On December 20th, congress passed The Tax Cuts and Jobs Act. It is an extensive bill with many parts, the effects of which are still being measured. But for those of you preparing 2017 taxes and looking ahead to 2018, we want to offer some insight into what the bill means for high-income earners. We know many of our clients are curious as to what impact this will have on annual taxes, and, as always, we want to keep you as informed and up-to-date as possible.
NOTE: This is not offered as tax advice. We encourage you to speak with a tax professional for advice specific to your financial situation.
WHAT IS IN THE TAX CUTS AND JOBS ACT?
Most provisions go into effect after 2017, and many individual tax provisions expire after 2025. This is not a comprehensive description of the tax bill, but it highlights notable changes (NOTE: All information below was compiled by Wilmington Trust):
INDIVIDUAL INCOME TAX HIGHLIGHTS
The Act replaces the current seven individual tax brackets with rates ranging from 10% to 37% for income above $500,000 (single); $500,000 (head of household); $600,000 (married); $300,000 (married filing separate). Rates are indexed for inflation after 2018, and expire after 2025.
The Act nearly doubles the standard deduction for taxpayers. New rates are $12,000 (single and all other taxpayers); $18,000 (head of household); $24,000 (married). Rates are indexed for inflation after 2018, expire after 2025, and retains the current additional standard for the elderly and blind. The new bill eliminates personal exemptions.
Itemized deductions are mainly limited to home mortgage interest; state and local income, sales, and property taxes; and charitable contributions. Here are a few notable changes to itemized deductions:
The Act limits the deductions for state and local income, sales, and property taxes to $10,000.
The Act retains the home mortgage interest deduction for new mortgages for principal and second residences, but limits the interest deduction to a $750,000 mortgage. The deduction for home equity interest is eliminated.
The Act slightly increases the allowable deduction for cash contributions to public charities from 50% to 60%, and otherwise retains the current charitable contribution deduction rules.
The Act retains medical expense deduction for expenses in excess of 7.5% of AGI for 2017 and 2018.
The Act retains investment interest deduction and student loan interest deduction.
The Act eliminates miscellaneous itemized deductions subject to 2% floor, personal casualty loss except for disasters, tax preparation expenses, investment fees and expenses, personal exemption, and the itemized deduction phase-out,
For divorce decrees and separation agreements entered into after 2018, alimony would no longer be deductible by the payor and is not counted as taxable income to the payee.
The Act retains the individual alternative minimum tax (AMT) with increased exemption amounts to $70,300 (single); $109,400 (married); $54,700 (married filing separate). The exemption phases out at $1,000,000 (married) and $500,000 (all others). These rates are indexed for inflation after 2018, and revert back to the current law after 2025.
When utilizing 529 Plans, The Act permits distributions of $10,000 per year for elementary and secondary schools, and also allows rollover to ABLE accounts.
The Act repeals the individual mandate of the Affordable Care Act.
The Act changes the method for calculating inflation indices so amounts indexed for inflation will grow more slowly.
WEALTH TRANSFER TAX HIGHLIGHTS
The Act retains the estate, gift, and generation-skipping transfer (GST) tax and doubles the exemptions to $10,000,000 for the period 2018-2025.
Heirs will continue to have a fair market value basis in inherited assets under both bills, and the gift tax remains in place.
Portability of a deceased spouse’s unused exemption is retained.
CORPORATE AND BUSINESS TAX HIGHLIGHTS
• The Act reduces the corporate tax rate to a flat rate of 21% and eliminates the special rate for personal service corporations.
• The Act provides a deduction of 20% of qualified business income from a partnership, S-Corporation or sole-proprietorship, which results in an effective top rate of 29.6%, subject to a phase-out. Trusts and estates are eligible for the 20% deduction. Deduction limits are based on specific service income and on W-2 wages and capital, phased in at $315,000 (married).
• The Act allows a 100% first-year expensing of certain depreciable assets for assets placed in service by September 27, 2017, along with a limitation of interest expense deductions.
• The Act repeals the corporate AMT.
• The Act limits net operating loss deductions to 80% of taxable income.
• The Act implements a territorial tax system through a 100% exemption for certain foreign source dividends. It also imposes a one-time repatriation tax of 15.5% on earnings and profits (liquid) and 8% on illiquid, and a tax on base erosion payments.
PROVISIONS WITH NO CHANGES
No change made to the specific identification method for sale of stock (or donative transfers to family or charity), so transfers of stock are not required to be made on a First-in, first-out (FIFO) basis.
The contribution limits for IRAs and 401(k) plans are unchanged.
The Act does not change the capital gains tax, net investment income tax, or the Medicare surtax.
WHEN PREPARING 2017 TAXES
1. Consider whether to prepay 2017 state and local income and/or property taxes, up until the point that it puts you in AMT for 2017. Note that you cannot prepay any 2018 income tax. Consult your tax advisor on whether any part of your property tax may be paid in advance. In 2018, the deduction for state and local income and property taxes will be limited to a total of $10,000. It is important to have your tax advisor run the projected tax impact; for many taxpayers in high-tax states who are already subject to the AMT, a prepayment would not be of benefit.
2. Check your tax brackets to see if you will be in a different tax bracket and what the marginal tax rate will be next year. If it is a lower rate than this year, then consider deferring income to next year.
3. Determine whether you will be able to itemize deductions in 2018, in light of the increased standard deduction and the reduced deductions available.
4. If you are a sole proprietor, LLC member, or partner in a partnership, consider deferring income until next year to take advantage of the new pass-through income deduction.
5. If you will continue to be an itemizer in 2018, consider whether to defer charitable contributions until next year when there is no phase- out of itemized deductions. Also the AGI limitation for cash gifts to public charities will increase from 50% to 60%.
6. Alimony will remain deductible in 2018, but will be disallowed under agreements entered into after December 31, 2018. So If you are in a divorce situation, try to get a property settlement agreement executed by December 31, 2018.
7. The conference bill doesn’t contain the FIFO rules for accounting for stock, so investors may continue to use specific identification for the sale or transfer of stock.
HOW DOES THE NEW TAX BILL AFFECT ME?
This is the question everyone needs to know. The answer varies based on your personal situation. As stated above, we suggest you consult with a tax professional who can help you navigate the new tax provisions. Our goal is to help you stay as educated and up-to-date as possible regarding your income and investments.