Effective for 2018, Congress approved the largest tax reform legislation changes to our tax system in over three decades. Under the new Tax Cuts & Jobs Act (TCJA) legislation, substantial changes have been made to both individual and corporate tax rates.
These changes will affect individual and business taxpayers and will include both pros and cons. The one aspect sure to stay the same is the tax planning services we will continue to provide to you here at Eilts & Associates, Inc.
We hope to shed a little light on these changes by providing a summary in the pages that follow. This summary provides you with the opportunity to review the changes and determine which topics apply to your circumstances.
As always, please don’t hesitate to contact us with any questions. It is our pleasure to help you navigate these changes in a way that best meets your individual needs and goals.
Individual Tax Provisions
Tax Bracket Changes
While there are still seven tax brackets, they’ve all shifted downward slightly, which means nearly everyone will be in a lower tax bracket for 2018 than they were in 2017.
For the 2017 tax year, the tax brackets were 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent.
For 2018, the new tax brackets, along with the corresponding income ranges, are:
10 percent (up to $9,525 for individuals; up to $19,050 for married couples filing jointly)
12 percent ($9,526 to $38,700; $19,051 to $77,400)
22 percent ($38,701 to $82,500; $77,401 to $165,000)
24 percent ($82,501 to $157,500; $165,001 to $315,000)
32 percent ($157,501 to $200,000; $315,001 to $400,000)
35 percent ($200,001 to $500,000; $400,001 to $600,000)
37 percent ($500,001 and up; $600,001 and up)
Lower tax brackets mean a lot of us could see more take-home pay. But with all the other changes to deductions and exemptions, don’t assume that you will owe less tax.
Other Changes for Individuals:
Personal Exemption Deduction Eliminated
Under pre-TCJA law, the deduction for each personal exemption was $4,150 for 2018, subject to a phase-out for higher earners. Under current law for tax years 2018 - 2025, the deduction for personal exemptions is eliminated.
Standard and Itemized Deductions
Standard Deduction Increased. Under pre-TCJA law, for 2018, the standard deduction amounts were to be: $6,500 for single individuals and married individuals filing separately, $9,550 for heads of household, and $13,000 for married individuals filing jointly (including surviving spouses). Additional standard deductions may be claimed by taxpayers who are elderly or blind.
For tax years 2018 - 2025, the standard deduction is increased to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers, adjusted for inflation in tax years after 2018.
This increased standard deduction may result in many taxpayers no longer itemizing their deductions. If that is the case for you, you will no longer be deducting your state and local income taxes, mortgage interest, and charitable contributions. The potential to itemize EVERY OTHER YEAR might be something to explore to save on taxes EVERY OTHER YEAR.
Medical Expense Deduction Threshold Temporarily Reduced
For tax years 2017/18, the threshold for medical expense deductions is reduced from 10% of AGI to 7.5% of AGI for all taxpayers.
State and Local Tax Deduction Limited
For tax years 2018-2025, a taxpayer's itemized deduction for state and local taxes is limited to $10,000 ($5,000 for a married taxpayer filing a separate return). State and local taxes is the aggregate of (1) state and local property taxes and (2) state and local income taxes, paid in the tax year. This is potentially a substantially lower deduction for many of us living in Illinois.
Mortgage and Home Equity Indebtedness Interest Deduction Limited
Under pre-TCJA law, taxpayers could deduct as an itemized deduction qualified residence interest, which included interest paid on a mortgage secured by a principal residence or a second residence. The underlying mortgage loans could represent acquisition indebtedness of up to $1 million, plus home equity indebtedness of up to $100,000.
For tax years 2018-2025, the deduction for interest for mortgage interest is limited to underlying home acquisition and home improvement indebtedness of up to $750,000 ($375,000 for married taxpayers filing separately).
Note:Any acquisition indebtedness incurred before 12/15/17, will not be impacted by the new lower limit. However, home equity indebtedness interest is limited to what was borrowed for your home improvements only. Other draws on your home equity, such as for a car or college tuition, are not deductible.
