The U.S. House of Representatives and Senate passed the “Tax Cuts and Jobs Act” on December 20, 2017, and President Trump signed the law before Christmas. This piece of legislations is the most comprehensive change to the tax code since the Tax Reform Act of 1986.
Most of these provisions take effect for tax years after December 31, 2017, and many of the individual provisions expire after 2025. The Affordable Care Act’s individual mandate is repealed for tax-years beginning after December 31, 2018; this means you still could be assessed a penalty for 2018 if you do not have health insurance and do not qualify for one of the current exceptions.
Individual Income Tax Changes
Reduction in Tax Brackets and Increased Thresholds
The plan retains seven individual tax brackets from 10, 15, 25, 28, 33, 35, and 39.6%, down to 10, 12, 22, 24, 32, 35, and 37%, respectively. The following table shows how those new rates apply for each filing status. The rates are effective January 1, 2018, and expire after 2025. The marriage penalty has been mostly eliminated, except at the highest income brackets.
|Married Filing Joint||Married Filing Separate||Single||Head of Household||Estates and Trusts|
|10%||$0 to $19,050||$0 to 9,525||$0 to $9,525||$0 to $13,600||$0 to $2,550|
|12%||$19,051 to $77,400||$9,526 to $38,700||$9,526 to $38,700||$13,601 to $51,800||N/A|
|22%||$77,401 to $165,000||$38,701 to $82,500||$38,701 to $82,500||$51,801 to $82,500||N/A|
|24%||$165,001 to $315,000||$82,501 to $157,500||$82,501 to $157,500||$82,501 to $157,500||$2551 to $9,150|
|32%||$315,000 to $400,000||$157,501 to $200,000||$157,501 to $200,000||$157,501 to $200,000||N/A|
|35%||$400,001 to $600,000||$200,001 to $300,000||$200,001 to $500,000||$200,001 to $500,000||$9,151 to $12,500|
|37%||Over $600,000||Over $300,000
|Over $500,000||Over $500,000||Over $12,500|
Capital Gains Tax Brackets Sync with New Tax Brackets
The three capital gains tax rates of 0, 15, and 20% are kept under the new law and the income ranges and thresholds for the brackets have increased to coincide with the standard income tax brackets. The first table below shows the capital gains brackets. The second table shows the income thresholds for the 0% capital gains rate.
|L/T Capital Gain Rates||Married Filing Joint||Single and Married Filing Separately||Head of Household||Estates and Trusts|
|0%||$0 to$77,400||$0 to $38,700||$0 to $51,800||$0 to $2,600|
|15%||$77,401 to $479,000||$38,701 to $425,800||$51,801 to $452,400||$2,601 to $12,700|
|20%||Over $479,000||Over $425,800||Over $452,400||Over $12,700|
|0% Capital Gains Rate Thresholds|
|Filing Status||Top of 12% rate bracket||Standard deduction||Taxable income before capital gains are taxed|
|Married Filing Joint||$77,400||$24,000||$101,400|
|Head of Household||$51,800||$18,000||$69,800|
|Married Filing Separate||$38,700||$12,000||$50,700|
The “Kiddie Tax” gets simplified
The “kiddie tax” received a major change and simplification by applying the estate and trust regular tax rates and capital gain rates to the net unearned income of children. Parents and their child-dependents can no longer elect to have the child’s unearned income taxed at the parent’s rate.
In 2018 dependent children will have the first $1,050 of unearned income will be free of tax, the next $1,050 of income will be taxed at ordinary (10%) rates. The excess over the first $2,100 of unearned income will be taxed at the 37% estate and trust tax rate for regular tax and 20% rate on capital gains (with the possibility of the 3.8% surtax). Earned income will still be taxed at ordinary rates.
