Tax Cuts and Jobs Act
This tax reform legislation was signed into law on December 22, 2017. It represents the most significant overhaul of our tax laws in over 30 years. The Act contains substantial changes to the taxation of businesses, individuals, multi-national companies, tax-exempt organizations and others. Most of the provisions of the Act are effective January 1, 2018 or years beginning on or after that date. The following outlines some key provisions included in the Act.
For many of the provisions in the Act affecting individuals, the law was changed but only through December 31, 2025. Provisions which, unless extended by future legislation, revert to the law prior to the Act are indicated below.
Individual Tax Rate
The individual tax rates were reduced starting in 2018 with rates ranging from 10% to 37%. Prior to 2018 the individual tax rates were 10 percent to 39.6 percent. Generally, a given amount of taxable income will be subject to a lower effective tax rate. As an example, the maximum rate on taxable income of $75,900 for a married couple filing jointly was 15 percent in 2017. The maximum rate on taxable income of $77,400 for a married couple filing jointly is 12 percent in 2018. Individual tax rates revert to pre-Act law starting in 2026. The alternative minimum tax is retained but with higher exemption amounts.
Standard Deduction Increased, Personal Exemption Suspended
For tax years beginning after December 31, 2017 and before January 1, 2026, the standard deduction increases to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers and $12,000 for all other taxpayers. Additional standard deductions for elderly and blind still apply. The standard deduction for 2017 was $12,700 for joint filers, $9,350 for head-of-household filers and $6,350 for all other taxpayers.
Personal exemptions are suspended (exemption is zero) for years beginning after December 31, 2017 and before January 1, 2026. Personal exemptions for 2017 were $4,050 each for taxpayer, taxpayer’s spouse and each dependent.
Capital Gain Rates for Individuals
The Act generally retained the pre-2018 law maximum rates of 0 percent, 15 percent or 20 percent, depending on taxable income, on net long-term capital gains and qualified dividends. In addition, the 3.8 percent net investment income tax remains in place.
State and Local Tax Deduction
For tax years beginning after December 31, 2017 and before January 1, 2026, the itemized deduction for state and local income, property and sales taxes is limited to a maximum amount of $10,000. Prior to 2018 there was no limitation.
Miscellaneous Itemized Deductions
For tax years beginning after December 31, 2017 and before January 1, 2026, the Act suspends miscellaneous itemized deductions that are subject to the 2% floor. Prior to 2018 certain miscellaneous itemized deductions were allowed to the extent they exceeded 2% of the taxpayer’s adjusted gross income.
Moving Expenses Deduction
For tax years beginning after December 31, 2017 and before January 1, 2026, the deduction for moving expenses is not allowed except for moves by members of the Armed Forces on active duty pursuant to a permanent change of station. Prior to 2018 moving related expenses incurred in connection with starting a new job were generally deductible.
Child Tax Credit
For tax years beginning after December 31, 2017 and before January 1, 2026, the child tax credit is increased to $2,000 per qualifying child under the age of 17; the refundable portion of the credit increases to $1,400. In addition, the phase-out limits are increased to $400,000 for joint filers and $200,000 for all other filers. For 2017 the child tax credit was $1,000 per qualifying child under the age of 17.
Corporate Tax Rate
The top corporate tax rate was reduced to 21 percent on January 1, 2018. The 21 percent rate is a “flat” tax that will apply regardless of a regular corporation’s taxable income; the progressive rate structure imposing a maximum 35 percent corporate tax rate is eliminated. Personal service corporations will also be subject to the 21 percent rate. For a fiscal year regular corporation, with a tax year ending in 2018, the new 21 percent rate will be “blended” with the rates in place prior to January 1, 2018. The Act also repeals the corporate Alternative Minimum Tax for tax years beginning after December 31, 2017.
Qualified Business Income Deduction
For tax years beginning after December 31, 2017, the Act generally allows a new deduction for individuals, trusts and estates of 20 percent of the domestic qualified business income generated by certain sole-proprietorships and pass-through entities (partnerships, S corporations and LLCs). Qualified business income includes qualified items of income, gain, deduction and loss effectively connected to a trade or business within the United States.
