On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (the Act), enacting the most comprehensive tax reform legislation since 1986. While the Act includes sweeping changes affecting all taxpayers, provide below is a summary of the more significant provisions impacting individuals.
Under the old tax law, the top tax rate was 39.6%. Under the new law, the top rate is 37% on income over $600,000 for married filing joint taxpayers and over $500,000 for single taxpayers.
Increased from $12,700 to $24,000 for married filing joint taxpayers and to $12,000 for single taxpayers.
Alternative Minimum Tax (AMT)
The AMT is a tax system separate from the regular tax that is intended to prevent a taxpayer with substantial income from avoiding tax by using various exclusions, deductions, and credits. If the tax determined under the AMT exceeds the regular tax, the larger AMT amount is owed. The new law marginally increases the exemption amounts but substantially increases the income threshold at which those exemptions are phased out. As a result, we anticipate a large decrease in the number of taxpayers subject to the AMT.
State and Local Tax Deduction
The law limits the deduction for state and local taxes, including real and personal property taxes, and income taxes, to $10,000.
Mortgage Interest Deduction
Under the old law, a taxpayer could deduct interest paid on mortgages secured by a primary residence and one additional residence up to an aggregate principal balance of $1 million plus home equity indebtedness of up to $100,000.
Under the new law, for mortgage debt incurred after December 15, 2017, the deduction for mortgage interest is limited to underlying indebtedness of up to $750,000. The deduction for interest on home equity indebtedness is suspended until 2026, even for pre-existing loans.
Refinancing a grandfathered loan causes no harm if the principal balance of the new loan does not exceed the balance of the old loan at the time of refinancing.
The limitation on cash contributions to public charities has increased from 50% to 60% of adjusted gross income (AGI).
Medical Expense Deduction
The threshold for medical expense deductions has been reduced to 7.5% for all taxpayers for 2017 and 2018.
Miscellaneous Itemized Deductions
Under the old law, taxpayers were allowed to deduct certain deductions to the extent they exceeded, in the aggregate, 2% of the taxpayer’s AGI. Examples include tax preparation fees, investment management fees, safe deposit box fees, etc. These deductions have been suspended until 2026.
Overall Limitation on Itemized Deductions
Under the old law, higher-income taxpayers who itemized their deductions were subject to a limitation on these deductions. For taxpayers who exceeded the threshold, the otherwise allowable amount of itemized deductions was reduced by 3% of the amount of the taxpayers’ adjusted gross income that exceeded the threshold. This limitation has been temporarily suspended.
Child Tax Credit
Under the old law, a married couple filing jointly could claim a child tax credit of up to $1,000 per qualifying child under the age of 17. This credit began to be phased out at income exceeding $110,000. Under the new law, beginning in 2018, the credit has been increased to $2,000 per qualifying child and the phase out does not begin until your AGI exceeds $400,000.
Under the old rule, children under 19 (or under 24 and a full-time student) with unearned income over $2,100 were taxed on that unearned income at their parents’ rate to prevent parents from shifting income to their children in order to avoid their own higher income tax rate. Under the new rule, children subject to the Kiddie Tax are taxed using the trust tax rates, which reach the highest tax bracket of 37% on ordinary income at an extraordinary low income level ($12,500 in 2018).
Long Term Capital Gains and Qualified Dividends
Retains the favorable tax rates under the new law.
New Deferral Election for Qualified Equity Grants
Beginning in 2018, a taxpayer may elect to defer income recognition for Restricted Stock Units (RSUs) settled or options exercised for up to five years on the difference between the stock’s fair market value at the time of vesting and the amount paid by the employee, if any.
529 Education Savings Plans
Funds from 529 Education Savings Plans can now be used for tuition at an elementary or secondary public, private or religious school, up to $10,000 per year.
Roth IRA Recharacterizations
Under the old rules, if you converted an IRA to a Roth IRA, you were able to unwind that conversion up until you filed your tax return for the year in which you converted. This would be beneficial if the value of your IRA dropped from the time you converted to a Roth to the time you filed your tax return. Under the new rules, once you convert an IRA to a Roth IRA, you can no longer unwind the transaction.
Repeal of Obamacare Individual Mandate
Under pre-Act law, the Affordable Care Act required that individuals who were not covered by a health plan that provided at least minimum essential coverage were required to pay a “shared responsibility payment” (also referred to as a penalty) with their federal tax return. Beginning in 2019 this requirement is permanently repealed. The 3.8% Net Investment Income Tax is unaffected.
Estate and Gift Taxation
In 2018, the exemption amounts for estate, gift and generation-skipping transfer is increased to $11.2 million for each individual. This provision expires after 2025. Lifetime gifts over the exemption amount, and estates over the exemption amount, will continue to be taxed at the current rate of 40%. Property included in a decedent’s estate at death will continue to receive a step-up in basis to fair market value.
S Corporation, Partnership and LLC owners along with sole proprietorships that meet certain conditions will be eligible for a 20% deduction on their business income. Pass-through owners who file jointly and earn at least $315,000 in business profits are subject to limitations on the deduction based on how much the pass-through pays in wages or invests in equipment and machinery. Service businesses, such as law, accounting and consulting firms, are eligible for the deduction if owners are under the threshold. The law also includes a provision that would limit a partnership’s ability to offset passive income—dividends or interest or rental income—with losses from an active trade or business in excess of $500,000 for joint filers or $250,000 for an individual. Read more about this in our other insight, Effect of the 2017 Tax Reform on the Investment Management Industry.