Increase of Standard Deduction Reduced by Loss of Personal/Dependency Exemptions
Effective for tax years after 2017, the tax plan temporarily (through 2025) increases the married filing joint standard deduction from $12,700 to $24,000, but eliminates the personal exemptions and dependency exemptions, ($4,150 per exemption for 2018). The additional standard deduction for elderly or blind is $1,300 for married filing joint ($1,600 for single filers).
|Standard Deduction||Old Law-2017||New Law-2018|
|Head of Household||$9,550||$18,000|
|Married Filing Joint||$13,000||$24,000|
The loss of the personal and dependent exemptions is offset by an increase in the child tax credit from $1,000 to $2,000 per child, and the creation of a $500 nonrefundable credit for non-child dependents. Unfortunately no exemption credit was created for the taxpayer or spouse.
The income phase-out ranges for child and family tax credits increase from $110,000 to $400,000 for married couples filing a joint return and increased to $240,000 for single, head of household, and married filing separate returns.
|Credit for Children||$1,000||$2,000|
|Credit for other Non-Child Dependents||$0||$500|
|Refundable Amount of Child Tax Credit||$1,000||$1,400|
Alternative Minimum Tax Receives Significant Changes
The current Alternative Minimum Tax is retained under the current law but the exemption amounts have increased. Since the deduction for state and local income taxes and property taxes has been limited to $10,000, many people will no longer be subject to AMT since those deductions are one of the major adjustments that trigger the tax. The income level where the AMT exemption phases out is increased substantially under the new law.
|AMT Exemptions and Phase-out||2017||2018|
|Single or Head of Household||$54,300||$70,300|
|Married Filing Joint||$84,500||$109,400|
|Phase-out Begins-Single and Head of Household||$120,700||$500,000|
|Phase-out Begins, MFJ||$160,900||$1,000,000|
Major Cuts to Itemized Deductions and Adjustments to Income
The overall limitation on itemized deductions is eliminated under the new law.
Those who itemize their deductions will feel the greatest impact from this bill. The deduction for sales tax, or state and local income tax, and real and personal property tax is capped at $10,000. The law prohibits claiming a deduction for amounts paid in 2017 for a taxpayer’s liability on their 2018 return.
State, local, and foreign property taxes, and state and local sales taxes, paid or accrued, that directly relate to a trade or business, or for the production of income (Code Section 212) will still be allowed.
The combined cap on acquisition indebtedness eligible for the mortgage interest deduction on primary and secondary residences is decreased from $1,000,000 down to $750,000 for any amounts borrowed after December 15, 2017; the cap on existing debt before enactment of the law remains $1,000,000. The deduction for home equity interest (money borrowed for purposes other than purchasing, building, or improving your home) is eliminated under the bill regardless of when the debt was incurred.
The final bill kept the medical expense deduction; furthermore, for 2017 and 2018, amounts in excess of 7½ % of adjusted gross income are deductible for all taxpayers. This is one of only a few retroactive changes in the tax bill.
Charitable contributions are allowed, and the bill increased the allowable limits on charitable donations. The percentage limitation on charitable donations increases from 50% to 60%. The bill eliminates the charitable deduction of 80% of amount paid for the right to purchase tickets to athletic events (typically seen with college athletic events).
The bill retained the deduction for student loan interest and investment interest expense. Beginning in 2018, student loan debt forgiveness will not be taxable as a consequence of the student’s death or disability.
Additionally, the bill eliminates the deductions and adjustments to income for:
- Moving expenses repealed through 2025 except military
- Personal casualty losses except for disasters declared by the president
- Alimony will no longer be taxable or deductible for agreements executed after December 31, 2018. Also if an existing divorce agreement is modified after December 31, 2018 the alimony will no longer be deductible.
- Miscellaneous Itemized Deductions Subject to 2% of AGI limitation. This includes all form 2106 unreimbursed employee expenses, tax preparation fees, union dues, and safety deposit box fees.
Disasters Declared by the President (Casualty Losses)
If the casualty resulted from a disaster declared by the president, taxpayers can increase the standard deduction by allowable losses in excess of $500; this increase is allowable for both regular tax and alternative minimum tax.
