On December 15, 2017, the U.S. Congress’ Joint Committee on the Tax Cuts and Jobs Act released their bill making significant changes to the Internal Revenue Code. The changes impact virtually every individual and business. The President wishes to sign the bill into law before the end of 2017. At this point, there appear to be few obstacles to the bill being enacted. The provisions in the bill will generally be effective in 2018.
The following is a general summary of some of the bill’s provisions. Certain provisions, such as the deduction for flow‐through entity income, the limitation on business losses, and business interest expense limitations, are new and will require further guidance and analysis.
TAX RATES: The current seven brackets (10%, 15%, 25%, 28%, 33%, 35%, and 39.6%) will be changed to
10%, 12%, 22%, 24%, 32%, 35%, and 37%. For married taxpayers filing jointly, the 12% bracket would begin at taxable income of $19,050, 22% at $77,400, 24% at $165,000, 32% at $315,000, 35% at $400,000, and 37% at $600,000. For unmarried individuals and married filing separately, the bracket thresholds will be half the thresholds for married taxpayers filing jointly, except the 37% bracket for unmarried individuals will begin at $500,000 instead of half of the joint amount, or $300,000.
MAXIMUM RATE ON CERTAIN BUSINESS INCOME OF INDIVIDUALS: Certain flow‐through entity income will be treated as “business income” potentially eligible for a deduction equal to 20% of the qualified income. The deduction is subject to limitations based on the wages paid by and the original cost basis of qualified property placed in service by the qualified business. In general, flow‐through income in excess of certain amounts from certain personal services businesses will not be eligible for the 20% deduction. The personal services businesses include the fields of health, law, consulting, athletics, financial services, brokerage services, investing and investment management trading, performing arts, or any trade or business where the principal asset is the reputation or skill of an individual. The deduction is not allowed in computing adjusted gross income but is allowed in computing taxable income, whether or not the taxpayer itemizes deductions. Further guidance and analysis will be required to determine how this provision will be applied.
The bill creates new Code Section 461(l) in order to limit the amount of “excess business losses” an individual may deduct in a particular year. Excess business losses are carried forward to future years. Further guidance and analysis will be required to determine how this provision will be applied.
ENHANCED STANDARD DEDUCTION: Under the current law, an individual reduces adjusted gross income by any personal exemption deduction and either the applicable standard deduction or itemized deductions to determine taxable income. Under the bill, the standard deduction will be increased to
$24,000 for joint filers and $12,000 for individual filers. Single filers with at least one qualifying child would claim a standard deduction of $18,000. The personal exemption will be eliminated.
DEDUCTIONS: The bill preserves deductions for charitable contributions, medical expenses, and teachers’ classroom expenses, but makes significant changes to some popular individual deductions.
Most notably, the bill limits annual itemized deductions for all nonbusiness state and local tax deductions, including property taxes, to $10,000. In order to stop any attempt to maximize state and local income tax deductions in 2017, the bill disallows a 2017 deduction for any prepayment of state and local income tax imposed for a year after 2017.
The mortgage interest deduction will be retained; however, for home mortgage debt incurred after December 15, 2017, only interest on up to $750,000 of acquisition indebtedness will be deductible, a reduction from the current debt limit of $1.1 million. Mortgage interest on second homes will continue to be deductible, within the applicable debt limit amount; however, no deduction will be allowed for home equity debt.
The bill repeals all miscellaneous itemized deductions subject to the 2% limit under current law. Moving expenses (except for some military service related moves) will no longer be deductible. Casualty losses will only be deductible if attributable to a Presidential declaration of disaster. The so‐called Pease Limitation, which reduces itemized deductions for higher income individuals, will be repealed.
Effective for divorce or separation instruments executed after December 31, 2018, the bill repeals the deduction for alimony payments and their inclusion in the recipient’s income.
CHILD TAX CREDIT: The child tax credit will be increased to $2,000, and a credit of $500 will be allowed for qualifying dependents other than qualifying children. These credits will generally phase out to zero for higher income taxpayers.
HIGHER EDUCATION INCENTIVES: Unlike the House version of the bill, the final bill does not overhaul higher education tax credits available under current law, and preserves the student loan interest deduction, the U.S. Savings Bond interest exclusion, the exclusion for employer‐provided education assistance programs, and the exclusion for graduate student tuition waivers; however, the “above the line” tuition and fees deduction will be repealed.
ALTERNATIVE MINIMUM TAX (AMT): The AMT for individuals is retained with higher AMT exemption amounts (and phase‐out of the exemption starting at much higher income levels) than under current law.
RETIREMENT PLANS: The bill disallows a recharacterization of a Roth IRA into a Traditional IRA in order to unwind a Roth conversion; however, recharacterization is still permitted with respect to other Roth IRA contributions.
HEALTH INSURANCE: The bill repeals the Affordable Care Act’s individual responsibility requirement, making the payment amount zero, for penalties assessed after 2018.
ESTATE AND GIFT TAX: The bill will double the lifetime gift and estate tax exemption after 2017, with no provisions for a later repeal of the tax or a reduction in the rate of tax.
FLAT “C CORPORATION” INCOME TAX RATE: The bill will replace the current four tier system with a single 21% tax rate. Personal service corporations will be subject to the same flat 21% tax rate.
ALTERNATIVE MINIMUM TAX (AMT): The AMT for corporations will be repealed.
INCREASED EXPENSING: The bill will allow 100% expensing of qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. Unlike the current bonus depreciation provisions, personal property is not required to be “new,” only new to the taxpayer. For the first taxable year ending after September 27, 2017, the present‐law 50% bonus depreciation allowance may be elected instead of the 100% allowance.
SECTION 179 EXPENSING: The bill will increase the Section 179 expensing limitation to $1 million for tax years beginning after 2017. The bill expands the definition of eligible property to include (1) tangible personal property used to furnish lodging and (2) qualified real property improvements to existing buildings for roofs, HVAC, and fire alarm and security systems.
ACCOUNTING METHODS: The proposal will allow more businesses to use the cash method and completed contract methods of accounting for tax purposes. It will also expand exceptions to the so‐called UNICAP rules of Section 263A.
NET OPERATING LOSSES (NOLs) & OTHER DEDUCTIONS ELIMINATED OR LIMITED: Effective for losses arising in taxable years after December 31, 2017, the bill eliminates carrybacks of most net operating losses and limits the amount of net operating loss that can be used in a particular year to 80% of taxable income. The bill will allow net operating losses to be carried forward indefinitely.
The bill subjects every business, regardless of its form, to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. The disallowance will be determined at the entity level. Adjusted taxable income is a business’s taxable income computed without interest expense, interest income, net operating losses, and depreciation & amortization. Disallowed amounts will be carried forward indefinitely. Opportunities for members in a flow‐through entity to utilize amounts disallowed at the entity level may exist. Businesses with less than $25 million of average gross receipts will be exempt from this interest expense disallowance, as will real property trades or businesses, and interest paid on vehicle floor plan financing.
The bill repeals the domestic production activities deduction and generally eliminates deductions for entertainment, amusement, or recreation activities.
LIKE‐KIND EXCHANGES: The bill will limit the tax deferral on a like‐kind exchange to real estate transactions only.
BUSINESS AND ENERGY CREDITS: The bill will modify the credit for rehabilitation of qualified historic buildings. The bill creates a temporary credit in 2018 and 2019 for payments to employees in connection with a qualified written policy allowing for not less than two weeks of annual paid family and medical leave. The bill did not adopt any of the energy credit repeals or modifications proposed in the House version of the bill.
Thank you to ABC Member Albin, Randall & Bennett for providing the update