As anticipated, we now have clarity that the bill caps the deduction for real estate taxes and state taxes at $10,000 starting in 2018. Depending on your income level and tax situation, we had been recommending that clients pre-pay their real estate taxes before year end. In addition, we recommended factoring in a generous 2017 state fourth quarter estimated tax voucher and mailing it in with payment before year-end to hopefully work in your favor. While the tax reform does contain language to disallow prepayments for 2018 state tax, the mechanics and enforcement behind the potential limitation is still a bit unclear. Please note that if you are anticipated to be in Alternative Minimum Tax (AMT) for 2017, pre-payment of real estate tax and state tax will not benefit you.
The new tax reform is quite extensive, impacting not only individuals in a variety of ways, but sole proprietors, flow-through business entities and C corporations as well. We can help you navigate these changes and maximize any potential opportunities going forward.
Below are bullets to highlight some of the more significant elements of the tax reform bill:
- The new tax bill will not affect your 2017 income taxes. Almost all aspects of the new tax laws will not be effective until you file you 2018 taxes.
- The new tax bill maintains seven tax brackets but the percentages and income ranges have changed. Here is a comparison of the old and new rates for single and for married filing joint:
- The standard deduction has essentially been doubled. For single filers, the standard deduction has increased from $6,350 to $12,000; for married couples filing jointly, it’s increased from $12,700 to $24,000.
- The personal exemption is gone. Previously, you could claim a $4,050 personal exemption for yourself, your spouse and each of your dependents, which lowered your taxable income. This deduction is now gone.
- The Child Tax Credit has been expanded. The child tax credit has doubled to $2,000 for children under 17. It’s also now available, in full, to more people. The entire credit can be claimed by single parents who make up to $200,000, and married couples who make up to $400,000.
- New tax credit for non-child dependents, like elderly parents. Taxpayers may now claim a $500 temporary credit for non-child dependents. This can apply to a number of people adults support, such as children over age 17, elderly parents or adult children with a disability.
- Fewer people will have to deal with the alternative minimum tax. The alternative minimum tax, a parallel tax system that ensures people who receive a lot of tax breaks still pay some federal income taxes, remains in place for individuals. But fewer people will have to worry about calculating their tax liability under the AMT moving forward. The exemption has been raised to $70,300 for singles, and to $109,400 for married couples. These exemptions begin to phase out at $500,000 for individual filers and $1,000,000 for married filing joint.
- The mortgage interest deduction has been reduced. Current homeowners are in the clear. But from now on, anyone buying a new home will only be able to deduct the first $750,000 of their mortgage debt. That’s down from $1 million. In addition, interest on home equity loans will no longer be deductible.
- Eligibility to use Section 529 Education Savings Accounts has been expanded. Previously the earnings on a 529 savings account could be taken out tax-free as long as they were used for qualifying educational expenses. Now, up to $10,000, per student, can be distributed annually to cover the cost of sending a child to a “public, private or religious elementary or secondary school.”
- The deduction for alimony and the corresponding inclusion of alimony in gross income have both been repealed. Alimony payments, which are codified in divorce agreements and go to the ex-spouse who earns less money, are no longer deductible for the person who writes the checks. In addition, the recipient in no longer required to include the alimony in gross income. This provision will apply to couples who sign divorce or separation paperwork after December 31, 2018.
- The current deduction for miscellaneous itemized deductions has been repealed. This deduction included items like investment expenses, tax preparation fees, and unreimbursed employee business expenses which were over 2% of the taxpayer’s AGI. This deduction will no longer be available for 2018 and after.
- The deduction for moving expenses by a non-military individual has been repealed.
- Individual provisions in the new legislation technically expire by the end of 2025, though many people expect that a future Congress won’t actually let them lapse.
