The Tax Cuts and Jobs Act (TCJA) has officially become law and will affect you starting this year. This is the most sweeping tax reform in 30 years. Like with any tax bill, there will be winners and there will be losers. It’s universally agreed that “most” Americans will pay lower taxes in 2018. Californians, however, may not reap as much of the benefit because of new limits on mortgage interest deduction and a cap on “SALT” (State and Local Tax) deductions. Large corporations appear to be the biggest winners with the corporate tax rate dropping from 35% to 21%. Below are some key elements and planning considerations resulting from the law. Please be advised that this is not an exhaustive summary; this law is quite complex and affects many areas of the tax code and economy. Prior to making any substantial financial changes, please consult with us and your accountant.
Who benefits from TCJA?
- Large Corporations
- The corporate tax rate will drop from 35% to 21%.
- Repatriation of currently deferred foreign profits will be taxed at 15.5 percent for profits and 8 percent for reinvested foreign earnings.
- These two significant changes will help corporate profitability and promote greater reinvestment in the USA.
- Certain small businesses will receive a tax deduction on their profits.
- “Most” Americans will pay lower taxes in 2018. How this will occur could be the result of a higher Standard Deduction, higher Child Tax Credit, a lower Federal Tax Bracket, or another attribute.
What are the major changes for most individuals?
Standard Deductions, Personal Exemptions and Tax Brackets
Personal exemptions were eliminated. The Standard Deduction will be doubled to $24,000 for married couples ($12,000 for individuals). The highest individual marginal tax rate is now 37%, and most brackets have been lowered. For any divorce agreement executed after 2018, alimony is also no longer deductible by the payor and no longer included as income by the recipient.
Alternative Minimum Tax
The “Pease Limitation”, which reduced itemized deductions for higher income earners, has been removed. Essentially, Alternative Minimum Tax (AMT) has been adjusted to kick in at higher incomes, which will make AMT applicable to fewer people.
Itemized Deduction Changes
The ability to deduct mortgage interest will be reduced to new indebtedness of $750,000 from the current $1,000,000. Those with existing mortgages will be grandfathered in. Interest payments on Home Equity loans (new and existing) will no longer be tax deductible. “SALT” (State and Local Tax) deductions will be capped at $10,000. Miscellaneous Itemized Deductions subject to a 2% AGI floor were eliminated. This means that itemized deductions for tax preparation and investment advisory fees associated with taxable accounts have been eliminated, along with all other miscellaneous itemized deductions.
College and Family Benefits
The child tax credit was increased from $1,000 to $2,000. It also expanded the number of families eligible to claim it by increasing the AGI phase outs ($400,000 for married couples, up from $110,000 in 2017). Up to $10,000 annually from a 529 account can now be used for primary and secondary school, not just college.
Kiddie tax was modified such that earned income from a child will be taxed as a single individual (as opposed to the parent’s rate). Net unearned income (typically from an investment portfolio) will be taxed at the same rate as trusts. For most families, this will lower the taxes that result from their child’s portfolio income or working wages.
Retirement Account Changes
The majority of the 401(k) and IRA rules that we all know have not been affected. The maximum employee contribution for 401(k) Plans has increased from $18,000 to $18,500 per year. 401(k) borrowers will now have more time to repay loans. The current deadline is 60 days after departing your current company. That has be extended to the day you file your federal tax return.
Roth re-characterizations are going away. Be sure to work with your CPA to come up with an accurate number for your Roth conversion this year. And err on the side of a lower conversion amount. No more “do-overs.”
Estate Tax and Gift Tax Exemptions Doubled
The federal estate tax, gift tax, and generation‐skipping tax exemption amounts have doubled to $22.4 million for couples ($11.2 million per person). For many families this will no longer make them subject to Estate Tax upon their death. The annual gifting limit has also increased from $14,000 to $15,000.
Fringe Benefit deductions will change. Deductions for entertainment expenses have been eliminated (the 50% deduction on business meals has not been removed).
Qualified Business Income (QBI) from “pass‐through” entities such as partnerships, S corporations, sole proprietorships, rental real estate, and real estate investment trusts will receive a new 20% deduction for this type of income. However, most “service-based” companies will not qualify for this and the income phase-out start at $315,000 for married tax filers.
Section 179 deductions (the ability to deduct 100% of certain business property in the year purchased) has been increased to $1,000,000 and the income phase-out threshold increased to $2,500,000
Keep in mind that nearly all of these tax changes (except for the corporate rate decrease) are only effective through 2025. At that point, unless Congress passes another law, these tax changes will revert back to the laws as of 2017. Tax laws tend to change over time, so when it comes to long term planning, flexibility is key. For example, the recent increase in the Estate Tax Deduction could make in-depth estate planning seem unnecessary, but active planning and adjustments may still need to be considered.
Certainly, there are many more changes that we have not covered here and by no means is this a comprehensive review of the new law. Your CPA will have information specific to your unique situation. For additional information about tax bracket changes, here’s a link to an article from Fidelity with good information: Click here to read more.
With best wishes,
The Donnelly Wealth Advisors Team