Tax Reform - Summary of Conference Agreement
As this is being written the Joint Conference Committee has approved tax reform legislation and it is expected to be voted on by the House of Representatives and the Senate in the next few days. Indications are that the legislation will be passed by both houses and signed by the President.
The legislation contains a number of significant changes affecting individuals and businesses. Because the legislation includes changes that reduce tax and other changes that increase tax, the impact on any two individuals at the same level of income can be very different.
This summary is intended to provide a brief overview of many of the provisions we expect to have the most significant impact on our clients and friends.
Individuals
The legislation affects individual taxpayers by reducing tax rates, increasing the standard deduction, capping the deduction for state and local income and property taxes at $10,000, capping the amount of mortgage debt on which interest can be deducted at $750,000, eliminating the deduction for home equity indebtedness, significantly increasing the alternative minimum tax exemption, eliminating miscellaneous itemized deductions, eliminating the personal exemption deduction, and other various changes.
Estate and Gift Taxes
The bill would double the estate and gift tax exemption for estates of decedents dying and gifts made after Dec. 31, 2017, and before Jan. 1, 2026. The basic exclusion amount would increase from $5 million to $10 million and would be indexed for inflation occurring after 2011. (The inflation-adjusted exclusion amount is $5.49 million in 2017.) This would allow married couples to combine for a $22 million exclusion (after adjustment for inflation) in 2018.
Businesses
The tax rate for subchapter C corporations has been reduced from a top rate of 35% to 21%, effective in 2018. Pass-through entities, such as partnerships, S corporations, and sole proprietorships, and their owners, will benefit from a deduction equal to 20% of qualified income. This provision is subject to certain limitations and restrictions, including restrictions on specified personal service businesses, such as law firms.
Cost recovery deductions are also enhanced under the new legislation, with bonus depreciation increasing from 50% to 100% for property placed in service after September 27, 2017 and the application of bonus depreciation has been extended to used property. In addition the Section 179 limitation has been increased to $1 million and the investment limitation at $2.5 million.
International
In an extremely significant change the legislation moves the United States to a territorial system of taxation. In addition, a one-time deemed repatriation of overseas earnings and profits of foreign subsidiaries would be taxed at 15.5% for cash assets and 8% for illiquid assets.
What to do
· Since the deduction for state and local income taxes and property taxes will be capped at $10,000 in 2018, it may make sense to pay your 2017 state income taxes in 2017. This would include your fourth-quarter state estimated payment as well as any additional state income tax expected to be due with your 2017 state tax return. However, if you are subject to the alternative minimum tax (AMT) in 2017 this will provide little or no benefit.
· Prepaying 2017 property taxes normally due in 2018 will also provide a benefit, as long as you are not subject to AMT in 2017.
· If you expect to claim the standard deduction in 2018 consider accelerating charitable contributions into 2017. This can be done simply by making your expected 2018 charitable contributions early, or by establishing or adding to a donor advised fund.
· Even if you will be able to itemize in 2018, accelerating charitable contributions into 2017 may provide a slightly larger tax benefit than you would obtain by deducting the same contribution in 2018. For example, someone in the top tax bracket in each year would receive a benefit of 2.9% of the contribution by making it in 2017 instead of 2018.
Summary of Individual Provisions
· Reduction in Tax Rates
o Currently the top individual income tax rate is 39.6%, which, for a married couple filing a joint return, applies to taxable income above $470,700. Under the new law beginning in 2018 the top individual rate will be 37% and for a married couple filing a joint return will apply to taxable income above $600,000.
· Reduced Deduction for State and Local Taxes
o Currently one is able to deduct the full amount of state and local income taxes paid in a year along with property taxes on an unlimited number of properties. While state and local income taxes and property taxes will continue to be deductible, the deduction is capped at $10,000. This change will have a significant impact on residents of higher tax states and those living in the areas where property values and property taxes are high.
o As noted above, most people will benefit from making sure to pay their 2017 state and local taxes in 2017. Note that the legislation contains a provision denying the deduction for any 2018 state and local taxes paid in 2017.
· Increase in standard deduction
o The legislation increases the standard deduction for a married couple filing a joint return from $12,700 in $2017 to $24,000 in 2018. Similarly a single individual will see their standard deduction increase from $6,350 to $12,000. The increased standard deduction, combined with the cap on the deduction for state and local income and property taxes, will result in far fewer individuals itemizing their deductions.
