by Scott Wolkens
Late last year and early this year, we sent newsletter articles about the 2018 Tax Reform and Jobs Act (TCJA) that was hurriedly passed into law in December 2017. Throughout this year the IRS has been slowly and incrementally releasing information pertaining to the changes.
Recently, some significant guidance that the tax professional community has been anxiously awaiting has finally been distributed. In this post, we’ll summarize the major revisions so that you’re aware of what’s changing. Keep in mind that the individual tax cuts and changes are temporary. Therefore, unless the changes in the TCJA are made permanent, the previous rates and structure would be restored in 2026. As your professional tax preparers, we don't require you to understand the technicalities of these changes because… that’s our job! Instead, the tax questionnaire that you fill out is your assurance that we’re aware of tax related events we’ll need to know. As always, our mission is to simplify the tax filing process for you. So please consider this optional reading!
Individual Tax Rates — The TCJA contains hundreds of changes that affect taxable income, including new tax brackets. The legislation created lower individual income tax brackets as follows: 10%, 12%, 22%, 24%, 32%, 35% and 37%. See the chart for a comparison.
While applicable tax rates at any given level of income have generally gone down by two to three points, some individuals will see an increase in taxes due to the tax brackets at which the rates apply. For example, the tax rate for single payers with taxable income between $200,000 and $400,000 goes from 33 percent to 35 percent. Also, high-income taxpayers are also subject to a 3.8 percent net investment income tax (if applicable) and/or the .9 percent Medicare surtax.
Keep in mind that U.S. taxes are still based on a “progressive” system, which means your tax rate increases as your taxable income amount increases. A common misconception is that all income is taxed at the rate in the bracket a person’s income falls. For example, if you’re single and got a pay raise that resulted in a taxable gross income of, say, $83,000, only $500 is taxed at the 24% tax bracket. The other amounts are taxed at each of the lower corresponding tax rates. Therefore, in general, pay raises and taking in more income is always going to put more money in your pocket! Also, taxable income is the basis for the values in the tables above. It is calculated as gross income, less any adjustments, less either the sum of itemized deductions or the standard deduction, whichever is larger.
Employment Tax Withholding — If you’re an employee, you should have completed a W-4 form when your employment began that showed your employer how much tax to withhold from your paycheck based on a withholding table. Due to tax reform changes, the tables used to determine withholding needed to be revised. Your employer should have used the revised tables beginning February 15, 2018. Accordingly, some tax changes may result in either a lower tax refund or larger balance due because your tax savings may be reflected as increased take-home pay. Also, keep in mind that while the tables provide an approximate amount to properly withhold for basic returns, the tables are generally less reliable for taxpayers with multiple sources of income and more complex returns ; e.g., Schedule A, C, D, E, etc.
Alternative Minimum Tax (AMT) - The legislation increases the exemption amount and phaseout thresholds, which means that fewer people will be subject to AMT. From 2018 through 2025, a higher AMT exemption will apply to income, beginning with $109,400 for joint filers and $70,300 for other taxpayers in 2018. The exemption will phase out at $1 million for joint filers and $500,000 for other taxpayers. The thresholds will be adjusted for inflation.
Standard Deduction — The standard deduction increases significantly from $12,700 to $24,000 for joint filers, from $9,350 to $18,000 for heads of households, and from $6,350 to $12,000 for single filers. Additional amounts apply for upper age brackets and blind persons. However, to ensure that we claim the maximum deduction for you, we’ll still be requesting clients to provide us with all their tax-deductible expenses. These include mortgage interest, property taxes, charity donations, medical, sales tax paid on specific purchases (e.g., a vehicle purchase), etc. After we calculate those deductions, we will closely compare the results and determine which reporting method provides you the most advantageous benefit.
Personal Exemptions — Before the TCJA, taxpayers could claim an exemption for themselves, their spouse, and their dependents (if eligible). Each exemption lowered taxable income by $4,050 under pre-TCJA (2017) law. The TCJA has suspended all personal and dependent exemptions. New tax provisions, including a higher standard deduction, may or may not make up for the removal of personal and dependent exemptions, as taxpayers’ situations vary.
Affordable Care Act (commonly referred to as “Obamacare”) — You may have heard that tax reform eliminated the Affordable Care Act (ACA) individual penalty. However, it’s important to note that the removal of the healthcare tax penalty is not effective until the 2019 tax year! This means that you must still have had Healthcare this year (2018) or be subject to a penalty when your return is prepared in 2019. Accordingly, we will be required to ask you about Healthcare coverage and have you send us Form(s) 1095 that you receive for the 2018 tax year.
Child and Dependent Credits — From 2018 through 2025, the reform legislation increases the value of the child tax credit from $1,000 to $2,000 per child under 17 years-old at the end of the tax year. As much as $1,400 of the credit will be refundable, thus allowing you to claim the benefit even if you don’t have a tax liability. In addition, a $500 nonrefundable tax credit for dependent children over age 16 and all other dependents for whom you provide at least half their support. As before, you will need to provide us your child's full name, Social Security Number (SSN), date of birth, relationship to you, and they must pass an IRS dependency “test” to claim the refundable portion (don’t worry - we’ll guide you on the “test” qualifications). The legislation also expands eligibility for the credit by increasing the phaseout threshold to $400,000 of adjusted gross income for joint filers (up from $110,000 under prior law), with a threshold for all other filers set at $200,000. A $500 nonrefundable credit for dependents other than children will be available.
