On Friday, December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law. The TCJA is a sweeping tax package. Unless otherwise noted, the changes are generally effective January 1, 2018 through December 31, 2025. After that date, many of the rules revert back to existing law. Part One of this alert will look at those elements of the new law that will have the greatest impact on individuals. Part Two of this alert will provide possible action steps to be done before year-end to potentially minimize your overall 2017 and 2018 tax liabilities.
PART ONE–OVERVIEW OF CHANGES
- Tax rates. The new law imposes a new tax rate structure with seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Each rate applies to a higher range of income, reducing the taxes owed: For example, for 2017, the top rate of 39.6% started at $418,400 for a single taxpayer and at $470,700 for a married couple filing jointly. For 2018 and beyond, the top rate was reduced from 39.6% to 37% and applies to taxable income above $500,000 for single taxpayers, and $600,000 for married couples filing jointly. The rates applicable to net capital gains and qualified dividends were not changed.
- Standard deduction. The new law increases the standard deduction to $24,000 for joint filers, $18,000 for heads of household, and $12,000 for singles and married taxpayers filing separately. Given these increases, some taxpayers will no longer be itemizing deductions. These figures will be indexed for inflation after 2018.
- Exemptions. The new law suspends until 2026 the deduction for personal exemptions. Thus, starting in 2018, taxpayers can no longer claim personal or dependency exemptions.
- New deduction for “qualified business income.“ Starting in 2018, taxpayers are allowed a deduction equal to 20% of “qualified business income” (QBI), otherwise known as “pass-through” income (i.e., income from partnerships, S corporations, LLCs, and sole proprietorships). The income must be from a trade or business within the United States. Investment income does not qualify as QBI, nor do amounts received from an S corporation as reasonable compensation, or from a partnership as a guaranteed payment for services provided to the trade or business. The deduction is not used in computing adjusted gross income, only taxable income. For taxpayers with taxable income above $157,500 ($315,000 for joint filers), (1) a limitation based on W-2 wages paid by the business and depreciable tangible property used in the business is phased in, and (2) income from the following trades or businesses is phased out of qualified business income: health, law, consulting, athletics, financial or brokerage services, or any business in which the principal asset is the reputation or skill of one or more employees or owners.
- Child and family tax credit. The new law increases the credit for qualifying children (i.e., children under 17) from $1,000 to $2,000, and increases to $1,400 the refundable portion of the credit. It also introduces a new (nonrefundable) $500 credit for a taxpayer’s dependents who are not qualifying children.
- Medical expenses. Under the new law, for 2017 and 2018, medical expenses are deductible to the extent they exceed 7.5 % of adjusted gross income for all taxpayers. Previously, the AGI “floor” was 10% for most taxpayers.
- State and local taxes. Starting in 2018, the itemized deduction for state and local income and property taxes is limited to a total of $10,000.
- Mortgage interest. Under the new law, mortgage interest on loans used to acquire a principal residence and/or a second home is only deductible on debt up to $750,000 (down from $1 million) for loans taken out in or after 2018. There is no longer any deduction for interest on home equity loans, regardless of when the debt was incurred.
- Miscellaneous itemized deductions. There is no longer a deduction for miscellaneous itemized deductions which were formerly deductible to the extent they exceeded 2% of adjusted gross income. This category included items such as tax preparation costs, investment expenses, and unreimbursed employee expenses.
- Overall limitation on itemized deductions. The new law suspends the overall limitation on itemized deductions that formerly applied to taxpayers whose adjusted gross income exceeded specified thresholds.
- Alimony. For divorce decrees and separation agreements entered into after January 1, 2019, alimony will not be deductible by the paying spouse and will not be taxable to the receiving spouse.
- Estate and gift tax exemption. Effective for decedents dying, and gifts made, in 2018, the estate and gift tax exemption has been increased to roughly $11.2 million ($22.4 million for married couples).
- Alternative minimum tax (AMT) and the exemption. The AMT has been retained for individuals by the new law, but the exemption has been increased to $109,400 for joint filers ($54,700 for married taxpayers filing separately) and $70,300 for unmarried taxpayers. The exemption is phased out for taxpayers with alternative minimum taxable income over $1 million for joint filers, and over $500,000 for all others.
PART TWO–POSSIBLE ACTION STEPS TO TAKE BEFORE YEAR END
Income Deferral Strategies
- Defer receipt of any 2017 bonuses or income to 2018.
- Fully fund tax-deferred accounts in 2017 such as 401(k)s and SEPs.
- Delay non-required retirement plan distributions until 2018.
- Postpone conversion of Roth IRAs until 2018.
- For businesses using the cash basis of accounting, defer billing and collections until 2018.
Maximize Deduction Strategies
- If you are not going to be subject to the AMT, prepay 2017 state and local income taxes (4th quarter estimates, or estimated amounts due) by year end. Prepayment of 2018 state or local obligations will not be deductible in 2017. Any overpayments of 2017 state or local income taxes will be taxable income in 2018, but subject to the lower 2018 tax rates.
- If you are not going to be subject to AMT, prepay any remaining installments on outstanding real estate or personal property tax assessments.
- If you are not currently subject to AMT, prepay mortgage payments on primary or secondary residences to increase your mortgage interest deduction for 2017.
- If you are not currently subject to AMT, prepay January home equity interest to increase your deduction in 2017, as this interest will no longer be deductible after 2017.
- Make charitable contributions before year end if you will no longer be itemizing and simply claiming the increased standard deduction going forward.
- Prepay business entertainment expenses by year end, as these expenses will no longer be deductible after 2017.
- Accelerate other business expenditures before year end.
Please keep in mind that the above action steps may not be applicable or beneficial to everyone, especially if you are subject to the AMT. Everyone’s tax situation is unique. If you would like to discuss the impacts of the new tax legislation as it pertains to your specific situation, please contact Serge Bechade, the author of this alert, at 617.456.8016 or email@example.com, or Robert Maloney, the chair of the Corporate Practice Group, at 617.456.8008 or firstname.lastname@example.org.