Now that tax season is over and many 2017 tax returns are complete (except those that were extended), it’s time to start thinking about 2018.  There are a lot of changes applicable to 2018 and most taxpayers should consider a review or projection for 2018 so they can understand how the tax law changes will affect them. 

On December 22, 2017, the President signed into law the Tax Cuts and Jobs Act of 2017 (TCJA). TCJA is the largest tax overhaul since the 1986 Tax Reform Act and it will affect almost every individual and business in the United States. Generally, the new law goes into effect in 2018, with many of the provisions relating to individuals expiring at the end of 2025.

Because there were so many changes to the law, we’re going to prepare a series of articles over the summer to address the specifics of the TCJA. 
 

OVERVIEW OF TCJA CHANGES AFFECTING INDIVIDUALS

Tax Rates and Brackets. TCJA provides seven tax brackets, with most rates being two to three points lower than the 2017 tax brackets (the top rate goes from 39.6 percent to 37 percent). The top rate kicks in at $600,000 of taxable income for joint filers, $300,000 for married taxpayers filing separately, and $500,000 for all other individual taxpayers.

While applicable rates at any given level of income generally go down by two to three points, some go up. For example, the rate for single individuals with taxable income between $200,000 and $416,700 goes from 33 percent to 35 percent.

Capital Gain Rates and Net Investment Income Tax. Tax rates on capital gains and the 3.8% net investment income tax (NIIT) are unchanged by TCJA.  The 15% long-term capital gain rate increases to 20% when income reaches $479,000.  The 0% long-term capital rate is still in place when taxable income remains below $51,200. 

Limitation on Business Losses. TCJA disallows a deduction for aggregate losses in excess of $250,000 for single filers and $500,000 for joint tax returns attributable to the taxpayer’s trade or business, and losses that are deductible under the passive activity loss rules. 

Personal Exemptions and Standard Deduction. TCJA repeals the personal exemption deductions, but nearly doubles the standard deduction amounts to $24,000 for joint filers and surviving spouses, $18,000 for heads of household, and $12,000 for single individuals and married filing separately (additional amounts for the elderly and blind are retained).

The fact that the standard deduction has nearly doubled may create the misleading impression that you'll reap a large tax benefit from the change. But, because the increase in the standard deduction was coupled with the repeal of the deduction for personal exemption ($4,150, per exemption in 2018), the actual benefit is fairly modest. For example, the overall amount of income that is exempt from tax will increase by $2,700 for joint filers - a nice increase, but nowhere near double the $13,000 standard deduction under prior law.

Because the standard deduction is generally claimed only when the amount exceeds available itemized deductions, the increases will not benefit you if you itemize (the repeal of personal exemptions, by contrast, will affect you whether you itemize or not).

Exemption for Dependents and Child Tax Credit. As part of the repeal of personal exemption deductions, TCJA repealed exemptions for dependents. To compensate, TCJA increases the child tax credit to $2,000 ($1,400 is refundable), up from $1,000 (fully refundable) under present law. The modified adjusted gross income threshold where the credit phases out is $400,000 for joint filers and $200,000 for all others (up from $230,000 and $115,000, respectively). The maximum age for a child eligible for the credit remains 16 (at the end of the tax year).

TCJA also provides a $500 nonrefundable tax credit for dependent children over age 16 and all other dependents.  Typically this will include children who are full-time college students and adult family members that can claimed as a dependent on your tax return. Most families with non-child dependents will lose some ground here, as the $500 credit will generally be less valuable than the $4,150 exemption deduction it replaces.

Other Tax Breaks for Families Unchanged. The child and dependent care expenses credit, the adoption credit, and the exclusions for dependent care assistance and adoption assistance under employer plans are all unchanged by TCJA.

Moving Expenses. TCJA repealed the deduction for all moving expenses, except for members of the Armed Forces.

Pass-through Tax Break. TCJA creates a new 20 percent deduction for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. The deduction, which is available to both itemizers and non-itemizers, is claimed by individuals on their personal tax returns as a reduction to taxable income. The new tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below $315,000 ($157,500 for single filers) are simpler and more permissive than the ones that apply above those thresholds.

