To heighten an already exciting time of year, yesterday both Houses of Congress passed a substantial re-write of major portions of the Internal Revenue Code of 1986. All that awaits now is the formality of President Trump’s signature, which as of this writing has not occurred. However, once the President signs the landmark legislation, Americans can expect changes to the Internal Revenue Code. Only time will tell if the controversial1 and historic tax reform bill will result in a gift to the United States in the form of tax simplification, job creation and a strengthened economy or as some fear, a lump of coal for middle class and low wage earners.
With homage to David Letterman, what follows is a summary of 10 of the most significant provisions taxpayers should pay attention to under this new law.
1. Lower Individual Income Tax Rates and Child Care Tax Credit
a. Starting in 2018, income tax rates are dropping on average 3% across the board from 39.6% to 37% for the highest earners and from 15% to 12% for those at the lowest earnings level. Tax bracket break points have been raised as well so that it will now take more income under the new law to jump up in brackets. One aspect of the bracket adjustments should be noted, however. Under current law the brackets are automatically adjusted upwards slightly each year by an established economic measure to account for inflation. Under the new law, the standard used to make this upward adjustment has changed from the Consumer Price Index to something called the Chained Consumer Price Index. This is a slower moving index which will result in smaller bracket increases over time as incomes rise making it easier to jump to the next higher bracket sooner than would otherwise have occurred if the current standard is used.
b. The exemption allowed for children has been eliminated and replaced with a larger child tax credit of up to $2,000 per child. The credit can also result in a refund of up to $1,400. Apparently, this provision was central to gaining support from Senator Mark Rubio, without which the entire legislation appeared doomed.
Both the individual rates and the child care tax credit sunsets in 2025, so absent further Congressional action legislation they will be automatically repealed after 2025.
2. Standard and Itemized Deductions
a. $10,000 Limit on State and Local Tax Deductions: Starting in 2018, those who itemize will now only be able to deduct up to $10,000 in property tax and state income and sales tax. Reducing itemization in the bill’s proponents’ view will simplify the tax filing process.
b. Expansion of Medical Expense Deduction: Under the new law the floor for deductible medical expenses is lowered to 7.5% of adjusted gross income from its current level of 10%. Individuals with large out of pocket medical expenses will be able to more easily deduct those expenses This provision only applies for 2018 and 2019. For tax year 2020 it reverts to its 2017 level of 10%.
c. Larger Standard Deduction: The standard deduction has been increased to $12,000 for single taxpayers and $24,000 for married taxpayers. This provision also sunsets after 2025. The increased standard deduction along with the child care tax credit is intended to offset the loss of the dependent child exemption and encourage fewer people to itemize, which Republicans posit will make the tax return preparation process easier.
3. $750,000 Limit on Mortgage Interest Deductions
Starting in 2018, interest on new mortgages on a first and second home is only deductible on the first $750,000 borrowed. This provision will not affect existing mortgages. Under current law the principal limitation is $1,000,000. This provision will also sunset after 2025.
4. Lower Corporate Tax Rates and Expensing
The top corporate rate has dropped from 35% to 21%. Interestingly, this provision is not subject to the sunset provisions, and therefore will not require Congressional action to be maintained. In fact, it is just the opposite in that it can only be changed with express Congressional action.
5: Repatriation Incentives
Perhaps among the most hotly debated parts of the new legislation are provisions intended to encourage U.S. corporations to repatriate earnings from foreign subsidiaries. Currently the US corporate tax system taxes U.S. resident multi-national corporations on world-wide income. Dividend distributions from those subsidiaries to the U.S. parent are presently taxed at the U.S. corporate rate. The new law abandons the worldwide tax system for a new territorial regime. In principle, the new system only taxes corporate income earned in the U.S. It does this by allowing an exemption for dividends from foreign subsidiaries. The act imposes a new onetime transition tax on accumulated overseas profits. The onetime tax rate ranges between 15.5% and 8% percent.
Those who disfavor this provision argue it will encourage over-seas expansion where labor costs are lower if profits can then be repatriated without tax cost. Proponents conversely argue it will encourage U.S. corporations to withdraw that capital and use it in the U.S. to expand operations and increase jobs domestically. Proponents also argue the U.S. will become a more effective competitor for international companies in selecting a country in which to establish a business.
