The Tax Cuts and Jobs Act (“TCJA”) resulted in sweeping changes to the US income tax code. Individuals saw changes in tax rates and brackets, suspension of the personal exemption, an increase to the standard deduction and a reduction in the amount and types of itemized deductions allowable.
The benefit to individuals resulting from the change in rates and brackets could potentially be offset by the elimination of the personal exemption and the limitation of certain itemized deductions, especially those that utilized the state and local tax deduction.
In an effort to reduce the overall cost of the law, a substantial portion of TCJA will sunset on December 31, 2025, especially the parts relating to individual taxation. Upon its expiration, the pre-TCJA provisions of the Internal Revenue Code will once again become law.
Individual Tax Rates
The new individual income tax rates and brackets are as follows:
Married Filing Joint
Married Filing Separate
Head of Household
|Up to $19,050||Up to $9,525||Up to $13,600||Up to $9,525|
|$19,051 to $77,400||$9,526 to $38,700||$13,601 to $51,800||$9,526 to $38,700|
|$77,401 to $165,000||$38,701 to $82,500||$51,801 to $82,500||$38,701 to $82,500|
|$165,001 to $315,000||$82,501 to $157,500||$82,501 to $157,500||$82,501 to $157,500|
|$315,001 to $400,000||$157,501 to $200,000||$157,501 to $200,000||$157,501 to $200,000|
|$400,001 to $600,000||$200,001 to $300,000||$200,001 to $500,000||$200,001 to $500,000|
|Over $600,000||Over $300,000||Over $500,000||Over $500,000|
In 2017, the top individual income tax rate was 39.6% and applied to taxable income over $470,700 (for married filing joint taxpayers). Note that the tax brackets for single taxpayers are ½ the tax brackets for married filing joint taxpayers, except for the highest tax bracket, providing some relief from the marriage penalty. The current tax treatment of capital gains and qualified dividends was not changed.
The new law increases the tax on certain children with unearned income (the “kiddie tax”). For the period after December 31, 2017 and before December 31, 2025, children subject to the kiddie tax will be taxed on their net unearned income at the ordinary and capital gains rates applied to trusts and estates (see below), regardless of the income of their parents and siblings. This is a change from the prior law which taxed this income at the parent’s tax rate.
The tax brackets and rates applicable to estates and trusts under the plan are as follows:
|10% for income under $2,550|
|24% for income from $2,551 to $9,150|
|35% for income from $9,151 to $12,500|
|37% for income over $12,500|
The law indexes the new brackets for inflation with changes effective for tax years beginning after December 31, 2017 and before December 31, 2025.
The TCJA would nearly double the standard deduction and index it for inflation beginning after 2018. The new standard deductions are as follows:
|$24,000 for married individuals filing a joint return|
|$18,000 for head-of-household|
|$12,000 for all other individuals|
The additional standard deduction for the blind and elderly remains intact. Increases to the basic standard deductions are temporary and expire after December 31, 2025.
The personal exemption is repealed beginning in 2018. Taxpayers will no longer be able to claim personal exemptions for themselves, a spouse, or any dependents. The repeal expires on December 31, 2025.
Alternative Minimum Tax (AMT)
Both the AMT exemption and phase-out amounts are increased from the current law. Beginning January 1, 2018, the AMT exemption amounts are as follows:
|$109,400 for married filing jointly|
|$70,300 for single|
|$54,700 for married filing separately|
The exemption begins to be phased out once a taxpayer’s income reaches the following amounts:
|$1,000,000 for married filing jointly|
|$500,000 for single|
|$500,000 for married filing separately|
The above amounts are adjusted for inflation after 2018. These increases are effective for tax years beginning after December 31, 2017 and expire after December 31, 2025.
The increase in the exemption amount should result in fewer taxpayers being subject to the AMT; however, the real force that pushed most individual taxpayers into AMT was the state and local tax deduction. Due to the state and local tax deduction limitation, it is likely that most individual taxpayers would fall outside AMT even before the exemption increase.
