On December 22, 2017, the President signed the bill known as the “Tax Cuts and Jobs Act,” enacting the most significant tax reform law in thirty years. The new provisions provide sweeping income tax changes for businesses and individuals and a significant increase in estate and gift tax exemptions. Most of the provisions go into effect next year and many of the provisions relating to individuals are temporary and expire after 2025. There are a few moves that can be made before the end of 2017 to take advantage of changes in the law. The following is a summary of key provisions and planning moves to consider before the end of 2017.
For Individual Taxpayers
Individual Rates: The top individual rate will be 37% for individuals earning $500,000 and above, and joint filers earning at least $600,000. There will be seven tax brackets – 10, 12, 22, 24, 32, 35, and 37%. Individuals should consider deferring income until 2018 and accelerating deductions into 2017, but be mindful that acceleration of certain deductions may not result in tax savings if you are subject to the Alternative Minimum Tax (AMT). The law nearly doubles the standard deduction – to $24,000 – for a couple filing jointly. The tax rates and standard deduction expansion expire in 2026.
State and Local Tax Deduction: The new law significantly limits deductions for state and local income taxes and real estate taxes. Taxpayers will only be allowed to deduct up to $10,000 of state and local taxes paid – property taxes and either income taxes or sales taxes. To avoid this limitation, consider paying the last installment of estimated state and local taxes for 2017 no later than December 31, 2017, rather than on the 2018 due date, if you are not projected to be subject to the AMT in 2017. In light of the significant reduction in state and local tax deductions, Congress was concerned taxpayers would pre-pay 2018 taxes to take advantage of this expiring provision. The law therefore has a provision disallowing deductions of pre-payments of 2018 income taxes on 2017 income tax returns. The pre-payment limitation however does not apply to prepaid real estate taxes. Individuals should consider pre-paying real estate taxes, noting that pre-payment of real estate taxes will likely not result in a tax benefit for taxpayers subject to the AMT.
Mortgage Interest Deduction: The bill preserves the deduction for existing mortgages and caps it at $750,000 for newly purchased homes starting January 1, 2018. The law also ends the deduction for interest on home equity loans.
Medical Expense Deduction: The law allows taxpayers to deduct medical expenses exceeding 7.5% of adjusted gross income for 2017 and 2018.
Charitable Contributions: The itemized deduction for charitable contributions is still allowed under the new law, but because most other itemized deductions will be eliminated in exchange for a larger standard deduction (e.g., $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for those who do not itemize deductions. If you think you will fall in this category, consider accelerating some charitable giving into 2017.
Miscellaneous Itemized Deductions: The new law eliminates all miscellaneous itemized deductions; the most common of which are tax planning and preparation fees, investment management fees and various unreimbursed employee business expenses, including home office expenses. Consider pre-paying these types of expenses before the expiration in 2018, but again, be mindful that these expenses are not deductible in calculating the AMT.
Individual Alternative Minimum Tax: The new law retains the AMT for individuals, so taxpayers must continue to calculate their taxes under two regimes. However, the exemption amounts have been increased for 2018 ($70,300 for single filers and $109,400 for joint filers). The exemptions will begin to phase out for single filers at $500,000 of income and joint filers at $1 million of income.
Child Tax Credit: The child tax credit is increased to $2,000 per child, with up to $1,400 of it being refundable.
Estate and Gift Taxation: In 2018, the exemption amounts for estate, gift and generation-skipping transfers doubles, from $5.6 million to $11.2 million per 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.
For Business Taxpayers
Corporate Rate: The corporate rate will be cut to 21% starting January 1, 2018 and the Corporate Alternative Minimum Tax is repealed. Corporations should consider strategies to defer income to 2018 and accelerate deductions before the end of the year.
Pass-through Taxation: S Corporation, Partnership and LLC owners 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. The restriction is 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 provides that trusts and estates are eligible for the 20% deduction under the provision with limitations based on wages paid. 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.
International Regime: The law moves toward a territorial system, and will include a base erosion and anti-abuse tax (BEAT), which requires U.S. multinationals making “excessive” deductible payments to their foreign affiliates to pay a 10% tax on their income without those deductions, after a one-year, 5% transition rate. The plan also imposes a tax on global intangible low-taxed income (GILTI). Overseas profits will be taxed automatically at a 15.5% rate for cash assets and an 8% rate for illiquid assets.
Business Interest Deductibility: The law limits interest deductions to 30% of a company’s earnings before interest, tax, depreciation, and amortization (EBITDA) for four years. After that, the law limits the deduction to 30% of earnings before interest and taxes (EBIT). The law exempts taxpayers with average gross receipts of $25 million or less from the interest limitation.
Business Expensing: Full expensing of new and used capital investments is permitted for five years. After 2022, the 100% allowance will be phased down by 20% each year. Section 179 expensing, which doubles the amount eligible for the special small business investment write-offs to $1 million, is now permanent.
Carried Interest: The legislation imposes a three year holding period requirement for partnership interests received in connection with performing services to be eligible for the long-term capital gain tax rate. The change would triple the length of time an asset must be held to qualify for the lower rate. Carried interest is the portion of an investment fund’s profit – usually a 20% share – that is paid to investment managers.
Entertainment expenses eliminated: For amounts incurred or paid after December 31, 2017, deductions for entertainment expenses are disallowed, eliminating the subjective determination of whether such expenses are sufficiently business related; the current 50% limit on the deductibility of business meals is expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer; and deductions for employee transportation fringe benefits (e.g., parking and mass transit) are denied, but the exclusion from income for such benefits received by an employee is retained.
Planning for the Future
There will be significant planning opportunities to take advantage of these and other changes in Corporate, Business, Individual and Estate Tax regimes. Many of these provisions expire after 2025 so planning will have to consider both mid-term and long-term implications. We look forward to working with you to customize your planning strategies.