H.R. 1 also known as the Tax Cuts and Jobs Act passed both houses of Congress on December 20, 2017 and was signed into law by the President on December 22, 2017. Because of Senate budgeting rules, the changes and provisions discussed will expire at the end of 2025 unless made permanent before then.
Tax Rates
Seven tax brackets remain with the top bracket being reduced from 39.6% to 37%. The top bracket starts at taxable income of $600,000 for joint filers compared to $470,700 in 2017. The 35% bracket has been expanded to capture taxable income between $400,000 and $600,000 for joint filers and $200,000 to $500,000 for single filers. For single filers this represents a significant increase in income that will now be taxed at the 35% rate versus 33% in 2017. The other brackets are reduced as follows: 33% is now 32%, 28% is now 24%, 25% is now 22% and 15% is now 12% and the lowest 10% bracket remains the same. The marriage penalty has been eliminated except in the highest bracket.
The standard deduction for 2018 has been essentially doubled to $24,000 for joint filers and $12,000 for single filers with Head of Household filers in the middle at $18,000. Along with this substantial increase in the standard deduction, personal exemptions have been eliminated from the code. According to the Tax Foundation and the most recent IRS data, 30.1% of households itemize their deductions. The above net increase in the standard deduction combined with lower overall tax rates likely reduces federal income taxes for most Americans.
Child Tax Credit
The popular child tax credit is being increase from $1,000 to $2,000 per child in 2018 with the phaseout beginning at $200,000 for single filers and $400,000 for joint filers. Up to $1,400 per child of this credit will be refundable to the taxpayer versus $1,000 in 2017.
Itemized Deductions
Mortgage Interest – In 2018 only interest related to “acquisition indebtedness” will be deductible. This includes debt related to “acquiring, constructing, or substantially improving” your qualified residence. For new mortgages taken out after December 16, 2017, only interest on the first $750,000 will be deductible. Under these new rules, interest on home equity loans and lines of credit will no longer be deductible.
State and Local Taxes – The deduction for state and local taxes (including income and property taxes) remains in place as well as the option to deduct state and local sales taxes instead. However, this overall deduction is now subject to a $10,000 cap. This has been the subject of much debate especially among residents of high tax states like New York and California.
Charitable Contributions – The act increased the income-based percentage limitation from 50% to 60% of adjusted gross income (AGI). However, the ability to deduct payments made to colleges and universities that provide seating rights for athletic events has been eliminated.
Medical Expenses – The deduction for medical expenses remains under the new law with the deductibility threshold lowered from 10% of AGI to 7.5% for 2017 and 2018, then increasing to 10%.
Miscellaneous Itemized Deductions – These expenses which were subject to a 2% of AGI floor included unreimbursed job-related expenses, investment expenses and tax preparation fees. Under the new law all miscellaneous itemized deductions are eliminated.
Pass-Through Income Deduction
Taxpayers with income from pass-through entities (sole proprietorships, partnerships and S-Corporations) will be eligible for a deduction of up to 20% of such pass-through income. Several complicated limitations are imposed on joint taxpayers with pass-through income above $315,000 ($157,500 for single filers). If your business is a “specified service trade or business” (provides services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or the primary asset of your business is the reputation or skill of one or more employees) your deduction will be reduced or eliminated or your deduction may be limited to 50% of your wages from such business.
The detail regulations surrounding these pass-through provisions have yet to be drafted. As we progress through 2018 more clarity is likely to emerge.
Other Provisions and Changes
Alimony – For divorces becoming final in 2019 or later, alimony payments will no longer be deductible to the payer nor includable income to the payee.
Education – 529 college savings plans will now be allowed to distribute up to $10,000 per student for tuition incurred by the taxpayers during the tax year at elementary and secondary schools.
Estate and Gift Taxes – The Act doubles the estate and gift tax exemption for estates of decedents dying and gifts made after December 31, 2017. The exemption is now $11.2 million per person through December 31, 2025. The annual gift tax exclusion was also raised from $14,000 to $15,000 per gift.
Alternative Minimum Tax (AMT) – The new law does not eliminate the individual AMT but does increase the exemption amount from $84,500 to $109,400 for joint filers and from $54,300 to $70,300 for single filers. Thus, fewer individual taxpayers will be subject to AMT.
Conclusion
Overall the Tax Cuts and Jobs Act will result in lower federal income taxes for “most” taxpayers. However, like any new tax laws, the impact on each taxpayer will be different depending on a number of factors including your income level, how much you currently pay in state and local taxes, and how large of a new mortgage you take on. According to the Tax Foundation the average taxpayer (either single or married) with income ranging from $30,000 to $2 million will get some tax relief with the more significant relief going to lower and middle-income taxpayers with families.
