Tax Reform Series: Individuals
On December 22, 2017, President Trump signed Public Law No. 115-97 (the "Act " also referred to as the "2017 Tax Act"). The Act is the culmination and byproduct of the reconciliation process between House and Senate legislation originally called the "Tax Cuts and Jobs Act of 2017."
The 2017 Tax Act delivers sweeping changes that will ultimately affect most every provision in the area of tax law directly or indirectly. The Act is generally effective for tax years beginning after 2017. Some of these changes will only be temporary (2018-2025) and will "sunset" for individuals in 2026 but others, mostly related to business taxpayers, will be permanent.
Although a stated purpose for the Act was simplification, there are many new and quite significant complexities under the law. For this reason, 2018 is the time to learn how these nuances or complications may affect you. Please find below a selection of information essential to obtaining the most tax efficient outcomes available under the new law, and be certain to discuss particular circumstances and questions with your attorney.
Changes to Individual Income Taxpayers (2018-2025)
Lower Rates and Temporary Changes. The 2017 Tax Act temporarily lowers the individual tax rate structure. The top marginal rate drops to 37% from 39.6%, and the income levels to which the rates apply were generally raised. For instance, taxable income of a single filer now needs to be over $500,00 to reach the top rate. Although the top rate decreased, not all taxpayers will be better off. However, these rates along with changes and limitations to deductions set forth below will sunset after 2025. The prior rate structure and other individual taxpayer provisions are set to return to pre-Act law in 2026. A table to compare your new 2018 tax brackets to your 2017 tax bracket is located at the end.
Standard Deduction Up but Personal Exemptions Out. The standard deduction nearly doubles under the Act. In 2018, the standard deduction is: $24,000 for a married taxpayer; $12,000 for a single taxpayer; and $18,000 for heads of household. These thresholds purposefully encourage most American taxpayers to claim the standard deduction instead of itemizing. This simplification comes with a cost though, because the personal exemption is eliminated. Larger families and single parents may particularly feel the sting from losing the personal exemption. In 2017, each exemption was valued at $4,050 and available for the taxpayer, their spouse, and dependents.
Deductions Eliminated or Limited. The elimination and limitation of many deductions for individuals, combined with the increased standard deduction, means there will no longer be a tax benefit from itemizing deductions to many taxpayers. A diminished or lost tax benefit is anticipated related to residential mortgage interest payments, charitable giving, and state and local tax payments. Likewise, deductions for employee expenses and the miscellaneous itemized deduction are eliminated for expenses incurred between 2018 and 2025.
Home Mortgage Interest Deduction. Under the Act, there is no deduction for interest on home equity debt allowed from 2018-2025. The mortgage interest deduction remains available but is capped to interest on $750,000 (down from $1 million) of so-called acquisition indebtedness. Pre-Act law continues to apply to those mortgages existing prior to December 15, 2017 and generally upon their subsequent refinancing.
State and Local Tax Deduction. Over the protests of many, on both sides of the aisle, the ability to deduct state and local property taxes, and either income or sales taxes ("SALT") paid was largely curtailed for individual taxpayers. Rather than total elimination, a compromise was reached among Republicans to limit the deduction to $10,000 for joint and single filers (i.e. no doubling for marriage). For taxpayers living in states with high property tax or income tax, this represents a very significant change and potentially larger federal tax bills in 2018 through 2025.
The SALT deduction cap may encourage more domicile planning for purposes of reducing contacts with high-tax states. Clients should be aware that simply buying a residence in another state is not enough to sever ties with a high-tax state (e.g. New Jersey and New York) that desperately wants to continue taxing its share of a resident's income. Additionally, even though the Act reduces concerns of a taxable federal estate for many (discussed below), the deduction cap may encourage the use of more sophisticated estate planning techniques establishing various trusts that could own taxpayers' residences in order to allow each trust to have its own $10,000 SALT deduction.
Charitable Giving. The 2017 Tax Act maintains the deductibility of charitable contributions. In fact, there is an increased limitation on cash contributions from 50% of the contribution base (similar to AGI) to 60%. Nevertheless, it is very apparent that any incremental tax benefit will be unavailable to most taxpayers, because it is expected that many more Americans will forego itemizing deductions through 2025 and instead claim the increased standard deduction. For the charitably motivated without itemized deductions exceeding the new standard deduction, a new concept of "bunching" deductions to targeted years may prove beneficial. This would allow one to exceed the standard deduction hurdle in a given year (e.g. donate $40,000 in a single year instead of $10,000 a year over 4 years.)
Kiddie Tax. Prior to the 2017 Tax Act, a child's earned income was taxed at the same rates as a single filer, but unearned income was subject to the "kiddie tax." Generally speaking, that meant the unearned income of a child (under age 18 but also some children up to age 23) in excess of $2,100 was taxed at the parents' rate if that rate was higher than the child's rate. The Act maintains status quo for earned income, but now unearned income is taxed according to the brackets applicable to trusts and estates. The resulting rates may often be higher than the parents' rates. The kiddie tax change also sunsets in 2025.
Alternative Minimum Tax ("AMT") - Here to Stay. The long loathed AMT is essentially a parallel tax code, which requires some households to calculate their tax liability a second time to ensure they are paying a certain minimum rate. The AMT was not repealed under the Act. However, through 2025, the Act does increase the exemption amount and its phaseout thresholds. The AMT exemption is the amount a taxpayer can deduct from the alternative minimum taxable income before calculating their AMT liability ($109,400 for married joint filers in 2018). The exemption gradually phases out by a reduction of the exemption for taxpayers over certain income thresholds ($1 million for married joint filers in 2018). The result is that fewer households are likely to be subject to the AMT and those still subject will face a temporarily reduced AMT liability relative to pre-Act tax law. Unfortunately, the complexity involved to calculate household tax liability twice appears here to stay.
Just FYI Travis Scales is a tax attorney focused on efficient wealth accumulation and preservation strategies.