What’s in a name? Rumor has it that the President had pushed to call the bill the “Cut, Cut, Cut Act”, but it was decided it would be called The Tax Cuts and Jobs Act of 2017. However, Senate rules deemed the name too short, so after some delineation on the matter, the actual name of the bill became “An Act to provide reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018”.
The bill keeps seven tax brackets, as under current law, but will result in slight cuts to the tax rates for most taxpayers. However, these cuts are temporary and are currently set to expire on December 31, 2025.
Taxpayers in the lowest bracket will still pay 10% of their taxable income, though the actual amount of tax paid will be lower for most due to an increase in the standard deduction. The balance of the brackets will result in lower rates ranging from 1% to 4%.
The top tax rate for the wealthiest Americans will fall from 39.6% to 37 %, and the income threshold will increase to $500,000 for a single person or $600,000 for a married couple.
This is a more generous cut than proposed in either the initial Senate or House bill.
The bill nearly doubles the standard deduction, but this provision also expires on December 31, 2025, at which point it will revert to current levels, adjusted for inflation. The new deduction will be $12,000 for singles, $18,000 for heads of household and $24,000 for married couples, which stopped just short of doubling the 2017 deduction amounts.
While the standard deduction is being raised dramatically, the bill suspends personal exemptions, which currently allows taxpayers to deduct $4,150 per person in a household from their taxable income, with some exceptions. The exemptions will be suspended until December 31, 2025, when the increased standard deduction expires.
Raising the standard deduction will provide a larger deduction for the 70% of taxpayers who do not itemize, however this will be largely offset by the loss of the personal exemptions. For larger households, this loss of the personal exemptions will prove especially costly.
For those who itemize, the bill will limit the deduction for combined state and local income tax and property taxes to $10,000 for both singles and married couples. For many taxpayers, the limitation on these deductions is significant and will create opportunity for “lumping” these expenses in alternate years.
Current homeowners can deduct mortgage interest on the first $1 million of acquisition debt that existed prior to December 15, 2017. The new law limits the deduction to interest on up to $750,000 of acquisition indebtedness for mortgages originated after December 15, 2017.
If you refinance an existing mortgage, you will be limited to deducting interest on the prior mortgage balance. This is a subtle but significant change which will impact the ability to access home equity through cash out refinancing. The law also eliminates deductibility of interest on all new and existing home equity loans.
Employees can no longer claim a number of miscellaneous deductions for unreimbursed expenses, including travel and automobile, home office, union dues, licensing fees, professional organization memberships, and work-related education.
To help offset the impact of eliminating personal exemptions, the new law raises the child tax credit and makes a portion of it refundable, meaning low-income families who owe no income taxes will actually get a refund up to the refundable portion of the credit. The credit was increased to $2,000 per child with $1,400 refundable, up from the current $1,000 of which none is refundable. Filers may claim the full credit if they have income up to $200,000 for single filers (up from $75,000 currently) and up to $400,000 for married couples (up from $110,000 currently) making it available to many more households.
The AMT was designed to prevent high-income individuals from avoiding income tax by piling up deductions. It is essentially a parallel method for calculating your income tax liability. Despite the high income target, households making between $200,000 and $500,000 were most likely to pay the AMT under the current system.
The new law makes changes designed to reduce the impact of the AMT tax. The law will raise the minimum income level at which the AMT could apply, from $50,600 to $70,300 for individuals and from $78,750 to $109,400 for couples married filing jointly. The old AMT system would also reduce your exemption if your income hit a certain threshold: $120,700 for singles and $160,900 for couples. Under the new law, those exemption thresholds are now significantly higher, $500,000 for an individual and $1 million for a couple. This will substantially reduce the number of taxpayers subject to AMT.
The new law provides further relief for parents (and grandparents) saving for their children’s education by liberalizing 529 plans to permit tax-free withdrawals for primary and secondary education in addition to college. The new law allows for up to $10,000 per year for primary and secondary expenses beginning in 2018. Most states will most likely follow this federal legislation, but it is up to each state to declare whether they will participate or not. For Ohioans, in June of 2017, Governor John Kasich signed into law Ohio’s Biennial Budget Bill, which included a provision that doubled the amount of the annual 529 state tax deduction from $2,000 to $4,000 beginning in 2018.
The student loan deduction will stay as it is under current law.
Graduate students can breathe a sigh of relief because the final bill does not count tuition waivers as taxable income, a proposed provision many universities feared would damage Ph.D. programs and collegiate research.
The bill makes the existing deduction for health insurance and medical expenses more generous in 2017 and 2018, allowing people to claim a deduction for unreimbursed expenses exceeding 7.5% of adjusted gross income. After 2018, the deduction will revert to the current 10% threshold.
The bill also eliminates the Affordable Care Act penalty for individuals who do not buy health insurance starting in 2019. The politics of this provision would require more space than we have available.
The bill will immediately cut the current tax rate on corporations from 35% to 21%. Unlike tax cuts for individuals, the corporate rate cut is permanent. In addition, businesses will be permitted to immediately deduct capital purchases rather than spread the deduction over multiple years.
One of the major changes for business owners is the taxation of pass through entities and a new deduction related to that income. Pass through entities consist of S Corporations and partnerships and refer to entities where the income/loss “passes through” to the owner and the tax implications are calculated on the personal return.
The new tax law creates a deduction for pass through income in an effort to provide these business owners with lower taxes, since they will not get the benefit of the lower corporate rate. The deduction is 20% of your “qualified business income (QBI)” from a partnership, S corporation or sole proprietorship.
For taxpayers in trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners the benefits are phased out with taxable income above $157,500 for singles and $315,000 for joint filers.
Under the new law, you will be able to pass $11 million to your heirs tax-free, or $22 million if you are a married couple. These amounts will be indexed for inflation.
The House bill had eliminated the estate tax entirely, but the final bill kept the estate tax in place while doubling the exemption. This provision is temporary and will sunset on December 31, 2025.
The new tax law is a significant piece of legislation that will have a meaningful impact on your financial plan. As the final regulations and technical corrections are released, we will be reaching out to schedule a complete update to your financial plan to measure the impact and identify adjustments and strategic planning opportunities. We will also be rolling out new collaborative tools to allow you to monitor your progress and support intentional decisions in achieving all of your goals.
A detailed financial plan along with a prudent investment methodology and the discipline to follow it will be your best path to prosperity and peace of mind. We sincerely appreciate being your partner in this endeavor.