Tax Update 2018
March 29, 2018
On December 22, the Tax Cuts and Jobs Act of 2017 (“TCJA”) was signed into law. The TCJA is billed as the largest overhaul of the Internal Revenue Code since the Tax Reform Act of 1986 and it will affect almost every individual and business in the United States. Generally, the new law goes into effect on January 1, 2018, with many of the provisions relating to individuals expiring at the end of 2025. The following is a summary of the TCJA’s more salient aspects:
The new tax rate structure will consist of seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%. 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 remain unchanged. The “kiddie tax” rules were simplified. The net unearned income of a child subject to the rules will be taxed at capital gains and ordinary income rates that apply to trusts and estates. A child’s tax liability will no longer be affected by his or her parent’s tax situation, or the unearned income of his or her siblings.
The standard deduction is increased to $24,000 for married couples filing jointly, $18,000 for heads of household and $12,000 for single taxpayers and married taxpayers filing separately. In order to determine taxable income, taxpayers are allowed to reduce their adjusted gross income by either the standard deduction, or the sum of his, her or their itemized deductions. An increase in the standard deduction should result in a corresponding reduction in the number of taxpayers who itemize their deductions. The standard deduction is indexed for inflation after 2018.
Under the new law, personal exemptions are suspended effective for tax years starting after December 31, 2017 and before January 1, 2026. Starting in 2018, taxpayers can no longer claim personal or dependency exemptions. The rules for withholding income tax on wages will be adjusted to reflect this change. The Internal Revenue Service was given the discretion to leave the withholding rules unchanged for 2018.
NEW PASS-THROUGH INCOME TAX DEDUCTION
Effective for tax years starting after December 31, 2017 and before January 1, 2026, taxpayers are allowed a deduction equal to 20% of the “qualified business income” of a partnership, S corporation, LLC, or sole proprietorship, as well as 20% of qualified real estate investment trust dividends, qualified cooperative dividends and qualified publicly traded partnership income. The income must be from a trade or business within the United States. Investment income does not qualify, 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, just taxable income. For taxpayers with taxable income above $157,500 ($315,000 for joint filers), (a) a limitation based on W-2 wages paid by the business and depreciable tangible property used in the business is phased in, and (b) income from the following trades or businesses is phased out of qualified business income: health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners.
CHILD AND FAMILY TAX CREDIT
The credit for qualifying children (i.e., children under 17) increases from $1,000 to $2,000, and increases the refundable portion of the credit to $1,400. There is also a new (nonrefundable) $500 credit for a taxpayer’s dependents who are not qualifying children. The adjusted gross income level at which the credits begin to be phased out has been raised to $200,000 ($400,000 for joint filers).
STATE AND LOCAL TAXES
The itemized deduction for state and local income and property taxes is limited to $10,000 ($5,000 for single filers and married taxpayers filing separately). Please note that the conference report on the bill specifies that taxpayers may not deduct prepaid 2018 income tax payments on the taxpayer’s 2017 income tax return.
MORTGAGE INTEREST AND HOME EQUITY LOANS
Mortgage interest on loans used to acquire a principal residence and a second home is deductible up to $750,000 (down from $1 million) for loans taken out in 2018. There is no longer a deduction for interest paid on home equity loans regardless of the year the loan was taken out.
MISCELLANEOUS ITEMIZED DEDUCTIONS
Miscellaneous itemized deductions, such as tax preparation costs, investment expenses, union dues and unreimbursed employee expenses, which were formerly deductible to the extent they exceeded 2% of adjusted gross income, have been eliminated. ?
For tax years 2017 and 2018, medical expenses are deductible to the extent they exceed 7.5% of adjusted gross income for all taxpayers. Previously, the adjusted gross income “floor” was 10% for most taxpayers.
CASUALTY AND THEFT LOSSES
The itemized deduction for casualty and theft losses has been suspended except for losses incurred in a federally declared disaster.
OVERALL LIMITATION ITEMIZED DEDUCTIONS
The overall limitation on itemized deductions that formerly applied to taxpayers whose adjusted gross income exceeded specified thresholds is suspended. The itemized deductions of such taxpayers were reduced by 3% of the amount by which AGI exceeded the applicable threshold, but the reduction could not exceed 80% of the total itemized deductions, and certain items were exempt from the limitation.
Effective for tax years starting after December 31, 2017 and before January 1, 2026, the deduction for job-related moving expenses has been eliminated, except for certain military personnel. The exclusion for moving expense reimbursements has also been suspended.
Effective for divorce or separation agreements signed after December 31, 2018, alimony will no longer be deductible by the paying spouse and will not be taxable to the receiving spouse.
HEALTH CARE “INDIVIDUAL MANDATE”
Beginning in 2019, there is no longer a penalty for individuals who fail to obtain minimum essential health coverage.
Beginning January 1, 2018, the definition of “qualified higher education expenses” was expanded to include tuition at an elementary or secondary public, private or religious school. The amount of tuition is limited to $10,000 per year/per child.
ESTATE AND GIFT TAX EXEMPTION
Effective for tax years starting after December 31, 2017 and before January 1, 2026, the estate and gift tax exemption has been increased to $11.2 million per person ($22.4 million for married couples).
ALTERNATIVE MINIMUM TAX EXEMPTION
The alternative minimum tax has been retained for individuals, but the exemption has been increased to $109,400 for joint filers ($54,710 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.