Casualty and Theft Loss Deduction Eliminated
For tax years 2018-2025, the personal casualty and theft loss deduction is eliminated, except for personal casualty losses incurred in a federally-declared disaster. However, where a taxpayer has personal casualty gains, the loss suspension doesn't apply to the extent that such loss doesn't exceed gain.
Miscellaneous Itemized Deductions Eliminated
For tax years 2018-2025, the deduction for miscellaneous itemized deductions that are subject to the 2% floor is eliminated. This includes tax preparation fees, investment fees, and employee expense reimbursement. Therefore, miles and other unreimbursed expenses incurred as an employee will no longer be deductible.
Limitation on Itemized Deductions Eliminated
Under pre-TCJA law, higher-income taxpayers who itemized their deductions were subject to a limitation on these deductions. For tax years 2018-2025, the limitation on itemized deductions is eliminated. For those of you who make over $261,500 (single) or $313,800 (married filing jointly) this is a nice benefit of the new law.
Affordable Care Act Individual Mandate Repealed
Beginning January 1, 2019, the amount of the individual shared responsibility payment is permanently reduced to zero. However, for 2018 the penalty for non or substandard coverage is still subject to a penalty.
Alimony Deduction by Payer and Income Inclusion by Payee Repealed
For any divorce or separation agreement executed after 2018, or executed before that date but modified after it (only if the modification expressly provides that the new amendments apply), alimony and separate maintenance payments are not deductible by the payer spouse and are not included in the income of the payee spouse.
Moving Expense Deduction and Reimbursements Eliminated
For tax years 2018-2025, the deduction for moving expenses and the income exclusion for qualified moving expense reimbursements is eliminated, except for members of the Armed Forces on active duty (and their spouses and dependents) who move pursuant to a military order and incident to a permanent change of station.
Alternative Minimum Tax (AMT) Retained with Increased Exemption Amounts
The TCJA retains the individual AMT but with increased exemption amounts and increased phase-out thresholds for years 2018-2025. Previously, the AMT exemption was $54,300 (single) and $84,500 (married filing jointly) and was not indexed for inflation. The new AMT exemption is $70,300 (single) and $109,400 (married filing jointly) and will be indexed for inflation. With the loss of 2% miscellaneous itemized deductions and the $10,000 limit on state and local income taxes, both of which were previously not deductible for AMT calculations, many of you in the AMT in 2017 will see some relief in the new tax laws.
Distributions from Qualified Tuition Programs (QTPs) (aka 529 Plans)
Under pre-TCJA law, the earnings on funds in a QTP could be withdrawn tax-free only if used for qualified higher education expenses at eligible schools. Eligible schools included colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education.
For distributions after 2017, "qualified higher education expenses" is expanded to include tuition at an elementary or secondary public, private, or religious school, up to a $10,000 limit per tax year.
Child Tax Credit Increased
For tax years 2018-2025, the child tax credit is increased from $1,000 to $2,000 per qualifying child under the age of 17. Under pre-TCJA law, the credit phased out for AGI over $75,000 for single or head of household filers, $110,000 for married joint filers, and $55,000 for married individuals filing separately. Under the TCJA, the income level at which the credit phases out is increased to $400,000 for married taxpayers filing jointly ($200,000 for all other taxpayers). This is a substantial increase and could benefit many of you in 2018.
Non-child Dependents. The TCJA allows a new $500 non refundable credit for dependents who do not qualify for the child tax credit. Taxpayers can claim this credit for children who are too old for the child tax credit, as well as for non-child dependents, such as parents. There is no SSN requirement to claim this credit, so taxpayers can claim the credit for children with an Individual Tax Identification Number (ITIN) or an adoption tax identification number (ATIN) if the otherwise qualify. Taxpayers cannot claim this credit for themselves.
Refundability. The amount that is refundable is increased to $1,400 per qualifying child, and this amount is indexed for inflation, up to the $2,000 base credit amount. The earned income threshold for the refundable portion of the credit is decreased from $3,000 to $2,500.
