Here is Your New Simplified Tax Law
Here is Your New Simplified Tax Law
By Jon Aldrich
The House and Senate have now both approved the reconciled version of the Tax Cuts and Jobs Act (TCJA) of 2017 and it will soon be on the President’s desk awaiting his signature to become law. The House and Senate versions were somewhat different, this is the result of a lot of late night meetings to arrive at a bill that the Republican’s agree on (Democrats probably not so much) but that will be enough for it to become law starting in 2018.
Despite the promise of tax “reform” or “simplification,” the bill actually adds hundreds of pages to our tax laws. And the initial idea of reducing the number of tax brackets was apparently tossed aside in the final version; the new bill maintains seven different tax rates: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Most people will see their bracket go down by one to four percentage points, with the higher reductions going to people with higher income. And the tax brackets, going forward, will be indexed to inflation, meaning that the “real” income brackets will remain approximately the same from year to year.
The new brackets break down like this:
Joint Return Taxpayers
Taxes for trusts and estates were also changed to:
Let’s look at the other major provisions that will affect the most people. There is a lot more to the law than what is described below, but you probably don’t feel like reading “War & Peace” so I will try to keep it relatively short.
Remember, AGI = Adjusted Gross Income.
Standard Deduction & Elimination of Exemptions:
One of the biggest changes is that the standard deduction is basically doubled, to $12,000 (single) or $24,000 (joint), $18,000 (head of household), and in an interesting provision, persons who are over 65, blind or disabled can add $1,300 to their standard deduction. The current standard deductions in 2017 are $6,350 for (single), $12,700 (joint) and $9,350 (head of household).
However, the bill giveth and the bill taketh away as it calls for no personal exemptions for 2018. The personal exemption in 2017 was $4,050 per person. Thus, a married couple that uses the standard deduction (does not itemize) in 2017 would currently get $12,700 for the standard deduction + $8,100 for their 2 personal exemptions for a total of $20,800. Under the new tax bill this combined amount is now $24,000, so someone in this situation is better off.
This new combined standard deduction/exemption is not such a great deal for everyone though. Consider a family of 5, with 3 kids all under age 17 with a joint income of $150,000. Under the current tax law they would get the $12,700 standard deduction plus 5 personal exemptions @ $4,050 = $20,250, for combined total deductions of $32,950, versus the new $24,000 standard deduction. Sounds like a raw deal for them. But, wait, there is a silver lining:
The family above did not qualify for the current child tax credit of $1,000 per child under 17 because their income was too high. The income phaseouts to be able to claim this credit were $75,000 for singles and $110,000 for joint. Under the new law the child tax credit will now be $2,000 for child under 17 and the income phaseouts rise to $300,000 for singles and $400,000 for joint filers. The ability to utilize this tax credit will more than offset the reduced standard deduction and a family in this situation will save about $2,700 in taxes in 2018 versus 2017.
If you currently itemize, you will now need to have itemized deductions that exceed the amounts discussed above to continue to itemize. There have also been a few changes and eliminations of some key itemized deductions:
Itemized: State & Local Income and Property Taxes
There will be a $10,000 limit on how much any individual can deduct for state and local income tax and property tax payments. Before you rush to write a check to the state or your local government, know that a provision in the bill states that any 2018 state income taxes paid by the end of 2017 are not deductible in 2017, and instead will be treated as having been paid at the end of calendar year 2018. The original proposals wanted to do away with all state, local and property tax deductions, so here is an example of some of the compromises that were made to get to this point.
Itemized: Elimination of Miscellaneous Expenses > 2% of AGI
This was the area where things such as Investment Advisor fees, tax return prep fees, legal expenses, unreimbursed job expenses, Union dues, etc. could be deducted for everything that was greater than 2% of your adjusted gross income. This has now been eliminated and you will not be able to deduct these in the future. This is a bummer.
Itemized: Pease Out!
