President Trump signed the sweeping 2018 tax reform bill into law last Friday, with most provisions taking effect on January 1, 2018. The following article identifies key changes in the new legislation that will affect both individual and corporate taxes for 2018 and beyond. In general, the changes to individual provisions expire at the end of 2025, but the corporate changes are permanent.
Individual Tax Changes
One of the most significant changes in the tax bill is adjusted tax rates. For 2018 through 2025, the following is an outline of the new tax brackets for individuals (IND) and married couples filing jointly (MFJ):
10% (income up to $9,525 IND; up to $19,050 MFJ)
12% (over $9,525 to $38,700 IND; over $19,050 to $77,400 MFJ)
22% (over $38,700 to $82,500 IND; over $77,400 to $165,000 MFJ)
24% (over $82,500 to $157,500 IND; over $165,000 to $315,000 MFJ)
32% (over $157,500 to $200,000 IND; over $315,000 to $400,000 MFJ)
35% (over $200,000 to $500,000 IND; over $400,000 to $600,000 MFJ)
37% (over $500,000 IND; over $600,000 MFJ)
The standard deduction is doubled to $12,000 for single filers and $24,000 for joint filers. Additional standard deductions for the elderly and blind are preserved.
The tax bill repealed all personal exemptions through 2025. Therefore, the personal exemption phase out (PEP) rule will be modified accordingly.
Alternative Minimum Tax
While the alternative minimum tax (AMT) is retained in the new bill, the exemption amounts and thresholds for phasing out exemptions are increased.
For tax years beginning after Dec. 31, 2017 and beginning before Jan. 1, 2026, the AMT exemption amount increases to $109,400 for married taxpayers filing a joint return (half this amount for married taxpayers filing a separate return) and $70,300 for all other taxpayers (other than estates and trusts). The phaseout thresholds are increased to $1 million for married taxpayers filing a joint return and $500,000 for all other taxpayers (other than estates and trusts). These figures will be indexed for inflation in future years.
Child Tax Credit
The child tax credit doubled from $1,000 per qualified child to $2,000, with a refundable portion up to $1,400 under a late amendment. Additionally, the new law establishes a $500 nonrefundable credit for non-child dependents.
State and Local Taxes
The new tax law limits all state and local tax deductions (SALT) to $10,000. This includes any annual combination of 1) state and local property taxes or 2) state and local income or sales taxes.
While deductions for prior debt is grandfathered, the new law limits the mortgage interest deduction to interest payments on $750,000 of acquisition debt, a decrease from $1 million. The new law also eliminates deductions for interest paid on home equity debt.
The estate and gift tax remains, but the exemptions have been doubled, resulting in an inflation-indexed exemption of $11.2 million in 2018.
While the new tax reform bill eliminates or scales back other itemized deductions, the deduction for medical expenses is temporarily improved. The act reduced the threshold for deducting medical expenses to 7.5% of adjusted gross income for 2017 and 2018.
Taking effect in 2019, the new law repeals the health insurance mandate for individuals established by the Affordable Care Act.
Casualty and Theft Losses
This itemized deduction is eliminated; however, under the act, taxpayers are only able to take a deduction for casualty losses incurred in federal disaster areas.
The act expands the list of qualified expenses for Section 529 plans to include tuition at an elementary or secondary public, private or religious school, plus home schooling expenses, for up to $10,000 per year.
The student loan interest deduction remains the same. Taxpayers may deduct up to $2,500 of interest paid on student loans each year.
The rule permitting taxpayers to recharacterize a Roth IRA back into a traditional IRA after a conversion is repealed.
Business Tax Changes
In contrast to the individual tax provisions in the new law, the key changes related to businesses are generally permanent.
Corporate Tax Rates
Businesses see a significant decrease in their tax rate from a top rate of 35% to a flat rate of 21%.
For tax years after 2017 and before 2026, passthrough entities, such as partnerships, S corporations, limited liability companies (LLCs) and sole proprietors, will be allowed to deduct 20% of “qualified business income.” In addition, they can also claim a 20% deduction on qualified real estate investment trust (REIT) dividends, qualified cooperative dividends and publicly traded partnership income, subject to special rules restrictions.
The deduction is not available to “specified service trades or businesses,” such as law or financial services, and phases out for a taxpayer with taxable income in excess of $157,500 ($315,000 for joint filers).
Corporate Alternative Minimum Tax (AMT)
Unlike the individual AMT, the corporate AMT is completely repealed.
Under the new law, the maximum Section 179 expensing allowance is doubled from $500,000 to $1 million. The phaseout threshold for Section 179 deductions is also increased from $2 million to $2.5 million. These amounts will be indexed for inflation after 2018.
In addition, the new tax bill expanded the definition of Section 179 property to include certain depreciable tangible personal property that is used to furnish lodging. It also expanded the definition of qualified real property allowed for Section 179 expensing to include the following improvements to nonresidential real property: heating, ventilation, and air conditioning; roofs; fire protection and alarm systems; and security systems.
The first-year bonus depreciation deduction is also doubled from 50% to 100%, but it phases out after five years and will not be available after 2026. Bonus depreciation is now allowable for used asset purchases as well as new purchases.
The new bill limits corporations’ deductions for net interest expense to 30% of annual gross income, subject to certain special rules. However, a business with average gross receipts of $25 million or less for the past three years is exempt.
Net Operating Losses
Beginning in 2018, the deduction for net operating losses is limited to 80% of a corporation’s income. The new tax bill repeals existing net operating loss carry back rules. Excess losses are able to be carried forward indefinitely.
A one-time repatriation tax of 15.5% for liquid assets and 8.0 percent for illiquid assets has been established for earnings from overseas.
The above-mentioned provisions only touch upon the complexity of the new tax reform bill signed into law. There are a number of other provisions that have been either repealed or modified that will affect taxpayers in the coming years.
We look forward to helping each client navigate these changes to find the most effective strategy that aligns with their personalized needs and goals.
Please contact your advisor at (805) 963-7811 with any questions or to get started on finding ways to maximize your tax savings.