Individual Taxpayer Changes Starting in 2018
Changes to Tax Rates & Brackets – This has been modified
- The Act would have seven tax brackets (ranging from 10% to 37%): 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
- The 37% bracket would begin at: $600,000 for joint returns/surviving spouses (39.6% rate starts at $470,700 for 2017)
- The 37% bracket would begin at: $500,000 for single and head of household (39.6% rate starts at $418,400 for 2017 for a single and $444,500 for head of household)
Somerset Observation: for 2017 $600,000 of taxable income for a joint filer/surviving spouse creates a federal income tax liability of $182,830. For 2018 $600,000 of taxable income for a joint filer/surviving spouse creates a federal income tax liability of $161,379. That is a tax savings in 2018 compared to 2017 of $21,451.
Caveat: The above comparison does not take into account the possible lost deductions for 2018 that may cause the 2018 taxable income of a joint filer/surviving spouse to have higher taxable income in 2018 compared to 2017 using the same facts. A detailed projection should be completed for 2018 early in the year to determine the impact of such rule changes.
Capital Gains Income Brackets
- 15% breakpoint = $77,200 married filing jointly, $38,600 single
- 20% breakpoint = $479,000 married filing jointly, $425,800 single
Increased Standard Deduction & Elimination of Personal Exemptions
- $24,000 for joint filers ($12,700 for 2017) and $12,000 for single filers ($6,350 for 2017).
- Elimination of personal exemptions in 2018. Compared to $4,150 for 2017.
Somerset Observation: The increase in the standard deduction benefit seems to be offset by the loss of personal exemptions, especially if the taxpayers have several dependent children. However, for 2017, personal exemptions start getting phased out for higher income taxpayers so no tax benefit saved for many higher income taxpayers, so the exemption repeal is not a significant loss in benefits. However, high income taxpayers typically itemize deductions, thus the standard deduction increase does not provide a benefit for high income taxpayers. For middle and low-income taxpayers, the above changes may benefit or hurt such taxpayers’ dependent upon facts and circumstances.
Enhanced Child Tax Credit & New Family Tax Credit
- Child credit is increased to $2,000 in 2018 compared to $1,000 in 2017.
- Refundable child credit would be up to $1,400 per qualifying child.
- Phase-out – The Act would also increase the income levels at which the credit phases out. Under current law, the credit is phased out beginning at income levels of $75,000 for single filers and $110,000 for joint filers. The Act would raise these amounts to $200,000 and $400,000, respectively.
Somerset Observation: The child credit is increased by $1,000 per dependent. Note that the 2018 phase out amounts are significantly higher than 2017. This is a very favorable change for lower income all the way up to high-end middle income individuals in 2018 compared to 2017 given the added $1,400 refundable credit for lower income individuals and the increase to $400,000 of income before the $2,000 credit starts phasing out in 2018 for high-end middle income individuals.
Deduction from Certain Pass-Through Income
- An individual taxpayer may deduct 20% of domestic qualified business income from a partnership, S Corporation, or sole proprietorship.
- Qualified services businesses such as health, law and accounting are not allowed to utilize this provision unless under the threshold amount referenced below. Architectural and Engineering firms are allowed to utilize the provision regardless of threshold amount.
- The amount of the deduction is limited to 50% of the W-2 wages of the taxpayer, or the sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis, immediately after acquisition, of all “qualified property” unless the taxable income of the affected individual is under the threshold limit referenced below. If under the threshold amount, then 20% deduction is allowed regardless of wages of the taxpayer.
- The threshold amount for both the limitation on specified service business and the wage limit is $315,000 for married filing jointly and $157,500 for single. The total phase out would be $415,000 for married filing jointly, and $207,500 for single.
- The 20% deduction is not allowed in computing adjusted gross income, but is instead allowed as a deduction for reducing taxable income, and is available to both itemizers and non-itemizers.
Somerset Observation: It appears that this 20% deduction is going to work similar to the Qualified production activities deduction (QPAD) that has been repealed as part of this legislation. The good news is that this deduction is 20% versus 9% for the QPAD. This 20% deduction is broader than the QPAD. Unfortunately, most professional service corporations (PSCs) will not qualify except for architects and engineers. Some owners of PSCs that operate in a flow thru entity such as an S-Corporation, LLC, or partnership may qualify if such owner’s income is under the threshold amounts referenced above.
