On Friday, December 22, 2017, the President signed the Tax Cuts and Jobs Act (the “Act”). The Act provides the most comprehensive update to the tax code since 1986 and includes several provisions of particular interest to our private clients.
As was proposed in the earlier Senate bill, individual tax reform is temporary. Unless noted, the provisions discussed below would go into effect on January 1, 2018, and expire on December 31, 2025. [Click here] for a print-friendly version of this document.
Ordinary Income Tax Rates
The Act replaces the existing tax rate structure with a seven-rate structure.
Capital Gains and Qualified Dividends
Long-term capital gains and qualified dividends tax rates remain largely unchanged from present law and apply these rates based on taxable income:Long-term
The Act calls for a child’s earned income to be taxed at the rates applied to single filers and a child’s net unearned income to be taxed as ordinary income and preferential (i.e. capital gains) rates applied to estates and trusts. A child’s income would no longer be taxed at the parents’ rate. However, the parent can elect to report the child’s income his/her return if these conditions are met:
- Child’s only source of income is interest, dividends, and capital gain distributions
- Child’s gross income is less than $10,500
- Child doesn’t file a joint return
- Child made no estimated tax payments and had no federal income tax withholding
The breakpoints for the ordinary income, long-term capital gains, and qualified dividends tax brackets would be adjusted in future years for inflation. However, inflation would be measured using the Chained Consumer Price Index (C-CPI), which generally provides a slower inflationary adjustment than the Consumer Price Index (CPI) measurement. This measurement of inflation is applied for all individual tax inflation adjustments permitted in the Act and would be permanent, not expiring in 2025 with the other individual provisions.
Standard Deduction and Personal Exemptions
The Act increases the standard deduction beginning in 2018 to $24,000 for joint filers, $18,000 head-of-household filers, and $12,000 for all other individual filers. The deduction would be indexed for inflation in future years. The additional standard deduction for the elderly and the blind was retained.
Further, the Act suspends the deduction for personal exemptions through 2025. The Act, however, retains the $100 and $300 exemptions for complex and simple trusts, respectively, and a $4,150 exemption for qualified disability trusts to be adjusted for inflation in future years.
Child Tax Credit
The Child Tax Credit would be increased to $2,000 per qualifying child, with up to $1,400 being fully refundable. A qualifying child is a dependent child under age 17. The Credit would phase out for joint filers with adjusted gross income exceeding $400,000 and other filers with adjusted gross income exceeding $200,000. The child must have a social security number before the Child Tax Credit is available.
An additional $500 non-refundable credit may be available for other dependents including a child under the age of 17 that does not have a social security number. The additional credit is available to non-citizen dependents only if they are a resident of the United States.
Deferral Election for Qualified Equity Grants
A qualified employee can elect to defer recognition of the income attributable to stock received regarding options exercised or restricted stock units from the employer. The election is made within 30 days after the first time the employee’s right to the stock is substantially vested or is transferable, whichever occurs earlier. The deferral can be for as long as five years but triggering events may cause the income to be recognized sooner than five year. The employer must not have its stock readily traded on an established securities market during the preceding calendar year and the corporation must have a written plan that covers not less than 80% of all employees who provide services to the corporation in the US. A 1% owner, the CEO (and his/her lineal family), the CFO (and his/her lineal family) and the top four highest compensation officers, either currently or in the preceding 10 years, are not eligible for this deferral.
IRAs converted to a Roth can no longer be recharacterized back to an IRA.
Adjustments to Income (“Above-the-Line” Deductions):
The Act suspends through 2025, the deduction for moving expenses except in the case of a member of the U.S. military who moves under a military order.
For any divorce or separation agreements entered into after December 31, 2018, the deduction for alimony or separate maintenance payments is repealed and recipients of alimony or separate maintenance payments will no longer be required to include the alimony payments in their gross income. Under the new provisions, alimony or separate maintenance payments will be treated similar to child support because they are not accounted for in the tax system (no deduction and no inclusion). Existing alimony and separate maintenance agreements are grandfathered in as are any modifications to existing agreements unless, however, the parties to a modification expressly provide that the new rules should apply to the modified agreement.
