On December 19, 2017, Congress passed a major tax package (H.R. 1) designed to cut taxes on individuals and businesses, and to stimulate the economy and create jobs. The tax cuts are projected to be nearly $1.5 trillion. The long-term impact on the deficit is unclear; the measure adds to the deficit in the short term but could reduce it in the long term if predictions of economic growth come true. The following is a roundup of the key provisions impacting individuals. Those impacting businesses are in a subsequent column. All of the following provisions apply starting in 2018 unless otherwise noted. Most of the provisions for individuals are temporary; they expire after 2025 unless Congress takes further action.
Tax Rate Reduction
The linchpin to this tax legislation is a reduction in individual tax rates. While the current number of tax brackets has been retained, each one has been reduced slightly.
The brackets for individuals are cut to 10%, 12%, 22%, 24%, 32%, 35%, and 37% (Code Sec 1). The top tax rate applies to joint filers with taxable income over $600,000 (single filers over $500,000).
Tax Rates for Owners of Pass-Through Entities
There is no special tax rate or cap for taxes on pass-through income. There is, however, a new 20% deduction for business income, although many restrictions apply that prevent this break from being claimed by most attorneys, accountants, and number of other professionals (new Code Sec. 199A).
Capital Gains and Dividends
The 15% and 20% tax rates on long-term capital gains and qualified dividends have been retained. Those in the 10% or 12% tax bracket pay zero tax on these gains and dividends. Also, there had been proposals to require the use of first-in, first-out (FIFO) in determining basis on the sale of stock and mutual fund shares rather than allowing investors to designate which shares are being sold when shares were acquired at different times. This measure was not included in the final package.
The tax rates for the alternative minimum tax (AMT) are retained, but the exemption amounts are increased (Code Secs. 53, and 55-59). More specifically, the exemption amounts increase to $109,400 for joint filers, $54,700 for married filing separately, and $70,300 for other filers. The phase-out threshold for the exemption increases to $1 million for joint filers and $500,000 for other filers; phase-out amounts are indexed for inflation after 2018. Also, the current 10%-of-AGI threshold for medical expenses deductible for AMT purposes is decreased to the 7.5%-of-adjusted-gross-income (AGI) threshold for 2017 and 2018.
The personal and dependency exemptions are repealed, while the deduction for student interest that had been slated for repeal has been retained. Other changes to deductions include:
The alimony deduction is eliminated, but this repeal only applies for payments under agreements entered into or substantially changed after 2018 (Code Sec. 71). This means that recipients of alimony under agreements entered into or substantially changed after 2018 will not be taxed on the payments they receive. The deduction for moving expenses is also repealed, except for members of the military (Code Sec. 217). A deduction for legal fees and court costs in whistleblower cases can be deducted from gross income.
The standard deduction increases to $24,000 for joint filers, $18,000 for heads of households, and $12,000 for other filers. These amounts are indexed for inflation after 2018. The additional standard deduction amounts for age and blindness have been retained. Currently, about two-thirds of individuals claim the standard deduction. The number of taxpayers who do not itemize their personal deductions is expected to increase when the higher standard deduction amounts are implemented.
Many of the itemized deduction rules have changed:
• The medical deduction is retained, with the 7.5%-of-AGI floor retained for all taxpayers for 2017 and 2018 (Code Sec. 213). After 2018, the threshold returns to 10%-of-AGI.
• The cap for deducting mortgage interest for buying or building a home is reduced from the current $1 million cap to $750,000; no interest is deductible for home equity debt (Code Sec. 163(h)).
• The deduction for state and local income, property, and sales taxes is capped at $10,000 (Code Sec. 164). This so-called SALT deduction, which stands for state and local taxes, is a substantial reduction from the former rule allowing all property taxes, plus all state and local income or sales taxes, to be claimed as an itemized deduction. Prepaying 2018 state and local income taxes in 2017 does not help; no deduction in 2017 is allowed for such prepayment.
• The percentage of AGI for charitable contributions is increased from 50% to 60% for cash donations, but no deduction is allowed for donations in exchange for college athletic event seating rights (Code Sec. 170). The cents-per-mile rate for driving for charitable purposes has not been changed; it remains at 14 cents per mile.
• The casualty loss deduction is repealed, except for losses in federally-declared disasters (Code Sec. 165). Miscellaneous itemized deductions subject to the 2%-of-AGI floor, such as unreimbursed employee business expenses and tax preparation fees, are repealed (Code Secs. 61, 67, and 212)).
• The phase-out of itemized deductions for high-income taxpayers is also repealed.
Despite various proposals in the House bill, the final measure retained most current tax credits, including the child and dependent care credit, the credit for the elderly and permanently disabled, and the credit for plug-in electric drive motor vehicles. However, some credit changes were made:
Child Tax Credit
The amount of the credit increases to $2,000 per qualifying child (up from $1,000) (Code Sec. 24). The refundable portion of the credit increases to $1,400. There is a nonrefundable $500 credit for a qualifying dependent other than a qualifying child that applies through 2025. The AGI phase-out for the child tax credit increases substantially, but is not indexed for inflation.
There are some modifications to the earned income tax credit (Code Sec. 32). The credit for nonbusiness energy property for installing insulation, storm windows, etc., which expired at the end of 2016, has not been extended.
The new law contains various other tax rules of note, including:
The shared responsibility payment for individual mandate, which is a penalty for not having required minimum essential health coverage and no exemption from the mandate, is repealed (Code Sec. 5000A). However, this change does not take effect until 2019. Thus, it continues to apply for 2017 and 2018. No changes have been made in the premium tax credit for those who choose to buy health coverage from a government Marketplace.
Roth IRA Conversions
The ability to unwind a Roth IRA conversion by recharacterizing it as an IRA by October 15th can no longer be done (Code Sec. 408A). This means that conversions are permanent.
The use of these plans is expanded in two ways:
• Tax-free distributions up to $10,000 can be made for tuition at elementary and secondary schools, whether public, private, or religious (Code Sec. 529).
• Rollovers of funds from 529 plans to ABLE accounts—special savings accounts for the benefit of a qualified disabled individual—can be made on a tax-free basis (Code Secs 529 and 529A).
There had been proposals to change the rules for excluding gain on the sale of a principal residence (Code Sec. 121). The proposals were not included in the final measure.
Estate and Gift Taxes
These transfer taxes are retained but the exemption amount is increased substantially. The $5 million exemption doubles to $10 million (Code Secs. 2001 and 2010). The $10 million amount is indexed for inflation after 2011, making it more than $11 million for 2018. For a couple, this means estates can be transferred tax free up to $22 million.