The most significant changes under tax reform is the tax treatment of businesses. Unlike changes to the individual tax scheme, which are temporary and somewhat piecemeal, the changes to the business tax scheme are permanent and fairly comprehensive.
Changes in tax law always results in winners and losers. This time is no exception. Here’s a quick synopsis of the five biggest winners and losers with the new tax law:
· Stockholders/owners of C-Corporations. The maximum tax rate on C-Corps is permanently reduced from 35% to 21%.
· Self-employed taxpayers with pass-through income. S-Corps, LLCs and partnerships now benefit from a permanent new 20% deduction on qualified business income (subject to income limits).
· CPAs who prepare tax returns. The law adds complexity in tax planning for higher income individuals, even as some lower income taxpayers with basic tax returns may find some simplification due to loss of many deductions (i.e. more people will use the one-page Form 1040EZ, which some have incorrectly referred to as a “postcard”).
· Married couples earning less than $600,000. They benefit from a temporary elimination of the marriage penalty built into the tax rate schedules.
· Parents of young children who plan to send their kids to private schools. They can now utilize 529 college-savings plans to cover much of the cost of private elementary, middle and high school using these tax-advantaged plans.
· Individuals, families and businesses who pay for health insurance. The elimination in 2019 of the Affordable Care Act’s “individual mandate” (that requires all citizens to maintain health insurance or face penalties) will raise premiums by an estimate 10% for those who are insured. Hospitals and State governments may be negatively impacted by having to provide higher cost emergency room treatment to potentially larger number of uninsured and indigent patients.
· High income taxpayers in mostly blue states. Many will lose part of their deductions for state and local income taxes, sales taxes and property taxes, potentially reducing their ability to itemize deductions at all. The states with the highest combined income tax, property tax and sales tax rates are New York (12.7%), Connecticut (12.6%), New Jersey (12.2%), Illinois (11.0%), California and Wisconsin (11.0%).
· Homeowners and Realtors. Many homeowners will lose all or part of the benefit of real estate tax and interest deductions. These provisions may also negatively affect all homeowners. Realtors who sell homes may also be hurt if limits on the deductibility of mortgage interest, home equity loan interest and property taxes negatively impact home prices and home sales activity.
· Virtually all US taxpayers …if the law is allowed to expire. Only the business entity tax law changes are permanent. Owners of the C-Corps, S-Corps, LLCs and partnerships get a permanent tax break. All other taxpayers will see any benefits under the new law expire in 2025 unless a future Congress and President decide to extend them or make them permanent.
· Kids under age 24 with taxable income. Young people who are dependents on their parents return will now pay 37% tax on income over $12,500 (due to changes in the calculation for “kiddie tax”).
· Future generations. $1.5 trillion added to the national debt ($1.0 trillion assuming the CBO’s best-case scenario for added revenue growth).
And now the details… Here’s a summary of the two dozen tax law changes that have the greatest impact on most Americans:
1. Bigger Standard Deduction, Goodbye Exemptions
A hallmark of the new law is the near doubling of the standard deduction to $12,000 on single returns, $18,000 for head-of-household filers and $24,000 on joint returns … up from $6,350, $9,350 and $12,700 in 2017. As under present law, individuals age 65 or older and blind people get even higher standard deductions. Two 65-year-olds filing a joint return, for example, would add $2,500 to the $24,000 standard deduction. An individual taxpayer age 65 or older would add $1,550, bringing the standard deduction to $13,550.
Congressional analysts say bulking up the standard deduction will let more than 30 million taxpayers avoid the hassle of itemizing write-offs on their tax return because the bigger standard deduction would exceed their qualifying expenses. However, that isn’t true for many since personal exemptions are being eliminated simultaneously.
In exchange for the bigger standard deductions, personal exemptions (the $4,050 deduction for each exemption claimed on the return) are eliminated. A married couple with four kids would lose $24,300 in exemptions in exchange for the $11,300 boost in their standard deduction.
2. Say Hello to a Higher Child Tax Credit and a New Family Tax Credit
Starting in 2018, the $1,000 tax credit for each child under age 17 is doubled to $2,000, with $1,400 of the credit refundable to lower income taxpayers. Additionally, the package significantly increases the income phase-out thresholds. The credit begins to phase out for couples with adjusted gross incomes over $400,000 (up from $110,000 in 2017) and $200,000 for all other filers (up from $75,000).
