For years Congress has tinkered with the federal tax laws. Usually, there are months of congressional hearings and testimony from experts before implementing changes to the tax law. However, in a rush to pass some type of tax “reform,” Congress enacted the new tax law one week before the end of the year with no public hearings or analysis and made changes effective January 1, 2018.
Due to Senate rules, while the changes to the corporate tax law are permanent, all changes to individual taxpayers and estate and gift taxes expire on December 31, 2025. Unless Congress acts in 2025, these laws expire and the law as of December 31, 2017 is reinstated. We have seen this with the Bush tax cuts enacted in 2001. That law gradually increased the estate tax exemption through 2009 and ended with repeal in 2010. However, in 2011 Congress repealed the repeal and reinstated the estate tax retroactive to January 1, 2009 (albeit at a higher exclusion amount).
- Reduces income tax brackets: The bill retains seven brackets, but at reduced rates, with the highest tax bracket dropping to 37 percent from 39.6 percent. The individual income brackets are also expanded to expose more income to lower rates (see charts below).
- Doubles standard deductions: The standard deduction nearly doubles to $12,000 for single filers and $24,000 for married filing jointly. Personal exemptions and most additional standard deductions are suspended to help cover the cost.
- Limits itemized deductions: Many itemized deductions are no longer available or are now limited. Here are some of the major examples:
- Caps state and local tax deductions: State and local tax deductions are limited to $10,000 total for all property, income and sales taxes.
- Caps mortgage interest deductions: For newly acquired homes, mortgage interest will be deductible only for mortgage indebtedness of no more than $750,000. Existing homeowners are unaffected by the new cap. The bill also suspends the deductibility of interest on equity debt.
- Limit of theft and casualty losses: Deductions are now available only for federally declared disaster areas.
- No more 2 percent miscellaneous deductions: Most miscellaneous deductions subject to the 2 percent of adjusted gross income threshold are now gone.
- Cuts some above-the-line deductions: Eliminated are the moving expense deduction except for active-duty military personnel, along with alimony deductions beginning in 2019.
- Weakens the alternative minimum tax (AMT): The bill retains the alternative minimum tax but changes the exemption to $109,400 for joint filers and the phaseout threshold to $1 million. The changes mean the AMT will affect far fewer people than before.
- Bumps up child tax credit, adds family tax credit: The child tax credit increases to $2,000 from $1,000, with $1,400 of it being refundable even if no tax is owed. The phaseout threshold increases sharply to $400,000 from $110,000 for joint filers, making it available to more taxpayers. Also, dependents ineligible for the child tax credit can qualify for a new $500-per-person family tax credit.
- Expands use of 529 education savings plans: Tax-deductible contributions to 529 education savings plans can now pay tuition for students in K-12 private schools.
- Doubles estate, gift, and generation skipping tax exemptions to $11.2 million ($22.4 million for married couples). However, remembering the retroactive imposition of the estate tax in 2011, there are many opportunities for high net worth individuals. Also, the step-up in basis available upon death remains in effect.
What Stays the Same:
- Itemized charitable deductions: Remain largely the same.
- Itemized medical expense deductions: Remain largely the same. The deduction threshold drops back to 7.5 percent of adjusted gross income for 2017 and 2018 but reverts to 10 percent in the following years.
- Some above-the-line deductions: Remain the same, including educator expenses and student loan interest.
- Gift tax deduction: Remains and increases to $15,000 from $14,000 for 2018.
- Kiddie tax threshold: Remains at $2,100 (amount of unearned income taxable at your child’s lower tax rate). However, there is a major benefit for trusts created for minors with special needs.
New 2018 tax bracket structures for individuals
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Married filing jointly
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- Cuts to the corporate tax rate: Corporate tax gets cut and simplified to a flat 21 percent rate, changed from a multi-bracket structure with a 35 percent top rate.
- Reduces pass-through taxes: Most owners of pass-through entities such as S corporations, partnerships, and sole proprietorships will see their income tax lowered with a new 20 percent income reduction calculation. However, this does not apply to professional entities such as law and accounting firms.
- Increases capital expensing: Through 2022, short-lived capital investments in such items as machinery and equipment may be fully expensed as soon as they are placed in service, using bonus depreciation. The rules now also apply to used items instead of only new ones; they just must be placed in service for the first time in your business. After 2022, allowable bonus depreciation is then lowered incrementally over the next four years.
- Strengthens Section 179 deduction: Section 179 deduction limits get raised to enable expensing of up to $1 million, and the phaseout threshold increases to $2.5 million. Section 179 is now applicable expenses related to improvements to non-residential real estate.
- The 20% corporate AMT applied to businesses goes away entirely.
- Expands use of cash-method accounting: Businesses with less than $25 million in gross receipts over the last three years may adopt the cash method of accounting.
- Reforms international taxation: Treatment of international income moves to the territorial system standard, in which foreign investments are generally only taxed in the place in which they operate. The new laws allow tax deductions for certain foreign-sourced dividends, reduced tax rates for foreign intangible income and reduced tax rates for repatriation of deferred foreign income.
- Repeals business entertainment deduction: Businesses can no longer deduct 50 percent of the cost of entertainment, amusement or recreation directly related to their trade or business. The 50 percent deduction for business-related meals remains in place, however.
- Modifies several business credits: The law maintains several business credits with modifications, including the orphan drug credit, the rehabilitation credit, the employer credit for paid family or medical leave and the research and experimentation credit.
- Boosts luxury automobile depreciation: Luxury automobiles placed in service after 2017 will have allowable depreciation of $10,000 for the first year, $16,000 the second, $9,600 the third and $5,760 for later years.
It will take time to comprehend all implications of the new statute. Unquestionably there will be unintended consequences of this new law. We will be monitoring the effects of the law and alert you about planning opportunities and consequences as they develop.
Meanwhile, please contact us at any time with your questions.