Since passage of the recent tax reform bill, the Tax Cuts and Jobs Act of 2017 (TCJA), major changes have been made to the U.S. tax code. Given the magnitude of the changes and the variety of versions reviewed and debated by Congress, there is plenty of confusion and misunderstanding around what was approved in the final version of the bill. Here is a summary of the most significant changes in the new tax bill and how they may impact you:
Top Corporate Tax Rate was reduced from 35% to 21%. This change is probably the most impactful change of the new legislation. In summary, if you are in the top tax bracket and own a C corporation your profits inside the corporation are taxed at 21%. If you want to distribute profits from your company, you will issue yourself a dividend which would be taxed at the dividend rate. Adding the top dividend rate of 23.8% and corporate tax rate of 21% your total top tax rate would be 44.8%.
20% Deduction for pass-through businesses*. The provisions surrounding how to qualify for the 20% deduction on pass-through entities (S-corporations, LLCs, sole proprietors, and partnerships) are quite complex. To provide an overly simplistic summary: if you own a pass-through entity and your taxable income is less than $157,500 (single) or $315,000 (married, filing jointly) you will be able to take a 20% deduction on your pass-through income. If you are above these limits, there are restrictions depending on the type of company you operate, W-2 wages, and unadjusted basis of qualified property. Translation: talk to your CPA.
Inflation Rate Measure changed to “Chained CPI.” The bill changes the IRS inflation index from the Consumer Price Index for urban consumers (CPI-U) to the chained CPI (C-CPI-U). Many economists consider the chained CPI to be a more accurate reflection of cost-of-living changes as it accounts for substitution. Substitution is the theory that holds if the costs of a good increase, then the market will substitute with a cheaper good or reduce the amount used. However; making the adjustment for substitution will lower the growth rate of the index, resulting in smaller adjustments to tax brackets, retirement account contribution limits, and other annual adjustments. This lower growth rate will result in higher taxes over time.
Reductions in individual tax rates*. The bill maintains the current structure of seven investor tax brackets, but changes the threshold amounts and lowers the marginal rate of five brackets. This reduction includes the sunset provision, meaning it’s a temporary arrangement from 2018 to 2025.
|Old Marginal Tax Rate||New Marginal Tax Rate||Taxable Income (Single Filers)||Taxable Income (Married Filing Jointly)|
|10%||10%||$0 — $9,525||$0 — $19,050|
|15%||12%||$9,525 — $38,700||$19,050 — $77,400|
|25%||22%||$38,700 — $82,500||$77,400 — $165,000|
|28%||24%||$82,500 — $157,500||$165,000 — $315,000|
|33%||32%||$157,500 — $200,000||$315,000 — $400,000|
|35%||35%||$200,000 — $500,000||$400,000 — $600,000|
|39.60%||37%||$500,000 and up||$600,000 and up|
Standard Deductions increased, and phase-outs eliminated*. For single filers, the standard deduction rises from $6,350 to $12,000; for married couples filing jointly, the standard deduction increases from $12,700 to $24,000. The previous law also limited itemized deductions based on income, which was repealed through 2025. The additional standard deduction for ages (65+) or blind was also maintained. This means single filers meeting this provision will receive an additional $1,600 deduction and each qualified married filer will receive an additional $1,300 deduction.
Personal exemptions eliminated*. Previous law allowed an exemption of $4,050 per person, which was eventually phased out for those with higher adjusted gross income. The new law repeals personal exemptions through 2025.
Child Tax Credit Increased to $2,000*. The child tax credit was expanded from a $1,000 credit to a $2,000 credit for each child under the age of 17 claimed as a dependent. The income phase-out was also increased from $110,000 to $400,000 for married couples filing jointly. $1,400 of the child tax credit is also refundable meaning your tax liability could be less than $0. The expanded child tax credit helps families who would have paid more under the new tax system due to exemptions being eliminated.
State and Local Tax (“SALT”) Deduction capped at $10,000*. Under the bill, you may only deduct up to $10,000 in state and local taxes, including sales, income, and property taxes. Previously, this deduction was not subject to limitation.