In addition to the enhanced child tax credit, there is a new, nonrefundable credit of $500 for each dependent who is not a qualifying child including, for example, an elderly parent or disabled adult child. This credit would phase out under the same income thresholds.
3. Tax Bracket Bingo
The proposal to shrink the number of income tax brackets to four was left on the cutting room floor. The new law keeps seven tax brackets, but with different rates and different break points. For example, not only is the top rate lowered from 39.6% to 37%, but that rate also kicks in at a higher income level. And, note that whatever new bracket you fall in, more of your taxable income will be hit with lower rates. (On the other hand, restrictions or elimination of some tax breaks probably may mean more of your income will be taxed.) The marriage penalty is eliminated for those in the lower brackets, but remains in place for couples earning combined income of $600,000 or more.
Here are the current tax brackets and the new ones set to apply for years 2018.
4. Squeezing Homeowner Tax Breaks
Lawmakers decided to reduce – from $1,000,000 to $750,000 – the amount of debt on which homeowners can deduct mortgage interest. The limit applies to mortgage debt incurred after December 15, 2017, to buy or improve a principal residence or second home. Older loans are still subject to the $1 million cap.
The law also bans the deduction of interest on home-equity loans. And this change applies to both old and new home-equity debt. Interest accrued on home-equity debt after December 31, 2017, is not deductible. Taxpayers with home equity loan debt should consider refinancing if their total loan amount is $750,000 or less and if they have enough other deductions to exceed the standard deduction.
A proposal to extend the time you must own and occupy a home to qualify for tax-free profit when you sell it was dropped from the final legislation. As in the past, the law allows you to shelter up to $250,000 of such profit, or $500,000 if you’re married, as long as you have owned and lived in the house for two of the five years before the sale.
5. Deduction for State and Local Taxes
One of the most valuable tax deductions allowed for individuals—the write off for what you pay in state and local income, sales and property taxes—is getting squeezed.
Starting in 2018, the new law sets a $10,000 limit on how much you can deduct of the state and local taxes you pay. A plan to limit the write-off to property taxes only was scrapped. You can deduct any combination of state and local income or sales taxes or residential property taxes, up to the $10,000 cap.
Don’t assume that you can beat this crackdown by prepaying 2018 taxes before December 31, 2017. Although a fourth quarter 2017 estimated state income tax bill due in January or a property tax bill due in January that covers 2017 can be paid in 2017 and deducted on your 2017 return without being subject to the new limit, Congressional tax writers specifically noted that prepaying 2018 taxes won’t earn a fatter deduction.
(Note this: Even under the new rules, property and sales taxes will remain deductible for taxpayers in a business or for-profit activity. For example, if you own a residential rental property, you can continue to fully deduct property taxes paid on that property on Schedule E.)
6. Casualty Losses
Going forward, the new law greatly restricts the opportunity for individuals who suffer unreimbursed casualty losses from sharing the pain with Uncle Sam. Under the old rules, such losses were deductible by those who itemize to the extent the loss exceeded $100 plus 10% of their adjusted gross income. Starting in 2018, the law allows a deduction of such losses only if they occur in a presidentially declared disaster area.
There’s the opposite of a crackdown for 2016 and 2017 losses in presidentially declared disaster areas. The new law permits individuals who suffered such losses to deduct the loss without reducing the write-off by 10% of adjusted gross income. To be deductible under this rule, the loss must exceed $500. Also, for covered losses, the deduction is available even for those who claim the standard deduction.
7. Estate Tax Dodges a Bullet (again)
Efforts to kill the federal estate tax fell short, but the new law doubles the amount that can be left to heirs tax-free in 2018, to about $11 million for couples and about $22 million for married couples. The amount will rise each year to keep up with inflation.
But, as with many changes in the law, this one expires at the end of 2025, when the tax-free amount will revert to earlier levels.
The law does not change the rule that “steps up” the basis of inherited property to its value on the date the benefactor died. As in the past, any appreciation during the life of the previous owner becomes tax-free.
8. Medical Deductions Survive . . . and Get Healthier
Despite efforts to eliminate the deduction for medical expenses, the new law is actually more generous than the old one. Under the old rules, medical expenses were deductible only to the extent they exceeded 10% of adjusted gross income. For 2017 and 2018, however, the threshold drops to 7.5% of AGI. Come 2019, the 10% threshold returns.