The TCJA made substantial changes to the amount of itemized deductions a taxpayer could deduct. The changes are mostly temporary, taking effect for tax years beginning after December 31, 2017 and ending on or before December 31, 2025. One exception is the change to the medical expense deduction which takes effect as of January 1, 2017 and ends December 31, 2018.
State & Local Income Taxes and Real Estate Taxes
The aggregate amount of nonbusiness state and local real property taxes, personal property taxes and state and local income taxes that may be deducted is capped at $10,000 ($5,000 for a married taxpayer filing a separate return).
This provision significantly affects taxpayers in high income tax states, such as New York, New Jersey and California.
Mortgage Interest Deduction:
The TCJA allows a mortgage interest deduction related to new home acquisition loans up to $750,000 (instead of the current $1 million). The mortgage could be on one’s primary or secondary (i.e. vacation) home. Loans entered into prior to December 15, 2017 are subject to the $1 million limitation. In addition, if there was a binding contract on December 15, 2017 to close on the purchase of a principal residence before January 1, 2018 and the residence is purchased before April 1, 2018, the related loan is subject to the $1 million limitation. The law repeals the deduction for interest on home equity indebtedness (i.e. a home equity line of credit).
The adjusted gross income floor is reduced to 7.5% from the current 10% floor for all taxpayers for the 2017 and 2018 tax years.
Taxpayers should revisit their medical and dental expenses due to the lower AGI limitation. Qualified medical expenses include a wide variety of regular and alternative medical treatments, prescription drugs, travel expenses, medical supplies and even qualified automobiles and capital improvements.
Miscellaneous Itemized Deductions:
All miscellaneous itemized deductions subject to the 2% floor are disallowed for tax years beginning after December 31, 2017 through December 31, 2025. Some common examples of these deductions include tax preparation fees, investment advisory fees, and indirect miscellaneous itemized deductions from pass-through entities. Other miscellaneous itemized deductions not subject to the 2% floor such as amortizable bond premium and estate tax on income in respect of a decedent are not affected by the new law.
Trusts and estates generally compute taxable income in the same way as individuals. Certain expenses, such as fiduciary fees, are unique to the administration of trusts and estates in so far as they would not be incurred if there was no trust or estate. Under the current statutory framework, it is believed that these administrative expenses incurred by trusts and estates are not subject to the disallowance of miscellaneous itemized deductions subject to the 2% floor. However, until the Internal Revenue Service issues guidance on their deductibility, there will be uncertainty.
- Personal Casualty Losses: Personal casualty losses are no longer deductible, subject to certain exceptions related to losses incurred in a federally-declared disaster area.
- Moving Expenses: The new law suspends the deduction of moving expenses as of December 31, 2017, and before January 1, 2026. The deduction would remain available to active duty members of the Armed Forces.
- Overall Limitation on Itemized Deductions: The phase out of itemized deductions based on a taxpayer’s adjusted gross income (the “PEASE” limitation) is repealed. While this provision might not garner a lot of attention, it is substantial as the limitation generally resulted in a 1.2% tax increase.
- Charitable Contributions: The adjusted gross income limitation on cash contributions to public charities and certain private foundations is increased from 50% to 60%, effective for contributions made in tax years after 2017 and before 2026. Any contribution in excess of the 60% limitation is allowed to be carried forward for five years.
The elimination of deductions subject to the 2% floor, the overall limitation on nonbusiness state and local income tax and real property taxes, and the reduced mortgage interest deduction will force many taxpayers to utilize the increased standard deduction in lieu of itemizing deductions.
Though this may lead to an overall simplification of tax filings, many taxpayers will be dismayed to find that expenses which used to reduce their taxable income will no longer have that effect. Financial incentives for purchasing property could potentially dwindle and charitable giving may be reduced as the tax benefit of doing so falls by the wayside for many taxpayers.
High tax states such as California and New York are looking into providing a state income tax credit equal to any charitable contribution made to the state or a state specific fund. This would allow a taxpayer to take an allowable charitable contribution deduction for what is an income tax substitute payment. Whether the federal government will permit taxpayers to take a charitable deduction for this in lieu of income tax payment remains to be seen.