While this will simplify the tax filing process for many, it will also mean those claiming the standard deduction will not benefit from making additional charitable contributions until they surpass a certain threshold.
· Qualified dividends and capital gains
o The legislation does not change the treatment of qualified dividends and long-term capital gains.
· Home mortgage interest
o For debt incurred after December 14, 2017, taxpayers are able to deduct interest on acquisition debt up to $750,000. As under current law, interest on a first and second home may be deducted. However, the legislation eliminates the deduction for interest on up to $100,000 of home equity debt.
o Mortgage debt in place before December 15, 2017, will continue to be covered under current law, with interest on acquisition debt up to $1 million being deductible.
· Miscellaneous itemized deductions
o The deduction for miscellaneous itemized deductions has been repealed effective for 2018. Miscellaneous itemized deductions include unreimbursed employee business expenses, tax preparation fees, investment advisory fees, and other expenses for the production of income or preservation of capital.
· Medical expenses
o The itemized deduction for medical expenses has been retained, and the floor for calculating the deduction reduced from 10% to 7.5% of adjusted gross income for 2017 and 2018 only.
· Child tax credit
o The child tax credit has increased from $1,000 to $2,000 per child with up to $1,400 refundable. (Refundable meaning that a taxpayer paying income tax below the credit amount will receive a refund of the excess credit.) In addition, a $500 credit for dependents other than qualifying children, such as a parent, has been added to the law. The phase-out for the enhanced child credit begins at $400,000 of adjusted gross income.
· Alimony
o Under the new law, for divorce or separation agreements entered into after December 31, 2018, alimony paid will no longer be deductible and alimony received will no longer be treated as taxable income.
· Section 529 Plans
o The bill would allow such plans expanded benefits to include tax free-distributions to pay for K-12 expenses. Specifically, the legislation would allow distributions of not more than $10,000 in expenses for tuition incurred during the taxable year in connection with the enrollment or attendance of the designated beneficiary at a public, private or religious elementary or secondary school.
Summary Business provisions
· Reduced corporate tax rate
o The legislation provides for a 21% corporate tax rate beginning in 2018, and makes the new rate permanent. The maximum corporate tax rate is currently 35%. The corporate AMT is repealed.
· Pass-through businesses
o Under current law, the owners of pass-through businesses such as partnerships, S corporations, and sole proprietorships, pay tax on the income of the pass-through entity that their individual tax rate, with the current highest individual rate being 39.6%. Under the new legislation a deduction of 20% of qualified pass-through income can be claimed, subject to certain limitations if the owner's taxable income exceeds $315,000 (married-joint) or $157,000 (other filing statuses). A limitation applicable to all taxpayers is based on 50% of W-2 wages paid by the passthrough entity, and another limitation applies to "specified service trades or business," which includes businesses involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or any business where the principal asset of the business is the reputation or skill of one or more or its employees or owners.
· Bonus depreciation
o The 50% bonus depreciation allowance is increased to 100% for property placed in service after September 27, 2017. The requirement that the original use of qualified property must commence with the taxpayer is removed, allowing bonus depreciation on the purchase of used property.
· Section 179 deduction
o The maximum Section 179 deduction is increased to $1 million and the investment limitation is raised to $2.5 million. While at first glance this may appear unnecessary given the 100% bonus depreciation allowance the Section 179 deduction allows greater flexibility as the election can be made on an asset-by-asset basis.
· Entertainment expenses
o The new law repeals the deduction for entertainment expenses directly related to a taxpayer's trade or business. However, the deduction for 50% for meals is still allowed.
· Interest deductions
o The deduction for net interest expense is capped by the legislation at 30% of adjusted taxable income. Exceptions exist for small businesses, including exemption for businesses with average gross receipts of $25 million or less. The intent of the provision is to reduce the tax incentive for capitalizing a business with debt instead of equity.
· Net operating losses (NOLs)
o For losses arising in tax years beginning after December 31, 2017 the legislation denies the carryback of NOLs while providing for an indefinite carryforward. However the annual NOL deduction would be limited to 80% of taxable income.
· Repatriation of foreign earnings
o A portion of the earnings and profits of foreign subsidiaries would be taxed at a reduced rate of 15.5% for cash assets and 8% for illiquid assets. This deemed repatriation of foreign earnings could be offset by foreign tax credits.
· Section 199 Domestic Production Activities Deduction
o The legislation repeals the Section 199 deduction.