The Tax Cuts and jobs Act is the most sweeping tax reform measure in over 30 years. The new legislation makes fundamental changes to the Internal Revenue Code that will upend the way all taxpayers (individuals, businesses, foreign taxpayers) calculate their federal income tax liability.
The changes affecting individuals include new tax rates and brackets, and increased standard deduction, elimination of personal exemptions, new limits on itemized deductions (state taxes, mortgage interest), and the repeal of the individual mandate under the Affordable Care Act.
The changes affecting businesses include a reduction in the corporate tax rate, increased expensing and bonus depreciation, limits on the deduction for business interest, and a new 20% deduction for pass-through business income.
The foreign provisions include an exemption from U.S. tax for certain foreign income and the deemed repatriation of off-shore income.
We are diligent in researching the changes made to the tax code in order to provide an ongoing value to you as our client. According to our viewpoint, the following topics are the most relevant changes that will affect our clients.
1. Personal Tax Changes
- New income tax rates and brackets
- Standard deduction increased
- Personal exemptions suspended
- Kiddie tax modified
- 529 Plan account funds may be used for elementary or secondary school tuition
- Child tax credit increased; partial credit for non-child dependents
- State and local tax (SALT) deduction limited
- Mortgage interest deduction limited
- Medical expense deduction threshold temporarily reduced
- Individual charitable contribution deduction limitation increased
- Overall limitation (“Pease” limitation) on overall itemized deductions suspended
- Individual AMT retained, with higher AMT exemption amounts
2. Business Tax Changes
- Corporate tax rates reduced
- Increased code section 179 expensing
- Recovery period for certain real property improvements is shortened
- Limitations on deduction of business interest
- Modification of net operating loss (NOL) deduction
- Employer’s deduction for fringe benefit expenses limited
- New credit for employer-paid family and medical leave
- New deduction for pass-through income
Tax law change details:
Standard deduction increased
The standard deduction is increased to 424,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers. These amounts are adjusted for inflation in tax years beginning after 2018. No changes are made to the current law additional standard deduction for the elderly and blind.
Personal exemptions suspended
The deduction for personal exemptions is effectively suspended because the statutory exemption amount is reduced to zero.
Kiddie tax modified
The tax on certain children with unearned income (“the kiddie tax”) is imposed as follows: the child’s taxable income attributable to earned income is taxed under the rates for single individuals, and the child’s taxable income attributable to net unearned income is taxed according the brackets applicable to Trusts and Estates. This rule applies to the child’s ordinary income and his or her income taxed at preferential rates.
529 Plan accounts may be used for elementary or secondary school tuition
The amount of cash distributions from all 529 plans with respect to a beneficiary during any tax year can’t in aggregate, include more than $10,000 in expenses (tuition, fees, books, etc.) incurred during the tax year. That is, the limitation applies on a per student basis, rather than a per-account basis. So, although an individual may be the designated beneficiary of multiple 529 accounts, that individual may receive a maximum of $10,000 in tax-free distributions for elementary or secondary school tuition, regardless of whether funds are distributed from multiple accounts. Any excess distributions received by the individual would be treated as a distribution subject to tax under the general rules of Code Se. 529.
Child tax credit increased; partial credit for non-child dependents
The child tax credit is increased to $2,000. The income levels at which the credit phases out are increased to $400,000 for married taxpayers filling jointly ($200,000 for all other taxpayers) (not indexed for inflation). The amount of the credit that is refundable is increased to $1,400 per qualifying child, and this amount is indexed for inflation, up to the base $2,000 base credit amount. The earned income threshold for the refundable portion of the credit is decreased from $3,000 to $2,500. No credit will be allowed to a taxpayer with respect to any qualifying child unless the taxpayer provides the child’s SSN. In addition, a $500 nonrefundable credit is provided for certain non-child dependents.
State and local tax (SALT) deduction limited
Except as described below, state, local, and foreign property taxes, and state and local sales taxes, are deductible only when paid or accrued in carrying on a trade or business activity (generally for the production of income). State and local income, and excess profits are not allowed as a deduction.
However, a taxpayer may claim an itemized deduction of up to $10,000 ($5,000 for married taxpayers filing separately) for the aggregate of (i) state and local property taxes not paid or accrued in carrying om a trade or business or activity; and (ii) state and local income and excess profits taxes (or sales taxes in lieu of income, etc. taxes) paid or accumulated in the tax year. Foreign real property taxes may not be deducted.
Medical expense deduction threshold temporarily reduced (ending before January 2019)
The threshold on medical expense deductions is reduced to 7.5% of adjusted gross income (AGI) for all taxpayers. In addition to the 10% of AGI threshold that applied under pre-Act law for alternative minimum tax (AMT) purposes doesn’t apply during the temporary reduction.
