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NEW TAX LAW UPDATE
Lower tax rates coming. The Tax Cuts and Jobs Act will reduce tax rates for many taxpayers, effective for the 2018 tax year. Additionally, many businesses, including those operated as passthroughs, such as partnerships, may see their tax bills cut.
UPDATED December 21, 2017
So, on December 20, the House approved H.R. 1, the “Tax Cuts and Jobs Act,”a sweeping tax reform measure, by a vote of 224 to 201. The Senate had passed the measure, as revised to address some procedural complications, the night before, and the bill will soon make its way to President Trump for his expected signature.
Here are some of the key components of the changes contained in the new law. The following is an abbreviated summary of key components of the new law that I felt would affect my client base. It is not the full text of all the changes enacted.
New Income Tax Rates & Brackets
To determine regular tax liability, an individual uses the appropriate tax rate schedule.
Under pre-Act law, individuals were subject to six tax rates: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, seven tax brackets apply for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The Act also provides four tax brackets for estates and trusts: 10%, 24%, 35%, and 37%.
For example the tax brackets for those filing jointly are illustrated below.
Standard Deduction Increased
Taxpayers are allowed to reduce their adjusted gross income (AGI) by the standard deduction or the sum of itemized deductions to determine their taxable income. Additional standard deductions may be claimed by taxpayers who are elderly or blind.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, 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. No changes are made to the current-law additional standard deduction for the elderly and blind.
Personal Exemptions Suspended
Under the current law, taxpayers determined their taxable income by subtracting from their adjusted gross income any personal exemption deductions. Personal exemptions generally were allowed for the taxpayer, the taxpayer’s spouse, and any dependents. The amount deductible for each personal exemption was scheduled to be $4,150 for 2018, subject to a phaseout for higher earners.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the deduction for personal exemptions is effectively suspended by reducing the exemption amount to zero.
INCOME FROM PASS-THROUGH ENTITIES
New Deduction for Pass-Through Income
Since the new law reduces the corporate tax rate, congress is attempting to “equalize” that benefit as it pertains to pass through entities.
Under pre-Act law, the net income of these pass-through businesses— sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations—was not subject to an entity-level tax and was instead reported by the owners or shareholders on their individual income tax returns. Thus, the income was effectively subject to individual income tax rates.
New law. Generally for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the Act adds a new section, Code Sec. 199A, “Qualified Business Income,” under which a non-corporate taxpayer, including a trust or estate, who has qualified business income (QBI) from a partnership, S corporation, or sole proprietorship is allowed to deduct:
· (1) the lesser of: (a) the “combined qualified business income amount” of the taxpayer, or (b) 20% of the excess, if any, of the 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 of the taxpayer for the tax year; plus
· (2) the lesser of: (i) 20% of the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year, or (ii) taxable income (reduced by the net capital gain) of the taxpayer for the tax year. (Code Sec. 199A(a), as added by Act Sec. 11011)
The 20% deduction is not allowed in computing adjusted gross income (AGI), but rather is allowed as a deduction reducing taxable income. (Code Sec. 62(a), as added by Act Sec. 11011(b))
Limitations. For pass-through entities, other than sole proprietorships, the deduction cannot exceed the greater of:
· (1) 50% of the W-2 wages with respect to the qualified trade or business (“W-2 wage limit”), or
· (2) the sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all “qualified property.” Qualified property is defined in Code Sec. 199A(b)(6) as meaning tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year.
Caveat – And some people thought this new law could make CPA’s unnecessary
Thresholds and exclusions. The deduction does not apply to specified service businesses. However the service business limitation begins phasing out in the case of a taxpayer whose taxable income exceeds $315,000 for married individuals filing jointly ($157,500 for other individuals). The benefit of the deduction for service businesses is phased out over the next $100,000 of taxable income for joint filers ($50,000 for other individuals). The deduction also does not apply to the trade or business of being an employee.
Deduction for Personal Casualty & Theft Losses Suspended
Under pre-Act law, individual taxpayers were generally allowed to claim an itemized deduction for uncompensated personal casualty losses, including those arising from fire, storm, shipwreck, or other casualty, or from theft.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the personal casualty and theft loss deduction is suspended, except for personal casualty losses incurred in a Federally-declared disaster
CHANGES TO TAX CREDITS
Child Tax Credit Increased
Under pre-Act law, a taxpayer could claim a child tax credit of up to $1,000 per qualifying child under the age of 17. The aggregate amount of the credit that could be claimed phased out by $50 for each $1,000 of AGI over $75,000 for single filers, $110,000 for married filers, and $55,000 for married individuals filing separately.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the child tax credit is increased to $2,000. Phase-out. The income levels at which the credit phases out are increased to $400,000 for married taxpayers filing jointly ($200,000 for all other taxpayers).
