By Scott Wolkens and Ter Claeys, CPA
The recently passed Tax Reform law (officially known as the Tax Cuts and Jobs Act) made significant changes to the tax law, including increasing the standard deduction, removing personal exemptions, increasing the child tax credit, limiting or discontinuing certain deductions and changing the tax rates and brackets. In this article, we'll delve into highlights of the new tax law for personal returns that takes effect for the 2018 tax year.
Filing a tax return on a postcard isn't in the cards. Despite the goal to simplify the tax code, there will be no postcard tax form. In the rush to present the bill for signature by year-end, simplification efforts went to the wayside. Instead, the law introduces additional worksheets and schedules, many of which will get more complex. For example, for clients with children, we'll file Schedule 8812 that will allow you to take the expanded Child Tax Credit. For owners of pass-through businesses, for instance, we'll need to do myriad complex calculations to deduct 20 percent of the business income (we'll cover this topic in a future edition). But don’t fret about extra forms and complexity--that’s our job!
The law keeps seven tax brackets, but with different rates and break points. For example, not only is the top individual rate lowered from 39.6% to 37%, but that rate kicks in at a higher income level. However, note that whatever new bracket you fall into, more of your taxable income will be hit with lower rates than before.
There’s a secret hitch to the tax cut. Inflation indexing of income tax brackets and various tax breaks is altered. Tax brackets, standard deductions and many other items will be adjusted annually using a chained consumer price index, resulting in lower inflation adjustments and thus smaller annual increases than with the current index. According to critics, this is a hidden tax hike that over time will nail nearly all individual filers.
Standard deductions become larger. $24,000 for couples, $12,000 for singles and $18,000 for head of household. Folks age 65 or up get $1,250 more per person ($1,550 if unmarried). Given these higher amounts, we expect that more clients will take the standard deduction in lieu of itemizing. However, we’ll continue to ask most clients for qualifying deductions, such as mortgage interest, real estate taxes, charity, medical costs, etc. You may ask why we'd do this. The reason is because we'll still need to prepare Schedule A and do the math to figure out which method is most advantageous! Our objective is always to maximize the deductions for which youi qualify.
The new law pares back or axes many deductions claimed by individuals. Personal exemptions for individual filers and their dependents are repealed. These will partially offset the increase in the standard deduction.
Home mortgage deductions are nicked. Interest can be deducted on up to $750,000 of new acquisition debt on a primary or second residence, which is down from $1 million. The new limit generally applies to mortgage debt incurred after Dec. 14, 2017. Older loans and refinancings up to the old loan amount still get the $1-million cap. No write-off is allowed beginning in 2018 for interest on existing or new home equity loans (HELOCs).
The popular deduction for state and local taxes is squeezed. You can deduct any combination of residential property taxes and income or sales taxes up to a $10,000 cap. Property taxes remain fully deductible for taxpayers in a business or for-profit activity, and taxes paid on rental realty can be taken in full on Schedule E, as before.
The medical expense deduction is enhanced. Not only have lawmakers opted to keep this popular write-off, but they've also temporarily lowered the AGI threshold for deducting 2017 and 2018 medical expenses on Schedule A from 10% to 7.5% (as noted in our tax questionnaire). If you provide(d) us medical expenses, we always automatically prepare your return with the expenses and will file the deduction if your qualified expenses exceed the 7.5% threshold.
Several other write-offs are eliminated: Itemized Schedule A deductions for job-related moves, and miscellaneous personal write-offs subject to the 2% of Adjusted Gross Income (AGI) threshold, including unreimbursed employee business expenses, brokerage investment fees, hobby expenses, and theft losses. (Small business owners: these are not to be confused with Schedule C deductions and Home Office deductions, which continue as-is with no threshold.)
Tax rates on Long-Term Capital Gains and Qualified Dividends do not change. Currently, your capital gains (e.g., stock and security sales) and dividends rate depends on your tax bracket. But with the bracket changes, Congress decided to set income thresholds instead. The 0% rate will continue to apply for taxpayers with taxable income under $38,600 on single-filed returns and $77,200 on joint returns. The 20% rate starts at $425,800 for singles and $479,000 for joint filers. The 15% rate applies for filers with incomes between those break points. The 3.8% surtax on net investment income remains, kicking in for single people with modified AGI over $200,000 , and $250,000 for married.
The law keeps the individual Alternative Minimum Tax (AMT) with higher exemptions: $109,400 for joint return filers and $70,300 for singles and household heads. Additionally, the exemption phase-out zones start at much higher income levels ... above $1 million for couples and $500,000 for single people and heads of household.
The Affordable Health Care (AKA Obamacare) individual mandate isn't gone--yet. The requirement that folks have health insurance, qualify for an exemption, or pay a fine is repealed for post-2018 years. Keep in mind the mandate continues to apply for 2018, and will be a filing requirement for your taxes next year, too.
The Child Tax Credit is doubled to $2,000 for each dependent under age 17. The income phase-out thresholds are much higher ... AGIs over $400,000 for couples and $200,000 for all other filers.
There's a new $500 credit for each dependent who is not a qualifying child, including, for example, an elderly parent you take care of or a disabled adult child. It's nonrefundable and phases out under the same thresholds as the child credit.
The new tax law makes it riskier to convert a traditional IRA to a Roth IRA. In the past, you had until Oct. 15 of the following year to undo the switch and eliminate the tax bill by transferring the funds back to a traditional IRA. This is called a recharacterization and could make sense if the Roth lost money. Conversions done after 2017 are irreversible. You'll still have the ability to convert your traditional IRA to a Roth, but you won't be able to undo the switch. However, you still have time to reverse a 2017 conversion. According to the IRS, Roth conversions for the 2017 tax year can be properly recharacterized up until Oct. 15, 2018.
The IRS recently rushed out new Withholding tables. The new withholding tables reflect the new tax rates and tax brackets, higher standard deductions and repeal of personal exemptions. Your employer can use W-4s already on file. The Revenue Service will issue a revised W-4 form that takes into account the changes in the new tax law. However, employees won't be required to submit an updated form to their employers this year. The IRS plans to make further changes involving withholding. The agency will work with businesses and the tax and payroll communities to explain and implement these additional changes.
The new tax law is still being evaluated by the IRS. As we've said before, the IRS has a big job ahead to administer all the changes in the legislation. It will have to issue mounds of guidance, revise many of its forms and publications, reprogram its massive computer systems, and do outreach and education. All of this will take time. So while we shared what we know, keep in mind that projecting many scenarios for these changes right now can't be done with certainty until the IRS provides final guidance.
Keep in mind that, after 2025, all individual tax cuts will expire, while corporate rate cuts were made permanent. As a result, in nine years the Joint Committee on Taxation (JCT) estimates that a majority of Americans will either see little change in their tax bill or a tax increase relative to what they pay today.