Some states are also looking at decoupling the state tax codes from the TCJA. Instead of state tax law being tied to the federal tax law after enactment of the TCJA, the state tax code would be tied to the federal tax law in effect as of December 31, 2017, prior to the law’s implementation. One of the main goals of the decoupling would allow for full deduction of state and local taxes at the state level. While decoupling will not change an individual’s federal tax liability, it would result in a tax savings at the state level.
Unlike the bills passed earlier by the House and Senate, the final version of TCJA signed into law does not change the current treatment of the gain from the sale of a principal residence. The ability to exclude $500,000 of gain for joint filers ($250,000 for single filers) for qualified sales remains unchanged.
The TCJA provides non-corporate owners of pass-through entities a deduction of up to 20% on qualified business income allocated to them. With respect to each owner, the available deduction with respect to any eligible pass-through business is limited to the greater of (1) 50% of the individual’s share of W-2 wages paid by the business; and (2) 25% of W-2 wages paid by the business plus 2.5% of the unadjusted cost basis of the qualified property of the business.
There are several notable exceptions to the definition of qualified business income and there are exceptions to various limitations in order to allow small business owners a full deduction. A more complete analysis of this deduction can be found in our Tax Alert specifically addressing this issue here.
Deductions for Estates and Trusts
Trusts and estates are generally subject to the same reporting rules as individuals; therefore the limitation on the itemized deductions will apply to the trusts and estates as well. The two most significant are the state and local income tax limitation and disallowance of investment advisory fees. While the elimination of many deductions for individuals may be offset by changes to the tax rates, expansion of brackets and the increase in the standard deductions, those do not apply to trusts and estates.
There is no standard deduction available to trusts and estates and there was no significant change in the already compressed brackets. The modest exemption allowed to trusts and estates under current law will remain unchanged. The loss of deductions will result in many trusts and estates paying more in income tax.
Child Tax Credit/Family Tax Credit
The child tax credit is increased to $2,000 per child, $1,400 of which would be refundable (indexed for inflation beginning after 2018). It also provides a $500 nonrefundable credit for non-child dependents. The credit would begin to phase out once the taxpayer’s adjusted gross income reaches $400,000 for joint filers, an amount which would not be indexed for inflation.
The bill requires a taxpayer to provide the Social Security number of each qualifying child claimed on the tax return in order to receive the refundable portion of the credit. These provisions apply to taxable years beginning after December 31, 2017 and before January 1, 2026.
Education Related Provisions
Distributions of up to $10,000 are now allowed to be made from Section 529 plans for certain expenses associated with enrollment or attendance at an elementary or secondary public, private or religious school. The $10,000 allowance is applied on a per student basis. Discharge of student debt on account of death or disability is now excludible from taxable income.
The bill does not modify the current American Opportunity Tax Credit or the Lifetime Learning Credit, nor does it repeal the student loan interest deduction or the deduction for qualified tuition and related expenses as was proposed in the bill originally passed by the House.
Alimony payments are no longer deductible and receipt of alimony is no longer includible in gross income, effective for divorce agreements executed after December 31, 2018. This will effectively tax the income used for alimony payments at the payor spouse’s tax rate. Agreements made prior to the effective date will still be governed by prior law – deductible by payor and included in income of payee. Taxpayers have the ability to modify their preexisting agreement to elect in to the new rule by specifically referencing the new law in the modified agreement.
Affordable Care Act
The bill does not repeal the taxes created under the Affordable Care Act. Accordingly, the 3.8% net investment income tax and the additional .9% Medicare tax will remain intact. The individual mandate has been eliminated and the bill reduces to zero the penalty for failure to maintain health insurance coverage. The elimination of miscellaneous itemized deductions, which includes investment advisory fees, will cause an increase in the net investment tax for many taxpayers.
The current laws regarding retirement accounts were generally retained. However, the bill prohibits taxpayers from recharacterizing Roth IRA contributions as Traditional IRA contributions in order to unwind a Roth conversion.
The TCJA has resulted in substantial changes to individual income taxation. As with all new law changes, care must be taken to ensure that your current income tax planning is still viable under the new law and additional analysis is needed to take advantage of any new planning opportunities available.
Please consult your Mazars USA LLP professional for additional information.