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On December 15, the final version of the Tax Cuts and Jobs Act, a sweeping tax reform proposal was released. Here we describe key individual tax changes that are made under the Act, including the new rates and brackets, the increased standard deduction and elimination of personal exemptions, the repeal of the individual mandate under the Affordable Care Act, and a new deduction for pass-through income.

Tax Rates & Key Figures

New Income Tax Rates & Brackets: For tax years beginning after December 31, 2017 and before January 1, 2026, seven tax brackets apply for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The Act also provides four tax brackets for estates and trusts: 10%, 24%, 35%, and 37%. The specific application of these brackets, and the income levels at which they apply, is shown below.

FOR MARRIED INDIVIDUALS FILING JOINT RETURNS AND SURVIVING SPOUSES:

If taxable income is The tax is:
Not over $19,050 10% of taxable income
Over $19,050 but not over $77,400 $1,905 plus 12% of the excess over $19,050
Over $77,400 but not over $165,000 $8,907 plus 22% of the excess over $77,400
Over $165,000 but not over $315,000 $28,179 plus 24% of the excess over $165,000
Over $315,000 but not over $400,000 $64,179 plus 32% of the excess over $315,000
Over $400,000 but not over $600,000 $91,379 plus 35% of the excess over $400,000
Over $600,000 $161,379 plus 37% of the excess over $600,000

FOR SINGLE INDIVIDUALS (OTHER THAN HEADS OF HOUSEHOLDS AND SURVIVING SPOUSES):

If taxable income is The tax is:
Not over $9,525 10% of taxable income
Over $9,525 but not over $38,700 $952.50 plus 12% of the excess over $9,525
Over $38,700 but not over $82,500 $4,453.50 plus 22% of the excess over $38,700
Over $82,500 but not over $157,500 $14,089.50 plus 24% of the excess over $82,500
Over $157,500 but not over $200,000 $32,089.50 plus 32% of the excess over $157,000
Over $200,000 but not over $500,000 $45,689.50 plus 35% of the excess over $200,000
Over $500,000 $150,689.50 plus 37% of the excess over $500,000

FOR HEADS OF HOUSEHOLDS:

If taxable income is The tax is:
Not over $13,600 10% of taxable income
Over $13,600 but not over $51,800 $1,360 plus 12% of the excess over $13,600
Over $51,800 but not over $82,500 $5,944 plus 22% of the excess over $51,800
Over $82,500 but not over $157,500 $12,698 plus 24% of the excess over $82,500
Over $157,500 but not over $2000,000 $30,698 plus 32% of the excess over $157,500
Over $200,000 but not over $500,000 44,298 plus 35% of the excess over $200,000
Over $500,000 $149,298 plus 37% of the excess over $500,000

FOR MARRIEDS FILING SEPARATELY:

If taxable income is The tax is:
Not over $9,525 10% of taxable income
Over $9,525 but not over $38,700 $952.50 plus 12% of the excess over $9,525
Over $38,700 but not over $82,500 $4,453.50 plus 22% of the excess over $38,700
Over $82,500 but not over $157,500 $14,089.50 plus 24% of the excess over $82,500
Over $157,500 but not over $200,000 $32,089.50 plus 32% of the excess over $157,500
Over $200,000 but not over $300,000 $45,689.50 plus 35% of the excess over $200,000
Over $300,000 $80,689.50 plus 37% of the excess over $300,000

FOR ESTATES AND TRUSTS:

If taxable income is The tax is:
Not over $2,550 10% of taxable income
Over $2,550 but not over $9,150 $255 plus 24% of the excess over $2,550
Over $9,150 but not over $12,500 $1,839 plus 35% of the excess over $9,150
Over $12,500 $3,011.50 plus 37% of the excess over $12,500

 

Standard Deduction Increased: For tax years beginning after December 31, 2017, and before January 1, 2026, the standard deduction is increased to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers, adjusted for inflation in tax years beginning after 2018. No changes are made to the current law additional standard deduction for the elderly and blind.

Personal Exemptions Suspended: For tax years beginning after December 31, 2017, and before January 1, 2026, the deduction for personal exemptions is effectively suspended by reducing the exemption amount to zero.

New Measure of Inflation Provided: For tax years beginning after December 31, 2017, dollar amounts that were previously indexed using CPI-U will instead be indexed using chained CPI-U (C-CPI-U). In general, chained CPI grows at a slower pace than CPI-U because it takes into account a consumer’s ability to substitute between goods in response to changes in relative prices.

Kiddie Tax Modified: For tax years beginning after December 31, 2017, the taxable income of a child attributable to earned income is taxed under the rates for single individuals, and taxable income of a child attributable to net unearned income is taxed according to the brackets applicable to trusts and estates. This rule applies to the child’s ordinary income and his income taxed at preferential rates.

