The long-awaited Tax Cuts and Jobs Act tax reform bill was signed into law today.
The bill contains many provisions that affect individuals. However, to keep the cost of the bill within Senate budget rules, all the changes affecting individuals expire after 2025. At that time, if Congress does not act, the individual tax provisions will sunset, and, like Cinderella at midnight, the tax law will return to its current form. Some of the highlights that are most likely to affect HCM Clients include:
Changes to individual tax rates and brackets:
The new law keeps 7 tax brackets. As the following table shows, the marginal tax rates decline at most income levels. This will lower the tax burden for most HCM clients. The top rate is lowered to 37% from 39.6%. And, while long-term capital gains and qualified dividends will still receive preferential treatment, they do not get the benefit of the new rate structure. Instead, they continue to be taxed as they are today, with inflation adjustments.
The standard deduction was increased…:
The final tax bill nearly doubled the standard deduction through 2025, to $12,000 from $6,500 for single taxpayers, and to $24,000 from $13,000 for couples. The additional standard deduction for elderly and blind taxpayers was not changed.
…But the personal exemption was repealed:
This is the sneaky part. While there is a great deal of fanfare around the doubling of the standard deduction (you know – “file on a post card”), the $4,050 personal exemption allowed for each taxpayer and their dependents in 2017 is repealed beginning in 2018, offsetting most, if not all, of the advantage of a larger standard deduction.
Changes to itemized deductions:
- State and local income and property taxes are limited to a $10,000 deduction. The conference report on the bill specifies that taxpayers cannot take a deduction in 2017 for prepaid 2018 state and local income taxes. Commentators have expressed differing opinions on the application of this rule.
- The mortgage interest deduction was modified to reduce the limit on acquisition indebtedness to $750,000 (from the prior-law limit of $1 million).
- The home-equity loan interest deduction was repealed through 2025.
- Taxpayers can take a deduction for casualty losses only if the loss is attributable to a presidentially declared disaster.
- Regarding gambling losses, the act clarifies that the limitation on deducting losses from wagering transactions applies not only to the actual wagers, but also to other expenses the taxpayer incurs in connection with his or her gambling activity.
- Miscellaneous itemized deductions subject to the 2% floor are eliminated through 2025.
- Medical expense deductions will be preserved and temporarily reduced from the excess of 10% to 7.5% of adjusted gross income for tax years 2017 and 2018. Beginning in 2019, only medical expenses that exceed 10% of adjusted gross income will be deductible.
- Charitable donations will remain deductible, with a few exceptions (such as the deduction for payments made in exchange for college athletic event seats). The bill increased the income-based percentage limit for charitable contributions of cash to public charities to 60%.
- The overall limitation on itemized deductions for high income taxpayers was eliminated.
The child tax credit will increase:
The tax bill increased the child tax credit to $2,000 from $1,000. The tax credit is fully refundable up to $1,400, and begins to phase out for married/joint filers at income of $400,000 and for single filers at $200,000.
The alternative minimum tax (AMT) is modified:
One of the big promises not kept was the elimination of the AMT. However, beginning in 2018 and ending in 2025, the AMT exemption amount is increased to $109,400 for married taxpayers filing a joint return and $70,300 for all other taxpayers. The phase-out thresholds are increased to $1 million for married taxpayers filing a joint return, and $500,000 for all other taxpayers.
Roth IRA re-characterizations are eliminated:
HCM is a big fan of certain types of Roth IRA conversions. The new law will force an increased level of intentionality and planning for Roth IRA conversions, as it eliminates the ability to recharacterize (or reverse) a Roth conversion many months after completion. Currently taxpayers have until October 15 of the year after the year of conversion to change their mind. Recharacterizations will not be allowed after December 31,2017.
The use of 529 College Savings Plans is expanded:
Section 529 plans will be allowed to distribute up to $10,000 per year to cover the cost of K-12 expenses. 529 plans have previously been used only for post-secondary expenses.
The individual health insurance mandate is eliminated:
The new law eliminates the penalty imposed on taxpayers who do not obtain health insurance that provides at least minimum essential coverage, effective starting in 2019.
The Estate Tax exemption is doubled:
The act doubles the estate and gift tax exemption for estates of decedents dying and gifts made after Dec. 31, 2017, and before Jan. 1, 2026. The basic exclusion amount increased from $5 million to $10 million and will be indexed for inflation occurring after 2011.
There were a few important items that were not included in the final bill:
Calculation of cost basis on investment sales remains unchanged:
The Senate tax bill included a provision that would have required investors to use the “first-in, first-out” (FIFO) method to calculate taxable gain for security sales. If it had passed we would have lost the ability to minimize tax burdens through the specific identification of tax lots.
There will be no changes to tax-deferred retirement accounts:
Lawmakers had considered making changes to the deductions taxpayers receive for contributing to tax-deferred retirement accounts, such as IRAs or 401(k) retirement plans. The proposal was not included in the final tax bill.
Any year-end tax planning moves should be considered quickly as the door slams shut on most options on December 31st. Some decisions that should be considered by individual taxpayers include:
- Prepaying a portion of your 2018 real estate taxes, if permitted by your taxing authority
- Making sure that your 2017 state and local income tax bill is fully paid in 2017
- Consider paying your January mortgage payment in December if your financial institution will report the interest in 2017
- Accelerate charitable donations from future years into 2017. Many HCM clients are using Donor Advised Funds to pre-pay many years of charitable gifts this year in a way that allow them to distribute the gifts to charity in future years.
- Note: HCM sent a brief tax planning note covering pre-payments earlier today.
In planning these prepayments, it is very important to keep an eye on your marginal tax rate both this year and next year. It is also important to make sure that the steps you take will not move you into an Alternative Minimum Tax situation. You should consult your CPA prior to taking any actions.
Updates for Business Owners:
In addition to the personal tax issues outlined above there are two big changes that impact many of the business owners that HCM serves.
The corporate tax rate will decline for some, and increase for others:
The final tax bill reduced the maximum corporate tax rate to 21% from 35%. In creating the flat corporate rate, the new law does away with the 15% corporate rate for the first $50,000 of corporate income. This is a big step back for many small businesses operating in a corporate form.
Flattening the corporate tax rate will increase the profits of many larger companies, which should provide additional capital for business expansion, increased dividends to shareholders, and share buybacks. In addition, legislators believe these changes will make the U.S. a more attractive region in which to do business.
For tax years after 2017 and before 2026, individuals will generally be allowed to deduct 20% of “qualified business income” from a partnership, S corporation, or sole proprietorship. In addition, qualified real estate investment trust (REIT) dividends, qualified cooperative dividends, and qualified publicly traded partnership income will generally be eligible for the deduction.
A limitation on the passthrough deduction is phased in based on W-2 wages. The deduction is phased out, based on income, for specified professional organizations (accounting, health, law, consulting, athletics, financial services, brokerage services, or any business where the principal asset of the business is the reputation or skill of one or more of its employees) with income above a certain threshold (generally $157,500 for individuals and $315,000 for joint filers).
These are very complicated provisions and should be reviewed with your tax and business advisors before any actions are taken to modify business forms or practices to gain a tax advantage.
If you would like to discuss how the new law affects your Wealth Plan, please contact your HCM Wealth Advisor:
Mike Hengehold ([email protected])
Casey Boland ([email protected])
Jake Butcher ([email protected])
Jim Eutsler ([email protected])
Greg Middendorf ([email protected])
Steve Hengehold ([email protected])
Doug Johnson ([email protected])