The recently enacted Tax Cuts and Jobs Act (TCJA) is a sweeping tax package. New rules will affect income taxes, deductions, college savings, and more.
Here’s a look at some of the more important elements of the new law that have an impact on individuals. Unless otherwise noted, the changes are effective for tax years beginning in 2018 through 2025.
Tax rates. The new law imposes a new tax rate structure with seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The top rate was reduced from 39.6% to 37% and applies to taxable income above $500,000 for single taxpayers, and $600,000 for married couples filing jointly. The rates applicable to net capital gains and qualified dividends were not changed. The “kiddie tax” rules were simplified. The net unearned income of a child subject to the rules will be taxed at the capital gain and ordinary income rates that apply to trusts and estates. Thus, the child’s tax is unaffected by the parent’s tax situation or the unearned income of any siblings.
Standard deduction. The new law increases the standard deduction to $24,000 for joint filers, $18,000 for heads of household, and $12,000 for singles and married taxpayers filing separately. Given these increases, many taxpayers will no longer be itemizing deductions. These figures will be indexed for inflation after 2018.
The new law suspends the deduction for personal exemptions. Thus, starting in 2018, taxpayers can no longer claim personal or dependency exemptions. The rules for withholding income tax on wages will be adjusted to reflect this change, but IRS was given the discretion to leave the withholding unchanged for 2018.
New deduction for “qualified business income.” Starting in 2018, taxpayers are allowed a deduction equal to 20 percent of “qualified business income,” otherwise known as “pass-through” income, i.e., income from partnerships, S corporations, LLCs, and sole proprietorships. The income must be from a trade or business within the U.S. Investment income does not qualify, nor do amounts received from an S corporation as reasonable compensation or from a partnership as a guaranteed payment for services provided to the trade or business. The deduction is not used in computing adjusted gross income, just taxable income. For taxpayers with taxable income above $157,500 ($315,000 for joint filers), (1) a limitation based on W-2 wages paid by the business and depreciable tangible property used in the business is phased in, and (2) income from the following trades or businesses is phased out of qualified business income: health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners.
Child and family tax credit. The new law increases the credit for qualifying children (i.e., children under 17) to $2,000 from $1,000, and increases to $1,400 the refundable portion of the credit. It also introduces a new (nonrefundable) $500 credit for a taxpayer’s dependents who are not qualifying children. The adjusted gross income level at which the credits begin to be phased out has been increased to $200,000 ($400,000 for joint filers).
State and local taxes. The itemized deduction for state and local income and property taxes is limited to a total of $10,000 starting in 2018.
Mortgage interest. Under the new law, mortgage interest on loans used to acquire a principal residence and a second home is only deductible on debt up to $750,000 (down from $1 million), starting with loans taken out in 2018. And there is no longer any deduction for interest on home equity loans, regardless of when the debt was incurred.
Miscellaneous itemized deductions. There is no longer a deduction for miscellaneous itemized deductions which were formerly deductible to the extent they exceeded 2 percent of adjusted gross income. This category included items such as tax preparation costs, investment expenses, union dues, and unreimbursed employee expenses.
Medical expenses. Under the new law, for 2017 and 2018, medical expenses are deductible to the extent they exceed 7.5 percent of adjusted gross income for all taxpayers. Previously, the AGI “floor” was 10% for most taxpayers.
Casualty and theft losses. The itemized deduction for casualty and theft losses has been suspended except for losses incurred in a federally declared disaster.
Overall limitation on itemized deductions. The new law suspends the overall limitation on itemized deductions that formerly applied to taxpayers whose adjusted gross income exceeded specified thresholds. The itemized deductions of such taxpayers were reduced by 3% of the amount by which AGI exceeded the applicable threshold, but the reduction could not exceed 80% of the total itemized deductions, and certain items were exempt from the limitation.
Moving expenses. The deduction for job-related moving expenses has been eliminated, except for certain military personnel. The exclusion for moving expense reimbursements has also been suspended.
Alimony. For post-2018 divorce decrees and separation agreements, alimony will not be deductible by the paying spouse and will not be taxable to the receiving spouse.
Health care “individual mandate.” Starting in 2019, there is no longer a penalty for individuals who fail to obtain minimum essential health coverage.
Estate and gift tax exemption. Effective for decedents dying, and gifts made, in 2018, the estate and gift tax exemption has been increased to roughly $11.2 million ($22.4 million for married couples).
Alternative minimum tax (AMT) exemption. The AMT has been retained for individuals by the new law but the exemption has been increased to $109,400 for joint filers ($54,700 for married taxpayers filing separately), and $70,300 for unmarried taxpayers. The exemption is phased out for taxpayers with alternative minimum taxable income over $1 million for joint filers, and over $500,000 for all others.
Retirement savings incentives unaffected. The new rules do not call for changes to existing retirement savings incentives, preserving the favorable tax treatment and contribution limits for 401(k)s, IRAs, and other retirement savings accounts. The legislation also left the rules for health savings accounts intact. The bill does call for ending the Roth IRA re-characterization option starting in 2018, but 2017 re-characterizations will be permitted. Re-characterization allowed taxpayers to undo a Roth IRA conversion for a limited time, and was often useful if the value of the converted investments fell.
Temporary increase in federal estate tax exemption. The legislation will roughly double the federal estate tax exemption to $11 million per person ($22 million per couple). That limit will be indexed to inflation, but would expire and revert back to current law after 2025. Beneficiaries will still get a step up in basis, meaning there would be no capital gains tax due on inherited assets at the time of the transfer, and the cost basis—the value used to compute tax liability—would be reset to the price at that date. It is important to note that state level estate tax exemptions are often much lower than the federal level and are unaffected by this legislation. In addition, the temporary nature of the higher limit means that if you have an estate plan, you should proceed carefully before making any changes.
529 plans become more flexible. The tax legislation allows 529 college savings plan assets to be used for education expenses for grades K–12 as well as college and post graduate study. It will also temporarily increase the contribution limits to ABLE accounts under certain circumstances.
Does this have your head spinning yet? We strongly suggest that individuals should consult with their tax professional to understand how changes to the tax code may impact their strategies for deductions, estate planning, education funding, and small-business income.