6. AMT Reform
The corporate alternative minimum tax under the new bill has been repealed. The corporate minimum tax is intended to ensure that all corporate taxpayers pay some measure of income tax. Taxable income is calculated removing certain so-called preference items such as certain deductions and credits. A tax is then imposed on the newly determined alternative minimum taxable income.
Individual alternative minimum tax was not repealed under the new bill, however the level of income above which it is applied has been relaxed. Under current law, a single filer can exempt $54,300 and a married filing joint filer $84,500 as married filing joint. The new bill increases those exemptions to $70,300 and $109,400. Also, under current law if a single filer made more than $120,700 or a married joint filer more than $160,900 they lose the benefit of the exemption amount and the alternative minimum tax is applied to their entire income. The new bill increases those phase out levels to $500,000 and $1,000,000.
7. Charitable Deduction Expanded
Under current law charitable contribution deductions are limited to a maximum of 50% of adjusted gross income with the balance able to be carried forward for five years. Under the new bill this limit has been increased to 60%. For a large donor approaching end of life, this additional carrot of being able to use more of the deduction, combined with the estate tax effects of charitable giving, may be enough to incentivize that donor to go forward with a large charitable contribution that he or she might otherwise not make.
8. Individual Health Insurance Mandate Repealed
Under the Obama Administration Affordable Care Act, all individuals must purchase health insurance or pay penalty in the form of a tax. This provision is known as the individual mandate. Under the new bill the individual mandate is repealed starting in 2019.
9. Estate Tax Not Repealed But Exemption Doubled
Under the new bill the estate tax which currently applies to an individual with an estate over $5.6 million remains in effect. However, the exemption has been increased to $11.2 million or $22.4 million for a married couple.
10. 20% Pass Through Entity Deduction
Under the new bill, small business owners have been given relief. Those that operate under S corporation, sole proprietorship or partnership form, so-called flow through entities, do not pay tax at the entity level; rather income from the operations of the entity flows through and is reported on the owner’s personal income tax return. The new bill provides an exclusion from income for 20% of the amount of the entity’s income otherwise reportable on the owner’s return. The deduction is limited for individuals in service industries such as doctors, lawyers and accountants. Once income reaches $315,000, the deduction begins to phase out.
Whether these and the other provisions of the new bill will result in cataclysmic deficits as some suggest or, on the other hand a constant adrenaline shot to the U.S. economy as others predict, remains to be seen.
Pannone Lopes Devereaux & O’Gara will continue to stay up-to-date to keep you informed about the landmark tax reform legislation and other important related issues. If you would like further information or have questions, please contact PLDO Partner Gene M. Carlino at 401-824-5100 or [email protected]. Attorney Carlino has more than 25 years of experience in all areas of estate and tax planning, including advising and advocating for clients in all matters involving federal and state taxation and representing individuals before the IRS in contested assessments. We welcome your comments, questions and suggestions.
1On Friday, December 15, 2017, a uniform piece of legislation, called the “Tax Cuts and Jobs Act,” emerged from the U.S. Congress Joint Committee on Taxation that would be slightly tinkered with at the last minute by adjustments mandated by the Senate Parliamentarian over alleged violations of the so-called Byrd Rule, asserted by Senator Bernie Sanders of Vermont. The revised bill was passed by the U.S. Senate shortly before 1:00 am the following Wednesday morning (December 20, 2017), with the House of Representatives following suit early Wednesday afternoon. Passage was largely along party lines in the House of Representatives with only 12 Republican Representatives crossing the aisle and voting no, and strictly along party lines in the Senate with 51 of the 52 Republican Senators voting “yes” and 48 Democratic Senators voting “no.” Only Senator John McCain of Arizona, who was absent due to medical treatment, was not present. The provisions of the reconciliation bill that were challenged by Senator Sanders as violating the Byrd Rule were: 1. The name of the bill; 2. The proposed expansion of 529 plans contributions for home schooling and private grammar and secondary education; and 3. A proposed 1.4% tax on university endowment income.