For individuals with taxable income that exceeds $315,000 for joint filers or $157,500 for all others, the deduction is subject to limits based on the wages paid by the business or wages paid plus a capital amount, and certain service business activities may not qualify for the deduction. This deduction is slated to expire after 2025 like most other individual tax provisions in the Act.
On August 8, 2018, the U.S. Treasury Department released proposed regulations to provide guidance on the application of the qualified business income deduction. Although the regulations are proposed, taxpayers can rely on them pending issuance of final regulations. The proposed regulations provide important information on the application of the new Section 199A qualified business income deduction including key definitional terms, rules for identifying and aggregating trades or businesses, the parameters of the various limitations and classification rules for specified service trades or businesses that are generally not eligible for the deduction.
This deduction is a complex area of law and, despite guidance from the proposed regulations, will prove to be one of the most challenging areas of tax law ever enacted. In this first year of implementation, taxpayers and their advisors will struggle with its complexity.
Limitations on Net Business Interest Expense
Deductions for business interest expense are limited to the sum of (1) business interest income, (2) 30 percent of a business’s “adjusted taxable income,” and (3) floor plan financing interest for the tax year. Disallowed business interest expense is carried forward indefinitely. Adjusted taxable income is a specially defined term, and the definition changes after 2021 in a manner that will potentially make the limitation’s impact more significant. Businesses with average gross receipts of $25 million or less are generally exempt from this provision. In addition, certain businesses in the real estate and farming businesses can elect for the interest expense limitation to not apply.
Depreciation-Full Expensing of Business Assets
Qualifying new and used business property acquired and placed in service after September 27, 2017, and before January 1, 2023, will qualify for 100 percent (bonus) depreciation. Bonus depreciation phases down 20 percent per year starting in 2023.
The Act also increases the section 179 expensing limits. The Act increases the maximum Section 179 deduction to $1,000,000 for assets placed in service in 2018, subject to a dollar-for-dollar reduction to the extent the total cost of section 179 property placed in service during the year exceeds $2.5 million. It also expands the definition of section 179 property, for property placed in service after 2017, to include tangible personal property used in furnishing lodging (such as furniture and beds in apartments and dormitories) and certain improvements to non-residential real property (such as roofs, HVAC property, fire and alarm systems and security systems). Limitations relating to income from a trade or business and Section 179(d)(5) non-corporate lessor rules still apply.
Cash Method of Accounting for “Small” Businesses
The Act increases the gross receipts threshold for regular corporations and partnerships with regular corporation partners (other than tax shelters) that can use the cash method of accounting to $25 million, previously set at $5 million in most cases. Affected taxpayers now using the accrual method of accounting may want to consider a change to the cash method. In addition, under the Act, this increased threshold for gross receipts can simplify accounting for inventories and long-term contracts and complying with the sometimes-difficult uniform capitalization rules.
Like-kind exchanges (under section 1031) completed after 2017 are generally limited to exchanges of real property not primarily held for sale. Although like-kind exchanges will no longer apply for personal property placed in service after 2017, e.g. farm implements, the expensing provisions on new property acquisitions will in most cases offset the gain on sale (trade).
Estate and Gift Tax Changes
For estates of decedents and gifts made after December 31, 2017, and before January 1, 2026, the estate and gift tax exemption amount increases from $5 million to $10 million, before inflation adjustments. For 2018, the inflation adjusted exemption amount was $11.18 million; the amount increases to $11.4 million for 2019. The exemption amount remains unified for estate and gift tax purposes and eliminates the estate and gift tax on property transferred under these amounts via death or gift. Any use of the exemption for gift taxes decreases the estate tax exemption available at death. Prior law permitting a “step-up” in tax basis of assets to fair market value at death continues. The exemption reverts to the rules prior to 2018 (i.e., $5 million exemption) for deaths after December 31, 2025.