KTClient Alert: 2018 Tax Reform Highlights
The recent enactment of the federal tax bill, known informally as the “Tax Cuts and Jobs Act” (the “Act”) represents the most substantial overhaul of the U.S. tax system in over 30 years. The changes are wide-ranging and will impact virtually every individual and business taxpayer in the country. Most of the changes under the Act go into effect January 1, 2018. It is important to note at the outset, however, that many of the changes are not permanent and are set to sunset on December 31, 2025. This Alert provides some of the highlights of the Act. For further information, questions regarding the implications of the new Act, or to request a review of your estate, business, or tax plan, please contact us.
Individual Income Taxes
Standard Deduction and Exemptions: The Act raises the standard deduction to $12,000 for individuals and $24,000 for married couples, which is almost double the prior standard deduction. Personal and dependency exemptions of $4,050 formerly available for each member of a household have been eliminated. The loss of these exemptions will have the greatest impact on families with two or more children.
Deductions and Credits: Expanding the standard deduction will necessarily mean that fewer people will itemize deductions. Many of the itemized deductions and credits that were available under 2017 laws have been modified or eliminated. But for those who do itemize, the “Pease limitation” (reducing the benefit of up to 80% of itemized deductions for high earners) has been repealed.
|· Student loan interest deduction.
· Exclusion of certain gain on sale of personal residence.
· Tuition waivers for grad students.
· Most charitable deductions; cash contributions to public charities now deductible up to 60% of AGI (vs. 50%).
· Classroom supplies deduction.
· Taxpayers may deduct unreimbursed medical expenses exceeding 7.5% of AGI. This change is retroactive to Jan. 1, 2017, and expires Dec. 31, 2018, at which time the 10% floor is reinstated.
|· Mortgage interest deduction has been lowered to interest on $750,000 of acquisition indebtedness on homes purchased after 2017 (down from $1M). Existing mortgages are grandfathered in up to the $1M limit.
· All state and local tax deductions are now capped at $10,000.
· 1031 exchanges have been modified so that they are only available for real property, not for personal property.
|· Interest on current or future home equity loans.
· Alimony payments deduction.
· Investment fees deduction.
· Tax preparation deduction.
· Moving expense deduction.
· Bike commuter reimbursements.
· Ability to re-characterize Roth IRA contributions as traditional IRA contributions (e.g. to undo Roth conversions).
· Deduction for charitable contributions for college sports tickets.
Brackets and Rates: The seven tax brackets are maintained, but with different applicable rates. The new rates will start at 10% and top out at 37%, compared with the prior top rate of 39.6%.
Affordable Care Act: The Act eliminates the individual mandate beginning in 2019, which generally requires people who do not have healthcare to make a Shared Responsibility Payment. Other ACA-related taxes remain in place, including the 3.8% net investment income tax.
Alternative Minimum Tax: The alternative minimum tax for individuals has been maintained but the exemption amount has been raised to $70,300 for single people and $109,400 for married (with inflation adjustments).
529 Plans: 529 plan rules have been expanded to permit up to $10,000/year to be used for K-12 education expenses.
Kiddie Tax: The net unearned income of a child will be taxed at ordinary and capital gains tax rates applicable to trusts (reaching the highest tax rate after $12,500 of income), as compared to the parents’ tax rates under the prior law.
The basic exclusion amounts for federal estate, gift, and generation-skipping transfer tax exemptions have been doubled from $5 million per person (adjusted for inflation) to $10 million per person (adjusted for inflation). In 2018, the federal basic exclusion amounts will be $11.2 million for a single person and $22.4 million for a married couple. While this means that fewer people will be subject to federal transfer taxes, the higher limits are not permanent and will sunset after December 31, 2025. The unlimited charitable gift and estate tax deduction remains unchanged. The current income tax basis rules for gift and estate transfers are also unchanged, with carryover basis for gifts and basis step up for most bequests.
Substantial planning opportunities are available to higher net worth individuals in advance of the sunset date. In addition, clients whose estate plans include bequests based on the federal exemption amount, which has increased substantially, should review such plans.
While not affected by the Act, the annual gift tax exclusion increased to $15,000 per individual on January 1, 2018.
The Washington State estate tax remains in effect and the Washington estate tax exclusion amounts for 2018 will be $2,193,000 for a single person and $4,386,000 for a married couple. Washington State does not impose a gift or generation-skipping transfer tax.
Corporations: The corporate tax rate has been permanently reduced from 35% to 21% and the alternative minimum tax on corporations has been eliminated. There are a number of other significant changes, too numerous to discuss in detail here, that could have an impact on a business. For example, the Act modifies expensing of capital investments, repatriation of deferred foreign profits, which entities can use the cash method of accounting, the allowance of net operating loss deductions, deductions for employee entertainment, transportation and meals, amortization of research and experimental expenditures, and the temporary allowance of a credit for pay to an employee on family or medical leave.
Pass-through Entities: Individuals, trusts, and estates will now be allowed to deduct up to 20% of the aggregate “qualified business income” received from LLCs, S-Corporations and other pass-through entities, along with income from sole proprietorships. For “specified service businesses” (including law, accounting, medicine, performing arts, athletics, consulting and investment management), the 20% deduction is permitted on all qualified business income up to a total annual income threshold of $157,500 (or $315,000 for joint filers), with both thresholds indexed for inflation. For these service businesses, the 20% deduction benefit phases out over the next $50,000 of total income for single filers, and over the next $100,000 for joint filers.
Apart from the specified service businesses, many taxpayers who earn pass-through income from real estate, manufacturing, retail, hospitality, engineering, architecture or technology (to name a few) should be able to take advantage of the new pass-through deduction. As noted above, the maximum benefit is 20% of qualified business income. Thus, an individual who is taxed at the highest individual rate of 37% on qualified business income may be able to reduce the income tax rate by a full 7.4% to an effective rate of only 29.6%. Also, this deduction is available whether or not a person claims an itemized deduction. The 20% benefit is generally reduced unless the business in question pays a significant amount of W-2 wages. However, for capital intensive businesses, such as real estate, there is a special rule that gives credit based on asset values even if the wage base is low. The limitation rules are not yet finalized, but we can expect new reporting requirements for LLCs, S-Corporations and other pass-through entities.
If you have any further questions or comments regarding this topic, please reach out to your KTC attorney.
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