On December 22, the “Tax Cuts and Jobs Act” became law. This new law is the largest reform to the tax code since the Tax Reform Act of 1986.
This new law has been widely discussed for the significant cuts to the corporate tax rates. Below, however, we will summarize the changes that impact most individuals. Before we get started, let us first highlight some general themes in this new law. Most of the changes are effective for tax years 2018-2025. Interestingly, these changes will all revert to the current law in 2026, although we consider that very unlikely as there will be varying political changes in Washington between now and 2026.
Based on our analysis, it appears likely that most all individual taxpayers will see some form of tax cut from this new law. The depth of the cut will vary depending on the taxpayer’s unique circumstances.
New Income Tax Rates and Brackets
Old Law: Under pre-Act law, individuals were subject to 7 tax rates: 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
New Law: Starting in 2018, there will still be 7 tax rates; however, the rates will be lower and the brackets of your income will be adjusted upward. The new rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. This is the most wide-reaching change that will benefit the most taxpayers.
Planning Idea: Even though rates and brackets are changing favorably, it will still be prudent to plan so to avoid ending up in a higher tax bracket. Retirees with large retirement account balances should pay close attention so to avoid moving up in brackets. Required Minimum Distributions (RMDs) from these retirement accounts begin at age 70 ½. Consider withdrawing from these accounts earlier than required or consider Roth IRA conversions.
The Standard Deduction is claimed by nearly 70% of all taxpayers. The other 30% itemize their deductions. The Standard Deduction is a fixed amount that you can subtract from your taxable income in lieu of itemizing your deductions.
Old Law: Under pre-Act law, the Standard Deduction for a single individual was $6,350 and for married taxpayers, it was $12,700.
New Law: Starting in 2018, the Standard Deduction nearly doubles to $12,000 for singles and $24,000 for joint tax returns. It is estimated that now 85% of all taxpayers will claim the Standard Deduction.
Planning Idea: By increasing the Standard Deduction, this will clearly increase the number of taxpayers who will claim the Standard Deduction and forgo itemizing deductions. This will be a meaningful tax savings to most taxpayers who were already taking the standard deduction by simply increasing the amount they can deduct. This is one part of the Act that will likely make filing a tax return easier (tax simplification). We will discuss this further below when we highlight the Personal Exemptions and Itemized Deductions.
Every taxpayer has been allowed a Personal Exemption on their tax return. This amount for 2017 is $4,050 per taxpayer. So, a couple that files a joint tax return is eligible to claim two Personal Exemptions for a deduction of $8,100 from their taxable income. A family of four would be able to claim $16,200. Under the new law Personal Exemptions are gone (I suppose this can be called “simplification” too, but not the kind of simplification most taxpayers like).
Analysis: This change is clearly unfavorable for all taxpayers. The main mitigating offset is the fact that the Standard Deduction is nearly doubling. The impact of Personal Exemptions being repealed will depend on other factors in the new Act and each taxpayer’s unique situation.
There are several key changes to Itemized Deductions (Schedule A of your tax form). Below are highlights of the key changes:
Medical & Dental Expenses: Qualifying and unreimbursed medical and dental expenses have long been a part of itemized deductions. These deductions have had a threshold that first must be met before the expenses can be deducted. For tax years 2017 and 2018, medical and dental expenses must first exceed 7.5% of Adjusted Gross Income (AGI). Starting in tax year 2019, that deduction threshold will increase to 10% of AGI.
Taxes Paid: Common deductions in this section of the Schedule A include real estate property taxes, sales taxes, and state and local income taxes. We Floridians do not pay state income taxes, so we typically focus on property tax and sales taxes. This change under the new Act likely received the most press. The change to pay attention to is a cap on the dollar amount that can be deducted for taxes paid. The cap is $10,000. This cap will be felt the most by wealthy taxpayers. These taxpayers will be subject to higher state income taxes and will likely have higher property taxes or may have a vacation home as well where property taxes are paid. The cap of $10,000 is unlikely to impact the middle class taxpayers as they will likely be claiming the new higher standard deduction.
Interest Deductions: Under the old law, homeowners could deduct mortgage interest on their home or vacation home as long as that debt didn’t exceed $1,000,000. Homeowners could also deduct interest on a home equity line of credit up to $100,000 of debt.
The new law reduces the indebtedness limit to $750,000. The new lower limit does not apply to any acquisition indebtedness incurred before December 15, 2017. As for home equity loans, the interest deduction has been completely eliminated.
Gifts to Charity: The only change here is a minor one for most taxpayers. The income limit for being able to deduct all of your cash contributions was increased from 50% to 60%.
Planning Idea: Although the change here is minor, it would be a good idea to consider making charitable gifts from your IRA directly to a qualified charity. This is only available to taxpayers over 70 ½ who are taking RMDs. The RMD could be directed to the charity, and the income would be excluded from your taxes.
Casualty and Theft Losses: This section of the Schedule A is not used very frequently and has now been scaled back to be allowed only in the case of a presidentially declared disaster. There is uncertainty as to the continuation of theft losses.
Miscellaneous Itemized Deductions: Under the old law, these deductions were allowed if they first exceeded 2% of AGI. Under the new law, these deductions have been eliminated entirely. Deductions usually claimed here include unreimbursed employee business expenses, income tax preparation fees, investment management fees, and safe deposit box rent.
Planning Idea: Investment management fees will no longer be deductible. We will be reviewing alternative ideas for these fees such as having IRAs pay their own fee (basically using pre-tax dollars to pay a fee) and other possible solutions.
Deduction for Living Expenses for Member of Congress: It is doubtful that any of the readers of this document are members of Congress, however, I am very glad to see that the $3,000 deduction they were afforded for living away from home has been eliminated.
Under pre-Act law, taxpayers whose AGI exceeded certain limits saw their itemized deductions reduced. They could be reduced as much as 80%, allowing only 20% of the actual deductions. This was seen as a hidden tax. This restriction has been eliminated, allowing those who itemize their deductions to actually claim them.
Child Tax Credit
Old Law: Under pre-Act law, a taxpayer could claim a child tax credit of up to $1,000 per child under the age of 17. That credit was phased out for a married couple when their AGI exceeded $110,000.
New Law: Starting in 2018, the child tax credit is increased to $2,000 per child under age 17, and the phase out does not begin until a married couple’s AGI exceeds $400,000. This will go a long way and is likely more favorable for families who will lose their personal exemptions. A tax credit is always better than a deduction.
Other Individual Provisions
Alimony: For divorce or separation agreements executed after December 31, 2018, alimony will no longer be taxable to the recipient and will no longer be deductible by the payor.
IRA Recharacterizations: IRAs that are converted to a Roth IRA will no longer be allowed to be reversed (or recharacterized back to a traditional IRA).
Estate and Gift Provisions
Old Law: Under pre-Act law, the first $5.6 million ($11.2 million for a married couple) was exempt from estate and gift tax.
New Law: For estates of decedents dying, and gifts made after December 31, 2017, the Act doubles the estate and gift exemption to $11.2 million ($22.4 million for a married couple).
Individual Alternative Minimum Tax (AMT)
The House version of the bill would have repealed the AMT for individuals, but the final Act kept the tax with increased exemptions.
During the drafting of this Act, many areas of change were discussed. Two items in particular included teacher classroom expense deduction and sale of a principal residence. It is good to note that there are no changes to these provisions.
Please understand that this is simply a summary of a few of the major provisions and cannot be relied upon for authoritative or actionable advice. If you would like to discuss any of these provisions with us, please call our office.