- Pass-through Income Deduction – Starting in tax years after 2017, there will be a new deduction for which many business entities will be eligible. The deduction will be for 20% of “qualified business income” from a partnership, S corporation, or sole proprietorship, as well as 20% of qualified real estate investment trust (REIT) dividends, qualified cooperative dividends, and qualified publicly traded partnership income. There are several exceptions and specialized rules which apply to this deduction. Here are two of the major items:
- If the taxpayer has income above a certain threshold, a limitation on the amount of this deduction is based on the business owner’s share of W2 wages the business paid. This income threshold for phase out is between 157,500 and $207,500 for singles and $315,000 to $415,000 for married filing joint. Alternatively, capital intensive businesses may yield a higher deduction as there is a secondary, relatively complex, formula to weigh against the 20% deduction.
- A special limitation applies to businesses defined as “special service businesses.” “Special service businesses” include any business involving the performance of services in the field of health, law, accounting, consulting, athletics, financial services and any trade or business the principal asset of which is reputation or skill of one or more of its owners. These businesses are phased out of the deduction between $157,500 to $207,500 for singles and $315,000 to $415,000 for married filing joint. Architects and engineers are specifically excluded from this limitation.
This new deduction for 20% of “qualified business income” will likely be one of the most highly utilized and beneficial deductions within the new tax bill. It is also one of the most complicated new rules and will take careful consideration to apply correctly.
- The new tax bill reduces the corporate tax rate for C-corporations. Here is a comparison of the old rate to the new rate:
- Corporate Alternative Minimum Tax (AMT) – The corporate AMT has been repealed by the new tax law. Similar to the individual AMT, the corporate AMT required calculation of a corporation’s tax liability based on an alternative set of rules. This calculation will no longer be required for tax year 2018 and beyond.
- Full Expensing for Qualified Property – One hundred-percent expensing is allowed for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. Qualified property includes (1) property to which MACRS applies with an applicable recovery period of 20 years or less; (2) water utility property; (3) computer software other than computer software covered by section 197; or (4) qualified improvement property. “Full expensing” is similar to Section 179 in that it allows deduction of the full cost of the property in the year acquired.
- Limit on Deductible Interest Expense – The deduction for net interest expense incurred by a business will be limited to 30% of the sum of the business’s adjusted taxable income, business interest income and the floor plan financing interest. Adjusted taxable income is taxable income computed before net interest expense or income, net operating losses, and depreciation expense. Any disallowed interest expense can be carried forward indefinitely. There is an exception for small businesses with average gross receipts of $25 million or less. These businesses are not subject to the limitation. In addition, certain businesses within the real estate field are exempt from this limitation.
- The rules for carryover of net operating losses have been modified. Losses generated in tax years beginning after December 31, 2017, can only be carried forward to offset up to 80% of taxable income in future years. In addition, the rules allowing carryback of net operating losses to 2 years back have been repealed.
- The current tax law allows a special deduction for businesses who are manufacturing and producing goods within the United States. This deduction called the “Domestic Production Activities Deduction” has been repealed.
- Entertainment Expense Deduction: Under the current law, businesses are allowed to deduct 50% of entertainment, amusement, and recreational expenses paid for employees or for other purposes. The new law reduces this allowance to 0%. 100% of these expenses will be non-deductible. Meals expenses are still allowed at 50%.
- Loosening of Restrictions for Use of Cash Basis: Permits businesses with average gross receipts of $25 million or less to use the cash method of accounting even if the business has inventories as long as it treats inventory as non-incidental materials and supplies or the method of accounting conforms to the taxpayer’s applicable financial statements. Under current law, average gross receipts must be under $5 million. This could offer a valuable tax planning opportunity for businesses under the threshold with high accounts receivable and prepaid expenses at year-end.
- Unlike the individual tax provisions, most of the business tax provisions have no set expiration date and will be permanent unless new legislation is passed to change or repeal the provisions.
- The estate tax exemption per person doubles from $5.6 million to $11.2 million. This expires on December 31, 2025. The exemption will increase inflation.
- International taxation-various changes beyond the scope of this article inclusive of transitioning to a territorial corporate tax system (vs. current worldwide)