Prenuptial agreements are not grandfathered in and taxpayers may wish to revisit those agreements, given these new provisions.
The medical expense deduction threshold would be temporarily lowered to permit a deduction against both the regular tax and alternative minimum tax (AMT) for medical expenses over 7.5-percent of adjusted gross income for all taxpayers itemizing deductions in 2018.
The sum of the itemized deductions for state and local real property taxes, state and local personal property taxes, and state and local income or sales taxes may not exceed $10,000 ($5,000 for married individuals filing separate returns). The deduction for foreign real property taxes is suspended through 2025. The $10,000 limitation does not apply to foreign income taxes paid or taxes paid or accrued in carrying on a trade or business.
IRS issued guidance regarding the tax treatment of making charitable contributions in exchange for an income tax credit.
Home Mortgage Interest
The itemized deduction for mortgage interest has been reduced to permit only the deduction of interest on acquisition indebtedness not exceeding $750,000 ($375,000 for married filing separate taxpayers) on the taxpayer’s primary or second home. The interest deduction for home equity indebtedness is suspended.
Currently, taxpayers can take a combined acquisition and home equity indebtedness interest expense deduction on $1,100,000 of debt. Debt incurred on or before December 15, 2017, is grandfathered in and subject to the current limitations. Further, taxpayers who entered into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and who purchases such residence before April 1, 2018, are also eligible for the current higher limitations.
The Act modifies current charitable contribution rules. First, the Act increases the percentage limitation for cash contributions to public charities from 50-percent of adjusted gross income to 60-percent of adjusted gross income.
Second, the Act denies a charitable deduction for payments made in exchange for college athletic event seating rights.
Finally, the Act repeals the substantiation exception for certain contributions reported by the charitable organization. Taxpayers must obtain a contemporaneous written acknowledgement of contributions over $249.
The deduction for personal casualty losses is suspended through 2025 except in the case of losses attributable to a Federally declared disaster; provided, however, that taxpayers with a personal casualty loss gain for any taxable year during the suspension period may continue to deduct personal casualty losses not attributable to a Federally declared disaster in an amount equal to no more than the personal casualty loss gain.
Further, the Act contains special casualty loss relief for taxpayers who suffered losses in certain 2016 disasters. Primarily, taxpayers affected by such disasters may be able to take up to a $100,000 disaster distribution from their retirement plan. In addition, casualty losses resulting from such disasters would be deductible if they exceed $500, without application of the 10 percent of adjusted gross income threshold. Such losses may be claimed even by taxpayers who elect the standard deduction.
Miscellaneous Itemized Deductions Subject to the 2 percent Floor
All miscellaneous itemized deductions subject to the 2% adjusted gross income floor have been suspended. This includes the miscellaneous itemized deductions for investment fees and expenses, tax preparation fees, and unreimbursed employee business expenses among others.
Overall Limitation on Itemized Deductions
The overall limitation on itemized deductions enacted in 1990, often called the “Pease limitation” (named after former Congressman Donald Pease) has been repealed through 2025.
The Act expands the definition of qualified higher education expenses that may be paid from a 529 account to include up to $10,000 of expenses for tuition at an elementary or secondary public, private, or religious school.
The shared responsibility payment for individuals failing to maintain minimum essential health insurance coverage has been reduced to $0 beginning after December 31, 2018.
Beginning after December 31, 2017, nonrecognition of gain from like-kind exchanges would be limited to real property not held primarily for sale. Transitional relief is provided for exchanges where property was either disposed of or received in an exchange on or before December 31, 2017.
Electing Small Business Trusts (ESBTs)
ESBTs are eligible S corporation shareholders and are currently permitted to only have as beneficiaries, individuals or entities that would otherwise be eligible to own S corporation stock directly. A nonresident alien individual is currently an impermissible S corporation shareholder and as such, an impermissible current beneficiary of an ESBT. The Act permits nonresident alien individuals to be a potential current beneficiary of an ESBT.
