On November 2nd, the House Ways and Means Committee unveiled a sweeping tax bill, Tax Cut and Jobs Act, designed to undo many of the complexities of the Tax Reform Act of 1986. Please understand that this is not law yet. There’s still a long journey, with lots of hurdles, before some version of this bill becomes law. Whatever happens, this won’t affect your 2017 tax return adversely. Most provisions will take effect for “tax years after 2017.”
In the meantime, let me give you a brief overview of how this law will affect you, starting in 2018. After all, you don’t want the entire 429 page information here, on something that isn’t really a law yet.
Please understand, my focus is on individuals and small businesses, only. I will not touch on the large, mult-nationals, and offshore profits at all, though, those provisions are an important factor in balancing the effects of this law.
Glossary
Some abbreviations we will use are M = Married, S = Single, HOH = Head of Household.
AGI – Adjusted Gross Income – the bottom line on the page 1 of the long Form 1040.
Nonrefundable credits – the tax credits may only be used to zero out a taxpayer’s tax liability, not to generate any extra refunds.
Refundable credits – tax credits will be given to taxpayers in excess of their total tax liability – even if they have had nothing withheld.
Tax Credits – they reduce taxes, on a dollar-for-dollar basis.
Tax deductions – they only reduce income times your tax bracket.
- Tax Brackets – Reduced to 4 brackets – 12%, 25%, 35% and 39.6%. Currently, we have 8 tax brackets – 0%, 10%,15%, 25%, 28%, 33%, 35%, and 39.6% . (I know, you keep hearing that there are 7. The legislators keep omitting the current 0% tax bracket for the lowest income people!)
- The lowest bracket of 12% will apply to the income of single people at $45,000, married couples at $90,000 and heads of household at $67,500.
- The average person with income above those amounts will pay 25% until they reach these thresholds – S to $130,000, MFJ to $260,000, HOH to $195,000.
- Folks will hit the 39.6% bracket when their income reaches $500,000 for S, $1,000,000 for MFJ and $500,000 for HOH.
- Impact on you. There will no longer be a 0% tax bracket at all. So that may cause taxes to increase on the poorest taxpayers – if the increased family-related tax credits and increased standard deductions don’t reduce their taxes.
- Personal Exemptions – all gone.
- Impact on you. For 2018, your personal exemption would have been $4,150. A family of four would lose $16,600 in deductions.
- Child Tax Credit – Increased to $1,600 from $1,000 per child under age 17
- Impact on you. That $600 increase is designed to balance out the loss of the $4,150 per child. In a 12% tax bracket – that actually works.
- The refundable portion of $1,000 (to be indexed for inflation) will require a Social Security number.
- The income level to claim the credit has been increased – $115,000 (S), $230,000 (MFJ) (possibly, although not specified – $172,500 for HOH)
- Family Flexibility Credit – New – worth $300 per non-child dependent. It’s temporary – it expires on 12/31/2022. And it’s not refundable.
- Impact on you. This is designed to replace the personal exemption for the taxpayer, spouse and any other adult (like a parent, girl-friend, college-age child). This still doesn’t really replace the value of the lost exemptions. It leaves a shortfall of about $300 per person.
- The income level to claim the credit has been increased – $115,000 (S), $230,000 (MFJ) (possibly, although not specified – $172,500 for HOH)
- Standard Deduction – Increased to $12,200 (S), $24,400 (MFJ, and $18,100 (HOH) – under current law it is $6,500 (S), $13,000 (MFJ), and $9,550 (HOH)
- Impact on you. This appears to be a significant increase in deductions you can use without having to report any expenses or save any receipts. This increase is designed to simplify your tax return preparation. This is, essentially, the basis of their “postcard tax return” concept.
- For people who rent their residences and have jobs that reimburse all their expenses, this standard deduction and the increase in family-related tax credits will keep your taxes about the same as before – with fewer record-keeping requirements.
- Itemized Deductions – All of them are being eliminated except for mortgage interest and property taxes. Even those deductions have new caps on them. This means, no deductions for moving expenses, employee business expenses, medical expenses, and so on. In addition, entertainment expenses are totally abolished – for business and employees. Tax preparation fees and fees for financial advice are no longer deductible. Note: The current phase out of itemized deductions and standard deductions for high-income taxpayers will be repealed. Not that it matters since we won’t have any exemptions or many deductions left to take.
- Impact on you. Folks who traditionally have high deductions for medical expenses, job-related costs, and state tax deductions will be hit hard. All those deductions are gone. There is nothing to replace those tax deductions at all. Who will be the hardest hit?
- The elderly and disabled who don’t have enough insurance coverage, or must pay for in-home care or must live in care facilities.