Estate and Gift Tax Retained with Increased Exemption Amount
Under pre-TCJA law, the first $5 million (as adjusted for inflation in years after 2011) of transferred property was exempt from estate and gift tax. For estates of decedents dying and gifts made in 2018, this "basic exclusion amount" was $5.6 million ($11.2 million for a married couple). For estates of decedents dying and gifts made after 2019 and before 2026, the TCJA doubles the base estate and gift tax exemption amount from $5 million to $10 million. The $10 million amount is indexed for inflation occurring after 2011 and is expected to be approximately $11.2 million in 2018 ($22.4 million per married couple).
New Deduction for Business Income from Pass-through Entities and Sole Proprietorships. See Entity-specific Tax Provisions BELOW.
Tax Items That Stay the SAME:
Educator Expense Deduction. K-12 educators can still deduct up to $250 per year for unreimbursed classroom supplies.
Student Loan Interest. Interest expense up to $2,500 can be deducted by qualifying taxpayers for interest paid on student loans. The phase-out limits still start at $65,000 for singles and head of households and $130,000 for married filing jointly.
Sale of Personal Residence. The first $250,000 of gain (single) and $500,000 of gain (married filing jointly) is not taxable if you have lived in the home 2 of the last 5 years.
Health Savings Account (HSA) Deduction. No changes.
IRA Deduction. No changes.
Deduction for Self-employed Taxpayers (SE tax, SE health insurance, SE qualified retirement plan contributions) No changes.
Some Education Benefits Remain the Same, Others Modified.Taxpayers can continue to claim the American Opportunity Credit, a credit of up to $2,500 per year for the first four years of college education, and the lifetime learning credit, a credit of up to $2,000 per year for qualifying education expenses.
Entity-Specific Tax Provisions
Under the TCJA, C corporations, S corporations, partnerships, and sole proprietorships will see dramatic changes.
C Corporations: Tax Rates
Currently, C corporations use graduated tax rates, with a top rate of 35% if taxable income exceeds $10 million. In addition, personal service corporations are taxed at a flat rate of 35%. For tax years beginning after 12/31/17, the TCJA lowers the corporate tax rate to a flat 21%. This applies to personal service corporations as well. Before you consider becoming a C Corporation you need to make sure you completely understand the double taxation of C Corporations. Generally, a C Corporation is not your best entity of choice.
New Deduction for Business Income from Pass-through Entities and Sole Proprietorships
This portion of the TCJA applies to business owners of flow through entities and can be a bit complicated. This is provided as a summary for you but a tutorial might be needed if you own a flow through entity and your income exceeds $315,000 (married) or $157,500 (single).
For tax years 2018-2025, an individual may deduct 20% of qualified business income from a partnership, S corporation, or sole proprietorship or rental income. In general this 20% deduction will be allowed for taxpayers with less income than $315,000 for married filing jointly taxpayers or $157,500 for all others. Easy peasy and a nice perk of the 2018 tax law to put small businesses on par with the steep reduction in corporate tax rates.
Taxable income above $315,000 (married) and $157,500 (single) is where it gets complicated. The deduction is reduced for taxpayers with taxable income above the level mentioned above based on a few factors such as W2 wages paid by the company and assets.
Further complicating matters…a disallowance of the deduction with respect to specified service trades or businesses has been added. A specified service trade or business (SSTB) means any trade or business involving the performance of services in the fields of health, law, accounting, consulting, entertainment, athletics, financial services, real estate agents, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners. In other words, A LOT OF US.
This disallowance does not apply to SSTB’s with taxable income below the threshold amounts of $315,000 (married) or $157,500 (single). The deduction is completely disallowed for specified service trades or businesses with taxable income above $415,000 (married) and $207,500 (single). If your SSTB is above the phase-out threshold, you at least get to take advantage of the lower income tax rates. In between these phase-out limits the 20% deduction is limited based on your business net income, W2 wages and assets.
