Major tax legislation generally only happens around once a decade. The last time we had a major re-write of the tax code was in 2003. Just like that round of legislation, most of the individual provisions in the Tax Cut and Jobs Act of 2017 (TCJA) are not permanent and will roll back in 2025. Legislators have indicated that they want to revisit the permanency of those provisions if fiscal indicators show that the bill is not adding to the deficit. Focusing on individual tax laws, we will look at the most common and impactful changes.
Beginning with income deductions, TCJA will remove personal exemptions from the tax code. In 2017, the value of this deduction was $4,050 per individual claimed on the tax return. This deduction was effectively collapsed into the standard deduction, which is currently $6,350 for a single person and $12,700 for a couple filing jointly. The new standard deduction will be $12,000 for a single person and $24,000 for a couple filing jointly. This creates a higher threshold for those seeking to utilize an itemized deduction. To make matters worse, many of the allowable itemized deductions have been either limited or fully eliminated. One sore spot for those taxpayers living in high tax states is a deduction cap of $10,000 on property taxes and state income Taxes. This limitation is an aggregated cap of these deductions. Miscellaneous itemized deductions have also been eliminated. The most common of which include tax preparation fees, investment management fees, and various unreimbursed employee expenses.
The mortgage interest deduction is also another itemized deduction that has come under scrutiny. The deductible limit of a new mortgage after December 15th, 2017 is $750,000 – a reduction from the current limit of $1 million. In addition to this, home equity interest will no longer be an allowable deduction on the Schedule A and there is no grandfathering of this rule. Charitable giving deductions were maintained, as well as medical expense deductions, with a lower threshold for two years. However, with the reduction of taxes paid deductions, removal of miscellaneous deductions, limitation of mortgage interest, and raising of the standard deduction; it will become more difficult to meet the threshold of itemized deductions going forward. This is especially true for retirees with paid off homes.
Now for some good news – tax rates are headed down. There will still be 7 tax brackets, but the rates are going down by 2-3% in each of the brackets. There are some adjustments to the income limits of each bracket, but the top bracket is reduced by 2% to 37%. Another sigh of relief for many taxpayers is that the Alternative Minimum Tax (AMT) will no longer affect taxpayers with under $500,000 of income for a single person, and $1,000,000 of income for a couple. In addition to raising the income limit, the exemption was also expanded. Additionally, those with minimum tax credits will be eligible to carry them forward and utilize them in future tax years. The relief on the tax rate and AMT front should help soften the blow of the lost deductions for many.
For those with children or grandchildren, the next two sections are important. With the loss of personal exemptions for dependents, this could have created a tax burden for families with more than two children. However, there was an expansion of the child tax credit, including an increase in the credit from $1,000 to $2,000, and an increase in the income phase out to $200,000 for a single person and $400,000 for a couple. As a result, a family with 4 children and income under $400,000 would receive an $8,000 tax credit. It is also important to note that there is a new tax credit for dependents who are not qualifying children, which could include college age students or even dependent parents or siblings.
The new law makes an important-to-note change to how kiddie taxes are calculated. Currently, unearned income is taxed at either the child’s tax rate, or the parent’s if it is above $2,100. Under TCJA, instead of the additional tax being calculated at the parent’s rate, it will now be calculated at the Estate/Trust tax rate. This is problematic, especially for inherited IRAs with minor beneficiaries because the tax rate hits the top tax bracket of 37% at just $12,500 of income. Fortunately, much of the income being earned by custodial accounts is tax-advantaged qualified dividends and capital gains, which will be taxed at the long-term capital gain rates of 15%, 20%, or 23.8% (where the Medicare Surtax applies). One strategy to reduce future tax rates in custodial accounts is to consider incurring capital gains in 2017 where the capital gain tax rate will be at or below 15% on the parent’s return. This is preferable because the tax brackets for individuals are much larger than the tax brackets for Estates and Trusts. A relatively small amount of income for minors will cause them to be taxed at the highest capital gain rate in 2018 and beyond. 529 plans also received some attention in the new law. The qualified usage of 529 dollars was expanded to include a $10,000 per student per year tax-free distribution for private elementary and secondary schools.
For those looking for additional estate planning options, TCJA has resulted in an expanded estate tax exemption of $11.2 million per person. This results in a maximum exemption of $22.4 million for a married couple utilizing both exemptions. The law continues to have a tandem gift tax exemption, tied to the amount of the estate tax. This means an individual is able to give away up to $11,200,000 without incurring any gift taxes.
There were a few notable new provisions, including a 20% deduction to “pass through” business income (excluding service based businesses like attorneys, medical professionals, and accountants, unless their total income is less than certain income limits), future alimony treatment, the repeal of the moving expense deduction, and changes to the Roth re-characterization rules. Additionally, corporate tax rates have been reduced to 21%, the new inflation measure for tax purposes will be Chained CPI, and the individual insurance purchase mandate has been repealed. These three provisions are permanent and will not rollback after 2025.
There were also a number of provisions floated in either the House or Senate bills along the way that never made it into the final bill. A few of these items are the removal of the student loan deductions, removal of the medical expense deduction, changing to “FIFO” or First in, First Out accounting method for selling stock, and changes to the capital gains exclusion for selling your primary residence.
It may be beneficial to defer income into 2018 as much as possible, and incur deductions in 2017 where possible. If you have questions about increasing charitable giving prior to the end of the year to take advantage of 2017’s lower standard deduction, reach out to your advisor as soon as possible. Our custodians work on a best effort basis as we near the end of the year. Those utilizing a Qualified Charitable Distribution from IRAs as their sole charitable giving mechanism are not affected by the changes to the standard deduction. With all of these changes, we continue to stay on top of optimal tax planning strategies both for end of year purposes, as well as looking forward into 2018.
Tax Cut and Jobs Act “Cliff Notes” Version
- Tax Rates:
- Overall, they are down, with 7 brackets continuing and rates of: 10%, 12%, 22%, 24%, 32%, 35%, 37%
- Personal exemptions are going away
- Standard deduction rising to $12,000 for a single person and $24,000 for a couple
- State, property, and sales tax deductions are aggregated and capped at $10,000
- Medical deductions remain, and AGI limitation reduces for next two years
- 2% miscellaneous itemized deductions are eliminated
- Mortgage interest deduction is limited to mortgages up to $750,000 and home equity debt is no longer eligible for deduction
- AMT remains, but with much higher exemptions and income phase-in limits of $500,000 for a single person and $1,000,000 for a couple
- Child Tax Credit
- Has been increased from $1,000 to $2,000 per qualifying child and income phase-outs are raised to $200,000 for a single person and $400,000 for couples
- Kiddie Tax
- Will now be subject to fiduciary (Trust/Estate) tax rates
- Includes inherited IRA income
- 529 Plans
- Now allow for up to $10,000 per child, per year tax-free distribution for private elementary and secondary education expenses
- Also now includes up to $10,000 per year tax-free distribution for home school expenses
- Estate Tax and Gift Tax Exemption
- Has been increased to $11,200,000 per person with portability of exemption between spouses
- Business pass-through rules
- Preferential tax deduction for pass through entities, not in the service industry. However, Engineers and Architects are able to take advantage of this deduction.
- Of pass through income, 20% is eligible to be taken as a deduction from income
- For those in service based fields, namely physicians, accountants, attorneys, etc, deduction is still eligible for MFJ taxpayers with less than $315,000 income
- Proposed Changes that did not make the final bill
- First in, First out recognition of capital gains for appreciated securities
- Removal of the student loan deduction
- Removal of medical expense deduction