Capital Gains Provisions Conformed: The Act generally retains present-law maximum rates on net capital gains and qualified dividends. It retains the breakpoints that exist under pre-Act law, but indexes them for inflation using C-CPI-U in tax years after December 31, 2017.

For 2018, the 15% breakpoint is: $77,200 for joint returns and surviving spouses (half this amount for married taxpayers filing separately), $51,700 for heads of household, $2,600 for trusts and estates, and $38,600 for other unmarried individuals. The 20% breakpoint is $479,000 for joint returns and surviving spouses (half this amount for married taxpayers filing separately), $452,400 for heads of household, $12,700 for estates and trusts, and $425,800 for other unmarried individuals.

Income From Pass-Through Entities

New Deduction for Pass-Through Income: Generally, for tax years beginning after December 31, 2017, and before January 1, 2026, the Act adds a new section, Code Sec. 199A, “Qualified Business Income,” under which a non-corporate taxpayer, including a trust or estate, who has qualified business income (QBI) from a partnership, S corporation, or sole proprietorship is allowed to deduct:

  • the lesser of: (a) the “combined qualified business income amount” (QBI) of the taxpayer, or (b) 20% of the excess, if any, of the taxable income of the taxpayer for the tax year over the sum of net capital gain and the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year; plus
  • the lesser of: (i) 20% of the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year, or (ii) taxable income (reduced by the net capital gain) of the taxpayer for the tax year.

The “combined qualified business income amount” means, for any tax year, an amount equal to:

  1. the deductible amount for each qualified trade or business of the taxpayer (defined as 20% of the taxpayer’s QBI subject to the W-2 wage limitation; see below); plus
  2. 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of the taxpayer for the tax year.

QBI is generally defined as the net amount of “qualified items of income, gain, deduction, and loss” relating to any qualified trade or business of the taxpayer. QBI does not include: certain investment items; reasonable compensation paid to the taxpayer by any qualified trade or business for services rendered with respect to the trade or business; any guaranteed payment to a partner for services to the business under Code Sec. 707(c); or a payment under Code Sec. 707(a) to a partner for services rendered with respect to the trade or business.

The 20% deduction is not allowed in computing adjusted gross income (AGI), but rather is allowed as a deduction reducing taxable income.

Limitations: For pass-through entities, other than sole proprietorships, the deduction cannot exceed the greater of:

  • 50% of the W-2 wages with respect to the qualified trade or business (“W-2 wage limit”), or
  • the sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all “qualified property.” Qualified property is defined in Code Sec. 199A(b)(6) as meaning tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year.

The second limitation, which was newly added to the bill during Conference, apparently allows pass-through businesses to be eligible for the deduction on the basis of owning property that qualifies under the provision (e.g., real estate).

Thresholds and Exclusions: The deduction does not apply to specified service businesses. However, the service business limitation does not apply in the case of a taxpayer whose taxable income does not exceed $315,000 for married individuals filing jointly ($157,500 for other individuals), both indexed for inflation after 2018. The benefit of the deduction for service businesses is phased out over the next $100,000 of taxable income for joint filers ($50,000 for other individuals).

Deduction for Personal Casualty & Theft Losses Suspended: For tax years beginning after December 31, 2017, and before January 1, 2026, the personal casualty and theft loss deduction is suspended, except for personal casualty losses incurred in a Federally-declared disaster.

Gambling Loss Limitation Modified: For tax years beginning after December 31, 2017, and before January 1, 2026, the limitation on wagering losses under Code Sec. 165(d) is modified to provide that all deductions for expenses incurred in carrying out wagering transactions, and not just gambling losses, are limited to the extent of gambling winnings.

Changes To Tax Credits

Child Tax Credit Increased: For tax years beginning after December 31, 2017, and before January 1, 2026, the child tax credit is increased to $2,000, and other changes are made to phase-outs and refundability during this same period.

Modified Deductions & Exclusions

State and Local Tax Deduction Limited: For tax years beginning after December 31, 2017, and before January 1, 2026, a taxpayer may claim an itemized deduction of up to $10,000 ($5,000 for a married taxpayer filing a separate return) for the aggregate of (i) state and local property taxes not paid or accrued in carrying on a trade or business or activity described in Code Sec. 212; and (ii) state and local income, war profits, and excess profits taxes (or sales taxes in lieu of income, etc. taxes) paid or accrued in the tax year. Foreign real property taxes may not be deducted.

Prepayment provision – For tax years beginning after December 31, 2016, in the case of an amount paid in a tax year beginning before January 1, 2018 with respect to a state or local income tax imposed for a tax year beginning after December 31, 2017, the payment will be treated as paid on the last day of the tax year for which such tax is so imposed for purposes of applying the above limits. In other words, a taxpayer who, in 2017, pays an income tax that is imposed for a tax year after 2017, can’t claim an itemized deduction in 2017 for that prepaid income tax.