What You Need To Do: If you are a SSTB and expect to have income over $315,000 (including your spouse’s income, investment income and other income) or $157,500 if you are single, tax planning is more important this year than in the past. Accelerating expenses into 2018, retirement contributions or deferring income to 2019 are all part of the mix. A good, accurate summary of your year-to-date numbers through October will be needed for us to best advise you.
Other General Business Tax Provisions
Many of the tax incentives that businesses have grown accustomed to have been repealed, modified, or limited in some way.
Expensing and Depreciating Property
Section 179 Deduction. Under pre-TCJA law, the maximum Section 179 deduction was scheduled to be $520,000 for 2018. In addition, the qualifying property phase-out threshold was scheduled to be $2,070,000. The TCJA increases the maximum Section 179 deduction and phase-out threshold to $1 million and $2.5 million, respectively, for property placed in service in tax years beginning January 1, 2018. For tax years beginning after 2018, these amounts will be indexed for inflation. The TCJA also expands the definition of Section 179 property to include certain tangible personal property used predominantly to furnish lodging and certain improvements to nonresidential real property such as roofs, HVAC, fire protection and alarm systems, and security systems.
Immediate Expensing of Qualifying Business Assets
The TCJA establishes a 100% first-year deduction for qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023.
Increased Luxury Automobile Depreciation Limits
IRC Sec. 280F limits the annual amount of depreciation that can be claimed for passenger autos. For passenger autos placed in service after 2017 for which bonus depreciation is not claimed, the maximum amount of allowable depreciation is increased to $10,000 for the placed-in-service year, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years. These amounts will be indexed for inflation for autos placed in service after 2018. For passenger autos eligible for the bonus first-year depreciation, the increase to the first-year depreciation limit remains $8,000.
Shortened Recovery Period for Real Property
For property placed in service after 2017, the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property are eliminated. The TCJA imposes a general 15-year recovery period and straight-line method for qualified improvement property. For landlords this is a nice benefit for 2018.
Regardless of its form, every business may be subject to a net interest expense disallowance. For tax years beginning after 2017, net interest expense in excess of 30% of the company's adjusted taxable income will be disallowed. Adjusted taxable income is generally defined as taxable income computed without regard to deductions for depreciation, amortization, depletion, or the Section 199 deduction. However, taxpayers with average annual gross receipts for the prior three years of $25 million or less are exempt from this limitation.
The TCJA limits the like-kind exchange rules so they apply only to real property that is not held primarily for sale. However, under a special transition rule, the like-kind exchange rules continue to apply to exchanges of personal property if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before December 31, 2017.
Changes to Meals and Entertainment Expenses
One of the more talked about changes, the TCJA disallows deductions for entertainment expenses. No deduction for games, events or parties. Meals are still allowed as deductions and will be subject to the same 50% limitations as in the past. The TCJA also limits the deductibility of business meals to those provided in an in-house cafeteria or otherwise on the employer's premises. Those so called 100% deductible meals are now 50% deductible.
Congratulations! You are now well-educated on the new tax law!
In summary, lots of changes here; for most of you the key changes are:
Lower tax rates
Limited state and local tax deductions
Expanded Child Tax Credits up to income of $400,000
For business owners the biggest change is:
New Deduction for Business Income from Pass-through Entities and Sole Proprietorships.
We have been reading up on this all summer and following the latest (and very late) guidelines from the IRS, some of which are still being completed by the IRS. We are ready to talk through your questions and run some tax projections if needed. Don't let your neighbor sway you by claiming they are getting tax deductions that no longer exist. (No, dry cleaning is not deductible unless you pay for it at a hotel and that is too expensive). We promise to keep you informed and prepared.
Business owners will really need to work up tax projections or at least have a discussion before year end.
Additionally, the IRS is reformatting many of the tax forms. I think this will lead to some initial confusion in the tax arenas early in the year and might even delay the date at which we can start to file and process tax returns, so stay tuned.