Victims in disaster areas declared by the president can take up to $100,000 penalty free hardship distributions from retirement accounts. Income from these distributions can be reported over three years.
Under the new law, all deductions for expenses incurred in gambling transactions, not just losses, are limited to the extent of winnings. Under previous law, gambling losses were limited to winnings, and in addition, taxpayers could deduct travel, lodging, and other related expenses.
Retirement Account, 529, and ABLE Account Changes
The bill eliminates the special rule allowing recharacterization of Roth IRA conversions after tax year 2017. Taxpayers can still recharacterize regular Roth contributions to a traditional IRA contribution.
Taxpayers who have taken out loans on qualified plans (such as 401(k)s) have until the due date of their individual tax return (including extensions) to contribute the loan balances to an IRA to prevent the loan amounts from becoming taxable income; this provision applies in situations where the taxpayer is facing a loan balance treated as a taxable distribution as a result of termination of the qualified plan or separation from employment.
Up to $10,000 in distributions from 529 plans may be used for qualified expenses for elementary and high school. The new law allows rollovers from 529 accounts to ABLE accounts. Designated beneficiaries of ABLE account can claim the Saver’s Credit for contributions to the account. Effective after enactment date of the law, after the $15,000 contribution limit for ABLE accounts is reached, additional contributions can be made up to the lesser of the federal poverty line for a single person, or the person’s earned income for the year.
Estate and Gift Tax Exemptions Increased
The law increases the estate and gift tax exemption to $11,200,000 for 2017 and before 2026. The exemption is indexed for inflation. The step-up/step-down in basis for assets under Code Section 1014(a) remains unchanged under the tax act.
Since these increased exemptions will expire in 2026, wealthy individuals might want to consider gifting amounts up to the increased exemption amounts to their beneficiaries before the exemption amounts revert back to pre-2018 law.
The annual gift tax exclusion increases from $14,000 to $15,000 in 2018.
Changes Affecting Business and Investments
New Code Section 199A – 20% Deduction for Income from Qualified Business Income (QBI)
For tax years beginning after 12/31/17, taxpayer will receive a 20% deduction (new Code Section 199A) on the lower of Qualified Business Income or taxable income excluding net capital gains and qualified corporate dividends. The 20% deduction is not an adjustment to income, but instead is a deduction against taxable income (below-the-line). The deduction is allowed whether the taxpayer itemizes their deduction or uses the standard deduction.
Qualified business income includes self-employment income (Schedule C and F), residential and commercial rental income (Schedule E), ordinary income from S corporations and partnerships, certain dividends from REITs, patronage dividends, and qualified publicly traded partnership income. Qualified business income does not include dividends, interest income (unless related to a trade or business, e.g. interest on accounts receivable), capital gains or losses, commodities or currency gains (unless related to normal course of business), compensation of S Corporation shareholders, and guaranteed payments for services from a partnership.
For activities other than primarily personal service businesses, the 20% deduction is limited to the greater of 50% of W-2 wages paid by the pass-through entity or sole proprietorships or 25% of wage income plus 2.5% of the cost of depreciable property. These limitations do not apply from taxable incomes below $157,500 for single filers, and $315,000 for married filing joint taxpayers; furthermore, the limits gradually phase-in from $315,000 to $415,000 for married filing joint, $157,500 to $227,500 for all other filing statuses. If QBI is above these amounts, all the income from the entity is fully subject to these limits.
Personal service businesses such as accounting, law, and financial services (exception carved out for engineering and architectural companies) are eligible for the special QBI rate, but only if taxable income is less than $415,000 for married filing joint, and $227,500 for single filers. If taxable income is above these amounts, the taxpayer receives no deduction on QBI, and furthermore, the deduction is phased out from $315,000 to $415,000 for married filers, and $157,500 to $227,500 for all other filing statuses.
Income and losses from more than one business are netted to produce combined qualified business income. Net combined losses are carried forward and used to reduce net qualifying income in subsequent years. It is not known yet if married filing joint taxpayers will need to net their business activities together or separately.
