The Tax Cuts and Jobs Act (H.R. 1) as approved by Congress, impacts virtually every individual and business on a level not seen in over 30 years. As with any tax bill, there will be 'winners' and 'losers.' This historic bill calls for lowering the individual and corporate tax rates, repealing countless tax credits and deductions, enhancing the child tax credit, boosting business expensing, and more. The bill also impacts the Affordable Care Act (ACA), effectively repealing the individual shared responsibility requirement. Most provisions are effective starting in 2018.
H.R. 1 carries temporary tax rates of 10, 12, 22, 24, 32, 35, and 37 percent after 2017. Under prior law, individual income tax rates have been 10, 15, 25, 28, 33, 35, and 39.6 percent.
RESULT The IRS has announced that initial withholding guidance (Notice 1036) to reflect enactment of the Tax Cuts and Jobs Act, would be issued in January 2018, “which would allow taxpayers to begin seeing the benefits of the change as early as February.”
H.R. 1 nearly doubles the standard deduction. It increases the standard deduction to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other individuals, indexed for inflation for tax years beginning after 2018. All increases are temporary, starting in 2018 but ending after December 31, 2025. Under prior law, the standard deduction for 2018 had been set at $13,000 for joint filers, $9,550 for heads of households, and $6,500 for all other filers. The additional standard deduction for the elderly and the blind ($1,300 for married taxpayers, $1,600 for single taxpayers) is retained.
RESULT Goal of higher standard deduction is to simplify tax filing through cutting, by more than half, those taxpayers who would otherwise do better by itemizing deductions. Of course, that group will realize less of a net tax benefit than those taxpayers who do not now itemize. Supporters argue that, in addition to simplification, it effectively creates a more broadly applicable “zero tax bracket” for taxpayers earning less than the standard deduction amount.
Doubling of the standard deduction effectively eliminates most individuals from claiming itemized deductions other than higher-income taxpayers. For the vast majority of married taxpayers filing jointly, only those with allowable mortgage interest, state income and local income/property taxes (up to $10,000), and charitable deductions that exceed $24,000 will claim them as itemized deductions (absent extraordinary medical expenses). With fewer individuals claiming those deductions, this could have broad impact on both real estate prices and charitable organizations despite retaining those two deductions, in modified form.
New law eliminates the deduction for personal exemptions and the personal exemption phase-out through 2025. That repeal, as scored by the Joint Committee on Taxation, will raise $1.22 trillion in revenue over the next 10 years. That repeal will reduce the net benefit of the standard deduction for most taxpayers. An enhanced child and family tax credit is positioned to make up some of the difference for certain families. H.R. 1 does not change the current tax treatment of qualified dividends and capital gains. The new law does not repeal the Affordable Care Act’s taxes, except for the penalty under the 'individual mandate'. Left untouched are the net investment income (NII) tax, the additional Medicare tax, the medical device excise tax, and more.
Mortgage interest deduction
The new law limits the mortgage interest deduction to interest on $750,000 of acquisition indebtedness ($375,000 in the case of married taxpayers filing separately), in the case of tax years beginning after December 31, 2017, and beginning before January 1, 2026. For acquisition indebtedness incurred before December 15, 2017, the new law allows current homeowners to keep the current limitation of $1 million ($500,000 in the case of married taxpayers filing separately).
New law also allows taxpayers to continue to include mortgage interest on second homes, but within those lower dollar caps. However, no interest deduction will be allowed for interest on home equity indebtedness.
State and local taxes
The new law limits annual itemized deductions for all non-business state and local taxes deductions, including property taxes, to $10,000 ($5,000 for married taxpayer filing a separate return). Sales taxes may be included as an alternative to claiming state and local income taxes.
RESULT The new law short-circuits an immediate year-end tax strategy by adding a provision that disallows prepayment in 2017 of state and local income taxes imposed for a year after 2017 to avoid the new dollar limitation.
Miscellaneous itemized deductions
The new law temporarily repeals all miscellaneous itemized deductions that are subject to the two-percent floor under current law.
The new law temporarily enhances the medical expense deduction. It lowers the threshold for the deduction to 7.5 percent of adjusted gross income (AGI) for tax years 2017 and 2018.
RESULT The loss of many itemized deductions will channel an even greater number of taxpayers to the standard deduction. Big losers may include state and local governments that depend upon the federal itemized deductions for state and local income taxes and real estate taxes as an indirect subsidy for those taxes. Limitations on the mortgage interest deduction will also likely hurt the housing industry.
Once again, the concessions for retaining some deductions are valuable only to those taxpayers who will do better continuing to itemize deductions than taking the higher standard deduction.
The new law temporarily increases the current child tax credit from $1,000 to $2,000 per qualifying child. Up to $1,400 of that amount would be refundable. It also raises the adjusted gross income phase-out thresholds, starting at adjusted gross income of $400,000 for joint filers ($200,000 for all others). The child tax credit is further modified to provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children.
