- The Tax Cuts and Jobs Act – let the (tax) games begin
- February 5, 2018 | Authors: Sherman F. Levey; Jason W. Klimek
- Law Firm: Boylan Code, LLP - Rochester Office
On December 19, 2017, a 1097 page “simplified tax code” was passed by both the House and Senate and signed into law on December 22, 2017. The bill went into effect January 1, 2018 with paycheck withholding changes likely starting in February. This article will summarize the major provisions of the bill. We will also follow up from time to time to analyze some of the relevant provisions in more detail.
On the individual front, the bill eliminates many itemized personal deductions, including the very large list of miscellaneous itemized deductions such as the deductions for tax preparation, home offices, mileage, license fees, dues to professional organizations, job search expenses (with no hint of irony under the “Jobs Act”) and legal fees, to name a few. (Note, however, that some of these expenses may continue to be deductible as ordinary and necessary business expenses for a business or profession regularly carried on). However, the bill keeps charitable donations, property and state income tax deductions (though limited, as discussed below) and the residential mortgage interest deduction. Only the interest on mortgages of up to $750,000 (down from $1,000,000) will be deductible, but home equity loan interest will no longer be deductible. It’s worth noting that those who have mortgages in excess of $1 million will be “grandfathered” and will still be allowed to deduct the interest. However, that is not the case for home equity loans and all interest deductions will cease.
The bill nearly doubles the standard deduction to $12,000 ($24,000 for married couples) and eliminates personal exemptions. State and Local Tax (“SALT”) deductions are now limited to $10,000, allowing residents in states like New York to deduct a combination of state income tax and property tax up to $10,000. However, because the SALT deduction is capped at $10,000, combined with the elimination of many popular itemized deductions and the doubling of the standard deduction, a married taxpayer would have to come up with an additional $14,000 in deductions if he “maxed out” the SALT deduction to equal the standard deduction; an unlikely scenario for anyone but the most philanthropic of taxpayers.
A quick tax tip for the holidays: If your property tax bill is posted in 2017, you can attempt to pay it this year and take the deduction on your 2017 tax bill, squeezing in one more year’s worth of SALT deductions. However, it would be highly advisable to consult a tax return preparer before making that decision. There is no good “general rule.”
Initially, the draft House bill eliminated medical deductions. Currently, to deduct medical expenses, the expenses must be in excess of 10% of adjusted gross income (“AGI”). This bill reduces the 10% threshold to 7.5% of AGI, but only from medical costs incurred between January 1, 207 and December 31, 2018, after which point, the 10% floor is reinstated.
As noted, the president’s and Speaker Paul Ryan’s promise to “simplify” the tax code remains unfulfilled under this bill. The number of individual brackets remain at seven, instead of the proposed four under the House bill. However the rates have been generally lowered, and the maximum rate reduced from 39.6% to 37%. These brackets are now indexed to the “chained CPI” which is a less generous measure of inflation; meaning that this will create “bracket creep” whereby taxpayers are pushed into higher brackets by virtue of inflation outpacing bracket adjustments.
Other changes to the Code include raising exemptions under the alternative minimum tax (“AMT”) as well as increasing the phase-out threshold to $1 million and expanding the child tax credit from $1,000 to $2,000 with up to $1,400 of the child tax credit being refundable. Personal exemptions, worth $4,000 per person in a household, are eliminated, hitting families with children the hardest.
While the House proposal eliminated the Federal Estate Tax, which currently affects only 0.2% of U.S. households but contributes a substantial amount to the Treasury, the new bill keeps the Estate, Gift, and Generation Skipping Trust Taxes, but doubles the estate tax exemption to approximately $11.2 million per person, or $22.4 million for a married couple. Careful planning is still in order, but the substantially more generous exemptions will bring the number of affected households down to approximately 0.05%. (Note to dwellers of the Empire State: no word yet on whether New York will revise its estate tax to adopt the Federal exemptions. Stay tuned.).
Last to be discussed on the personal income side is the elimination of the Affordable Care Act (“ACA”) individual mandate. The individual mandate required people to purchase insurance or pay up to approximately $700 for adults and $350 for children without insurance. With this gone, the non-partisan Congressional Budget Office (“CBO”) estimates that over 13 million people will be “priced out” of health care insurance by 2027. When coupled with the statements from congressional Republicans that entitlement programs will be cut, millions of Americans may be unable to afford healthcare resulting in strains on hospitals and other charitable health care providers due to an increase in the number of non-paying patients.
The corporate tax rate, currently at 35%, is cut to 21% under this plan. While it is true that the US had one of the highest marginal rates in the world, few large corporations actually paid that amount. The average effective tax rate of corporations is 27.1% compared to the average tax rate of 27.7% from 30 other countries within the Organization for Economic Cooperation and Development (“OECD”). When looking at top US companies, the average effective tax rate is just 19.4%.
The bill allows for companies to immediately deduct items up to $1 million, meaning companies can purchase assets and immediately deduct their full amount, up to $1 million. Real property, though, is not able to be expensed immediately, but the amortization periods have been slightly shortened. This expensing provision expires in five years. Further, the bill places a limit on interest expense deductions. The deductibility of interest expense is limited to 30% of earnings before interest, taxes, depreciation, and amortization (“EBITDA”) for four years and 30% of earnings before interest and taxes (“EBIT”) after. The corporate AMT is also eliminated under this bill.
The changes regarding “pass-through” entities will almost certainly require more attention than anything else in the tax bill by taxpayers and their advisers. Examples of pass-through entities are Limited Liability Companies (“LLCs”), “S” Corps, partnerships and sole proprietorships. What they have in common is that the entity bears no separate (corporate) tax, but rather the income is “passed through” and taxed on the owners individual income tax returns. The bill allows for a 20% deduction on “qualified business income.” Qualified business income means “the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer”; essentially, profit. The language of the bill prohibits certain trades and businesses from enjoying these benefits, such as doctors, lawyers, athletes, consultants, and various other professions listed in § 1202 of the Code (except architects and engineers who apparently have very good lobbyists). However, it is clear that there is now a “new game in town” and future articles will discuss the new rules.
Cutting across all of this is – no surprise – politics. Many economists, from both major political parties, have taken quick note that the bill is clearly not “revenue neutral.” Paul Ryan has stated that entitlement programs such as Medicaid, Medicare and Social Security will receive funding cuts when congressional rules kick in requiring automatic spending cuts due to the expansion of the debt. Initial calculations show that this plan will add approximately $1.5 trillion to the federal debt over ten years. To put that into perspective, this plan increases the federal debt by approximately $1 million in about the time it has taken you to read this article.Given the lopsided nature of this bill and the highly partisan manner in which it was passed, there is a high likelihood that many provisions will be short lived, creating uncertainty when attempting to plan for the long term. By 2020 – or even 2018 – many provisions may be repealed or substantially modified. However, in the interim, and we suspect after any repeal or amendment, the IRS will be scrambling to come up with regulations to make sense of the great many loopholes and hasty draftsmanship contained in this bill. We will continue to discuss various tax planning as we dive deeper into the 1097 page bill.