The Tax Cuts and Jobs Act (TCJA) takes effect this year. The big question now is what are the big changes and how do they affect taxpayers with different situations?
More tax cut than tax reform, the measure is expected to reduce government revenues by $1.5 trillion over the next decade. The corporate and passthrough rate reductions are permanent, while the individual provisions are temporary. Some provisions start expiring within 5 years, such as 100% expensing for business assets. After 2025, most individual rules revert back to 2017 law.
Frazier & Deeter’s tax professionals spent many hours over the holidays sifting through the 708-page tax law conference report Conference Report, analyzing the legislation for our clients.
Reduced Taxes for Most Income Categories
The Congressional Joint Tax Committee projects that every income group, on average, will see tax cuts over the 10 years from 2018 to 2026. However, some households would pay more than under current law, particularly taxpayers in the upper middle income range who have no children and significant itemized deductions.
Loss of Personal Exemption and Itemizing
The taxpayers most likely to see a tax increase under the new tax rate structure are those who could take large itemized deductions (e.g., for state and local income taxes) under pre-Tax Cuts and Jobs Act law, but who will not be able to itemize under the new law. Taking the standard deduction coupled with the loss of personal exemptions could increase the amount of taxable income for these taxpayers, especially if the taxpayers have no child tax credits.
One bit of good news, married couples in the middle tax brackets, up to 32%, (see brackets below) will see their tax bill decrease because the new law reduces the so-called “marriage penalty” by making the tax brackets for married couples double the corresponding brackets for single taxpayers.
Child Tax Credits
The new law increases the child tax credit to $2,000 and allows it for higher earners because by raising the income threshold for those who can claim it. Under the new law, single parents with income up to $200,000 can claim the credit (up from $75,000), and married couples with income up to $400,000 can claim it as well (up from $110,000). This expansion of the child tax credit will make up for the loss of the personal exemption for many taxpayers.
Passthrough Income
Taxpayers with income from passthrough businesses could see a reduction in their taxes from the new 20% deduction allowed for profits from partnerships, LLCs and S Corporations. There are tight restrictions on the deduction, however, so each individual case will need to be evaluated to determine the extent of the potential benefit. See Frazier & Deeter’s analysis of the complex rules regarding passthroughs here.
Alternative Minimum Tax
Fewer taxpayers will pay the alternative minimum tax (AMT) under the new law. The AMT exemption applies until taxpayers reach $1 million in income for married couples and $500,000 for single filers. Stock options will now get more favorable treatment. Under prior law, stock options were fully included in alternative minimum taxable income. They are still includable under the new law, but more of that income is exempt from the AMT by the higher exemption amounts and higher phase-out thresholds.
Tuition for Private Schools
The TCJA allows taxpayers to spend up to $10,000 per student per year from Section 529 education savings plans on elementary and secondary education. Prior law only allowed withdrawals for college expenses, so families whose children attend private schools will benefit from this change.
Alimony
This change will impact divorce settlements going forward. The new rules make alimony not deductible to the one who pays it and not taxable as income to the spouse who gets it. The new law only applies to agreements or orders that become effective after 2018, so existing alimony arrangements are not affected.
Fewer Taxpayers Subject to Estate and Gift Taxes
The per person exemption from estate and gift taxes has been doubled to $11.2 million in 2018, taking into account inflation adjustments. Please note that this increase expires after 2025. As a result, taxpayers should consider increasing irrevocable gifts to take advantage of the higher exemption levels while they are in effect. Another implication is that, because the federal estate tax is a deduction from some states’ inheritance taxes, state taxes may be increased. Georgia is not one of these states, but taxpayers in many other states may be affected.
Kiddie Tax
Under the TCJA, children will no longer be taxed on unearned income at the parents’ tax rate (the “kiddie tax” rule). Instead, the estate and trust income tax rates will apply. Because the top 37% rate kicks in at $12,500 for estates and trusts and not until $600,000 for married couples, the kiddie tax has been increased. However, whether this change results in an actual increase in tax on children’s unearned income will depend on how much income is subject to the kiddie tax and which tax bracket the parents are in. The bottom line: this change is likely to result in a higher tax on children’s income for all but the highest-income parents.
