The “Tax Cuts and Jobs Act” What to Expect from Recent Changes to the Tax Code
On December 22, 2017 the “Tax Cuts and Jobs Act” was signed into law. In general, it lowers tax rates, but limits certain deductions. Except where noted, the changes begin with the 2018 tax year and expire in 2025. While most of the changes do not impact your 2017 taxes, they do create some new planning opportunities for the years ahead.
LOWER INCOME TAX RATES
Tax rates and the associated brackets have been lowered across the board. The tables below compare 2017 with 2018.
There were no changes to the dollar amounts at which capital gains are taxed. There were also no changes to the 3.8% net investment tax on investment income over $200,000 ($250,000 if married). Note that taxpayers with income below $38,600, or married couples below $77,200, are not required to pay taxes on capital gains.
INCREASE IN STANDARD DEDUCTION & ELIMINATION OF PERSONAL EXEMPTIONS
The standard deduction for 2018 has been nearly doubled to $12,000 from $6,350 for single filers, and to $24,000 from $12,700 for married joint filers. Many taxpayers who previously itemized their return will now find it more advantageous to use the standard deduction.
Planning Tip: It might also make sense to bundle itemized deductions, such as charitable donations, in one year to maximize itemization, and then opt for the increased standard deduction in subsequent years. A charitable gift fund is one option for managing your donations for optimal tax treatment.
The $4,050 per person deduction for personal exemption was eliminated. This will only impact taxpayers with income below $261,500 ($313,800 if married). The personal exemption was already phased out for taxpayers above those income thresholds.
CHANGES TO ITEMIZED DEDUCTIONS
The itemized deduction phaseout for incomes over $261,500 ($313,800 if married) is also eliminated, so taxpayers will now receive full benefit of itemized deductions regardless of income level. However, there have been significant changes to some specific deductions:
Home Mortgage Interest: Limited to $750,000 of acquisition debt on contracts entered into after December 15, 2017. Some refinances will still qualify. The previous debt limit of $1 million still applies to existing mortgages. Interest on home equity debt is no longer deductible.
State & Local Taxes: All state and local taxes, including income, sales and property taxes, are now limited to a combined $10,000 deduction.
Miscellaneous Itemized Deductions: Expenses that were deductible in conjunction with the production of income are no longer deductible. This includes investment expenses and tax preparation fees.
Planning Tip: To address the impact of these changes, taxpayers may want to consider paying for expenses with pre-tax dollars to the extent possible. For example, paying IRA investment management fees directly from an IRA and reducing your distribution by a corresponding amount will reduce your taxable income since paying fees directly is not considered a taxable distribution.
Charitable Contributions: The limit on deductions for cash contributions to qualified charities has been increased to 60% of gross income from 50%. Deductible contributions of appreciated securities are still limited to 30% of gross income.
Planning Tip: For taxpayers over 70.5 years old, charitable donations made directly from an IRA are excluded from gross income, up to a $100,000 annual limit.
Medical Expenses: For 2017 and 2018, the threshold for medical expense is 7.5% of gross income, reduced from 10%. Beginning in 2019, the threshold increases back to 10%.
Casualty Losses: Personal casualty losses are no longer deductible unless attributable to a Federally Declared Disaster Area.
ALTERNATIVE MINIMUM TAX
The alternative minimum tax (AMT) exemption amount was increased to $70,300 ($109,400 if married) from $54,300 ($84,500). Additionally, the phase out of the exemption does not start until taxable income exceeds $500,000 ($1,000,000 if married). As a result, very few individual taxpayers will be subject to the AMT going forward.
OTHER SIGNIFICANT CHANGES
Child Tax Credit: Increased to $2,000 per child and phaseout increased to $400,000 for married filers, up from $110,000. An additional $500 credit is available for dependents that are not qualifying children.
Section 529 Plans: Up to $10,000 in distributions per year can now be used to pay for private or religious schools at the K-12 levels where as previously these funds could only be used for post-secondary education.
Alimony: For divorce or separation agreements executed after December 31, 2018 (included modified agreements), alimony is no longer deductible by the payor, nor includible in the recipient’s income.
IRA Recharacterizations: You can no longer unwind a Roth conversion and recharacterize it back to a traditional IRA. This does not affect the ability to convert a non-deductible IRA contribution to a Roth IRA.
Estate and Gift Tax Exemption: The estate and gift tax lifetime exemption amount is doubled to over $11 million per taxpayer from a current exemption of $5.49 million. Note that no states with estate tax provisions (including Washington State) have adjusted their exemption amounts, which means it’s still important to plan for estates under the federal threshold but above the state threshold.
The changes brought by the new law may offer new planning opportunities. Your Paracle advisor would be happy to facilitate a discussion with your tax planning professional to address the impact on your tax situation. We’d like to thank Don Archiable, CPA for helping us prepare this article.