The Tax Cuts and Jobs Act of 2017 (“TCJA”) was enacted into law on December 22, 2017. The TCJA is regarded as the most sweeping tax reform legislation in more than three decades. Hertz Schram has put together the following brief summary of the TCJA’s changes to help you prepare for 2018. This is by no means exhaustive, and should not be relied upon as tax advice.
The impact of the following changes will vary on the your income, size and composition of you restate. It’s important to note that that business provisions of the TCJA are permanent, but estate tax provisions are not permanent and sunset after 2025. All changes are effective now.
Below is a look at the impact in three parts: Individual Tax Reform, Estate, Gift and Generation-Skipping Transfer Tax Reform, and Business Tax Reform.
Part 1: Individual Tax Reform
(except as noted, applies to years beginning after 2017 and before 2026)
- The maximum individual income tax rate and brackets are reduced from 39% to 37% for taxable incomes of married couples at $600,000 ($300,000 for married filing separately and single persons).
- The capital gains tax rate is reduced to zero for taxable incomes below $77,200; 15% for taxable incomes below $479,000; and 20% for taxable incomes over $479,000.
- The standard deduction is raised to $24,000 for married couples filing jointly; $12,000 married filing separately and single persons.
- 529 Plans permit elementary or secondary schools expenditures limited to $10,000 of distributions per year.
- Mortgage and home equity interest deductions are limited to a deduction for the interest on home mortgage loan amounts not exceeding $750,000 (except for mortgages entered into before 2018, in which case the amount cannot exceed $1,000,000). No deduction is permitted for home equity interest.
- State and local taxes (including property taxes) for non‐business activities are limited to $10,000. Currently there is no limit.
- Charitable Contributions are increased from 50% of adjusted gross income (AGI) to 60% of AGI.
- For divorce agreements executed after December 31, 2018, alimony will no longer be deductible by the payor or counted as income to the payee. Agreements executed before December 31, 2018 can also be modified to provide for non‐deductibility.
- The TCJA does not repeal the Alternative Minimum Tax for individuals. Rather, it increases the exemption amount threshold to $109,400 for married couples while increasing the phase‐out threshold to $1,000,000. The AMT rates continue at 26% and 28%. These amendments ameliorate some of the additional income taxes paid on account of the limitations on deductibility of real property taxes and state and local income taxes under the TCJA.
Part II: Estate,Gift, and Generation‐Skipping Transfer Taxes
(applies to years beginning after 2017 and before 2026)
- Estate, Gift and Generation‐Skipping Transfer (“GST”) Tax Exemptions. The TCJA increases the basic exclusion amount (“BEA”) applicable to gift tax, estate tax and GST tax from $5 million to $10 million, effective January 1, 2018. The BEA is indexed for inflation as of January 1, 2010, resulting in an effective estate, gift and generation‐skipping exemption of $11.2 million per person or $22.4 million for a couple after 2017.
- Estate, Gift and Generation‐Skipping Tax Rates. The tax rate remains unchanged at 40%. However, for a couple with a $22.4 million taxable estate, the increase in the BEA will avoid $4,480,000 of estate and gift taxes and GST tax.
Part III: Business Tax Provisions
- Corporate Tax. The TCJA reduces the corporate tax rate from a maximum of 35% to a flat rate of 21%.
- Alternative Minimum Tax (“AMT”) is repealed for C corporations.
- Pass‐through Entities. The TCJA provides tax relief to pass‐through entities by providing individual taxpayers with an income tax deduction equal to 20% of “qualified business income” from partnerships, limited liability companies, S corporations or sole proprietorships. A limitation based on W‐2 wages paid is phased in above a threshold amount of taxable income. A disallowance of the deduction for specified trades or businesses is also phased in above a threshold amount of taxable income.
The amount of this deduction is based upon qualified business income (“QBI”) which looks to qualified items of income of a qualified trade or business. A QBI excludes employment and income from specified trades or businesses. The W‐2 limitation is the greater of (i) 50% of W‐2 wages paid or (ii) the sum of (x) 25% of W‐2 wages plus (y) 2.5% of the unadjusted basis of all qualified property.
The W‐2 limitation as well as the specified service trade or business exclusion only applies for taxable income above $315,000 for joint filers. A specified service trade or business is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services. Specifically exempted from these rules are architects and engineers. At $415,000 for joint filers, the exclusion is totally phased out. These changes present opportunities for service providers either not included in the categories of the specified service trade or business or below the taxable income threshold (described above). The changes made by the TCJA to the taxation of pass‐ through entities represents a major shift in the taxation of pass‐throughs and presents significant tax‐planning opportunities.
- Cost Recovery. The TCJA alters the depreciation regime by allowing full expensing for property placed in service after September 27, 2017 and before 2023. For property placed in service after 2022, the amount goes down by 20% for each year. So, property placed in service in 2026 would only receive a 20% write off. The recovery period for nonresidential real and residential rental property remains the same at 39 and 27.5 years. The Section 179 expense limitation for business asset expensing is increased from $500,000 to $1,000,000 and the phase‐ out limitation is increased from $2,000,000 to $2,500,000. These amounts are indexed for inflation for tax years beginning after 2018.
- Interest expense is limited to an amount not to exceed the sum of business interest income and 30% of the adjusted taxable income, computed for this purpose without regard to deductions allowable for depreciation, amortization or depletion. Disallowed interest is carried forward for 5 years. These limitations do not apply to a business with annual gross receipts that don’t exceed $25 million for the three‐prior taxable‐years.
- Net operating losses are no longer eligible for carry‐back, but are eligible for unlimited carry‐forward. Loss utilization is limited to 80% of taxable income. Certain exceptions for farming and property and casualty insurance companies are provided.
- Taxation of Foreign Income and Foreign Persons. The TCJA makes extensive revisions to the tax treatment of income derived from foreign operations; the receipt of dividends from foreign corporation; the transfer of intangible property to a foreign corporation; and the deductibility of interest paid in connection therewith. These provisions are extensive and impact the foreign tax credit and the deductibility of interest on loans attributable to non‐taxable foreign source income. Given the breadth and complexity of these new rules, they are not discussed in detail.
There will no doubt be substantial analysis of the precise impact of the TCJA, as well as planning opportunities resulting from its enactment. We expect the need to maximize the opportunities and minimize any adverse impact will necessitate discussion with clients and their professionals.
We will be monitoring these developments carefully. On the estate planning front, our firm will be participating at the University of Miami Estate Planning Institute in late January. We will be updating all of you in early February to further inform you of these developments and planning opportunities. In any event, several observations regarding estate planning going forward are apparent:
- Clients whose estates exceed or are likely to exceed $11,200,000 and/or who are concerned about the sunset after 2025 and reinstatement of the $5,000,000 exemption will want to consider gift/sale techniques that will reduce their taxable estates. In some instances, this can be accomplished by techniques which allow a spouse to enjoy the trust income and principal during their life. Further, the form of these gifts can be structured to utilize discount leveraging techniques to achieve even greater estate tax savings.
- Existing irrevocable trusts should be reviewed to determine if their exclusion from the grantor’s taxable estate is necessary. In some instances, these trusts should be modified to cause them to be includible in the grantor’s estate in order to achieve a step‐up in basis upon the grantor’s death.
- Family limited liability companies/partnerships should similarly be reviewed in order to determine if a step‐up in basis can be achieved.
These techniques by no means are exhaustive of the planning techniques available to achieve your particular tax and non‐tax goals and objectives. Please do not hesitate to contact us with any questions you may have regarding the TCJA and its implications.