Hidden Tax Increase? Chained CPI
A very significant but little understood provision of the Tax Cuts and Jobs Act will change the way cost-of-living adjustments are computed, which affects the tax brackets, AMT exemptions and many other sections of the tax Code. Going forward, “chained CPI” will be used instead of the regular Consumer Price Index. Chained CPI takes into account consumers’ ability to substitute high priced items with lower priced items. This assumption results in smaller increases to the Consumer Price Index. This change could actually increase taxes significantly over time, due the phenomenon known as “bracket creep.” This change was a significant revenue raiser included in the TCJA, estimated to raise between $125 billion and $150 billion over 10 years.
Expiration of Individual Provisions
The majority of individual income tax changes are temporary, expiring after 2025. The adoption of chained CPI and the repeal of the individual health insurance mandate are permanent. The temporary nature of the tax bill when it comes to individuals leaves a lot of uncertainty, which makes it important for taxpayers to take advantage of the new tax cuts while they are in effect.
Below is a brief description of the major changes in the Tax Cuts and Jobs Acts for individuals. Review these changes and contact your Frazier & Deeter tax professional for an analysis of your personal situation and recommendations going forward.
DESCRIPTION OF INDIVIDUAL PROVISIONS OF
PUBLIC LAW 115-97
TAX CUTS AND JOBS ACT
| Treatment of Passthrough Income | A 20% deduction is allowed for income from passthrough businesses, such as partnerships, LLCs and S Corporations. This is equivalent to about a 29.6% top marginal rate for this type of income. There are many caveats for this deduction, based on the industry of the business, wages paid and more. For a detailed discussion read related article here. |
| Individual Tax Rates and Brackets | Retains seven brackets while reducing tax rates to 10%, 12%, 22%, 24%, 32%, 35% and 37%. The 37% rate is for single taxpayers with taxable income over $500,000 and married taxpayers filing jointly with taxable income over $600,000. (See brackets table below.) Note: These lower rates expire after 2025 and revert to 2017 tax rates unless Congress acts before then. |
| Standard Deduction | The standard deduction is increased to: –$12,000 for single filers –$18,000 for heads of household –$24,000 for joint filers (Indexed to chained CPI. See explanation above.) Note: These increases expire after 2025. |
| Personal Exemptions | Eliminates personal exemptions. (See family tax credits below.) |
| Child and Family Tax Credits | The child tax credit is increased to $2,000 and allowed for children up to age 17. The Act also raises the threshold for phase-out of the credit to $200,000 for singles and $400,000 for married taxpayers.Up to $1,400 per child is refundable for lower-income taxpayers. A new $500 credit is allowed for dependents who are not children of the taxpayer. |
| Estate and Trust Tax Rates | Estate and trust taxable income will be subject to four tax brackets: 10%, 24%, 35% and 37%. (See table below.) |
| Kiddie Tax | The new tax law modifies the tax on unearned income of children to apply the estate and trust tax rates instead of the parents’ tax rate, as under prior law. There is no change in the definition of children subject to this tax or the exemption amounts |
| Capital Gains and Net Investment Income | No change. The 0%, 15%/20% long-term capital gains rate will continue to apply as under current law.The 0% rate goes up to taxable incomes of $51,700 for singles and $77,200 for joint filers. The 15% rate is for incomes up to $425,800 for singles and $479,000 for joint filers. Taxpayers with taxable income over those amounts will pay a 20% rate on capital gains and dividends. Note: These income amounts will be indexed for inflation. The 3.8% net investment income tax was not repealed by the Tax Cuts and Jobs Act and remains in effect. |
| Carried Interests | The holding period for capital gains treatment for carried interests is extended from 1 to 3 years. Carried interests are a share of the profits that private equity fund managers receive as compensation. |
| Deferral of Tax on Private Company Stock Options and Restricted Stock Units | The new Act allows employees of some private companies to elect to defer the taxation of stock options and restricted stock units for up to five years after exercise of the options or settlement of the RSUs. |
