January 2018

Big Tax Changes

We plan to address the new 2017 Tax Act changes in a couple of ways. Below is a summary of many of the major provisions, both for businesses and individuals. Later, we'll take a closer look at some practical steps you should consider in light of the new tax law.

First, the corporate rate cuts are significant. The 2017 tax act provides for a 21% flat corporate tax rate. Businesses conducted as sole proprietorships, partnerships, or S corporations are subject to a special deduction under the 2017 tax act beginning in 2018.

Business Deductions and Credits

  • Section 179 Expensing:
    • The expensing limitation is increased to $1 million and the phase out amount to $2.5 million. The new limitations are to be adjusted for inflation. The act further expands the definition of §179 property and the definition of qualified real property for improvements made to nonresidential real property.
  • Research and Development Credit:
    • The research and development credit is preserved.
  • Deductions for Income Attributable to Domestic Production Activities:
    • Beginning in 2018, the deduction for income attributable to domestic production activities is repealed.
  • Entertainment Expenses Deductions:
    • Beginning in 2018, no deduction is allowed generally for entertainment, amusement, or recreation; membership dues for a club organized for business, pleasure, recreation, or other social purposes; or a facility used in connection with any of the above.
  • NOL Deduction:
    • Beginning in 2018, the limit on the NOL deduction is 80% of the taxpayer's taxable income and provides that amounts carried to other years be adjusted to account for the limitation. Amounts are to be carried forward indefinitely.

Corporations

  • Corporate Tax Rate:
    • Beginning in 2018, there is a 21% flat corporate tax rate; there is no special tax rate for personal service corporations.
  • Alternative Minimum Tax:
    • Beginning in 2018, the alternative minimum tax is repealed. In 2018, 2019 and 2020, if taxpayer has AMT credit carryforward, taxpayer is able to claim a refund of 50% of remaining credits (to extent credits exceed regular tax for year). For 2021, taxpayer is able to claim a refund of all remaining credits.

Pass-Through Entities

  • Pass-Through Tax Rate:
    • Beginning in 2018, generally a 20% deduction for qualified business income is provided in lieu of tax rate changes. Special rules apply when computing the deduction. The deduction expires after December 31, 2025.

The tax reform legislation recently passed by Congress also significantly changes the landscape for individuals beginning January 1, 2018, and continuing for many years come. For many taxpayers, the changes made by the legislation present a host of tax planning challenges and opportunities going forward. Due to the elimination or limitation on itemized deductions, and the elimination of personal exemptions, a key consideration in planning for 2018 is to first look at ways to lower your taxable income. You should thus consider maximizing all pre-tax contribution opportunities such as your 401(k), maximizing deductible IRA contributions, and consider investing in state and municipal bonds (whose interest is exempt from federal tax).

Further, despite the headlines, it will remain important for you to keep track of your medical expenses, mortgage interest, property and state income or sales tax payments and charitable contributions made during 2018 due to new restrictions on itemized deductions.

Highlighted below are some of the more significant changes made by the reform legislation and possible challenges and opportunities to lower your tax bill for 2018 and beyond.

Lower Individual Tax Rates - The legislation creates lower individual income tax brackets of 10%, 12%, 22%, 24%, 32%, 35%, and lowers the top rate from 39.6% to 37%, respectively. (The current rates are to be restored in 2026, i.e., 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%, respectively).

Modification of the Alternative Minimum Tax (AMT) - The legislation retains the AMT for individuals but increases the exemption amount and phaseout thresholds so fewer people will pay it. From 2018 through 2025, a higher AMT exemption will apply to income, beginning with $109,400 for joint filers and $70,300 for other taxpayers in 2018. The exemption will phase out at $1 million for joint filers and $500,000 for other taxpayers. The thresholds will be adjusted for inflation.

Increase in the Standard Deduction - Beginning in 2018, the standard deduction increases significantly from $12,700 to $24,000 for joint filers, from $9,350 to $18,000 for heads of households, and from $6,350 to $12,000 for singles. Since you can claim the higher of the standard deduction or itemized deductions, you will want to closely compare the two methods as you may now benefit from a higher standard deduction given the many changes to itemized deductions.

Elimination of Personal Exemptions - In exchange for lower tax rates and increase in the standard deduction, personal exemptions no longer may be claimed beginning in 2018.

$10,000 Cap on State and Local Tax Deduction - In a significant departure from prior law, the legislation will allow individuals to deduct no more than $10,000 of any combination of the following taxes - state and local income taxes, state and local property taxes, and sales taxes.

Limits on Mortgage Interest Deduction - The tax reform act reduces the amount of mortgage indebtedness on which taxpayers may deduct interest to $750,000 for mortgages incurred after December 15, 2017. (The $1 million limitation remains for older debt). Interest on your principal residence and a second home are deductible. Importantly, however, beginning in 2018, interest on home equity indebtedness no longer is deductible, regardless of when it was incurred.

Medical Expense Deduction - Individuals may continue to deduct medical expenses in 2018 and 2019 if the expenses exceed 7.5% of adjusted gross income. The threshold returns to 10% of adjusted gross income in 2019. Again, you will need to review whether claiming such expenses, when combined with other allowable itemized deductions, yields a higher deduction than the standard deduction.

Elimination of Deduction for Unreimbursed Employee Business Expenses - The reform act eliminates the deduction for miscellaneous itemized deductions through 2025. Thus deductions (subject to the 2% floor of adjusted gross income) for costs related to the production or collection of income, such as appraisal fees, investment fees, and safety deposit box rent are now non-deductible, and, importantly, expenses related to employment, such as uniforms, professional society dues, computer used for work, and job-hunting expenses also are non-deductible. Employees who incur significant unreimbursed business expenses may want to ask their employer about adjusting their compensation or establish an accountable expense reimbursement plan that would allow the employer to reimburse the employee tax-free while also entitling them to a deduction against their business income.

Alimony Deduction - The tax legislation repeals the above-the-line deduction for alimony paid for divorces or separations executed after December 31, 2018. After that date, alimony payments will not be included in the recipient's income and the payments no longer will be deductible by the payor. If you are currently contemplating divorce or separation, a careful review of the effects of the new law should be undertaken to determine the economic effect on your tax situation and timing of any agreements.