$10,000 Cap on State and Local Tax Deduction — In a significant departure from prior law, the legislation will allow individuals to deduct no more than $10,000 of any combination of the following taxes: state and local income taxes, state and local property taxes, and sales taxes. This overall limitation may result in the enhanced standard deduction yielding a larger deduction against your adjusted gross income and thus a lower tax bill. Again, we’ll determine what’s most advantageous for you and report that amount.
Mortgage Interest Deduction — The mortgage interest deduction on acquisition indebtedness (e.g., mortgages) of more than $750,000 obtained after December 14, 2017 is limited to the portion of the interest allocable to $750,000. The $1 million limitation remains for mortgages incurred before December 15, 2017. Interest paid on your principal residence and a second home are deductible. Under a grandfather rule, the TCJA changes do not affect up to $1 million of home acquisition debt that was taken out before December 16, 2017 and then refinanced later--to the extent the initial principal balance of the new (refinanced) loan does not exceed the principal balance of the old loan at the time of the refinancing. In other words, under the $1M grandfather rule, if you refinance for an amount that exceeds the current principal balance (including refinance costs built into the loan) the grandfather rule will no longer apply. Based on these new rules, anytime you are planning to refinance, we recommend you send us a quick email for guidance. Also, keep in mind that only the interest on home equity line of credit (HELOC) indebtedness used to purchase or make capital improvements to the home is deductible. For example, if you took out a HELOC to buy a new car, that would not qualify for a tax deduction.
Qualified Medical Expense Deduction — All individuals may deduct medical expenses for 2017 and 2018 if the expenses exceed 7.5% of adjusted gross income, regardless of age. However, the AGI threshold returns to 10% of adjusted gross income in 2019 for all taxpayers, regardless of age. Again, we will need to review whether claiming such expenses, when combined with other allowable itemized deductions, yields a higher deduction than the standard deduction.
Elimination of Deduction for Certain Miscellaneous Expenses — The reform act eliminates the deduction for certain miscellaneous deductions. Thus, deductions (subject to the 2% floor of adjusted gross income) for costs related to the production or collection of income, such as investment fees and a safety deposit box are now non-deductible. Also, expenses related to employment, such as uniforms, professional society dues, computer used for work, and job-hunting expenses also are non-deductible. Employees who incur significant unreimbursed business expenses may want to ask their employer about adjusting their compensation. Don’t confuse the repeal of miscellaneous deductions listed above with self-employed deductions or rental properties, which are still fully deductible on Schedule C and E, respectively.
Alimony Deduction — The tax legislation repeals the above-the-line deduction for alimony paid for divorces or separations executed after December 31, 2018. After that date, alimony payments will not be included in the recipient's income and the payments no longer will be deductible by the payor. If you are currently contemplating divorce or separation, a careful review of the effects of the new law should be undertaken to determine the economic effects on your tax situation and timing of any agreements.
Section 179 Expensing — The expensing limitation is increased to $1 million and the phase out amount to $2.5 million. The new limitations are to be adjusted for inflation. The act further expands the definition of §179 property and the definition of qualified real property for improvements made to nonresidential real property.
Entertainment Expenses Deductions — No deduction is allowed generally for entertainment, amusement, or recreation; membership dues for a club organized for business, pleasure, recreation, or other social purposes; or a facility used in connection with any of the above. Examples include tickets to not-for-profit high school or college sporting events, leased skyboxes for sporting events, transportation to/from sporting events, cover charge, taxes, tips and parking for entertainment events.
NOL Deduction —The limit on the NOL (Net Operating Loss) deduction is 80% of the taxpayer's taxable income and provides that amounts carried to other years be adjusted to account for the limitation. Amounts are to be carried forward indefinitely.
Corporate Tax Rate — Beginning in 2018, there is a 21% flat corporate tax rate; there is no longer a special tax rate for personal service corporations.
Alternative Minimum Tax — Beginning in 2018, the alternative minimum tax (AMT) is repealed for business returns. In 2018, 2019 and 2020, if the entity has AMT credit carryforward, the entity is able to claim a refund of 50% of remaining credits (to extent credits exceed regular tax for year). For 2021, the entity is able to claim a refund of all remaining credits.
Qualified Business Income (QBI) — The biggest—and most complex—change introduced by the tax reform law provides certain individual owners of sole proprietorships, rental properties (and other entities such as S corps, partnerships, etc.) to deduct up to 20% of their income earned from those entities. The regulations to claim and report this deduction are exceptionally complex to summarize in this article. But don’t fret! Our tax questionnaire will have a section pertaining to QBI that we'll ask you to complete so that we can determine your overall qualifications to take this deduction.
Again, we don’t expect you to be tax experts—that’s our job! Instead, we simply need to be aware of what occurred for you during the year. We’ll be asking you to complete the simplified tax questionnaire. Completing this questionnaire is your assurance that we’re aware of qualifying events that provide deductions and credits. The form takes about 5-10 minutes to fill out. It’s that simple!
With so many changes to the tax law and how the tax is determined and calculated on a return, most taxpayers should expect a change in their overall tax liability compared to the prior year. As a result, you might see a significant change in the amount you are over/under paid compared to the prior year(s). It just comes down to how much you paid into the system, through estimated tax payments and/or withholding from your paycheck.
As always, contact our office if you have questions.
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.