The Tax Cuts and Jobs Act of 2017 is now the law of the land, with wide-ranging ramifications for individual taxpayers, businesses, and others. Sorting out its many details and effects will take time, but here’s a first look at some of the law’s aspects.
What We Know
From individuals to businesses to non-profits to activities abroad, tax reform has implications for all. Some of the changes are permanent; some sunset after 2025. Most take effect 2018. Here are some of the highlights.
- Personal exemptions are gone and the standard deduction will double. Itemized deductions for state income taxes and real estate taxes have been combined into a joint deduction capped at $10,000 per tax return. Mortgage interest is deductible on only the first $750,000 of acquisition indebtedness for new home purchases. The deduction related to interest expense on a home equity loan goes away, as do 2% miscellaneous deductions such as investment fees, attorney fees, tax preparation fees, and unreimbursed employee expenses. As a result of these changes, most taxpayers currently itemizing their deductions will begin claiming the standard deduction. For those continuing to itemize, cash charitable contributions will be allowed up to 60% of adjusted gross income and the overall limitation on itemized deductions is lifted.
- Slightly more generous tax rates take effect in 2018. Based on where these rates hit, most taxpayers will see a drop in their marginal income tax rate. Whether this will translate into a decrease in the overall tax liability for any particular taxpayer will depend on the specific facts and circumstances, due to the law’s potential to impact multiple aspects of any one person’s tax situation. The so-called “marriage penalty” is alive and well, but only for those at the new top rate of 37%.
- Alternative Minimum Tax remains in play for individuals under the new law. However, with significantly increased income thresholds beginning 2018, fewer taxpayers will be paying AMT.
- The child tax credit is increased to $2,000 per child, with credit phasing out at $400,000 of income on a married-filing-jointly return. Taxpayers who have been previously unable to claim this credit due to income limitations may now be able to do so. Distributions up to $10,000 annually from 529 plans are now allowed for elementary and secondary school tuition. Unearned income for children will now be taxed at trust/estate income tax rates.
- Those doing business in a C Corporation will see federal tax brackets replaced by a 21% flat rate. This rate also applies to personal service corporations, which were previously taxed at a 35% flat rate. The new law repeals corporate AMT.
- Section 199A was created to provide non-C Corporation business owners the same tax break C Corporations were receiving under the new law. It allows for a 20% deduction of “Qualified Business Income” net income for owners of S Corporations, partnerships, and LLCs, as well as sole proprietors, and even trusts and estates. Limitations on the deduction apply for taxpayers with taxable income above $315,000 on a married-filing-jointly return, as well as for taxpayers in certain service fields. Other limitations also apply.
- The new law will disallow a current year deduction for so-called “excess business losses” for pass-through owners and sole proprietors. Such losses are not allowed in full for the current year to the extent they exceed $250,000.
- Taking a current 100% deduction for long-lived assets is now generally easier. The IRC Section 179 expensing threshold increases to $1,000,000 with an increased $2,500,000 phase out, as well as expanded definitions of what qualifies as 179 property. So-called “bonus depreciation” is set yet again at 100%, this time for property placed in service beginning September 27, 2017 through 2022, with subsequent annual percentage decreases. Further, bonus depreciation now covers certain types of assets collectively labeled “Qualified Improvement Property,” which has the potential to result in full initial-year expensing of leasehold improvements for many taxpayers.
- Expenses for entertainment activities are generally no longer deductible, even if incurred in a business context. Certain previous exceptions still apply, such as the 100% deduction for recreational, social, and other activities that primarily benefit non-highly compensated employees. Meals provided to employees for the employer’s convenience are no longer deductible.
- The Domestic Production Activities Deduction and like-kind exchanges for personal property are out. Net operating losses generally can no longer be carried back, can be carried forward indefinitely, and are only allowed to offset 80% of taxable income annually.
- Average annual gross receipts of $25,000,000 is a significant threshold. Above this number, limitations on deducting business interest expense can apply. Stay below this number and you might be able to use the cash-basis method of accounting for tax purposes if you previously were not.
What We Don’t Know
Congress wrote, debated, analyzed for impacts to taxpayers and the federal budget, and passed the most significant, sweeping change to US tax law since 1986 during the holiday season – all within weeks of most provisions taking effect. What could possibly go wrong? What could possibly be unclear?
In some cases, such as with the Qualified Business Income deduction and bonus depreciation, legislators’ original (presumed) intent didn’t make it into the law’s final wording. Technical corrections or further guidance of some sort is essential merely to make certain provisions make sense, let alone taxpayer-friendly.
In other cases, additional guidance may or may not be forthcoming; some situations may remain open to interpretation. One of the big questions for business owners will be, “Is my income Qualified Business Income?” In many cases this question will have no obvious or easy answer due to the wording of the law and the scope of a taxpayer’s business activities. Further, it appears that the allowable deduction can shift based on the type of entity in which the taxpayer is doing business. In modern terms, is this a bug or a feature? Will Congress eliminate this uncertainty or will business owners want to consider changing their business entity solely to take advantage of the QBI deduction? If so, what would the other tax and non-tax implications be? And are they worth it? If I am currently a W-2 employee, should/can I somehow start working for myself? And so on.
Further analysis of the new law will likely uncover other inconsistencies that warrant correction or at least inspire thoughtful debate among tax commentators. Although time and patience are required, subsequent analysis will seek to clarify where and how to apply aspects of the revised tax code.
What’s Next For You
For the more cut-and-dry components of the new law, your questions are:
- What applies to my current situation?
- What is the impact?
Your tax advisor can walk you through answers to these questions, based on the details of your situation.
For the less clear aspects, however, answers to those critical questions may not yet be available. Exercise caution and consult with your tax and/or legal advisor(s) before making any moves that are intended to comply with one or more tax reform changes.