On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law. This legislation is the most sweeping change in federal tax law in the last thirty years. The following is a summary of the key provisions affecting both individual and business taxpayers:
Individual Income Tax
Under the Tax Cuts and Jobs Act, there will still be seven tax brackets; however, the tax rates and ranges for the brackets will change as indicated in the tables below. The maximum tax rate will be reduced from 39.6% under prior law to 37% under the TCJA. The new brackets and rates will apply to tax years beginning after December 31, 2017 and before January 1, 2026.
Increase to Standard Deduction Amounts
The TCJA nearly doubles the standard deduction by increasing it to $24,000 for married individuals filing a joint return, $18,000 for head of household filers and $12,000 for all other individuals which will be indexed for inflation for tax years beginning after 2018. However, all increases are temporary and would end after December 31, 2025.
The doubling of the standard deduction is expected to effectively eliminate most individuals from claiming itemized deductions other than higher-income taxpayers. For example, for the vast majority of married taxpayers filing jointly, only those with allowable mortgage interest, state income and local income/property taxes, and charitable deductions would claim itemized deductions. With fewer individuals claiming itemized deductions, this could have a broad impact on real estate prices and charitable organizations, despite retaining these two deductions in modified form.
Repeal of Personal Exemption
The personal exemption amount is repealed for tax years starting in 2018 but only through 2025.
Mortgage Interest Deduction
The TCJA limits the mortgage interest deduction with respect to home acquisition indebtedness interest to $750,000 ($375,000 in case of married taxpayers filing separately), for debt incurred after December 15, 2017. For tax years beginning after December 31, 2025, the limitation reverts back to $1,000,000 regardless of when the debt was incurred. Taxpayers will still be able to include mortgage interest on second homes in this itemized deduction, but within the new limitation amounts. However, the act suspends the deduction for interest on home equity indebtedness for tax years beginning after December 31, 2017 and before January 1, 2026.
It is expected that these limitations on the mortgage interest deduction will likely negatively impact the real estate industry by triggering a decline in value of real estate prices.
State and Local Tax Deduction
Itemized deductions for all nonbusiness state and local taxes, including property taxes, will be limited to $10,000 or $5,000 for a married taxpayer filing a separate tax return. However, sales taxes may be included in this itemized deduction as an alternative to claiming state and local income taxes.
In addition, taxpayers will not be allowed a deduction in tax year 2017 for prepayment of state income taxes for a future year.
Under the TCJA, the adjusted gross income limitation on cash contributions would increase from 50% to 60%, effective for contributions made in tax years beginning after 2017 and before 2026.
Medical Expense Deductions
For tax years beginning after December 31, 2016 and ending before January 1, 2019, the TCJA would reduce the medical expense deduction floor to 7.5% of adjusted gross income.
Miscellaneous Itemized Deductions
Any miscellaneous itemized deductions that are currently subject to the two-percent floor will be repealed.
Child Tax Credit
The TCJA temporarily increases the child tax credit from $1,000 to $2,000 per qualifying child and up to $1,400 of that amount would be refundable. The phaseout threshold would be raised starting at adjusted gross income of $400,000 for joint filers as well as $200,000 for all others. In addition, this credit will also provide a $500 nonrefundable credit for qualifying dependents other than qualifying children.
The TCJA keeps the student loan interest deduction and modifies section 529 plans and ABLE accounts. The new law does not renew the pre-adjusted gross income (AGI) deduction for education expenses that expired at the end of 2016.
Individual Alternative Minimum Tax
The individual AMT exemption would be increased to $109,400 for joint filers ($70,300 for others, except trusts and estates). It would also raise the exemption phase-out levels so that the AMT would apply to an income level of $1 million for joint filers ($500,000 for others).
Affordable Care Act
The TCJA repeals the Affordable Care Act (ACA) individual shared responsibility requirement, making the payment amount $0. This change will be effective for penalties assessed after 2018.
The Internal Revenue Service has cautioned that, under current law, for tax year 2017, it will not consider a return complete and accurate if the taxpayer does not report full-year coverage, claim a coverage exemption, or report a shared responsibility payment on the tax return.
Estate and Gift Tax
Increase to Exemption
The estate and gift tax exemption would be doubled to $22 million for couples and $11 million for individuals for decedents dying and gifts made after 2017. However, the exemptions would revert to current levels after 2025.
The GST tax exemption would also double for generation-skipping transfers made after 2017 and before 2026.
Tax Rates and Alternative Minimum Tax
For tax years beginning after December 31, 2017, a 21% flat corporate tax rate will apply to all C-corporations. The corporate alternative minimum tax will be repealed.
Pass- Through Businesses
For tax years beginning after December 31, 2017, and before January 1, 2026, a new deduction of 20% will be available for taxpayers who have domestic “qualified business income” from a partnership, S corporation or sole proprietorship. The deduction reduces taxable income, and not AGI, and eligible taxpayers receive the deduction whether or not they itemize.
The deduction would generally be limited to the greater of either: (a) 50% of the taxpayer’s allocable share of W-2 wages paid by the qualified trade or business, or (b) the sum of 25% of the W-2 wages paid by the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property.
Note: The second option for calculating the wage limit was added by the Conference Committee to the bill and would permit real estate businesses with large capital investments, but few employees, to qualify for a deduction under this provision. Additionally, the W-2 wage limit would not apply to a taxpayer with taxable income not exceeding $315,000 (for married individuals filing jointly) or $157,500 (for other individuals) and the application of the wage limit would be phased in for individuals with taxable income exceeding these amounts.
Temporary Full Expensing of Business Assets
The TCJA increases the 50% “bonus depreciation” allowance to 100% for property placed in service after September 27, 2017 and before January 1, 2023. After that date, a 20% phase-down schedule would then be applied. The requirement that the original use of the property must begin with the taxpayer is removed; therefore used property newly acquired by the taxpayer is eligible for expensing.
Interest Expense Deductions
The deduction for interest expenses incurred by a business will be limited to 30% of adjusted taxable income. However, exceptions would exist for small businesses, including an exemption for business with average gross receipts of $25 million or less. Any unused business interest expense could be carried forward indefinitely.
Net Operating Losses
The net operating loss deduction will be limited to 80% of taxable income and will provide that amounts carried to other years be adjusted to account for the limitation for losses arising in tax years beginning after December 31, 2017. In addition, net operating loss carrybacks will be eliminated after 2017 except for a one-year carryback for small business in the case of casualty or disaster losses and a two-year carryback for farmers.
The TCJA moves the US to a territorial system. It also creates a dividend exemption system for taxing US corporations on the foreign earnings of their foreign subsidiaries when the earnings are distributed.
Part of the deferred overseas held earnings and profits of foreign subsidiaries will be taxed at a reduced rate of 15.5% for cash assets and 8% for illiquid assets. Foreign tax credits triggered by the deemed repatriation would still be partially available to offset the US tax.
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As with any new tax legislation, there will be “winners” and “losers” under this historic bill. Since these new tax provisions affect both individuals and business taxpayers, please contact us regarding any questions you may have and steps you should take now and in the future.
Bloomberg Tax — Roadmap to 2017 Tax Reform Act Compared to Pre-Reform Law
CCH – Tax Briefing Special Report on the New Tax Reform Act Signed Into Law