Example: In 2018, Joe has $50,000 of qualified business income from a side business that he runs as a sole proprietor. Joe has no other items of income or loss. Joe's deduction for qualified business income in 2018 is $10,000 (20 percent of $50,000).

The effective marginal tax rate on qualified business income for individuals in the top 37-percent tax bracket who are able to fully apply the new deduction will be 29.6 percent - fully 10 points lower than the top rate under current law.  We will more thoroughly break-down the benefits and pitfalls of the 20% deduction for qualified business income. 

ITEMIZED DEDUCTIONS

Deduction for State and Local Taxes (SALT). TCJA imposes a $10,000 limit on the deduction for state and local income taxes, real estate taxes, sales tax, and repeals the deduction for foreign property taxes. There was no limit on the amount of the SALT deduction under the pre-2018 tax law.

The SALT deduction limitation does not apply to taxes paid in conjunction with a trade or business, or income producing activity like a sole proprietorship (Schedule C), rental real estate activity, farming, fishing or horticultural activity or farm rental. 

Mortgage Interest Deduction. TJCA reduces to $750,000 (from $1 million) the limit on the loan amount for which a mortgage interest deduction can be claimed by individuals, with existing loans entered into before 12/15/17 grandfathered at the higher limit of $1 million. TCJA also repeals the deduction for interest on home equity loans.

Deduction for Medical Expenses. An early version of the tax overhaul passed by the House would have repealed the deduction for unreimbursed medical expenses. TCJA retains that deduction and enhances it for 2017 and 2018 by lowering the adjusted gross income (AGI) floor for claiming the deduction from 10 percent to 7.5 percent for all taxpayers.

Deduction for Casualty and Theft Losses. TCJA repeals the deduction for casualty and theft losses, except for losses incurred in presidentially declared disaster areas.

Deduction for Charitable Contributions. TCJA retains the charitable contribution deduction and increases the maximum contribution percentage limit from 50 percent of a taxpayer's contribution base to 60 percent for cash contributions to public charities.

Deduction for Certain Miscellaneous Expenses. TCJA repeals the deduction for any miscellaneous itemized deductions subject to 2-percent of AGI floor.  This includes investment advisory fees, tax preparation fees, union dues, and unreimbursed employee expenses. 

OTHER PROVISIONS

Repeal of Alimony Deduction. TCJA repeals the deduction for alimony paid and also the corresponding inclusion in income by the recipient, effective for tax years beginning in 2019. Alimony paid under separation agreements entered into before 2019 will generally be grandfathered (deductible / taxable income) under the old rules.

Education-Related Tax Breaks Preserved. TCJA retains deductions for student loan interest and educator expenses, and also exclusions for graduate student tuition waivers and employer educational assistance programs.

Alternative Minimum Tax. TCJA increases alternative minimum tax (AMT) exemption amounts to $109,000 compared to $78,750 in 2017, and sharply increases the income level where the exemption is phased out. Combined with the effects of other TCJA changes, many individuals who are currently subject AMT in 2017, will not be in 2018 and beyond.  Budgets have estimated that taxpayers subject to AMT will drop from 8 million to 800,000. 

Expanded Uses for 529 Plan Distributions. TCJA allows up to $10,000 in aggregate 529 distributions per year to be used for elementary and secondary school tuition. Under present law, 529 distributions can only be used for higher (college) education expenses.

Repeal of Individual Healthcare Mandate. Beginning in 2019, TCJA repeals the tax penalty on individuals who fail to carry health insurance enacted as part of the Affordable Care Act (ACA).  Its unclear what will happen to the exchange that sells health insurance subject to the ACA after 2019.

Estate and Gift Tax Exclusion. TCJA permanently doubles the basic exclusion amount for estate and gift tax purposes from $5.6 to $11.2 million. A provision fully repealing the estate tax beginning in 2025 was passed by the House, but didn't make it into TCJA, so the estate tax will remain in effect with the higher exclusion amount.

CONCLUDING THOUGHTS

As you can see, the provisions in the TCJA are quite extensive and also quite complicated.

Please call our office at your convenience so we can discuss how these changes will impact your tax situation, and what kind of strategies we can adopt to ensure that you get the best possible outcomes under the new rules.

Sincerely,

Elek & Noss CPAs