Almost every taxpayer will be affected by the new tax laws, TCJA, which take effect beginning tax year 2018. First off, under the new law, the individual tax brackets are set at 10%, 12%, 22%, 24%, 32%, 35%, and 37%. It is important to check and compare your tax bracket from last tax year to this tax year for tax planning purposes. For example, tax rate comparisons are necessary to determine if you should switch from owning a pass through business entity to a non-pass through business entity.
Let’s get into a few key highlights that will affect (1) the average tax payer; (2) pass-through business entities; (3) non-pass through non-exempt business entities; (4) a hodge-podge of tax-exempt non-profits, estates, trust, and other entities.
Average tax payer (w/out a pass-through business entity)
Personal Exemptions and Standard Deductions
The new law eliminates deductions for personal exemptions while increasing standard deductions to $12,000 for single filers and $24,000 for married, joint filers.
The following, well-known itemized deductions are being modified or eliminated:
• The deduction for state and local income, sales and property taxes is capped at $10,000.
• The deduction for mortgage interest is reduced, and only allowable on up to $750,000 of acquisition indebtedness (note that mortgages incurred on or before Dec. 15, 2017, are grandfathered in and thus still allowed $1 million of acquisition indebtedness).
• The home equity loan interest deduction is repealed.
• Taxpayers will be allowed to deduct medical expenses if they exceed 7.5% of adjusted gross income (instead of 10%) for tax years 2017 and 2018.
For those of you, who are used to deducting sizable state and local income taxes, work with your advisers to determine if accelerating the payment of state and local property taxes makes sense.
Those no longer allowed to deduct state income taxes should speak to their advisers about alternative solutions to avoid or mitigate state income taxes.
If possible, you may wish to accelerate medical expenses into 2017 and 2018 to take advantage of the lower 7.5% of AGI limitation.
Charitable Income Tax Deductions
The new law increases the charitable contribution limit to 60% of AGI for cash contributions (up from 50% now), while keeping the limit on contributions of appreciated property at 30% of AGI.
Individual Alternative Minimum Tax (AMT)
The AMT exemption is increased to $70,300 for single filers and $109,400 for married joint filers. The thresholds for the phase-out of the AMT exemptions are increased to $500,000 for single filers and $1 million for married joint filers.
Other Tax Provisions
• A three-year holding period is required for a carried interest to qualify as a long-term capital asset.
• The itemized deduction for personal casualty losses would be restricted to losses incurred in a presidentially declared disaster area. This takes effect after 2025.
• Tax-preparation fees are no longer deductible. This takes effect after 2025.
• Except for members of the armed forces, moving expenses are no longer deductible. This takes effect after 2025.
• Reversing or re-characterizing a Roth IRA is no longer permitted.
• The penalty for failing to maintain minimum health care coverage is effectively eliminated starting Jan. 1, 2019.
• 529 Plans can be used for K-12 schools and for homeschooling.
• The alimony deduction for the payor ex-spouse and the inclusion of alimony in gross income of the recipient ex-spouse is repealed for any divorce or separation instrument executed or modified after Dec. 31, 2018.
Pass-through Business Entities
TCJA provides for a 20% deduction on non-wage portions of pass-through income. In short and simply stated, if the pass-through income for a married couple is $315,000 or less ($157,500 for single filers), then the 20% deduction is limited to 50% of the W-2 wages, or in the case of a business that requires capital (a non-personal service business) 25% of W-2 wages plus 2.5% of the adjusted cost basis of the assets. Architects and engineers have been exempted from these limitations. Pass-through income exceeding the $315,000/$157,500 thresholds receives no 20% deduction.
In practice this means that pass-through businesses (partnerships, LLCs, S corporations, and sole proprietorships filing a Schedule C) will be effectively taxed on only 80% of their pass-through income – or, put another way, on only 80% of their normal rate on all business income!
Other Tax Provisions
• The limit on section 179 deductions wherein businesses can deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year is increased to $1 million.
• Deductions for certain fringe benefits, such as business entertainment expenses, have been limited.
• Net operating loss (NOL) deductions are limited to 80% of pre-NOL taxable income. There is an indefinite NOL carryforward, but no carryback to prior years for most companies.
• Full expensing of investments in new depreciable assets made after Sept. 27, 2017, and before Jan. 1, 2023, will be permitted.
• There is a 20% per year phase-down of the full expensing for property placed in service after Dec. 31, 2022, and before Jan. 1, 2027.
Corporate Income Taxes
The corporate income tax is reduced to 21%, down from 35%, and corporate alternative minimum tax is repealed.
Corporations need to revisit its key man life insurance strategies regarding tax benefits. In general, the expenses for the insurance premiums on those policies are non-deductible and likewise the insurance settlement/income from those policies is non-taxable.
TCJA does not repeal the estate tax as was proposed in the House version, however it doubles the estate, gift and GST tax exemption amounts from the original $5 million (which has grown to $5.49 million in 2017 and which will be $5.6 million in 2018, due to adjustments for inflation) to $10 million (which, when adjusted for inflation, is $10.98 million in 2017). The 2018 Unified Exemption – which is the gift and estate tax exemption combined, meaning if you use the exemption for gifting it will reduce the amount you can use for the estate tax — will be $10.6 million per person. It’s double that per couple, and the surviving spouse may use any unused portion left over from the spouse first to die. It also provides for increases to the exemptions based on inflation. The exemption expires after 2025.
With the exemption set this high only a tiny fraction of families will be affected by estate taxes. However, for those that are affected, it is an enormous tax bite at 40%! This can easily destroy a closely held business or large family farm – and for those affected it will definitely undermine family legacy goals! This means planning is still critical for families with large, closely held businesses or those that have a net worth significantly greater than the exemption amounts.
Considering that, barring further congressional action, the exemption amounts will revert back to $5 million for individuals in 2026. So planning now while the gift tax exemption is doubled for the next several years may be crucial. Make sure to discuss these matters with your adviser!
Clients who purchased life insurance to finance the payment of estate and other taxes and expenses should think carefully before canceling or reducing coverage. If your estate does not now nor is ever likely to exceed the inflation-indexed exemption amount(s), using the new-found exemption amounts to “un-wind” life insurance premium financing and note sale transactions may be attractive. Making large gifts to irrevocable life insurance trusts (ILITs) that have dynastic provisions could also be worth exploring.
Estate tax planning is still required for those who live in states that have decoupled and instituted their own state estate tax. In many cases, the state exemption may be significantly lower than the federal amount.
The TCJA is the first major tax change since 1986. For some, their tax situation just became really simplified but for others it just got a whole lot more complicated. While it may be years before we understand the full impact of the new laws, most of us will certainly be affected for tax year 2018. But, also keep in mind, as long as congress exists there is a strong possibility of some of these laws being repealed or cut short before making it through the pipeline.
Source – Kiglinger Newsletters 2018