Individual charitable contribution deduction limitation increased
Individual charitable contribution deduction limitation increased the 50% limitation for an individual’s cash contributions to public charities and certain private foundations is increased to 60%. Contributions exceeding the 60% limitation are generally allowed to be carried forward and deducted for up to five years, subject to the later year’s ceiling.
Overall limitation on itemized deductions (“Pease Limitation”) is suspended
The overall limitation on itemized deductions (also called the Pease Limitations or 3%/80% rule) limited the total amount of otherwise allowable itemized deductions paid during the tax year for certain high-income taxpayers. The overall limitation was applied last, after application of any other limitations on itemized deductions. It didn’t apply to medical expenses, investment interest, casualty, theft, or wagering losses, and charitable contributions up to the amount of any “qualified contributions.” The Tax Cuts and Jobs Act suspends this limitation.
Individual AMT retained, with higher AMT exemption amounts
The Act increases the amount of an individual’s alternative minimum taxable income (AMTI) that is exempt from AMT – the “AMT exemption” amounts as follows: (i) For joint returns and surviving spouses, $109,400 (ii) For single taxpayers, $70,300 (iii) For marrieds filling separately, $54,700 – These AMT exemption amounts are reduced (not below zero) to an amount equal to 25% of the amount by which the individual’s AMTI exceeds a phase-out amount, increased as follows: (i) For joint returns and surviving spouses, $1 million (ii) For all other taxpayers (other than estates and trusts), $500,000. For trusts and estates, the base figure of $22,500 and phase-out amount of $75,000 remain unchanged. All of these amounts will be adjusted for inflation after 2018 under the new CPI inflations measure.
Corporate tax rates reduced
The Act reduces the corporate tax rate to a flat 21% rate. The Act similarly reduces the withholding rate on dispositions of U.S. real property interests (USRPIs) from 35% as follows:
• The withholding rate on dispositions of USRPIs by domestic partnerships, trusts, or estates is determined by multiplying the gain by the highest corporate tax rate.
• The withholding rate on distributions of USRPIs by foreign corporations in recognition transactions is determined by multiplying the gain by the highest corporate tax rate.
• The withholding rate on distributions of USRPIs by regulated investment companies (RICs) or real estate investment trust (REITs) is determined by multiplying the gain by the highest corporate tax rate.
Conforming amendments eliminate:
• The alternative capital gains rate for corporations.
• The disallowance of graduated rates and accumulated earnings credit in the case of corporate transfer of property to a controlled transferee corporation.
• The rule that a RIC that is a personal holding company or that fails to comply with regs for the purpose of ascertaining the actual ownership of its stock is taxed at the highest corporate tax rate.
Recovery period for certain real property improvements is shortened
For property placed in service after December 31, 2017, the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property are eliminated, and a general 15-year recovery period and straight-line depreciation provided for qualified improvement property (generally a less restrictive category than the aggregate of the three categories that it replaces). A 20-year ADS recovery period is provided for such property.
Thus, qualified improvement property placed in service after Dec. 31, 2017, is generally depreciable over 15 years using the straight-line method and half-year convention.
For property placed in service after Dec. 31, 2017, the ADS recovery period for residential rental property is shortened from 40 years to 30 years.
For tax years beginning after Dec. 31, 2017, an electing real property trade or business – i.e., a real property trade or business electing out of the limitation on the deduction for interest – must use ADS to depreciate any buildings or qualified improvement property.
Limitation on deduction of business interest
Every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the businesses adjusted taxable income. The business interest limitation generally applies at the taxpayer level. However, for partnerships and S-Corporations, the limitation applies at the entity level.
Adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion and without the former Code Se. 199 domestic production activities deduction.
Under a small business exception, the business interest limitation doesn’t apply to taxpayers (other than tax shelters) for a tax year if the taxpayer’s average annual gross receipts for the three-tax year period ending with the prior tax year don’t exceed $25 million.
Employer’s deduction for fringe benefit expenses limited
Deductions for entertainment expenses are disallowed, eliminating the subjective determination of whether such expense are sufficiently business related; the current 50% limit on the deductibility of business meals is expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer; and deductions for employee transportation fringe benefits (e.g., parking and mass transit) are denied, but the exclusion from income for such benefits received by an employee is retained.
New credit for employer-paid family and medical leave
Businesses can claim a general business credit equal to 12.5% of the amount of wages paid to qualifying employees during any period in which the employees are on Family Medical Leave (FMLA) if the rate of payments is 50% of the wages normally paid to the employees. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the payment rate exceeds 50%. All qualifying full-time employees have to be given at least two weeks of annual paid family and medical leave (all less-than-full-time qualifying employees have to be given a commensurate amount of leave on a pro rata basis).