Tax Reform: Noteworthy Provisions

With the most extensive overhaul of the U.S. tax code in more than three decades having now been passed by both Houses of Congress, and officially signed by President Trump to enact it into law, tax reform is here.  These changes will require businesses and individuals to re-evaluate their long-term tax strategies starting in the 2018 tax year, but also means taking immediate year-end tax planning strategies for the final days of 2017 into consideration.

Here’s the rundown of some key provisions with the final bill:

INDIVIDUALS:

Tax Rates:

  • New Individual Tax Brackets: The new tax bill keeps seven tax brackets, but lowers the tax rate in the majority of the brackets—including lowering the max tax rate from 39.6% to 37%. Tax rates for individuals are as follow: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Rate is dependent upon the taxpayer’s income and filing status, i.e. single, married filing separately, married filing jointly.
  • Individual Alternative Minimum Tax (AMT): With the new tax bill, AMT for individuals is maintained, however the AMT exemption amount for individuals is increased to $109,400 for those filing married filing jointly and $70, 300 for those filing single. Also, the new bill will increase the exemption phase-out amounts to $1,000,000 for married filing jointly filers and $500,000 for single filers.

Tax Credits:

  • Earned Income Tax Credit: The earned income tax credit will be retained.
  • Child Tax Credit: The new bill will increase the child tax credit from the current $1,000 to $2,000. For qualifying children under the age of 17, the credit will continue to apply but will increase the phase-out threshold of the credit to $400,000 for married filing jointly filers.  This is up from the $110,000 under the current law.

Exemptions and Deductions:

  • Personal Exemptions: The new tax bill will eliminate personal exemptions beginning in 2018.
  • Standard Deduction: For married filing jointly, filers using the standard deduction will increase from $13,000 to $24,000, for head-of-household filers from $9,550 to $18,000, and for all other filers from $6,500 to $12,000 under the new tax bill.
  • Itemized Deduction Limitation: Under the current tax law, itemized deductions are limited upon a tax payer’s income reaching $313,800 for married filing jointly or $261,500 for single filers. The new bill will suspend these limitations.
  • Miscellaneous Itemized Deductions: All miscellaneous itemized deductions subject to the 2%floor will be suspended. Examples of miscellaneous itemized deductions are tax preparation fees, unreimbursed employee expenses, and investment expenses.  In addition, this bill retains the $250 above-the-line deduction for teacher expenses.
  • Medical Expense Deduction: With the new tax bill, the medical expense deduction floor will be reduced the current 10% of adjusted gross income to 7.5% for expenses incurred in 2018 and 2019.
  • Mortgage Expense Deduction: The mortgage expense deduction will be reduced to $750,000 of debt incurred from the current $1,000,000 limitation.  This deduction only applies to home acquisition indebtedness.  Mortgage interest paid on home equity indebtedness is no longer deductible.
  • State and Local Tax Deduction: This new tax bill will allow for the election of the deduction of sales tax, income tax, or property tax up to $10,000 by individuals. All tax payments will be deemed to have been paid on the last day of the tax year for which the tax was imposed, meaning taxpayers may not have to prepay taxes owed for 2018 to ensure their full deductibility prior to the 2018 implementation of this rule.
  • Moving Expense Deduction: The new tax bill suspends the deduction and tax-free receipt of reimbursement of moving expenses incurred when starting a new job at least 50 miles farther from the taxpayer’s former residence. The bill provides an exception for active duty members of the armed forces who move pursuant to a military order and will continue to allow the deduction for said persons.
  • Charitable Contributions: The adjusted gross income limitation on cash contributions made to qualifying charities increased from 50% to 60% under the new bill. Also, any contributions made to a university for seating rights to athletic events will no longer be deductible, as opposed to the current system where 80% of seating right payments to a university are deductible.
  • Alimony Payments: In general, the new tax bill will eliminate all the current above-the-line deduction for a tax payer’s alimony payments. In addition, alimony payment recipients would not be required to recognize alimony payment as income.  This provision will be delayed by one year and will not be applicable to payments made prior to December 31, 2018.

Estates, Gifts, and Trusts

  • Estate and Gift Taxes: Under the new tax bill, the gift tax, estate tax, and generation-skipping transfer tax exemption will be increased from $5 million (with inflation adjustments) to $10 million (with inflation adjustments). The exemption, including inflation adjustments, is expected to become $11 million in 2018.  Unlike the provisions outlined in the House’s version of the bill, there is no provision to repeal the estate tax or generation-skipping tax in the future.
  • Trust and Estate Income Tax: Beginning in 2018, similarly to individuals, trusts and estates will generally be limited to a $10,000 state and local tax deduction and will no longer be able to deduct investment fees.
  • Recharacterization of IRA Contributions: With the current law, payments made to a traditional IRA may be recharacterized as a contribution to a Roth IRA and recharacterized again as a payment made to a traditional IRA during a tax year. Under the new tax bill this type of reconversion would be rebuffed.

The Affordable Care Act (ACA)

  • Individual Mandate: Under the new tax bill, the individual mandate portion of the ACA will be repealed.

Pass-Through Taxation

  • General Rule: Under current tax law, income from pass-through entities, such as sole proprietorships, partnerships, limited liabilities companies, and S corporations, are taxed as ordinary income to individual owners. With the new tax bill, owners will be allowed to deduct 20% of their “qualified business income” from pass-through entities on their individual tax return.  Under this provision, “qualified business income” is defined as domestic income from a pass-through entity but does not include investment income (like dividends, capital gains, and investment interest), reasonable compensation, or guaranteed payments.

