President Signs Sweeping Tax Overhaul Into Law
On December 22, 2017, the “Tax Cuts and Jobs Act of 2017” (TCJA) was signed into law by President Trump. This is the most sweeping tax legislation since the Tax Reform Act of 1986.
The bill makes small reductions to income tax rates for most individual tax brackets, significantly reduces the income tax rate for corporations and eliminates the corporate alternative minimum tax (AMT). It also provides a large new tax deduction for owners of pass-through entities and increases individual AMT and estate tax exemptions. And it makes significant changes related to the taxation of corporate foreign income.
The TCJA also eliminates or limits many tax breaks, and much of the tax relief is only temporary.
As clear explanations and definitions have not yet been provided, and may take many months to be issued, we will be keeping an eye on the latest information as it comes out and will communicate any potential impact. Please note that the majority of these proposed changes would apply to tax years beginning January 1, 2018.
In the meantime, a summary of the most significant changes affecting individual and business taxpayers can be read below or at www.dkc-llp.com
The TCJA 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.
|Rate||Joint Return||Individual Return|
|10%||$0 – $19,050||$0 – $9,525|
|12%||$19,051 – $77,400||$9,526 – $38,700|
|22%||$77,401 – $165,000||$38,701 – $82,500|
|24%||$165,001 – $315,000||$82,501 – $157,500|
|32%||$315,001 – $400,000||$157,501 – $200,000|
|35%||$400,001 – $600,000||$200,001 – $500,000|
|37%||Over $600,001||Over $500,001|
The TCJA 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 (using chained CPI) 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 $6,350 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.
DEDUCTIONS AND CREDITS
The TCJA makes significant changes to some popular individual credits and deductions, effective starting in 2018. Many of the changes, however, are temporary, generally ending after 2025, in order to keep overall revenue costs for the new law within budgetary constraints.
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).
The 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 nonbusiness 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.
Miscellaneous itemized deductions. The new law temporarily repeals all miscellaneous itemized deductions that are subject to the two-percent floor under current law.
Medical expenses. 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. The threshold returns to 10% after 2018.
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 phaseout 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.
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.
The new law repeals the deduction for alimony payments and their inclusion in the income of the recipient beginning with divorce or separation instruments executed or amended after December 31, 2018 or prior if revised specifically to reflect the TCJA law.
The new law generally retains the current rules for 401(k) and other retirement plans. However, it repeals the rule allowing taxpayers to recharacterize Roth IRA contributions as traditional IRA contributions to unwind a Roth conversion. Rules for hardship distributions are modified, among other changes.
FEDERAL ESTATE TAX
The new law follows the original Senate bill in not repealing the estate tax, but rather doubling the estate and gift tax exclusion amount for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026. The generation-skipping transfer (GST) tax exemption is also doubled.
Alternative Minimum Tax
The 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). The 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
The 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.
Under the new law, the holding period for long-term capital gains is increased to three years with respect to certain partnership interests transferred in connection with the performance of services.
The TCJA 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 applicable to 2017 tops out at 35 percent.
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.
The TCJA 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. The Conference bill sets the Code Sec. 179 dollar limitation at $1 million and the investment limitation at $2.5 million.
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 real estate related activities and 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 partnerships, S corporations, and sole proprietorships – as “passthrough” entities – pay tax at the individual rates, with the highest rate at 39.6 percent.
The TCJA generally now applies a deduction equal to 20% of “qualified income” from passthrough entities subject to a number of limitations and qualifications beginning in tax year 2018.
The deduction applies to qualified business income from sole proprietorships and passthrough entities including partnerships (including publicly-traded partnerships), S corporations, trusts and estates, as well as real estate investment trusts and qualified cooperatives.
Generally, qualified business income may include all kinds of business income, including income from rental real estate. However, it does not include W-2 income (even if the W-2 income is from a pass-through entity owned in whole or in part by the taxpayer) or partner guaranteed payments.
The TCJA generally provides that a qualified trade or business generally means any trade or business other than “a specified service trade or business.” (IRC §199A(c)(1)) However, it then carves out an exception for taxpayers whose taxable income is below the phase-out ranges as follows:
- Married filing joint: $315,000 – $415,000; and
- All other filing statuses: $157,500 – $207,500
Thus, owners of services businesses can take the deduction if their income is below the top of the phase-out ranges.
Taxpayers with taxable income above the upper ranges lose the deduction entirely. Taxpayers within the range lose the deduction in proportion to the excess of the taxable income over the initial phase-out amount to the total phase-out range.
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 arising in tax years beginning after December 31, 2017. It also denies the carryback for NOLs in most cases while providing for an indefinite carryforward, subject to the percentage limitation.
The new law retains the credit for plug-in electric vehicles and did not adopt any of the other repeals of or modifications to energy credits from the House bill.
The new law does not modify or repeal the so-called “Johnson amendment.” This provision generally restricts Code Sec. 501(c)(3) organizations from political campaign activity.
The TCJA extends from nine months to two years the period for bringing a civil action for wrongful levy. The new law does not prohibit increases in IRS user fees, as proposed by the original Senate bill.
The new law moves the United States to a territorial system. It creates a dividend-exemption system for taxing U.S. corporations on the foreign earnings of their foreign subsidiaries when the earnings are distributed. The foreign tax credit rules are modified, as are the Subpart F rules. The look-through rule for related controlled foreign corporations are made permanent, among other changes.
A portion of deferred overseas-held earnings and profits (E&P) of subsidiaries will be taxed at a reduced rate of 15.5 percent for cash assets and 8 percent for illiquid assets. Foreign tax credit carryforwards will be fully available and foreign tax credits triggered by the deemed repatriation would be partially available to offset the U.S. tax.