9. Alimony Becomes Tax Free . . . but Not Until 2019
A big change is coming for divorce. In the past, alimony paid under a divorce decree was deductible by the ex-spouse who paid it and treated as taxable income by the recipient. Starting with alimony paid under divorce or separation agreements executed after December 31, 2018, the reverse will be true: Payors will no longer get to deduct alimony, but the payments will be tax-free for the ex-spouse who receives them. (That’s the same rule that has and will continue to apply to child support payments.)
10. Status Quo for Teachers' Tax Break
The Senate wanted to double to $500 the tax deduction teachers can claim for using their own money to buy classroom supplies. The House wanted to eliminate this write-off all together. In the end, neither happened. The deduction stays at $250 for teachers regardless of whether or not they itemize.
11. Squeezing Commuter Benefits
The new law eliminates, starting in 2018, the rule that allows employers to deduct up to $260 a month per employee for the cost of transportation-related fringe benefits, such as parking and transit passes. Employees can still use pre-tax money to cover such expenses, but employer subsidies may dry up. The new law puts the kibosh on the federal bike commuter benefit that had allowed employers to provide employees up to $20 a month tax-free to cover bike-related expenses.
12. Tax Breaks for Students Survive
The effort by the House of Representatives to eliminate the deduction for interest paid on student loans and to begin taxing tuition benefits earned by graduate students were snubbed by the Senate. Neither proposal made it into the new law.
As under the old law, you can continue deduct up to $2,500 a year of interest paid on student loans. This write-off can be claimed by those who take the standard deduction, but it phases out at higher income levels. Also, tuition waivers and discounts received by graduate students will retain their tax-free status.
The new law also declares that, if a student loan is discharged due to the borrower’s death or permanent disability, the amount discharged will no longer be considered taxable income.
13. A Reprieve for Dependent Care Plans
The House of Representatives called for preventing working parents from setting aside pre-tax money in dependent care flexible savings accounts to pay for child care costs. The Senate blocked the effort, so the tax break remains in the law. Parents can continue to set aside up to $5,000, pre-tax, in these accounts.
14. No More Roth Do-Overs
The new law will make it riskier to convert a traditional individual retirement account to a Roth. Under the old law, you could reverse such a conversion—and eliminate the tax bill—by “recharacterizing” the conversion by October 15 of the following year. Starting in 2018, such do-overs are done for. Conversions will be irreversible.
15. Investors Control Over Tax on Capital Gains
For a while, it looked like Congress might restrict the flexibility investors have to control the tax bill on their profits. Investors who have purchased stock and mutual fund shares at different times and different prices are allowed to choose which shares to sell in order to produce the most favorable tax consequences. You can, for example, direct your broker to sell shares with a high tax basis (basically, what you paid for them) to limit the amount of profit you must report to the IRS or, if the shares have fallen in value, to maximize losses to offset other taxable gains. (Your gain or loss is the difference between your basis and the proceeds of the sale.)
The Senate called for eliminating the option to specifically identify which shares to sell and instead impose a first-in-first-out (FIFO) rule. The oldest shares would be assumed to be the first sold. Because it is assumed that the older shares likely have a lower tax basis, this change would trigger the realization of more profit sooner rather than later.
In the end, though, this idea fell by the wayside. Investors can continue to specifically identify which shares to sell to arrange for the most favorable tax outcome. CMMS uses the “High Cost” method of selling partial lots which means that the current taxable gain is automatically minimized.
16. The Zero Percent Capital Gains Bracket Survives
The new law retains the favorable tax treatment granted long-term capital gains and qualified dividends, imposing rates of 0%, 15%, 20% or 23.8%, depending on your total income.
In the past, your capital gains rate depended on what tax bracket you fell in. But, with the changes in the brackets, Congress decided to set income thresholds instead. For example, the 0% rate for long-term gains and qualified dividends will apply for taxpayers with taxable income under about $38,600 on individual returns and about $77,200 on joint returns.
17. Like-Kind Exchanges Survive ... But Only for Real Estate
Generally, an exchange of property is a taxable transaction, just like a sale. But the law includes an exception when investment or business property is traded for similar property. Any gain that would be triggered by the sale of such property is deferred in the case of a like-kind exchange. This break has applied to assets such as real estate and tangible personal property such as heavy equipment and art work.
