On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA), HR1, into law. The complex nature and last-minute timing of the bill make year-end strategic decisions challenging to evaluate. Depending on your circumstances, you may want to consult with your accountant to ascertain if any tax-minimization strategies should be completed before December 31of this year. Below, we highlight some of the tax bill's major changes:
Four major changes to the individual tax code go into effect on Monday, January 1 and end on December 31, 2025 due to sunset provisions: Lower tax brackets, an expanded child tax credit, an increased exemption amount for the alternative minimum tax, and a doubled exemption for estate taxes.
The final version of the TCJA cuts the top tax rate to 37%. The proposed rate had been 38.5% rate in the Senate version of the bill or the 39.6% rate in the House version. While many of the bracket thresholds are adjusted, the TCJA preserves the seven tax brackets:
- 10% retained
- 15% lowered to 12%
- 25% lowered to 22%
- 28% lowered to 24%
- 33% lowered to 32%
- 35% retained
- 39.6% lowered to 37%
Cambridge Insight: To the extent that a standard deduction can be considered a "zero tax bracket," then it should be noted that a "zero tax bracket" under the TCJA can be as large or even larger when considering personal exemptions.
Individual and Family Incentives
- The standard deduction for tax filers moves from $6,350 for singles, $9,350 for heads of Household, and $12,700 for joint filers to $12,000, $18,000, and $24,000 respectively.
- The personal exemption (currently $4,050 per eligible exemption) is eliminated.
- The Affordable Care Act (ACA, also referred to as “Obamacare”) mandate is eliminated, and no penalty can be imposed on individuals who do not wish to enroll in a health insurance plan effective starting in 2019.
The TCJA repeals the "kiddie tax" that applies parents' tax rates to the children's unearned income once income reaches a specific threshold. After December 31, 2017, the unearned income of children will be taxed at the trust and estate rates.
The tuition waiver benefit is preserved by the final bill. The House Bill would have taxed tuition waivers as ordinary income.
Cambridge Insight: Most taxpayers will have no need to itemize with the doubling of standard deductions, simplifying their tax returns and making it easier to file.
- The $7,500 credit for the purchase of an electric car is gone, starting in January 2018.
- The child tax credit is doubled from $1,000 to $2,000 per eligible child. Additionally, the phase-out is increased from $110,000 to $400,000 of adjusted gross income for those who are married filing jointly.
Individual alternative minimum tax (AMT)
AMT is retained but with higher thresholds and phaseouts ensuring the wealthy pay some form of tax. Beginning in 2018, the exemption amounts are increased and the phaseout thresholds rise to $1 million for joint filers and $500,000 for all other taxpayers. These figures are indexed for inflation before the AMT reverts back to the current law in 2026.
Federal Estate, Gift, and GST Tax
The TCJA doubles the estate and gift tax exemption for decedents dying between January 1, 2018 and December 31, 2025. The increased, inflation- adjusted exemption amounts for 2018 are doubled to $11.2 million for single filers and $22.4 million for joint filers. After December 31, 2025, the exemption amounts would revert to the prior 5 million amounts plus inflation adjustments.
The TCJA make important changes to itemized deductions:
- Mortgage interest deductions are eliminated on home equity loans.
- Mortgage interest on home loans is limited to $750,000 for any home acquisition after December 15, 2017. The provision would expire in 2026.
- Medical expenses: The AGI threshold for deducting medical expenses is reduced from 10% to 7.5%.
- Charitable deductions: The AGI limit on cash contributions is increased from 50% to 60% from 2018 through 2025.
- The state and local tax deduction (SALT): Under the new law, taxpayers are limited to deducting a combined $10,000 in state, real estate, and sales taxes.
Cambridge Insight: Some homeowners will be able to pre-pay some or all of their 2018 real estate taxes if the local tax authority permits and one does not escrow payments with a mortgage. This is a thorny issue so reach out to your accountant or local tax authority for guidance.
There are slight changes to income thresholds for the 0%, 15%, and 20% rates beginning in 2018, and they do not match up with the TCJA tax rate brackets. Under previous tax law, the 0% rate was applied to the two lowest tax brackets, the 15% rate to the next four brackets and the 20% rate was applied to the highest tax bracket.
The TCJA retains the 3.8% Affordable Care Act tax on net investment income for certain high income earners with the same income thresholds.
The awful Senate draft bill “back door" capital gains hike on individual investors did not make it into the final bill. Taxpayers will continue to be able to select which shares of securities they sell or gift using the first in, first out (FIFO) rule from a pool of identical securities with different bases.
Business Income Tax:
One of the most significant changes under the TJCA is the tax treatment of businesses. U.S. corporate tax rates are now competitive with many other countries, and it’s expected to spur investment in equipment, buildings, and labor.
- The TJCA permanently cuts the corporate tax rate from 35% to a flat rate of 21% after December 31, 2017.
- Pass-through entities are allowed a new deduction for the lesser of 20% for qualified pass-through income or 50% of W-2 wages paid with respect to the business income to bring the rate lower. The deduction is not affected whether the owner is active or passive. However, it can get tricky since the deduction is subject to new restrictions and limits.
- Certain service businesses are prohibited from benefiting from the lower rate. Disqualified service businesses are defined as: law, health, investment management, partnership interests, engineers, and architects to name a few.
For a closer look at how the new rules will affect various pass-through entities, check out this piece by Forbes contributor, Kelly Phillips Erb.
The Bottom Line
Going forward in 2018, there are considerable areas of ambiguity in the TCJA that will create planning challenges for many tax filers (and additional revenue for large accounting and tax law firms). As with any sweeping legislation changes, possible amendments to rectify unintended consequences of the new law will evolve as practitioners become familiar with the TCJA.
You should strongly consider what year-end planning opportunities may be possible. Here are a few to contemplate:
- Consider potential changes in income and personal circumstances in light of potential tax law changes.
- Consider bunching itemized deductions.
- Accelerate or prepay deductions in 2017. Why? Higher tax rates this year = more valuable deductions plus potential complete loss of certain tax deductions in 2018.
- Prepay your 2018 property taxes (the new threshold is $10,000) if the local tax authority permits and you do not escrow payments with a mortgage.
- Pay down your home equity line or refinance your home mortgage.
- Consider AMT: Defer or accelerate income and bonuses to the extent possible.
If you would like to read the conference report here (downloads as a large pdf - 1097 pages).
Sources: The Tax Cut and Jobs Act of 2017, H.R.1, 115th Congress; Wall Street Journal Online; Bloomberg News; Forbes.com; CNBC News; The Heritage Foundation.org; Reuters News.
The information contained in this piece is intended for information only and should not be considered investment or tax advice. Please contact your financial adviser with questions about your specific needs and circumstances.
The information and opinions expressed herein are obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by Cambridge Wealth Management, LLC. Opinions expressed are current as of the date of this publication and are subject to change. Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties.