On December 20th, the Tax Cuts and Jobs Act was passed by The House and Senate. Once signed by President Trump, it will be the most significant overhaul to the US Tax Code in more than 30 years. The legislation will have major implications for both businesses and individuals. Depending on each individual or business’ unique tax situation, the outcome can vary drastically from taxpayer to taxpayer. The effective date for most of the provisions of the legislation will be January 1, 2018; however, we encourage all taxpayers to examine their individual tax situation prior to December 31, 2017. Strategies to implement prior to year-end may be beneficial for one taxpayer, yet ineffective for another. At Cassady Schiller CPA’s & Advisors, we take a holistic approach and analyze how all of the provisions come together to impact your tax situation. If you have questions or need additional assistance, please contact a Cassady Schiller team member at 513-483-6699.
While the bill contains hundreds of changes, below we have focused on the ones most commonly impacting individual and business taxpayers.
- Tax Rates. The top individual tax rate will decrease from 39.6% to 37%. The highest bracket will apply to single taxpayers with income over $500,000 and married filing joint taxpayers with income over $600,000. Lower brackets are widened and have lower corresponding rates.
- Personal Exemption. The personal exemption is repealed under the Tax Cuts and Jobs Act.
- The standard deduction for a single taxpayer is set to increase from $6,300 to $12,000 (from $12,600 to $24,000 for married filing joint status). This, along with the new limitations on itemized deductions outlined below, may result in many taxpayers receiving a greater benefit from the standard deduction beginning in 2018. As a result, it is important to consider the benefit of accelerating certain itemized deductions into 2017 to secure the tax deduction. Below is a list of many of the changes to itemized deductions followed by an example to help illustrate the potential tax savings strategies to consider with respect to these changes.
- Real Estate and State & Local Tax Deduction. Starting in 2018, the total combined deduction for real estate and state and local income tax is limited to $10,000.
- Charitable Contributions. The limitation is set to increase from 50% of adjusted gross income (AGI) to 60% of AGI for cash contributions. In addition, the deduction for payments made in exchange for college athletic event seating rights is eliminated.
- Home Mortgage Interest Deduction. For home acquisition indebtedness incurred on or after December 15, 2017, the principle is limited to $750,000 versus the $1 million limitation for indebtedness incurred prior to December 15, 2017. The new tax law also eliminates any deduction related to home equity indebtedness.
- Medical Expenses. The new law returns the deduction for expenses in excess of 7.5% of AGI for 2017 and 2018. For 2016, only expenses in excess of 10% of AGI were allowed and the 10% floor returns for 2019.
- Miscellaneous Expenses. Miscellaneous itemized deductions, which were previously permitted if in excess of 2% of AGI, are no longer allowed. This includes tax preparation fees, investment expenses and unreimbursed employee expenses.
Example of impact relating to itemized deduction and standard deduction changes:
Taxpayer A (married filing joint) incurs the following itemized deductions annually: mortgage interest ($8,000), real estate taxes ($10,000), state/local taxes ($20,000) and charitable donations ($5,000). In Scenario 1, due to the cap on real estate taxes and state and local taxes, Taxpayer A’s 2018 allowable state and local tax deduction is disallowed. In addition, the total allowed itemized deductions is less than the standard deduction of $24,000. Therefore, under Scenario 1, Taxpayer A would have received no tax benefit in 2018 for mortgage interest, real estate taxes, state and local taxes or charitable donations.
In Scenario 2, Taxpayer A (married filing joint) paid his 2017 real estate taxes due in 2018 by December 31, 2017. In addition, Taxpayer A chose to execute charitable donations planned to be made in 2018 by December 31, 2017. As illustrated below, Taxpayer A secured an additional $15,000 of itemized deductions in 2017. Taxpayer A would have received zero tax benefit for those itemized deductions in 2018 under the new tax law.
- Moving Expenses. The deduction for moving expenses is suspended.
- Child Tax Credit. The child tax credit is set to increase from $1,000 to $2,000 (per child) beginning in 2018. In addition, $1,400 of the credit will be refundable. Of significant importance is that the threshold at which a taxpayer may be phased out of the child tax credit will increase significantly, from $110,000 to $400,000 for married taxpayers filing jointly. The bottom line – more taxpayers will be eligible to claim the credit.
- Alternative Minimum Tax (AMT). Although a major talking point, AMT was retained. The Act increases the exemption amount and increases the exemption phase-out threshold to $1,000,000 for married individuals filing jointly ($500,000 for all others) subject to AMT which significantly decreases the likelihood of AMT applying to most taxpayers.
- Currently a taxpayer may take a deduction for alimony paid and the recipient must report the alimony as income. Under the new legislation, alimony agreements executed after December 31, 2018 are no longer deductible for the payer and no longer taxable to the recipient.
- Shared Responsibility Payment. Better known as the Obamacare penalty for failing to have health insurance. This amount is reduced to 0% for months beginning after 12/31/18.
- 529 Plans. Up to $10,000 (per individual) of funds from 529 Plans may now be used for elementary and secondary education per year.
- Roth IRA conversion recharacterization. The provision allowing a taxpayer to recharacterize a Roth IRA conversion before the extended due date of a return (ie. unwind the conversion) is eliminated.
- Estate and Gift Tax. The estate and gift tax exemption is increased to $11.2 million for every taxpayer through 2025.
- Credit for plug-in electric drive motor vehicles. Repealed for vehicles placed in service after 12/31/17.
With almost all of these changes taking effect in 2018, there’s still a window of opportunity to employ potential tax saving strategies in 2017. The examples show the impact of how the change to the standard deduction presents opportunities to save on 2017 taxes by paying 2017 real estate taxes in 2017 and accelerating charitable contributions into 2017, but some other things to consider would be accelerating employee business deductions if you are over the 2% floor, paying your January mortgage payment in December to get another month of interest in 2017, or possibly buying that electric plug-in electric vehicle that you have always wanted.
- Tax Rate. The new tax legislation cuts the corporate tax rate to 21%. For years beginning prior to January 1, 2018, corporate tax had graduated tax rates ranging from 15%-35%. Starting in 2018, the corporate tax rate is a flat 21%.
- Corporate Alternative Minimum Tax. Corporate AMT is repealed under the Tax Cuts and Jobs Act.
- The maximum amount of Section 179 expensing allowed is increased from $500,000 to $1 million. 100% bonus depreciation will be allowed on new and used equipment for property placed in service after 9/27/2017 and before 1/1/23. The luxury automobile depreciation limitation is increased to limit the depreciation on automobiles costing more than $50,000 (up from $15,800).
- Domestic Productions Activity Deduction (DPAD). The Tax Cuts and Jobs Act repeals the DPAD.
- Pass-through Income. Under current tax law, income from S Corporations, Partnerships and Sole Proprietorships is taxed at individual rates. Beginning in 2018, individuals and trusts will be allowed a 20% deduction of their allocable share of certain income from pass-through entities. However, the deduction comes with certain limitations:
- The deduction cannot exceed 50% of the individual or trusts’ share of W-2 wages paid by the business. The limitation may also be computed as 25% of the share of W-2 wages paid by the business plus 2.5% of the unadjusted basis of the property used in the production of income.
- Certain personal service businesses are not eligible for the deduction unless the individual’s taxable income is less than $157,500 (single) or $315,000 (married filing joint). Therefore, accountants, doctors, lawyers, consultants and numerous others may not be eligible for the deduction.
- Interest Expense. For tax years prior to January 1, 2018, there was no limit on the business interest expense. For tax years beginning January 1, 2018, the business interest deduction will be limited to 30% of adjusted taxable income. Adjusted taxable income does not include deductions allowable for depreciation, amortization or depletion. This provision does not apply for floor plan financing and also does not apply to taxpayers with average annual gross receipts for three preceding tax years of less than $25 million.
- Net Operating Loss Deduction (NOL). Prior to 2018, a NOL could offset 100% of income. For tax years beginning after 12/31/17, a NOL may only offset 80% of income. Additionally, net operating losses had been allowed to be carried back up to two years. For tax years beginning after 12/31/17, the carryback provision has been eliminated.
- Like Kind Exchanges. This provision has been modified to only include real property not held primarily for sale and is effective for exchanges completed after 12/31/17.
- Meals & Entertainment. The Tax Cuts and Jobs Act eliminates the business deduction for any activities considered to be entertainment, amusement or recreation (including meals, event tickets and club dues). Meals provided for employees while traveling along with meals provided to employees on business property will be 50% deductible.
- Technical Termination of a Partnership. The law repeals the technical termination provisions that applied when a greater than 50% change in ownership occurred.
- Carried Interest. The law provides for a three year holding period to receive long-term capital gain treatment.
- Amortization of Research and Experimentation Expenditures. For tax years beginning after 12/31/25, these expenditures will be amortized over five years (fifteen if performed outside the US).
So what strategies should you be considering with these business changes? For one, consider deferring income and accelerating expenses if you are a C corp and your taxable income is expected to be in the 25% bracket or higher in 2017. Similarly for C corps, if you are expecting a loss and had income in excess of the expected loss in the two prior years, consider deferring income and accelerating deductions to generate a larger NOL that can be carried back presumably to a year in a higher tax bracket than what will be in effect in 2018 and beyond. The income deferral and expense acceleration should also be considered for pass-through entities with the pass-through business income exclusion and reduced rates/widened brackets coming into play in 2018.
As previously mentioned, these are just some of the provisions in this legislation. There are many more provisions impacting businesses and individuals, as well as provisions specifically impacting non-profits, insurance companies, and businesses with foreign operations. Accordingly we would recommend that you contact Cassady Schiller to understand whether there are additional provisions that would apply to you or your business and to help you plan for the best results in light of these new rules.