On December 22, President Trump signed into law H.R.1, the Tax Cuts and Jobs Act. People are calling the new law the most significant tax reform in 31 years since the Tax Reform Act of 1976 passed by President Gerald Ford. The difficulty is the original law was passed in the House with tweaks, then passed in the Senate, with more tweaks. Then the House and Senate versions of the law needed to be reconciled into H.R.1, which also underwent eleventh hour changes before its final presentation on the 22nd, just in time for Christmas. Not surprisingly, many have not had the chance to read the full 500-odd page brand new law and so the details are sparse and whatever we thought we did know might not have made it into the final version of the passed law. Here are some highlights of what we do know:
How will tax reform impact individual taxpayers?[i]
The impact of the bill from 2018 through 2025 on individual taxpayers include:
1. The top individual tax rate is reduced from 39.6% to 37%;
2. In 2017, the standard deduction for a single taxpayer was $6,350, plus one personal exemption of $4,050. Under the new tax code, those deductions are combined into one larger standard deduction for 2018: $12,200 for single filers and $24,400 for joint filers[ii];
3. Personal exemptions are no longer deductible;
4. The individual Alternative Minimum Tax (AMT), which is meant to prevent high income earners from paying too little in taxes, has now been eased with a higher exemption amount and increased phase-out levels;
5. The mortgage interest deduction limit is reduced to $750,000 on new mortgages (previously, no limit) and home equity loan interest (HELOC) is no longer deductible;
6. Individuals are capped at deducting up to $10,000 in total state and local taxes, which include income or sales tax plus property taxes (previously, no limit);
7. The child tax credit is increased from $1,000 to $2,000;
8. Medical expenses in excess of 7.5% of Adjusted Gross Income (AGI) are deductible in 2017 and 2018, and then in excess of 10% of AGI thereafter;
9. Moving expenses are no longer deductible;
10. Alimony payments are no longer taxable or deductible starting in 2019;
11. Miscellaneous itemized deductions are no longer allowed;
Did Estate Taxes Go Away?
Eliminating the estate tax was high up on the Republican tax agenda and was part of the original Republican Blueprint and the House version of the Tax Reform presented back in November. However, the final version of the Tax Cuts and Jobs Act does not eliminate the estate tax. Rather, the tax exemption amount is doubled from $5.6 million to $11.2 million per person for 2018 through 2025. In other words, a married couple can pass up to $22.4 million of assets to their children upon their death, estate tax free.
How Does the Tax Reform Affect Small Businesses?
Small Businesses were one of the major parties affected by the Tax Reform. Changes to the individual taxes are temporary and expire after 2025, but the tax code changes to businesses are permanent.
Pass-through entities are companies such as S-Corporations or LLCs where the profits of the business flow through to the ownerâ€™s personal tax return. These entities are taxed at the ownersâ€™ individual tax rate, which was as high as 39.6% before the Tax Reform. Under the new legislation, pass-through entities could receive a deduction to their Qualified Business Income (QBI) as high as 20%, subject to limits, restrictions and phase-out[iii].
C-Corporations are entities with their own tax rate and tax filing. Shareholders pay taxes at their individual tax rates for dividends or distributions from the company, which created the double taxation adage. Under the new Tax Reform, Corporations will have a flat tax rate of 21%. Prior Corporations were subject to a tiered tax table that ranged from 15% to 35%[iv].
Long story short, while the Tax Cuts and Jobs Act was meant to simplify tax filings and remove loopholes, filing taxes for businesses just got more complicated. If you think you may be affected, reach out to your CPA or attorney to get ask for their advice as to how you can benefit from the new tax code.
How will this affect me?
For high tax states like California, the cap on your ability to deduct state and local taxes and property tax could reduce your eligible itemized deductions and therefore increase your taxes. You should consult your CPA to determine if you are affected.
The National Association of Realtors argues, anytime you make home ownership less appealing, home owners suffer through reduced or stagnant home values. The new Tax Act puts a cap on the amount of mortgage interest that can be deducted in your tax return and no longer allows home equity loan interest to be deducted. Only time will tell how much these changes truly affect the personal real estate market.
Other analysts have said the newly passed tax reform will greatly benefit corporations and stock holders which in turn benefits the stock market and ultimately mass America â€“ Trickle Down economics theory. Since the passage of the Tax Reform act in the House, we have seen the stock market react positively to the reduced taxation and therefore higher corporate profitability anticipated in the years to come.
Our hope is that the truly neediest Americans are able to benefit from Corporate Tax cuts. The changes discussed will affect your 2018 tax year which you will file in 2019. However, businesses considering a corporate structure change need to act by March 15th to have that change apply for the 2018 tax year. Consult with your CPA, attorney or Financial Advisor to ensure you are taking full advantage of opportunities.
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