We have a new tax law: The Tax Cuts and Jobs Act (H.R. 1). We’ll go through some of the new provisions (mostly for individuals), but here are some high level observations:
- If you file an individual return and earn between $200,000 and $400,000, you’ll probably have a higher marginal tax bracket. Some Married Filing Joint taxpayers will also have a higher rate, but far fewer. There will be a “marriage penalty” however, for some higher income couples where the bracket is not double the individual rate.
- Kids and trusts will probably pay more. Kids are subject to trust rates and trust rates are lower (and therefore tax is higher). Any taxable income over $12,500 will be taxed at a top marginal bracket of 37%.
- Capital gains tax stays the same. But we didn’t shake the NIIT (net investment income tax). It’s still an additional 3.8% ON TOP of the 15% or 20% tax. But here’s happy news: the proposed FIFO twist of only being able to sell your oldest shares of stock was dropped!
- You’ll have to be smarter about how you take itemized deductions going forward. More people will “bunch” to get over the standard deduction threshold.
- No more phase out of itemized deductions. Goodbye Pease limitation.
- Fewer people will have to pay Alternative Minimum Tax (AMT), but it’s still there.
- A visit to the estate attorney may be in order to reassess gifting plans or transfers to spousal exempt trusts or GRATs. Fewer people will need estate documents purely for tax reasons.
- If you have a “pass-through” business like an LLC or S-Corp, you may need to talk to an attorney about whether to make any entity changes.
Income Tax Brackets
Using the Senate version of the bill, we ended up with seven brackets (top rate of 37%) and avoided that nasty bump up to 45.6% in the House version. Not simple, but many people will see a lower tax bracket. That could be offset by a loss of itemized deductions (more on that soon).
Notably, individuals filing “single” versus “married” will fare worse. More of them will see an increase in marginal tax bracket if incomes range between $200,000 and $400,000. These rates last until 2026 when they revert to 2017 levels. So planning will have to include an eight-year period followed by “something else.” Who knows what could happen by then.
Trusts and Estates
Trusts now are subject to four brackets, not five. This generally applies to irrevocable trusts, not revocable trusts or intentionally defective grantor trusts where income flows through the individual return.
If you file a “kiddie tax” return, you now are subject to trust rates. Surprise! Parents with income over $600,000 were already paying at least this, so not much difference at those levels.
Note any taxable income for kids or trusts over $12,500 is taxed at a top marginal bracket of 37%.
Capital Gains Tax
The basic brackets of 0%, 15% and 20% stay the same. The Net Investment Income Tax (NIIT) is a 3.8% surtax on income over $250,000 (MFJ) or $200,000 (single). It’s a complicated calculation and unfortunately it won’t go away. So it sits on top of the 15% or 20% capital gains tax if you hit it.
While both the House and Senate versions of the bill changed how the exclusion applied, the final version leaves the current capital gains exclusion of $250,000 (single) and $500,000 (MFJ) in place.
Increased Standard Deduction, No Exemptions
Exemptions are out. Standard deductions are doubled: $12,000 single, $24,000 (MFJ).
Child tax credits get more generous: $2,000 per qualifying child with up to $1,400 of that refundable even if you don’t owe any tax. Marco Rubio pushed for this to help offset the loss of exemptions.
- The medical deduction made it through. The threshold was lowered to 7.5% of Adjusted Gross Income (AGI) —although only for two years (2017 and 2018). Then it’s back to 10% of AGI.
- You can take up to $10,000 in deductions for either state tax or real estate tax. But gone are the days you can deduct high state and property tax.
- If you have an existing mortgage, you can deduct interest on up to $1,000,000 of debt. If you take out a new mortgage after December 14, 2017, you can only deduct interest on up to $750,000 of debt. Chances are mortgage interest rates will continue to increase going forward, so even less reason to refinance.
- Charitable deductions are expanded to allow deducting up to 60% of AGI without carrying forward contributions. However, since there are less itemized deductions allowed overall, many people will “bunch” their deductions to get over the standard deduction threshold. (“Bunching” means that you wouldn’t give the same amount every year. You’d make higher contributions periodically.)
- The Pease limitation that phased out itemized deductions for higher incomes is gone. That means you’ll be able to take all of your eligible deductions.
- No more interest deductions on home equity lines.
- No more deductions for miscellaneous expenses over 2% of AGI.
Unfortunately, Alternative Minimum Tax (AMT) is still with us. Fewer people will be subject to this tax however as the exemption phase-out ranges have been considerably expanded to $500,000 (single) and $1,000,000 (MFJ). More people will finally be able to use AMT credits. If you have Incentive Stock Options (ISOs), you still need to be careful about triggering this tax.
Estate and Gift Tax
For the next eight years, the estate tax exemption levels double to $11.2 million per person, $22.4 million per couple. With the higher exemption, most people won’t have to pay estate tax. Looks like cost basis step-ups are still in. Top rates remain at 40%. Gift tax lifetime exemptions go up to the same levels as estate tax.
Unfortunately, most people have to plan for more than eight years when contemplating estate strategies. This also means more thought needs to be given to underlying state death tax rules.
The annual exclusion goes to $15,000 per person in 2018 (not part of the new bill, just an inflation increase). Those people trying to decrease their taxable estate will have less incentive to give while alive (except for the happiness it brings all concerned!). More people may want to give more than $15,000 a year and file a gift tax return with the higher lifetime exemption (no tax due).
Larger corporations (C-corporations) will see rates cut from 35% to 21% in 2018. Repatriation of overseas-held earnings and profits will be taxed at 15.5% for cash and 8% for illiquid assets. The expectation is that a lot of money will move back to the U.S. That may have the effect of pushing up the U.S. dollar. That would help U.S. investments, potentially hurt international investments.
Pass-through entities like S-Corps, partnerships, sole proprietors and LLCs will have a different set of rules—not as favorable. If you are a personal service corporation—financial advisors, CPAs, attorneys, engineers—you probably won’t see any decrease in tax. Income flows through to your marginal ordinary income tax brackets.
Non-personal service corporations may get a deduction of 20% of qualified income. That means only 80% of their income gets taxed at ordinary income tax rates. There are complex rules (beyond the scope of this article) that are meant to discourage employees of corporations to declare themselves pass-through entities.
Other Related Tax Implications
No More Roth Recharacterizations
Often referred to as a “free look,” you won’t be able to change your mind about a Roth conversion. Once you do it, it’s done. “Back door” Roth contributions are still OK.
Coverdell education accounts can be rolled over to 529 plans. 529s can be used for primary or secondary school costs (maximum of $10,000 a year), not just college. At the college level, you can use more than $10,000 per year to offset expenses.
Talk to your tax professional about what these changes mean to you. We will also be evaluating case-by-case how the new tax law affects your financial planning. Software will need to be revised in 2018. With the temporary nature of this new law for individuals, we’ll also need to think carefully about making changes that affect planning beyond 2025.
The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.