Mortgage interest deduction limited to $750,000*. The bill keeps the $1 million deductible limit for acquisition debt for current homeowners, but caps the interest deduction at $750,000 in mortgage debt for homes bought after Dec. 31, 2017. Previously $50,000 (single) or $100,000 (married) of home-equity loan interest could be deducted for non-acquisition debt. The bill eliminates this provision. Eliminating the home equity loan provision has created some confusion. Home equity loans used for acquisition debt (purchasing or improving your home) still qualifies for the interest deduction. Home equity loans or cash out refinances for non-acquisition debt will not qualify for the deduction.
Medical Expense Deduction Expanded. Previous law only allowed for deduction of medical expenses above 10% of adjusted gross income (AGI). Taxpayers now (this element of the bill was made retroactive for 2017) only need medical expenses to exceed 7.5% of AGI to qualify for the deduction. However; this provision ends at the end of 2018.
Miscellaneous Itemized Deduction subject to 2% AGI floor eliminated*. All miscellaneous itemized deductions under the 2% AGI floor rule were repealed which includes: various unreimbursed employee expenses, losses on a variable annuity, deduction for advisory fees, and tax preparation costs among others.
Individual Alternative Minimum Tax (AMT) exemption increased*. Both the AMT exemption amounts and phase out limits increased which will dramatically reduce the impact of the AMT tax. AMT exemptions increased from $54,300 to $70,300 for single filers and from $84,500 to $109,400 for married filing jointly. The phase-outs increased from $120,700 to $500,000 (single) and $160,900 to $1m (MFJ). With these changes, only people with extremely large AMT adjustment items will be subject to AMT tax.
Estate Tax Exemption Increased*. The bill maintains the 40% estate tax rate, but increases the exemption from 5.49m to 11.2m. Very high net worth families may want to examine opportunities to move money out of their estate utilizing the higher exemption levels.
Roth recharacterizations eliminated*. Under previous law, if you convert a traditional Individual Retirement Account (IRA) to a Roth IRA, you had the ability to “undo” the conversion and recharacterization back to a traditional IRA. The bill removes this ability for ROTH conversions taking place after Dec. 31st, 2017.
529 plans expanded to include private elementary and secondary school expenses*. Previously 529 plan assets could only be withdrawn tax and penalty free for qualifying college expenses. The new provisions allow $10,000 annually of 529 assets to be used for elementary and secondary school. If you live in a state that has an income tax and provides a state income tax deduction for contributing to a 529 plan, there may be a benefit to using the 529 plan for short term contributions. Otherwise, no federal income tax deduction is provided for contributing to a 529 plan so the benefits are limited to the tax-free growth of the account.
Charitable Contribution Limits Expanded*. Previously cash donations to charities were limited to 50% of your Adjusted Gross Income (AGI). The bill now allows you to include cash gifts to charity of up to 60% of your AGI as a deduction in that calendar year. In general, fewer people will itemizing their deductions so they may not receive a benefit for their charitable contributions. Qualified Charitable Distributions (QCDs) may be used more often as well as bunching gifts into one tax year instead of spreading out to go over the higher itemized deductions.
Taxation of Alimony Reversed*. Previously alimony payments were deductible for the individual paying the alimony and taxable to the individual receiving. Under the new law, alimony payments will no longer be deductible by payors or reportable by recipients. This provision will only apply to divorce agreements filed after December 31st, 2018.
1031 Exchanges limited to real estate transactions*. Previously other types of investment property like airplanes, boats, and classic cars were allowed.
Moving Expense Deduction Repealed*. This means you can no longer deduct moving expenses, and moving expenses reimbursed by your employer will be taxable. An exemption for active military was maintained.
What didn’t change:
First In First Out (FIFO) in the selling of securities. The senate bill FIFO provision that would have required investors to sell the shares they’ve held the longest first was eliminated. This is good for investors as it would have impacted your ability to help you realize losses, gains, or gift low basis stock as it fit with your financial plan.
No change to capital gains taxes.
No change to tax-free municipal bonds.
Individual Mandate for Health Insurance repealed beginning 2019, but Affordable Care Act was not repealed*. This means in 2019 there will no longer be penalties for not having an approved health insurance or exemption. However; since the ACA was maintained, so was the 3.8% Net Investment Income Tax (NIIT) and 0.9% Medicare surtax on income above $200k MAGI (single) and $250k MAGI (MFJ).
*Indicates provision will sunset after 2025