- Employees who have unreimbursed travel and meal expenses.
- Mortgage Interest – folks with current, qualifying mortgages will still be able to take their interest deductions. If you buy a new home starting in 2018, your mortgage interest deduction will be limited to the interest on a loan of up to $500,000
- Impact on you. No impact if you keep your current mortgage. But if you refinance, you will only be able to claim the interest on the acquisition debt – probably up to loans of $500,000.
- The interest deduction is limited to only one principal residence (unlike the two we used to be able to deduct)
- No deduction will be allowed for home equity debt at all, on new purchases.
- There is no longer a deduction for the PMI – mortgage insurance
- They don’t discuss points – but assume that they are only deductible on a new purchase, not on refinanced loans.
- NOTE: This $500,000 limit applies to all new loans and refinanced loans dated after November 2, 2017! So there is no time to do any refinancing or damage control.
- Real Property Taxes – limited to a total of $10,000 – regardless of the number of properties involved.
- Impact on you. Unlike the mortgage interest expense, existing property taxes are not grandfathered.
- All other state and local tax deductions are gone – which is a bit hit for taxpayers in high tax states like New York, California, Illinois, etc. No effect on the 9 states that have no income taxes, or the few states, like Alaska, that don’t have sales taxes either.
- Note: Businesses may still deduct all relevant state and local taxes related to their business operations.
- Charitable Contributions – Still deductible. The limit on deductions rises to 60% of AGI, instead of 50%. There are more complicated provisions, especially with respect to the carryover of unused deductions.
- Impact on you. For most people, the higher standard deduction will make deducting these donations impossible, since you won’t be able to itemize at all.
- Impact on charities. Probably a reduction of donations from moderate to lower-income taxpayers. It will practically put a stop to the year-end donations of personal and household goods to charities and thrift shops, since the primary donors will no longer be able to use the deductions.
- One small piece of good news for those who will still be able to itemize. For the first time in half a century or more, the IRS finally has the right to set the mileage deduction, and to increase it by inflation. It has been frozen at 14 cents per mile because only Congress could change that number.
- Personal Casualty Losses – gone, except for federally declared disaster areas
- Impact on you. If you experience a fire, theft, flood or other personal disaster and don’t get insurance compensation for the full amount of the loss – you won’t be able to take a deduction at all. You may need to reduce the deductibles on your various insurances. A real boon for the insurance industry.
- However, if you are in a disaster area, you will still be able to claim the deductions.
- Note: This does not impact business casualty losses. Those are still fully deductible.
- Alimony Expenses – will no longer be deductible at all.
- Impact on you. Spouses who pay out alimony, child support, or family support will no longer get any tax benefit for the share of the income they give to an ex-spouse. This will definitely cause a re-negotiation of all divorce settlements, since it will be so much more expensive to the paying spouse.
- Good news: The person receiving the alimony will no longer be paying taxes on this income. So, when the amounts are negotiated downwards, it won’t be as painful.
- Selling Your Home – in order to avoid paying taxes on the first $250,000/$500,000 of profits, you must now live in the home for at least 5 years out of eight.
- Impact on you. It’s no longer going to be possible to make a living buying a home, fixing it up and selling it at a profit every two years – and to live tax-free.
- Adult couples planning marry, who each own homes, might have to sell their homes before marriage, and buy a new home to live in together. Or to do some careful planning about the timing of home sales before and after marriage.
- More bad news. This exclusion of profits is reduced, dollar-for-dollar, when your AGI exceeds $500,000. (Note: It’s not clear if we must take the excluded profit into account before computing AGI. I hope not.)
- Education Deductions and Credits – Most have been consolidated into the American Opportunity Credit, with a fifth year of tuition. The 5th year of the American Opportunity Credit is limited to 50% of the usual amount (50% of up to $2500), not $500 (although the refundable portion of the credit would be $500, which is 50% of the full $1000).
- Impact on you.
- The Lifetime Learning Credit is gone. A bit of discouragement for folks wanting to continue to improve their skills or learn new skills as their jobs and industries are being phased out.
- No more deduction for student loan interest.
- No exclusion from income for interest on U.S. savings bonds.
- No exclusion from income for tuition-reduction programs.
- There will be some provisions for relief of debt for student loans that are unpaid due to death, total disability or other conditions.
- Sec 529 College Savings Plans & Coverdell IRAs – New contributions to Coverdell IRA plans are prohibited (like a student IRA). But you may roll over those Coverdell funds to your Sec 529 plan, tax-free
- Impact on you. You lose the extra $2,000 per year contribution to the Coverdell IRA.