Depreciation and Expensing of Business Assets
The new law allows expensing (Bonus Depreciation) of 100% of new and used tangible personal property (equipment and certain real property improvements) placed in service after 9/27/17 and before 2022, with a gradual phase-out from 2023 through 2026. Bonus depreciation is taken by default and you must make an election if you do not want to take the 100% depreciation.
The law increases the Code Section 179 expense deduction to $1,000,000, and the phase-out threshold is increased to $2,500,000.
Code Section 174 research and experimental expenditures, including software development, can be amortized over five years for tax-years after 12/31/21. Foreign research gets amortized over 15 years.
The annual limit on the write-off of business use vehicles increases under the new tax bill. The following table applies to vehicles with a gross vehicle weight under 6,000 lbs.
|Vehicle Depreciation||Old Law (Pre 2018)||New Law (Post 2017)|
|Year 1||$3,160||$10,000 ($16,400 including additional bonus allowed)|
|Year 4 and Subsequent Years||$1,875||$5,760|
Small Business Accounting Method Reform and Simplification
Small business will be eligible to use the cash method (Code Section 488) of accounting if their average annual gross receipts for the preceding three tax years are $25,000,000 or less. Also, businesses with a 3-year average of $25,000,000 or less in gross receipts can chose to not apply Code Section 263A Uniform Capitalization Rules and the Inventory Rules under Code Section 471 to constructed property, plant, and equipment, and certain inventory.
Inventory still may not be deducted until it is sold under the non-incidental materials and supplies rule of Reg. 1.162-3.
Also, the gross receipt exemption that allows contractors to opt out of the percentage-of-completion reporting on long-term construction contracts is increased from $10,000 to $25,000,000.
Preparation of form 3115 will be required to change from the accrual method of accounting to the cash method.
Special Rules for Taxable Year of Inclusion of Items of Income
In the case of an accrual basis taxpayer, the all-events test of Code Section 451 requiring inclusion of an item of income in gross income is changed under the new law. It must be included no later than the tax year in which the item was included in income in an applicable financial statement, or other financial statements as specified by the Secretary of the Treasury.
Limitation on Business Interest Deduction
Businesses with average gross receipts for the prior three years over $25,000,000 are limited in the amount of business interest expense that can be deducted. The limit is the interest income plus 30% of the adjusted taxable income of the entity for the year. Adjusted taxable income is the taxable income of the entity plus the allowance for depreciation, amortization, and depletion.
The limitation is calculated at the entity level (e.g. a partnership, not the individual partners, would calculate the limitation), and any disallowed interest can be carried forward indefinitely.
Certain real property, construction businesses, and farms can elect out of the limitation, but in order to do so, they must use the ADS rather than the regular depreciation system on business assets.
Repeal of Other Business Deductions
The business deduction for entertainment expenses is repealed. This will require bookkeeping changes to account for meals and entertainment separately.
Also eliminated is the deduction for qualified transportation fringe benefits, and the deduction for qualified parking fringe benefit.
Effective for amounts paid after date of enactment of the new law, no deduction is allowed for settlement, payout, or attorney fees related to sexual harassment or abuse if payments are subject to a nondisclosure agreement.
Eliminated Employer Provided Moving Expense Reimbursement
The exclusion from income for qualified moving expense reimbursements has been eliminated.
Under current law, Code Section 1031, like-kind exchange rules, is a provision requiring deferral of income on exchanges of like-kind personal and real property. After 12/31/17, only real property is subject to the like-kind provisions.
Domestic Production Activities Deduction
The Code Section 199 Domestic Production Activities Deduction is eliminated under the new law.
Net Operating Loss Deduction
Under pre 2018 law, net operating loss deductions get carried back two years, and then forward up to twenty years. The new law eliminates the carryback, and losses can be carried forward indefinitely. Furthermore, the legislation limits the amount utilized in a particular year to 80% of taxable income (90% for Alternative Minimum Tax).
New Annual Limitation on Business Losses of Non-Corporate Taxpayers
Net business losses in excess of $500,000 for married filing joint ($250,000 for single filers) are suspended and treated as a net operating loss carryover; these threshold amounts are indexed for inflation. In the case of partnership and S corporation losses, these limits apply at the shareholder level, and the provision applies after application of the passive activity loss rules.
Limitation on Excessive Employee Compensation
The $1,000,000 limitation on the deduction for employee compensation remains under the new law. The act repeals the exception to this rule for certain commissions, performance-based compensation including stock options, payments to qualified retirement plans, and amounts excluded from the executive’s gross compensation. Employees for this purpose include the CEO, CFO, and the three other highest paid employees.
Employer Credit for Paid Family and Medical Leave
The bill creates a temporary credit for employers paying employees who are on family and medical leave. The credit ranges from 12.5 to 25% of the applicable wages paid to employees while on family leave.
After 2017, U.S. tax regime with respect to foreign income moves from taxing worldwide income to a quasi-territorial tax system. The system of taxation more closely resembles the system of taxation employed by many of our trading partners, including the United Kingdom and the European Union.
Prior to 2018, generally US corporations pay tax on foreign earnings when the dividend income is brought back to the United States. For distributions after 2017, all foreign source dividends will be excluded from income when paid to a US corporate shareholder that owns 10% or more of the foreign corporation (100% dividends received deduction). This is the carrot that encourages US companies to repatriate overseas earnings and profits (E&P).
This regime only works in the case of a U.S. corporation receiving a dividend from a 10% or more owned foreign corporation. A U.S. company receiving income from an unincorporated branch of the U.S. company located in a foreign country would not receive this dividend received deduction. Also, generally, income includible under Section 951 as Subpart F, Section 956, or Global Intangible Low Taxed Income (GILTI) is not income that is treated as a dividend. Therefore, such amounts generally would not qualify for the DRD.
The stick in the new tax regime is a tax on earnings and profits for the period 1986 through 2017 that have not been previously taxed 10% or more US shareholders of the foreign corporation. The portion of this previously untaxed E&P consisting of cash or cash equivalents will be taxed at 15.5%; the other portion of the E&P would be taxed at 8%. The US taxpayer can elect to pay the tax on the E&P over eight years in annual installments.
Prior to 2018, undistributed foreign earnings of a US subsidiary that are reinvested in US property were subject to tax; after 2017, the law eliminates this tax.
Income from the sale of inventory will be taxed solely on the basis of where the inventory was produced.
Payments to a foreign subsidiary that are deductible as part of cost of good sold or included in the basis of depreciable property will be subject to a 20% excise tax unless the foreign sub elects to have these payments fully taxed in the U.S.
50% of foreign subsidiary income over a certain return (7 percentage points plus federal short term rate) will be taxed to the U.S. parent. An acronym for this is the GILTI inclusion. This regime discourages income-shifting incentives by Imposing a minimum tax on certain foreign income described as “global intangible low-taxed income.”
Taxable Corporations (Subchapter C, etc.)
Corporate Tax Rates: The top corporate rate is decreased from 35% to 21% with no graduated tax rate structure. This new rate also applies to personal service corporations.
Dividends Received Deduction: The general dividends received deduction available to C-Corporations that own less the 20% of the corporation paying the dividends has been lowered from 70% down to 50%. The deduction for corporations owning at least 20%, but less than 80% of the company paying the dividends is lowered from 80% to 65%. The dividends received deduction for dividends received from subsidiaries (parent owns 80% to 100% of subsidiary stock) remains 100%.
International: The law changes income reporting for corporations from worldwide, to a territorial system.
Corporate AMT Eliminated: The bill eliminates the corporate Alternative Minimum Tax.
Interest Deduction: The amount of interest expense C-Corporations can claim as a deduction is now limited if income is over $25 million.
There are many other changes beyond those summarized in this post. Please contact us if you have any questions or concerns. We are also happy to setup consultation appointments to help with tax planning in regards the law changes.