Further, ESBTs are currently permitted to take a charitable contribution deduction under the contribution deduction rules of trusts. Unlike individuals, trusts have no limitation on their contribution deduction and are prohibited from carrying forward excess contributions. The Act calls for ESBTs to determine their charitable deduction going forward under the rules applicable o individuals. Accordingly, ESBTs would be subject to the charitable deduction percentage limitations and carryforward provisions that individuals are.
Individual Alternative Minimum Tax (AMT)
The individual alternative minimum tax (AMT) has been retained. However, the exemption amounts have been temporarily increased to $109,400 for joint filers and $70,300 for single filers. The exemption phase-out thresholds are increased to $1,000,000 for joint filers and $500,000 for single filers. The phase-out threshold for estates and trusts would be unchanged. The exemptions and phase-out thresholds are indexed for inflation after 2018.
Estate and Gift Taxes
The lifetime exemption for estate and gift taxes is increased to $11,800,000 for 2018. The exemption will be adjusted for inflation. The estate, gift, and generation-skipping transfer taxes were not repealed.
Deduction for Qualified Business Income of Pass-Thru Entities
The Act permits an individual taxpayer, whether they choose to take the standard deduction or to itemize, to deduct 20-percent of their “combined qualified business income” from a partnership, S corporation, or sole proprietorship, subject to a wage limitation that is phased in for joint taxpayers with taxable income exceeding $315,000 and other taxpayers with taxable income exceeding $157,500.
“Combined qualified business income” includes the taxpayer’s qualified trade or business income, qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.
Specified service trades and businesses are generally not eligible for the deduction. The specified service income is from health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade where the principal asset is the reputation or skill of 1 or more owners or employees or any business that involves the performance of services that consist of investment and investment managing trading or dealing in securities, partnership interests or commodities. The trade or business where the principal asset is the reputation or skill of 1 or more owners or employees has been narrowly defined to include (a) any business in which a person receives fees, compensation, or other income for endorsing products or services, (b) any business in which a person licenses or receives fees, compensation or other income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity, and (c) receiving fees, compensation, or other income for appearing at an event or on radio, television, or another media format. However, there are exceptions to permit the deduction for engineering and architecture businesses, and small specified service trades and business. Small specified service trades and business begin to phase out of the deduction for joint taxpayers with taxable income exceeding $315,000 and other taxpayers with taxable income exceeding $157,500; joint taxpayers completely phase out of the deduction with $415,000 of taxable income, other taxpayers completely phase out at $207,500 of taxable income.
Estates and trusts are eligible for the 20-percent deduction.
Business Losses and Net Operating Losses
Business losses would only be permitted in the current year to the extent they do not exceed the sum of taxpayer’s net business income and, for joint filers, $500,000 ($250,000 for all other taxpayers). Excess business losses would be disallowed and instead added to the taxpayer’s net operating loss (NOL) carryforward.
The Act amends the non-corporate NOL rules to limit the deductible NOL to 80-percent of taxable income with an unlimited carry forward. Taxpayers would no longer be permitted to carryback their net operating losses to the previous two taxable years. NOL carryovers from 2017 and earlier have a 20 year carry forward period.
Extended Rollover Period for Rollover of Plan Loan Offset Amounts
The time period for plan loans treated as distributed in tax years beginning after December 31, 2017 may be contributed to an eligible retirement plan as a rollover contributions extended from 60 days after the date of offset to the due date (including extensions) for filing the federal income tax return for the tax year in which the plan loan offset occurs. A qualified plan loan offset amount is a plan loan offset amount that is treated as distributed from a qualified retirement plan solely due to the termination of the plan or the failure to meet the repayment terms of the loan because of the employee’s separation from service.
Please free to contact our office at 401-831-0200 if you have any questions.