Non-child dependents. In addition, a $500 nonrefundable credit is provided for certain
MODIFIED DEDUCTIONS & EXCLUSIONS
State and Local Tax Deduction Limited
Under pre-Act law, taxpayers could deduct from their taxable income as an itemized deduction several types of taxes paid at the state and local level, including real and personal property taxes, income taxes, and/or sales taxes.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, subject to the exception described below, 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. income). State and local income, war profits, and excess profits are not allowable as a deduction.
However, a taxpayer may claim an itemized deduction of up to $10,000 ($5,000 for a married taxpayer filing a separate return) for the aggregate of (i) State and local property taxes not paid or accrued in carrying on a trade or business or activity.
Mortgage & Home Equity Indebtedness Interest Deduction Limited
Under pre-Act law, taxpayer could deduct as an itemized deduction qualified residence interest, which included interest paid on a mortgage secured by a principal residence or a second residence. The underlying mortgage loans could represent acquisition indebtedness of up to $1 million ($500,000 in the case of a married individual filing a separate return), plus home equity indebtedness of up to $100,000.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the deduction for interest on home equity indebtedness is suspended, and the deduction for mortgage interest is limited to underlying indebtedness of up to $750,000 ($375,000 for married taxpayers filing separately. For tax years after Dec. 31, 2025, the prior $1 million/$500,000 limitations are restored, and a taxpayer may treat up to these amounts as acquisition indebtedness regardless of when the indebtedness was incurred. The suspension for home equity indebtedness also ends for tax years beginning after Dec. 31, 2025.
Treatment of indebtedness incurred on or before Dec. 15, 2017. The new lower limit doesn’t apply to any acquisition indebtedness incurred before Dec. 15, 2017.
Alimony Deduction by Payor/Inclusion by Payee Suspended
Under pre-Act law, alimony and separate maintenance payments were deductible by the payor spouse and includible in income by the recipient spouse.
New law. For any divorce or separation agreement executed after Dec. 31, 2018, or executed before that date but modified after it (if the modification expressly provides that the new amendments apply), alimony and separate maintenance payments are not deductible by the payor spouse and are not included in the income of the payee spouse.
Miscellaneous Itemized Deductions Suspended
Under pre-Act law, taxpayers were allowed to deduct certain miscellaneous itemized deductions to the extent they exceeded, in the aggregate, 2% of the taxpayer’s adjusted gross income.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the deduction for miscellaneous itemized deductions that are subject to the 2% floor is suspended. (Code Sec. 67(g), as added by Act Sec. 11045)
Exclusion for Moving Expense Reimbursements Suspended
Under pre-Act law, an employee could, exclude qualified moving expense reimbursements from his or her gross income and from his or her wages for employment tax purposes. These were any amount received (directly or indirectly) from an employer as payment for (or reimbursement of) expenses which would be deductible as moving expenses if directly paid or incurred by the employee.
New law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the exclusion for qualified moving expense reimbursements is suspended, except for members of the Armed Forces on active duty (and their spouses and dependents) who move pursuant to a military order and incident to a permanent change of station.
Repeal of Obamacare Individual Mandate
Under pre-Act law, the Affordable Care Act (also called the ACA or Obamacare) required that individuals who were not covered by a health plan that provided at least minimum essential coverage were required to pay a “shared responsibility payment” (also referred to as a penalty) with their federal tax return. Unless an exception applied, the tax was imposed for any month that an individual did not have minimum essential coverage.
New law. For months beginning after Dec. 31, 2018, the amount of the individual shared responsibility payment is reduced to zero.
HOWEVER: The Act leaves intact the 3.8% net investment income tax and the 0.9% additional Medicare tax, both enacted by Obamacare.
ALTERNATIVE MINIMUM TAX (AMT)
AMT Retained, with Higher Exemption Amounts
The alternative minimum tax (AMT) is a tax system separate from the regular tax that is intended to prevent a taxpayer with substantial income from avoiding tax liability by using various exclusions, deductions, and credits. Under it, AMT rates are applied to AMT income determined after the taxpayer “gives back” an assortment of tax benefits. If the tax determined under these calculations exceeds the regular tax, the larger amount is owed.
New Law. For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the Act increases the AMT exemption amounts for individuals. But the limitation on state and local tax deductions, as well as the elimination of miscellaneous itemized deductions essentially exempts many taxpayers who previously were subject to the tax.
Expanded Use of 529 Account Funds
New law. For distributions after Dec. 31, 2017, “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school.