The pass-through deduction would be further limited to the greater of:

  • 50% of the individual’s share of W-2 wages paid by the pass-through entity for its workforce, or
  • The sum of 25% of the individual’s share of W-2 wages paid by the pass-through entity plus 2.5% of the unadjusted basis of all qualified property.

However, an individual taxpayer would be exempt from this W-2 limitation if their taxable income does not exceed $315,000 for married filing jointly filers or $157,500 for single filers.

  • Specified Service Business: Income resulting from a “specified service trade or business” does not qualify for the pass-through income deduction, generally. Specified service trade or businesses examples include businesses engaged in the performance of services in the health, law, accounting, and financial services fields.  The income a taxpayer earns would still be eligible for the pass-through income deduction if the taxable income does not exceed $315,000 for married filing jointly or $157,500 for single filers.
  • Business Loss Limitation: The bill rebuffs excess business losses in a taxable year. But, the excess business losses can be carried forward under the net operating loss provisions.  Determining “excess business loss” under the new tax bill can be done by determining the excess of aggregate trade or business deductions over the aggregate gross income or gain plus the taxpayer’s threshold amount.  The threshold amount is $500,000 or $250,000 (amounts are indexed for inflation) for married filing jointly and single filers, respectively.

BUSINESSES:

Tax Rates:

  • Corporate Tax Rate: In the current system, C corporations are taxed based on a tiered system where the top rate is 35%. The new tax bill will eliminate the tiered system and replace it with a flat 21% income tax for C corporations. The new bill also will not have a special tax rate for personal service corporations.
  • Corporate Alternative Minimum Tax: The corporate alternative minimum tax is repealed under the new bill. But, corporations with prior year minimum tax credits will continue to be able to carry the credit forward and offset it against the corporation’s regular tax liability.
  • Contribution of Capital: Starting in 2018, contributions of capital to a corporation will be included in the gross income of the corporation unless the capital contribution is in exchange for stock. When a contribution is made in exchange for stock, the amount of the contribution made that is more than the fair market value of the stock issued will also be included in the gross income of the corporation.

Sales of Assets:

  • Like-Kind ExchangesFor taxpayers, like-kind exchanges allow for the deferral of gain on the exchange of assets of similar character. The new bill, however, limits the type of property that may be used in like-kind exchanges.  The limitation is set to real property that is not held primarily for sale.  This eliminates the ability of businesses to defer gain recognition on like-kind exchanges of personal property.
  • Basis in Sale of Securities: Taxpayers may continue to use the specific identification method when determining their basis in securities sold, because the provision from the Senate’s bill that would require a taxpayer to use the first-in-first-out (FIFO) method in determining their basis in securities sold is NOT included in the new tax bill.
  • Sale of Self-Created Property: With the new bill, gain from the sale of a self-created patent, invention, model or design, or secret formula would result in ordinary income for the taxpayer who created the property or the taxpayer with a substituted /transferred basis from the creator.

Business Expenses and Deductions:

  • Bonus DepreciationBusinesses will be entitled to expense 100% of the qualified property placed in service after September 27, 2017, and before January 1, 2023. Starting January 1, 2023, the amount of qualified property a business will be able to expense will decrease to 20% per year.  Most used property will also qualify for this 100% write-off.
  • Section 179 Expense: Current law allows businesses to deduct up to $500,000 (indexed for inflation) of qualified real property placed in service each year. The new bill increases the deduction amount to $1 million per year. In addition, the bill expands the definition of qualified real property to include all qualified improvement property and certain improvements made to non-residential real property.
  • Interest Expense Deduction: Deductions for business interest expenses will be limited to the sum of:
  1. business interest income
  2. 30% of the business’s adjusted taxable income
  3. interest from the floor plan financing.

Businesses with average annual gross receipts of $25 million or less will not be subject to this limitation and would be able to deduct any interest expenses in full. For this provision, adjusted taxable income is determined without regard to depreciation, amortization, or depletion deductions.

  • Domestic Production Activity Deduction: The new tax bill will repeal the deduction for domestic production activities.
  • Net Operating Loss Deduction: Net operating loss deductions will be limited to 80% of a business’s taxable income under the new tax bill.
  • Entertainment Expenses: Presently, a business may deduct 50% of expenses incurred for entertainment, amusement, or recreation. The new tax bill would eliminate this deduction, meaning that no amount of these expenses would be deductible by a business, but it will maintain the 50% deduction limitation on food and beverage expenses.
  • Research and Experimentation Expenses: Under present law, research and experimentation credits are fully deductible in the year they are incurred. The new bill requires research and experimentation expenses incurred after Dec. 31, 2021, to be amortized over a five-year period.

Business Credits:

  • Research and Development Credit: The new tax bill preserves the research and development credit.
  • Employer-Provided Child Care Credit: The employer-provided child care credit is preserved within the new bill.
  • Work Opportunity Credit: The Work Opportunity Credit is preserved under the new tax bill.
  • Rehabilitation Credit: The bill will provide a 20% rehabilitation credit for qualified rehabilitation expenditures made to historic structures. A taxpayer would claim the credit ratably over a five-year period beginning in the year the structure is placed in service.

Concerned about how the new bill may have an impact on your taxes?  If you would like more details about any aspects of the new bill or how it will affect you, please do not hesitate to contact us!  Feel free to give us a call at 706-855-9500 or send us an email to [email protected].