How Tax Reform Affects Individual Filers
Now that the Tax Cuts and Jobs Act has officially been passed, it’s time to start thinking about how these tax changes will affect taxpayers. Below is a brief overview of what’s in the tax bill and how individual taxpayers may be affected by the changes. It’s important to note that although these changes go into effect in 2018, they are set to sunset (or expire) in the year 2026.
Income Tax Rates and Brackets
The new reform preserves seven brackets of tax rates for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. If we were to compare the old and new tax brackets, it is clear that most taxpayers will be able to enjoy lower tax rates. High earners (those over $500,000 for single and over $600,000 for married couples filing jointly) will cap out at 37% under the new law as opposed to 39.6% under the old law. While that’s good news for a lot of folks, remember that these new tax rates are set to expire as of December 31, 2025.
Some middle class taxpayers may experience their tax rate going up under the new law — this mostly affects single taxpayers in the range of $157,000 – $200,000 income, whose rate will go up to 32% (previously 28%).
Note that the “marriage penalty” is still present in the new tax law. Single taxpayer’s top rate of 37% starts at $500,000, but for married taxpayers filing jointly, it starts at only $600,000 (rather than $1M, which, like all other tax brackets, would be double that of single taxpayers).
The standard deductions are increased to:
- $12,000 for single individuals and married individuals filing separately
- $18,000 for heads of household
- $24,000 for married individuals filing jointly (including surviving spouses)
- No change under the new law to the additional standard deduction for elderly or blind
The rule remains the same that the taxpayer can choose to deduct the greater of the above mentioned standard deduction or the sum of itemized deductions.
Under the new law, more of the low-income taxpayers will benefit by falling into a 0% bracket. The increased standard deduction will “bump” more taxpayers into claiming the standard deduction rather than itemizing, which creates less record keeping burden on taxpayers.
Personal exemptions are eliminated under the new law. As a tradeoff, the Child Tax Credit was increased as well as the refundable portion of the credit was increased to offset the elimination of the personal exemption.
Note that taxpayers earning more than $200,000 (single) and $400,000 (married filing jointly) do not get to enjoy the benefit of the offset as they are unable to claim these credits due to high income.
The tax on certain children with unearned income (the “kiddie tax”) is carried out 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 to 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. In a nutshell, under the new law, the child’s tax is no longer affected by the tax situations of the child’s parent(s).
Beginning 2018, the Act effectively imposes a 3 year holding period requirement in order for certain partnership interests received in connection with the performance of services (”carried interests”) to be taxed as long-term capital gain. If the 3 year holding period is not met with respect to an applicable partnership interest held by the taxpayer, the taxpayer’s gain will be treated as short-term gain taxed at the ordinary income rates.
This affects General Partners and Managers of Venture Capital, Private Equity, and/or Hedge Funds, etc. who are actively participating in investment activity of Funds and receive compensation in the form of greater capital gain allocation on investment, which is linked to the success of those investments.
The purpose of this provision is to close the “loophole” on carried interest (which is the percent of investment gains) that is arguably considered compensation for services and for assuming certain risks associated with investment management. As such, carried interest will be subject to a 3 year holding period, in which case some of the gains would be reclassified as short term gains and taxed at ordinary tax rates.
The limitation on wagering losses has been modified to provide that all deductions for expenses incurred in carrying out wagering transactions (including travel), and not just gambling losses, are limited to the extent of gambling winnings. Previously, there was no limit and individuals were allowed to generate a new loss.
State and Local Tax (SALT) Deduction
The state and local tax deduction (SALT) is limited to $10,000 when combined with the property tax deduction. Taxes for foreign real property are not deductible.
Prepayment provisions prevent a taxpayer from advance payment of income taxes. The payment will be deductible in the year the income tax was imposed. Simply put, a taxpayer can no longer benefit from paying income taxes accessed for 2019 in 2018. This provision does not apply to prepayment of property taxes but is still subject to the $10,000 limitation. This will mostly impact high earning taxpayers living in high-tax states as there are very few offsets that are available to them.
Mortgage Interest Deduction
The deduction for home mortgage interest is limited to interest up to $750,000 ($375,000 for married taxpayers filing separately) of home mortgages and no deduction is allowed for interest on home equity debt.
This lower limit will not apply to home loans incurred before December 15, 2017, these home loans (not including home equity loans) will be grandfathered. This means that there is a “binding contract” exception wherein the taxpayer who entered the contract before December 15, 2017 to close on the residence before April 1, 2018, is subject to the old rule of mortgage interest on a loan of up to $1M.
Medical Expense Deduction
As of January 1, 2018, medical expenses will be subject to 7.5% of adjusted gross income (AGI) until December 31, 2018 for all taxpayers, not just 65 years or older. After December 31, 2018, the rules revert back to a 10% floor.