Real estate trade or business activities may qualify for this 20% deduction. If a flow thru entity, the owner must be deemed a material participant in the activity. A passive activity will not qualify for such deduction. If the real estate activity qualifies, the 20% deduction could very well be obtained even if over the threshold amounts due to the rule regarding the allowance of the deduction up to 2.5% of the unadjusted basis, immediately after acquisition, of all “qualified property.” Qualifying property would include real estate in a real estate business which typically has a high cost and long depreciation life which makes the 20% deduction almost a sure thing for such taxpayers.
Somerset Observation: Somerset believes there is significant planning opportunities related to this particular provision of the new law. Please contact your Somerset advisor for more detailed and specific planning.
New Limitation on “Excess Business Loss”
- For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the Act provides that a non-corporate taxpayer’s “excess business loss” is disallowed.
- Excess business losses are not allowed for the current tax year, but are carried forward as part of the taxpayer’s net operating loss. The limitation applies after the passive loss rules are applied.
- An excess business loss is the excess of aggregate deductions of the taxpayer’s trade or business, over the sum of the aggregate gross income or gain. The threshold amount is $500,000 for married filing jointly, and $250,000 for other individuals, both indexed for inflation.
Somerset Observation: This provision basically reduces your current year active business losses to a maximum of $500,000 if married filing jointly, and $250,000 for other individuals, both indexed for inflation. Any loss over and above such amounts is carried forward to future years.
Somerset Observation: The good news of this provision is that if the business is operated thru a flow thru entity, the provision applies at the partner/shareholder level. Therefore, each partner/shareholder gets the maximum of $500,000 if married filing jointly, and $250,000 for other individuals, both indexed for inflation.
Itemized Deduction changes
- The Act repeals the deduction for interest on home equity indebtedness.
- The deduction for mortgage interest is limited to mortgage debt of up to $750,000.
- The Act would limit the deduction for State and local income, sales taxes, and property taxes to $10,000.
- For any divorce or separation agreement executed after Dec. 31, 2018, alimony and separate maintenance payments are not deductible by the payor spouse, and are not included in the income of the payee spouse.
- The Act repeals the overall limitation on itemized deductions.
- Repealed deductions
All miscellaneous itemized deductions, that are subject to the 2% floor under current law
Personal casualty losses, except for personal casualty loss incurred in a Presidentially-declared disaster
- Modified rules for charitable contributions
– The act will increase the 50% limitation for cash contributions to public charities and certain private foundations to 60%. Contributions exceeding the 60% limitation are generally allowed to be carried forward for up to 5 years.
– Repeals the current 80% deduction for contributions made for university athletic seating rights.
Somerset Observation: These itemized deduction changes will negatively impact many high income individuals who have large mortgage balances, pay large amounts of real estate taxes and state and county income taxes. Therefore, any of the above deductions repealed in 2018 should be paid, if possible, before the end of 2017.
Estate & Generation-Skipping Transfer Tax changes
- The Act would double the base exclusion amount under Code Sec. 2010 of $5 million (as indexed for inflation; $5.6 million for 2018 per taxpayer) to $11.2 million indexed for inflation, $22.4 million per married couple, effective for tax years beginning after Dec. 31, 2017.
Somerset Observation: All of the above provisions are a welcome change for very wealth taxpayers who want to pass on their family wealth to kids and Grandkids. The change effectively allows a husband and wife to pass on $22.4 million of assets to their beneficiaries without federal estate tax ramifications.
Alternative Minimum Tax – Modification
- The Act would NOT repeal the AMT, however, the exemption amounts have increased.
- AMT exemption amounts are as follows:
Joint returns and surviving spouses: $109,400
Single Taxpayers: $70,300
Married Filing Separately: $54,700
Somerset Observation: The final bill will not repeal the AMT, which differs from the House and the Senate’s original proposal. The exemption amounts referenced above start phasing out at $1,000,000 of alternative taxable income for joint returns and surviving spouses; $500,000 for other taxpayers. These phase-out levels started at much lower income amounts in the past. In addition, the elimination of most of the state and local income tax deductions and the complete elimination of miscellaneous itemized deductions will mean less addbacks for AMT making the likelihood of a taxpayer paying AMT in 2018 very unlikely.