Going forward, though, the new law restricts its use to like-kind exchanges of real estate, such as trading one rental property for another. It’s estimated that the change would cost affected taxpayers more than $30 billion over the next ten years.
18. Fewer Taxpayers Need Fear the AMT
Originally, both the Senate and the House bills called for eliminating the alternative minimum tax, a parallel tax system developed more than 40 years ago to ensure that the very wealthy paid some tax. Taxpayers who may fall into the AMT zone have to calculate their taxes twice to determine which system applies to them. In a last-minute change, though, the new law retains the individual AMT, but limit the number of taxpayers ensnared by it by significantly hiking the AMT exemption. (The new law does abolish the corporate AMT.)
19. Tax Relief for Passthrough Businesses
The new law slashes the tax rate on regular corporations (sometimes referred to as “C corporations”) from 35% to 21%, starting in 2018. The law offers a different kind of relief to individuals who own pass-through entities—such as S corporations, partnerships and LLCs—which pass their income to their owners for tax purposes, as well as sole proprietors who report income on Schedule C of their tax returns. Starting in 2018, many of these taxpayers will be allowed to deduct 20% of their qualifying income before figuring their tax bill. For a sole proprietor in the 24% bracket, for example, excluding 20% of income from taxation would have the effect of lowering the tax rate to 19.2%.
The changes to the taxation of passthrough businesses are some of the most complex provisions in the new law, in part because of lots of limitations and anti-abuse rules. They’re designed to help prevent gaming of the tax system by taxpayers trying to have income taxed at the lower passthrough rate rather than the higher individual income tax rate. For many pass-through businesses, for example, the 20% deduction mentioned above phases out for taxpayers with incomes in excess of $157,500 on an individual return and $315,000 on a joint return. At the end of the day, most individuals who are self-employed or own interests in partnerships, LLCs or S corporations will be paying less tax on their passthrough income than in the past.
21. Deductions (That Lots of People Take) Get the Ax but Two Credits Survive
The new law eliminates a popular deduction for moving expenses. The deduction, which was available to itemizers and non-itemizers, allowed taxpayers to deduct the cost of a job-related move. Going forward, only members of the military can claim it.
The new law also repeals all miscellaneous itemized deductions subject to the 2% of AGI threshold, including the write-off for tax preparation fees, unreimbursed employee business expenses and investment management fees.
The House of Representatives version of the tax overhaul wanted to scrap the credit for the elderly and the disabled, which is worth up to $1,125 to qualifying low-income taxpayers. It also unplugged the credit for plug-in electric vehicles, which is worth of up $7,500. The Senate refused to go along, though, so both tax breaks will continue.
22. Kiddie Tax Gets More Teeth
Under the old law, investment income earned by dependent children under the age of 19 (or 24 if a full-time student) was generally taxed at the parents’ rate, so the tax rate would vary depending on the parents’ income. Starting in 2018, such income will be taxed at the same rates as trusts and estates … which will produce a much higher tax bill. The top 37% tax rate in 2018 kicks in at $600,000 for a married couple filing a joint return. That same rate kicks in at $12,500 for trusts and estates . . . and, now, the kiddie tax, too.
22. Affordable Care Act (aka “ObamaCare”) Individual Mandate: Dead or Alive?
The new law does repeal the “individual mandate” – the requirement that demands that you have health insurance or pay a fine. But not until 2019. For 2018, the mandate is still in place.
23. Wither Withholding?
The new law is causing quite a ruckus in payroll offices around the country. Under the old law, the amount of tax withheld from paychecks was based on the number of allowances employees claimed on W-4 forms. And, the number of allowances was tied closely to the number of exemptions the worker claimed on his or her tax return. Starting in 2018, there are no exemptions, so there’s a mad scramble going on to figure out how to set withholding under all the new rules.
The new law orders the Secretary of the Treasury to come up with a new system, but also says 2018 withholding can be based on the old rules. Keep an eye out on this one.
24. 529 Plans Aren’t Just for College Anymore
The new law allows families to spend up to $10,000 a year from tax-advantaged 529 savings plans to cover the costs of K-12 expenses for a private or religious school. Previously, tax-free distributions from those plans were limited to college costs. This is a big win for 529 Plan providers as taxpayers with young children enrolled in private schools will be motivated to contribute more to these plans.