rate: The corporate tax rate for C corporations is a flat 21 percent beginning after Dec. 31, 2017. Note this does not apply to pass-through entities. Beginning after Dec. 31, 2017, the corporate alternative minimum tax is also repealed.
Increased Section 179 expensing: For property placed in service after Dec. 31, 2017, the maximum amount a taxpayer may expense under Code Section 179 is increased to $1 million and the phase-out threshold amount is increased to $2.5 million.
Section 179 has been expanded to include certain depreciable tangle personal property used predominantly to furnish lodging or in connection with furnishing lodging. The definition also now includes the following improvements to nonresidential real property after the date the property was first placed into service:
- Roofs;
- Heating, ventilation and air conditioning property;
- Fire protection and alarm systems; and
- Security systems.
100 percent bonus depreciation: A 100 percent first-year deduction for the adjusted basis is allowed for qualified property – new or used – acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. The first-year bonus depreciation deduction phases down as follows:
- 80 percent for property placed in service after Dec. 31, 2022, and before Jan. 1, 2024;
- 60 percent for property placed in service after Dec. 31, 2023, and before Jan. 1, 2025;
- 40 percent for property placed in service after Dec. 31, 2024, and before Jan. 1, 2026;
- 20 percent for property placed in service after Dec. 31, 2025, and before Jan. 1, 2027.
The first-year bonus depreciation sunsets after 2026.
Luxury automobile depreciation limits increased: The maximum amount of allowable deprecation for passenger automobiles placed in service after Dec. 31, 2017, for which the additional first-year depreciation deduction is not claimed is increased to:
- $10,000 for the year in which the vehicle is placed in service;
- $16,000 for the second year;
- $9,600 for the third year; and
- $5,760 for the fourth and later years in the recovery period.
For passenger vehicles eligible for the bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000.
Shortened recovery period for real property: For property placed in service after Dec. 31, 2017, the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property are eliminated. Instead, the new law provides for a 15-year recovery period for qualified improvement property, defined as any improvement to an interior portion of a building that is nonresidential real property if such improvement is placed in service after the date such building was first placed in service. Qualified improvement property does not include any improvement for the enlargement of the building, an elevator or escalator, or the internal structural framework of the building.
Deduction of business interest limited: Beginning after Dec. 31, 2017, every business is generally subject to a disallowance of a deduction for net interest expense in excess of 30 percent of the business’s adjusted taxable income. For 2018 through 2021, “adjusted taxable income” is computed without regard to deductions for depreciation and amortization. For pass-thru entities, the disallowance is determined at the entity level. However, an exemption to the interest disallowance rule applies for taxpayers with average annual gross receipts for the 3 prior taxable years that do not exceed $25 million.
Net operating loss deduction modified: The two-year carryback and the special carryback provisions are repealed beginning after Dec. 31, 2017, but a two-year carryback applies in the case of certain losses incurred in the trade or business of farming.
For losses arising in tax years beginning after Dec. 31, 2017, the NOL deduction is limited to 80 percent of taxable income. NOLs can be carried forward indefinitely.
Like-kind exchange treatment limited: For exchanges completed after Dec. 31, 2017, like-kind exchanges are allowed only with respect to real property that is not held primarily for sale. Therefore, restaurant equipment and restaurant franchises no longer qualify for like-kind exchange treatment.
Changes to employer’s deduction for meals and entertainment: Beginning after Dec. 31, 2017, deductions for entertainment expenses are disallowed. The current 50 percent limit on the deductibility of business meals is expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer. Deductions for employee transportation fringe benefits (e.g., parking and mass transit) are denied, but the exclusion from income for such benefits received by an employee is retained. Further, no deduction is allowed for transportation expenses that are the equivalent of commuting for employees, except as provided for the safety of the employee.
New credit for employer-paid family and medical leave: For wages paid in tax years beginning after Dec. 31, 2017, but not after Dec. 31, 2019, businesses can claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any time that the employees are on family and medical leave (FMLA) if the rate of payment is 50 percent of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent.
Again, the information outlined above is just a portion of the Tax Cuts and Jobs Act that may apply to the majority of our clients. We will continue to communicate with you to more fully explain these changes to the tax law and how they may impact you and your business. In the meantime, please give us a call should you have any questions.