Alimony is no longer deductible by the paying spouse and will no longer be includible in income of the spouse receiving the payment. This is likely to benefit the spouse receiving alimony, and there will be no benefit for the spouse paying the alimony. This provision only applies to divorces after December 31, 2018 and will not affect taxpayers already divorced or those whose divorce will be finalized by the end of the year.
Alternative Minimum Tax (AMT) remains in effect as of January 1, 2018, but with higher exemption amounts that are set to expire as of December 31, 2025. Bottom line is that AMT will apply to less people and kick in at higher income levels.
Personal Casualty and Theft Losses
This deduction has changed in that taxpayers may still deduct losses (fire, flood, or similar) only if the loss occurred during an event that the President declares to be a disaster.
For charitable contributions made after December 31, 2017 and before January 1, 2026, the 50% limitation for an individual’s cash contributions to charities 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.
Child Tax Credit
The child tax credit is increased from $1,000 to $2,000. The income levels at which the credit phases out has increased to $400,000 for married taxpayers filing jointly and $200,000 for all other taxpayers. The amount of the credit that is refundable has also increased to $1,400 per qualifying child. The earned income threshold for the refundable portion of the credit is decreased from $3,000 to $2,500. In addition, a $500 nonrefundable credit is provided for qualified non-child dependents.
ACA Individual Mandate
Previously, the Affordable Care Act (ACA or Obamacare) required individuals to have a qualifying health insurance plan or be subject to a penalty (unless they qualify for an exemption). The new law reduces the penalty to zero, theoretically reducing the amount of healthy individuals signing up for coverage. This is expected to result in higher premiums for those who do not qualify for premium subsidies.
The deduction for moving expenses has been suspended, with the exception of select members of the Armed Forces. Additionally, the exclusion for qualified moving expense reimbursements is also suspended, except for members of the Armed Forces on active duty (and their spouses and dependents).
Estate and Gift Tax
The Act doubles the base estate and gift tax exemption amount from $5M to $10M. The $10M amount is indexed for inflation occurring after 2011 and is expected to be approximately $11.2M in 2018 ($22.4M per married couple).
Achieving a Better Life Experience (ABLE) accounts allow people with disabilities and their families to open a tax-free savings account for qualifying expenses. The amount that can be deposited into an ABLE account is related to the federal gift tax exclusion, which has been raised from $14,000 to $15,000.
For distributions made after December 22, 2017, amounts from qualified tuition programs (QTPs, also known as 529 accounts) may be rolled over to an ABLE account without penalty. The rolled-over amounts are counted towards the overall limitation on amounts that can be contributed to an ABLE account within a tax year, and any amount rolled over in excess of this limitation is includible in the gross income of the distributor.
Qualified Bicycle Commuting Exclusion
Under new tax law, the exclusion from gross income and wages for qualified bicycle commuting reimbursements is suspended.
College Athletic Seating Rights
For contributions made after December 31, 2017, no charitable deduction is allowed for any payment to an institution of higher education in exchange for the right to purchase tickets or seating at an athletic event.
Combat Zone Treatment Extended To Egypt’s Sinai Peninsula
Members of the Armed Forces serving in combat zones are granted a number of tax benefits, including exclusion of certain pay and estate tax rules. Under new tax law, the Sinai Peninsula of Egypt is defined as a “qualified hazardous duty area” and any member of the U.S. Armed Forces in that combat zone is entitled to special pay under section 310 of title 37. This benefit lasts only during the period the entitlement is in effect.
Miscellaneous Itemized Deductions
The deduction for miscellaneous itemized deductions that are subject to the 2%-of-AGI floor is suspended.
Living Expenses for Members of Congress
For tax years beginning after December 22, 2017, members of Congress cannot deduct living expenses when they are away from home.
Time to Contest IRS Levy
For levies made after December 22, 2017 and for certain levies made before December 23, 2017, the nine-month period during which the IRS may return the monetary proceeds from the sale of property that has been wrongfully levied upon is extended to two years. The period for bringing a civil action for wrongful levy is similarly extended from nine months to two years.
Claiming Head of Household
Beginning in 2018, the Act expands the due diligence requirements for paid preparers to cover determining eligibility for a taxpayer to file as head of household. A penalty of $500 (adjusted for inflation) is imposed for each failure to meet these requirements.
Student Loan Discharged on Death or Disability
For discharges of indebtedness after December 31, 2017 and before January 1, 2026, certain student loans that are discharged on account of death or permanent disability of the student are excluded from gross income.
Certain Self-Created Property Not Treated as Capital Asset
For dispositions after December 31, 2017, patents, inventions, models or designs (whether or not patented), and secret formulas or processes, which are held either by the taxpayer who created the property or by a taxpayer with a substituted or transferred basis from the taxpayer who created the property (or for whom the property was created), are specifically excluded from the definition of a “capital asset.”
If you have any questions about what is included in the Tax Cuts and Jobs Act, or want to learn more about how these changes may affect you, we are here to help. Contact our tax professionals at 925.271.8700 or at firstname.lastname@example.org.