As of the writing of this article, the Senate and House of Representatives have passed the Tax Cuts and Jobs Act (the “Act”) and it is being sent to President Trump to sign into law. The new tax laws that are slated to become effective January 1, 2018 will be a bit of a shock to the system for everybody. Even though it is extremely likely the Act will become law, there will likely be a few corrections to the Act throughout 2018. This article will go over a summary of some of the changes that were made to the Internal Revenue Code effective January 1, 2018 and what you should start talking to your tax professional about.
The biggest change by far are the tax rates that have been lowered across the board. The corporate tax rate is lowered from 35 to 21 percent and while there will still be seven personal tax brackets, five of them have been reduced. The rates start at 10 percent and rise to 12, 22, 24, 32, 35 and 37 percent. The highest rate will apply to single individuals whose income exceeds $500,000 and $600,000 for joint filers. The alternative minimum tax (AMT) is also drastically changed. AMT is now eliminated for corporations and the exemption amount for joint filers is increased to $109,400 with the exemption phase-out increased to $1 million for joint filers. Accordingly, AMT will remain for some individual filers, but its impact has been softened.
The Act also allows taxpayers to claim a $2,000 credit for each qualifying child under the age of 17. The credit is for both single filers as well as married couples and is fully refundable up to $1,400. This means that if your income is low enough for the credit to be more than the tax you owe, the IRS will cut you a check up to the refundable amount.
The Act has doubled the standard deduction for a married couple to $24,000 so many taxpayers will no longer need to itemize their deductions on Schedule A to Form 1040. For those taxpayers that will still need to itemize their deductions on Schedule A, there is a cap of $10,000 for state and local taxes which also includes property taxes. The mortgage interest deduction will also be reduced. Previously, a taxpayer could deduct mortgage interest for a home mortgage of up to $1 million, but now the deduction is only for mortgages up to $750,000. However, this reduction only applies to new purchases after the Act goes into effect.
The Act keeps the current deduction for student loan interest and the tax free nature of tuition waivers received by graduate students. The medical expense deduction will also remain for expenses that exceed 7.5 percent of your adjusted gross income.
The Act now repeals the deduction for alimony payments and inclusion of those payments in income by the recipient for divorce or separation agreements executed after December 31, 2018. There would not be an impact on agreements executed prior to December 31, 2018. This could be a substantial change.
The Affordable Care Mandate for all taxpayers to have health insurance will be eliminated starting in 2019. This means you will no longer pay a tax penalty if you do not have health insurance. This does not mean that people will be losing their health insurance as everyone can still elect to have health insurance. They just are no longer mandated to have it and pay a penalty if they do not have it. Other than the repeal of the individual mandate, the other provisions of the Affordable Care Act remain in place.
The Act also provides the business community with a huge boost now that the Section 179 expense deduction will let companies write off equipment purchases up to $1 million, instead of $510,000.
The Act also repeals the domestic production activities deduction found under Internal Revenue Code (IRC) Section 199 and replaces it with the qualified business income deduction found under new IRC Section 199A. This new deduction partially mimics the domestic production activities deduction, but now applies only to pass-through income. The deduction is meant to have pass-through income subject to lower tax rates in a similar fashion to those of corporate tax rates. The Act provides a deduction of 20% of business income at the individual level for non-corporate taxpayers who have qualified business income from partnerships, S corporations, or sole proprietorships. The definition of business is very broad and rental real estate income is included. The business income can be either passive or active income on the individual’s tax return. The deduction is limited to 50% of qualified W-2 wages paid by the business, but that limit has two very large exceptions: (1) the W-2 wages paid limit does not apply to taxpayers with more than $315,000 of taxable income (before the deduction) for married filing jointly. The deduction limit is phased in over the next $100,000 of taxable income above $315,000; and (2) the W-2 wage limit on the 20% deduction also counts the unadjusted cost (original acquisition cost) of depreciable property (real or personal) towards the limit. Owners of professional service businesses (e.g., law, accounting, medical, but not engineering or architecture) cannot take the deduction unless their total income is below the same thresholds described above.
The Act also significantly increases the estate and gift tax exemption amounts such that the estate and gift tax will now be mostly eliminated for all but the wealthiest of all taxpayers. The estate tax rate will still be 40 percent, but the exemption amount has been doubled to $10.98 million for individuals and $21.96 for married couples. This also applies to gifts.
As an example of how the old and new rules stack up tax wise, assume a hypothetical family of 4 (2 qualifying kids) make $250,000 in California, with $15,000 in mortgage interest, $20,000 state income tax, $4,000 property tax and $1000 in charitable contributions. Under the old rules, the tax liability would be $41,148, however under the new rules, the tax liability would be around $38,819. These tax amounts are not quite the doomsday scenario some commentators are making the tax reform out to be. The hypothetical family would pay less tax under the new rules. This example is based on the tax calculator found at https://www.calcxml.com/calculators/trump-tax-reform-calculator?skn=#results. Other tax calculators can be found online by searching for “Trump Tax Plan Calculator” so you can run your own individual scenarios.
This is not going to be the end of the tax reform saga. Corrections and clarifications will be required so keep tuned. You likely have plenty of questions and I recommend you visit your tax professional to figure out how these changes affect you.
– Jason W. Harrel is a Partner at Calone & Harrel Law Group, LLP who concentrates his practice in all manners of Taxation, Real Estate Transactions, Corporate, Partnership and Limited Liability Company law matters. He is a certified specialist in Taxation. Mr. Harrel may be reached at 209-952-4545 or firstname.lastname@example.org
– Darren J. Pluth is an Associate at Calone & Harrel Law Group, LLP who concentrates his practice in all manners of Taxation. Mr. Pluth may be reached at 209-952-4545 or email@example.com