The Pease limitation (named for the Senator who created the rule), which is a gradual phaseout of itemized deductions as taxpayers reached higher income brackets (greater than $261,500 AGI for individuals and $313,800 AGI for joint filers), has been eliminated.
Itemized: Mortgage Deduction and Home Equity Interest
The mortgage deduction will be limited to $750,000 of principal (down from a current $1 million limit); any mortgage payments on amounts above that limit will not be deductible.
But the one that will affect more people is the loss of the tax deduction for interest on Home Equity loans. Starting in 2018 this will no longer be tax deductible. Another bummer!
Itemized: Charitable Contribution Limits Expanded
Hey, good news here, current rules limit the deduction for cash donations to charities at 50% of your AGI. Under TCJA that limit is expanded to 60% of AGI. This is going to make it easier for those that make substantial charitable donations to make larger donations to claim the full deduction and help those who may have charitable carryforward deductions from prior years that could not be deducted get utilized.
Itemized: Medical Deductions
For 2017 and 2018 only, Medical expenses will now only have to exceed 7.5% of your AGI to be deductible in these years. This is down from the current 10% of AGI level. Starting in 2019, though, it reverts back to the current 10%.
Alternative Minimum Tax (AMT)
Despite the hopes of many taxpayers, the dreaded alternative minimum tax (AMT), remains in the bill. The individual exemption amount is $70,300; for joint filers it’s $109,400. But for the first time, the AMT exemption amounts will be indexed to inflation. The good news is that even though AMT was not repealed, with the other changes with itemized deductions it is going to be very difficult to be impacted by AMT.
Interestingly, the new tax bill retains the old capital gains tax brackets—based on the prior brackets. The 0% capital gains rate will be in place for individuals with $38,600 or less in income ($77,200 for joint filers), and the 15% rate will apply to individuals earning between $38,600 and $452,400 (between $77,400 and $479,000 for joint filers). Above those amounts, capital gains and qualified dividends will be taxed at a 20% rate. The 3.8% Medicare surtax on net investment income remains in place for singles with AGI > $200,000 and joint filers AGI > $250,000.
Roth Recharacterizations Eliminated
In addition, the rules governing Roth conversion recharacterizations will be repealed. Under the old law, if a person converted from a traditional IRA to a Roth IRA, and the account lost value over the next year and a half, they could simply undo (recharacterize) the transaction, no harm no foul. Under the new rules, recharacterizing would no longer be allowed. This does not affect any other rules on making Roth conversions.
What about estate taxes? The bill doubles the estate tax exemption from the current projected amount for 2018 of $5.6 million to $11.2 million; $22.4 million for couples. Meanwhile, Congress maintained the step-up in basis, which means that people who inherit low-basis stock will see the embedded capital gains go away upon receipt. However, Illinois has no plans to change their exemption from the current $4,000,000 per person amount. So, estate plans will still need to consider this effect as will those in a number of other states.
529 College Savings Plans
The big change in 529 Savings plans is that distributions can now be used tax-free (up to $10,000 a year) for private elementary and secondary school expenses as well as homeschooling expenses. These types of expenses were not allowed under the old tax rules as everything had to pertain to college expenses.
Public “C” Corporations saw their highest marginal tax rate drop from 35% to 21%, the largest one-time rate cut in U.S. history for the nation’s largest companies. Of course, they are going to use this tax savings to pay their employees more 🙂 .
And pass-through entities like partnerships, S corporations, limited liability companies and sole proprietorships will receive a 20% deduction on taxes for “qualified business income,” which explicitly does NOT include wages or investment income. Since it appears that “C” Corporations will be receiving better tax treatment going forward, there is likely to be a lot of conversions from “S” Corp’s to “C” Corps. The accountants and attorneys are salivating right now.
Into the Sunset
As things stand today, all of these provisions are due to “sunset” after the year 2025, at which point the entire tax regime will revert to what we have now. I can already imagine all the fun we will be having again in late 2024 as lawmakers scramble to figure out what to do when this becomes imminent. But I am sure they will address this years ahead of time 🙂 .