Mortgage & Home Equity Indebtedness Interest Deduction Limited: For tax years beginning after December 31, 2017, and before January 1, 2026, the deduction for interest on home equity indebtedness is suspended, and the deduction for mortgage interest is limited to underlying indebtedness of up to $750,000 ($375,000 for married taxpayers filing separately).

Treatment of indebtedness incurred on or before December 15, 2017. The new lower limit doesn’t apply to any acquisition indebtedness incurred before December 15, 2017.

Refinancing – The $1 million/$500,000 limitations continue to apply to taxpayers who refinance existing qualified residence indebtedness that was incurred before December 31, 2017, so long as the indebtedness resulting from the refinancing doesn’t exceed the amount of the refinanced indebtedness.

Charitable Contribution Deduction Limitation Increased: For contributions made in tax years beginning after December 31, 2017, and before January 1, 2026, the 50% limitation under Code Sec. 170(b) for cash contributions to public charities and certain private foundations is increased to 60%. Contributions exceeding the 60% limitation are generally allowed to be carried forward and deducted for up to five years, subject to the later year’s ceiling.

Alimony Deduction by Payor/Inclusion by Payee Suspended: For any divorce or separation agreement executed after December 31, 2018, or executed before that date but modified after it (if the modification expressly provides that the new amendments apply), alimony and separate maintenance payments are not deductible by the payor spouse and are not included in the income of the payee spouse. Rather, income used for alimony is taxed at the rates applicable to the payor spouse.

Miscellaneous Itemized Deductions Suspended: For tax years beginning after December 31, 2017 and before January 1, 2026, the deduction for miscellaneous itemized deductions that are subject to the 2% floor is suspended. This includes safe deposit box rentals, investment management fees, attorney, and accountant fees.

Healthcare Provisions

Short-Term Reduction to Medical Expense Deduction Threshold: For tax years beginning after December 31, 2016, and ending before January 1, 2019, the threshold on medical expense deductions is reduced to 7.5% for all taxpayers.

In addition, the rule limiting the medical expense deduction for AMT purposes to 10% of AGI doesn’t apply to tax years beginning after December 31, 2016 and ending before January 1, 2019.

Repeal of Obamacare Individual Mandate: For months beginning after December 31, 2018, the amount of the individual shared responsibility payment is reduced to zero. This repeal is permanent.

The Act leaves intact the 3.8% net investment income tax and the 0.9% additional Medicare tax, both enacted by Obamacare.

Estate & Gift Tax

Estate and Gift Tax Retained, with Increased Exemption Amount: For estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026, the Act doubles the base estate and gift tax exemption amount from $5 million to $10 million. The $10 amount is indexed for inflation occurring after 2011 and is expected to be approximately $11.2 million in 2018 ($22.4 per married couple).

Alternative Minimum Tax (AMT)

AMT Retained, with Higher Exemption Amounts: For tax years beginning after December 31, 2017 and before January 1, 2026, the Act increases the AMT exemption amounts for individuals as follows:

  • For joint returns and surviving spouses: $109,400 (up from $86,200)
  • For single taxpayers: $70,300 (up from $55,400)
  • For marrieds filing separately: $54,700 (up from $43,100)

Under the Act, the above exemption amounts are reduced (not below zero) to an amount equal to 25% of the amount by which the alternative taxable income of the taxpayer exceeds the phase-out amounts, increased as follows:

  • For joint returns and surviving spouses: $1 million
  • For all other taxpayers (other than estates and trusts): $500,000

Education Provisions

Expanded Use of 529 Account Funds: For distributions after December 31, 2017, “qualified higher education expenses” include tuition at an elementary or secondary public, private, or religious school, and various expenses associated with home school, up to a $10,000 limit per tax year (Code Sec. 529(c)(7), as added by Act Sec. 11032(a)).

The Tax Cuts and Jobs Act has largely taken shape at a breakneck speed over a two-month period, passed by the House on November 16, 2017, and by the Senate on December 2, 2017. Republican leaders are now saying that they have the votes necessary for passage, and it is generally expected that the measure will be approved in both the House and Senate without any Democratic support-then make its way to President Trump for his anticipated signature shortly thereafter. It will be the largest major tax reform in over three decades.

We will continue to unpack the legislation, and issue additional news on details and planning opportunities. If you have questions in the meantime, please contact us we will be happy to look at your specific situation.

Paul Rozek, CPA

Paul provides tax research, consulting and compliance services to closely held businesses, tax-exempt organizations, individuals and fiduciaries. His clients include family offices, private foundations, trade associations, charitable organizations, schools, credit unions and other non-profit entities.