| Itemized Deduction | Restricts or eliminates most itemized deductions. Changes that are still allowed include: Mortgage Interest: Deduction for mortgage interest is limited to aggregate debt of $750,000 or less, for first and second homes. Home equity loan interest is no longer deductible at all and existing home equity loans are not grandfathered in. Binding Contracts: A taxpayer who has entered into a binding contract before December 15, 2017 to buy a residence can still get the interest deduction for the higher amount of $1 million. Refinancing: Taxpayers can refinance up to $1 million of pre-December 15, 2017 acquisition debt in the future and not be subject to the reduced limitation. Charitable Deductions: Cash Donations: The new Act increases the deduction for donations of cash to public charities by raising the AGI percentage limit from 50% to 60%. Donee Reporting: The new Act requires exempt organizations to substantiate contributions of more than $250. Athletic Tickets: Taxpayers can no longer get a deduction for donations to colleges or universities for the right to purchase sports tickets. State and Local Taxes: Personal deductions for all state and local taxes combined are capped at $10,000 per year. This includes income taxes, real property taxes, personal property taxes, and sales taxes. Note: Deductions are still allowed if they are related to a taxpayer’s trade or business. Medical Expenses: The medical expense deduction floor is reduced to 7.5%, meaning taxpayers can deduct excess medical expenses they incur over 7.5% of their AGI. This change is temporary only, goes back to 2017 and expires after 2018, when the floor moves back up to 10% of AGI. Casualty Losses: Going forward, personal casualty losses will be deductible only if they are attributable to a federally-declared disaster. Disaster losses incurred in 2016, however, get an enhanced deduction on 2017 returns. Itemized Deduction Phase-out: The phaseout of itemized deductions for high-income taxpayers (the “Pease” limitations) are suspended under the new law. |
| Miscellaneous Itemized Deductions | Miscellaneous itemized deductions are no longer allowed. Prior to the new law, miscellaneous itemized deductions were allowed for certain expenses to the extent those expenses in the aggregate exceeded 2% of a taxpayer’s Adjusted Gross Income (AGI). They included:
|
| Moving Expenses | The deduction for moving expenses is eliminated except for members of the armed forces |
| Alimony | Alimony will no longer be deductible by the spouse who pays and also will not be includible in income of the spouse who receives it. This rule only applies to agreements or orders that become effective after 2018, so existing alimony arrangement are not affected. |
| Retirement Accounts | Roth IRA Conversions: The bill bars taxpayers from undoing a conversion of pre-tax IRA contributions to after-tax Roth IRA contributions. Plan Loans: The law extends the time taxpayers have to rollover a loan offset to a qualified plan from 60 days to the due date of their tax return. |
| Section 529 ABLE Plans, and private school tuition | The Tax Cuts and Jobs Act modifies the student loan discharge exclusion rules to include certain discharges on account of death or disability. |
| Tax Breaks for Students and Teachers | Retains existing higher education tax breaks, including the $250 deduction for teacher classroom expenses, the education credits for part-time study and graduate school and the student loan interest deduction. |
| Estate and Gift Tax | The Act doubles the basic estate tax exemption to $10 million per person. When adjusted for inflation, the per person exclusion amount for 2018 should be around $11.2 million. |
| Alternative Minimum Tax | The new law temporarily increases the statutory AMT exemption amounts for marrieds filing jointly/surviving spouses—to $109,400 (from $78,750); and for single taxpayers to $70,300 (from $50,600). The new law also increases the threshold for phase-out of the exemption to $1 million for joint filers and $500,000 for single filers. |
| ACA Individual Mandate | The tax law sets the individual mandate penalty for not having health insurance at $0, effectively eliminating it after 2018. |
New Tax Bracket Tables
| Income Levels and Filing Status | ||
|---|---|---|
| Tax Rate | Single | Married-Joint |
| 10% | $0-$9,525 | $0-$19,050 |
| 12% | $9,526-$38,700 | $19,051-$77,400 |
| 22% | $38,701-$82,500 | $77,401-$165,000 |
| 24% | $82,501-$157,500 | $165,001-$315,000 |
| 32% | $157,501-$200,000 | $315,001-$400,000 |
| 35% | $200,001-$500,000 | $400,001-$600,000 |
| 37% | $500,000+ | $600,000+ |
| Estates and Trusts | Income Tax Rates |
| $0-$2,550 | 10% |
| $2,551-$9,150 | 24% |
| $9,151-$12,500 | 35% |
| Over $12,500 | 37% |