RESULT As a credit, in contrast to a deduction, the enhanced child credit has been highlighted as one of the provisions that will lower overall tax liability for middle-class families.
The new law retains the student loan interest deduction. It also modifies section 529 plans and ABLE accounts. It does not overhaul the American Opportunity Tax Credit, as proposed in the original House bill. The new law also does not repeal the exclusion for interest on U.S. savings bonds used for higher education, as proposed in the House bill.
RESULT Exclusion for graduate student tuition waivers is retained. New law does not renew the above-the-line deduction for education expenses that expired at the end of 2016.
The new law repeals the deduction for alimony payments and their inclusion in the income of the recipient.
RESULT To give taxpayers time to adjust, new rules will apply only to divorce or separation instruments executed after December 31, 2018.
The new law generally retains the current rules for 401(k) and other retirement plans. However, it repeals the rule allowing taxpayers to re-characterize Roth IRA contributions as traditional IRA contributions to unwind a Roth conversion. Rules for hardship distributions are modified, among other changes.
Alternative Minimum Tax
New law retains the alternative minimum tax (AMT) for individuals with modifications. It temporarily increases (through 2025) the exemption amount to $109,400 for joint filers ($70,300 for others, except trusts and estates). New law also raises the exemption phase-out levels so that the AMT will apply to an income level of $1 million for joint filers ($500,000 for others). These amounts are all subject to annual inflation adjustment.
Affordable Care Act
New law repeals the Affordable Care Act (ACA) individual shared responsibility requirement, making the payment amount $0. This change is effective for penalties assessed after 2018.
RESULT IRS has cautioned that, under current law, for tax year 2017, it will not consider a return complete and accurate if the taxpayer does not report full-year coverage, claim a coverage ex- emption, or report a shared responsibility payment on the return.
H.R. 1 calls for a 21-percent corporate tax rate beginning in 2018. The new law makes the new rate permanent. The maximum corporate tax rate currently tops out at 35 percent.
RESULT Although the current 2017 maximum corporate tax rate is 35 percent, many corporations now pay an effective tax rate that is considerably less.
Under the new law, the 80-percent and 70-percent dividends received deductions under current law are reduced to 65-percent and 50-percent, respectively. It also repeals the AMT on corporations.
H.R. 1 increases the 50-percent 'bonus depreciation' allowance to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for longer production period property and certain aircraft). A 20-percent phase-down schedule would then kick in. It also removes the requirement that the original use of qualified property must commence with the taxpayer, thus allowing bonus depreciation on the purchase of used property.
The new law raises the cap placed on depreciation write-offs of business-use vehicles. The new caps will be $10,000 for the first year a vehicle is placed in service (up from a current level of $3,160); $16,000 for the second year (up from $5,100); $9,600 for the third year (up from $3,050); and $5,760 for each subsequent year (up from $1,875) until costs are fully recovered. The provision is effective for property placed in service after December 31, 2017, in taxable years ending after such date.
Section 179 Expensing
The new law enhances Code Sec. 179 expensing; setting the Code Sec. 179 dollar limitation at $1 million and the investment limitation at $2.5 million.
RESULT Although the differences between bonus depreciation and Code Sec. 179 expensing are lessened if both offer 100-percent write-offs for new or used property, some remain. Code Sec. 179 property is subject to recapture if business use of the property during a tax year falls to 50 percent or less; but Code Sec. 179 allows a taxpayer to elect to expense only particular qualifying assets within any asset class.
Deductions and Credits
Numerous business tax preferences are eliminated. These include the Code Sec. 199 domestic production activities deduction, non-real property like-kind exchanges, and more. Additionally, the rules for business meals are revised, as are the rules for the rehabilitation credit. The new law leaves the research and development credit in place, but requires five-year amortization of research and development expenditures. It also creates a temporary credit for employers paying employees who are on family and medical leave.
The new law generally caps the deduction for net interest expenses at 30 percent of adjusted taxable income, among other criteria. Exceptions exist for small businesses, including an exemption for businesses with average gross receipts of $25 million or less.
Currently, up to the end of 2017, owners of 'pass-through' entities, pay tax at the individual rates, with the highest rate at 39.6 percent. The new law provides a 20 percent deduction against qualified pass-through business income equal to the lesser of 20% of the taxpayer's 'qualified business income' OR the greater of (a) 50 percent of wage income or (b) 25 percent of wage income plus 2.5 percent of the cost of tangible depreciable property, and many service businesses are excluded, such as trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners.
RESULT Rules are in place to deter high-income taxpayers from attempting to convert wages or other compensation for personal services into income eligible for the deduction.
Net Operating Losses
The new law modifies current rules for net operating losses (NOLs). Generally, NOLs will be limited to 80 percent of taxable income for losses in tax years beginning after December 31, 2017. It also denies the carry back for NOLs in most cases while providing for an indefinite carry forward, subject to the percentage limitation.