- Beneficiaries are expanded so you can designate a beneficiary to be a human fetus. (Yup, it specifies “species homo sapien,” not simian, or canine or ursine, or…)
- Note: To designate a beneficiary, you must have a name, address and Social Security Number – so that is a rather absurd provision in the proposed law.
- Funds may be used for elementary and high school costs up to $10,000
- Funds may be used to pay for apprenticeship programs
- And with all of these provisions, if you cannot make new contributions, none of this is really helpful, except to wealthy folks who front-loaded their family’s Sec 529 accounts with five years worth of maximum contributions – and have been funding these accounts since the birth of their children, grandchildren or relatives.
- And alternative investment option is – to buy your children whole life insurance policies for your children as early in life as possible. Those funds will grow as you make annual payments. When your child is ready for college, he or she may borrow from the cash value of the life insurance policy with no tax effect.
- Tax-Free Employee Awards – Repealed.
- Impact on you. Your employer used to be able to give you tax-free awards for achievements or safety each year worth $400 (up to $1,600 per year). They may still give you these awards. But the awards will be fully taxable.
- Employer-Paid Dependent Care Assistance – Repealed
- Impact on you. Your employer was able to provide a tax-free benefit of up to $5,000 for dependent care assistance. This is no longer a tax-free benefit.
- Employer-Paid Moving Expense Reimbursements – Repealed
- Impact on you. In the past, part of the moving expense reimbursements were tax-free – as long as they were for moving the household and direct transportation of the members of the household. The other relocation expenses were taxable. Now – it’s all taxable.
- Employer-Paid Adoption Expenses – Repealed
- Impact on you. In the past, your employer could provide up to $13,570 to help cover your adoption expenses as a tax-free benefit. This was in addition to the tax credit you could take for any expenses in excess of the job-related benefit. This benefit is gone.
- Note: The tax credit for adoptions will still be available – as a nonrefundable credit.
- Alternative Minimum Taxes (AMT) – Repealed
- Impact on you. This was originally designed to ensure the wealthy paid taxes, even after their expensive tax planning was put into place. Instead, the income levels where the AMT took effect, affected taxpayers whose income was barely over the poverty level. For the average person, this is a valuable benefit.
- However, instead of repealing the AMT, they should have left it in effect at much higher income levels – more like $250,000 or $500,000, instead of the $53,900 (S & HOH) or $83,800 (MFJ). This is a HUGE tax break for the wealthy.
- Note: Most of the average income people who were affected were those who had high employee business expenses, or home equity interest. But since both of those deductions are gone anyway, the average person would not face AMT even without this provision.
- Folks with an AMT credit carryforward may be able to use them up, at the rate of 50% per year, starting in 2019 – 2021. Whatever’s left may be fully used up in 2022.
- Estate Taxes – The exclusion from estate tax is doubled to $10,000,000 per person, indexed by inflation. The estate tax totally phases out in 2023. The top estate tax rate drops to 35% from 40%.
- Impact on you. Not much really. Since, according the IRS statistics of wealth, only about .34% (that’s about a third of ONE percent) of the population have assets in excess of $5 million dollars.
- The good news. They did include a provision to keep the step-up in basis intact. Normally, when estate taxes are repealed, that also means that the heirs have to struggle to figure out the tax cost to the person who died. Getting a step-up in basis means that when you inherit something, your tax cost (or basis) is the fair market value (FMV) on the date of death.
- Gift taxes will still be due on lifetime gifts of $10 million or more, indexed for inflation. The gift tax will be 35%
- The annual gift tax exclusion will remain as is, currently $14,000 to any one person for 2017, and indexed for inflation. It will rise to $15,000 for 2018.
- Impact on you. Folks who traditionally have high deductions for medical expenses, job-related costs, and state tax deductions will be hit hard. All those deductions are gone. There is nothing to replace those tax deductions at all. Who will be the hardest hit?
This only covers most of the information in the first 26 pages (out of 82 pages) of the summary of the proposed law, plus the estate & gift taxes and AMT. There are lots more things in there, both good and bad.
For more information, you will find some excellent articles and incisive summaries of this law written by folks like Kelly Phillips Erb at Forbes https://www.forbes.com/sites/kellyphillipserb/
and Kay Bell blog – Don’t Mess With Taxes https://www.dontmesswithtaxes.com/ – and her articles at BankRate.com – https://www.dontmesswithtaxes.com/about.html
And the House Ways and Means press release announcing this plan can be found here – https://waysandmeans.house.gov/category/press-releases/
Updated to correct the info on Sec 529 plans and the American Opportunity Credit – thanks to Uncle Bill Porter, EA
