Last week, Congress released a new tax bill which may affect nearly all American taxpayers. Many of the changes will impact your taxes beginning in 2018. However, due to some of the provisions which are changes to the current tax law, there are some actions you may wish to take before year end to take advantage of those deductions which may be going away in next week.
Overview of the tax changes: Tax Bracket Changes
The most far reaching change of the new tax bill for individuals, is the change in the tax brackets themselves. While the bill opted to keep the 7 tax brackets, each tax rate has been lowered and the threshold for each tax bracket has increased.
The following tables show the new tax brackets:
|Taxable income over||But not over||Is taxed at|
Married taxpayers filing joint returns and surviving spouses
|Taxable income over||But not over||Is taxed at|
The new tax bracket thresholds for married taxpayers filing joint returns are double that of single individuals except for the highest 37% bracket. This means that the “marriage penalty” only applies to those in the highest tax bracket.
The new tax law also increased the exemption for those who are paying the Alternative Minimum Tax, however the details of the changes are beyond the scope of this article.
Increase in the Standard Deduction, Repeal of Personal Exemptions & Repeal of the overall Limitation on Itemized Deductions (Pease Limitation)
|Standard Deduction||$6,350 Single / $12,700 Married||$12,000 Single / $24,000 Married|
|Personal Exemptions||$4,050 per person||Repealed|
|Itemized Deduction Limitation (Pease)||AGI Above $261,500 Single / $313,800 Married||Repealed|
Under the previous tax law, the standard deduction for individuals was $6,350 and $12,700 for married individuals filing a joint return. The new tax law increased the standard deduction to $12,000 for individuals and $24,000 for married individuals filing a joint return. This means that those who may have itemized deductions in past years might take the standard deduction going forward. Also, for those taxpayers who itemized their deductions and whose adjusted gross income exceeded $261,500 ($313,800 Married Filing Jointly), the total amount of itemized deductions was reduced by 3% of the amount by which their adjusted gross income exceeded the threshold. (This limitation is known as the Pease Limitation after the late congressman Donald Pease.) The new tax bill has repealed this 3% AGI limitation on itemized deductions for high earners.
In 2017, for each individual claimed on the return, an exemption of $4,050 was allowed. However, for individuals with an adjusted gross income of $261,500 ($313,800 Married Filing Jointly) this exemption was limited and phased out. Although the new tax bill eliminates the exemption allowance for all taxpayers, it provides a significant increase in the Child Tax Credit (discussed next).
Action → Analyze your tax return to determine if under the new tax bill you will continue to itemize your deductions, or if the new standard deduction will exceed your total deductions. Keep in mind that new limitations to deductions for mortgage interest and state and local taxes may affect this determination.
If you determine that you will no longer be claiming itemized deductions after this year, your future charitable contributions will no longer give you a tax benefit even though charitable contributions are allowed under the new tax bill. If this situation applies to you, before year end you may want to consider increasing your charitable giving or setting up a Donor Advised Fund.
Increase and Expansion of the Child Tax Credit
|Child Tax Credit (per child under 17)||$1,000||$2,000|
|Phase-Out||$150,000 MFJ||$400,000 MFJ|
Under the previous tax law, the child tax credit was $1,000 per child, however, this credit was phased out at an adjusted gross income of $110,000 and fully phased out at $150,000 for married taxpayers filing a joint return [MFJ]).
The new tax law doubles the child tax credit to $2,000 per child with the phase-out beginning at $400,000 (MFJ). This new provision will allow many more taxpayers with large families who may have been phased out previously to claim the child tax credit.
Limitation on the Deduction for State, Local & Property Taxes
|State and Local Tax Deduction||Unlimited||Limited to $10,000|
Under the previous tax law, taxpayers who itemized their deductions were able to deduct taxes they paid for: (a) State and Local Income Tax (SALT) or a deduction for general sales taxes, and (b) property taxes. There was no limit to this deduction, however, these deductions were not allowed in the calculation of the Alternative Minimum Tax (AMT). Therefore, those taxpayers who were previously subject to the AMT will not be materially affected by a change in this deduction.
The new tax law will still allow these deductions to be calculated as an itemized deduction, however, the total deduction for taxes will be capped at $10,000 for all taxpayers other than married individuals filing separate returns, which will be capped at $5,000.
Action → If, in general, your itemized tax deductions exceed $10,000 per year, and you are a taxpayer who is not subject to the AMT, consider pre-paying any state, local or property taxes before the end of the year to take advantage of these deductions. Note that the new tax bill expressly prohibits deducting any state income taxes for tax periods beginning after December 31, 2017 (i.e. you cannot pre-pay your 2018 state income tax in 2017). You may pay any property taxes to your locality if it has already been invoiced, even if the property tax payment covers a time period which extends into 2018.
Modification of the deduction for Home Mortgage Interest
|Mortgage Principal Limitation||$1,000,000||$750,000|
|Home Equity Line Principal Limit||$100,000||Repealed|
Under the previous tax law, taxpayers who itemized their deductions were able to deduct the interest they paid on home acquisition mortgages on principal amounts up to $1,000,000. Taxpayers were also able to deduct the interest they paid on a Home Equity Line on principal amounts up to $100,000.
The new tax law will still allow the deduction for home acquisition mortgages, but will limit the principal amount to $750,000. This limitation is only in effect for home purchase contracts which are effective after December 15th, 2017. If a taxpayer has already entered a home purchase contract prior to this date, they have until April 1, 2018 to close on the mortgage to be grandfathered in to the previous principal threshold. Interest paid on a Home Equity line will be disallowed under the new law.
Action → If you have entered into a home purchase agreement before December 15, 2017, have not closed yet on the mortgage, and the principal amount on the mortgage is more than $750,000, make sure to close on the mortgage before April 1, 2018. If you are already a mortgage paying homeowner, you are grandfathered in under the old rules.
Repeal of Certain Miscellaneous Itemized Deductions Subject to the 2% Adjusted Gross Income Floor
|Miscellaneous Itemized Deductions||Allowed||Repealed|
Under the previous tax law, taxpayers who itemized their deductions were able to deduct various expenses under a miscellaneous bucket which was subject to a floor of 2% of a taxpayer’s adjusted gross income. (This means that if a taxpayer has an adjusted gross income of $100,000, these deductions would only be deducted to the extent the sum surpassed $2,000.) It should be noted that these deductions were not allowed for the purposes of calculating the Alternative Minimum Tax (AMT). Therefore, taxpayers who were subject to the AMT will not be materially affected by a change in this deduction.
An example of such deductions include:
- Tax Preparation Fees
- Investment Fees and Expenses
- Safe Deposit Rental Fees
- Unreimbursed Employee Expenses
The new tax law will repeal the provision to deduct these expenses.
Action → If, in general, you have miscellaneous expenses which exceed 2% of your AGI, and you are a taxpayer who is not subject to the AMT, consider pre-paying these expenses before year end to take advantage of the deduction.
Expansion of the Use of Funds from State Sponsored Section 529 Qualified Tuition Programs
|Use of 529 Plan Funds||2017||2018|
|College and Higher Education||Unlimited||Unlimited|
|Private Elementary & High Schools||Not Allowed||Up to $10,000 per student|
Qualified tuition programs (Section 529 Plans) are education savings plans. With these plans, taxpayers elect a beneficiary who will ultimately use the funds for educational purposes. While contributions to a section 529 plan are not deductible for federal tax purposes, the income and capital gains which accrue while in the account are tax-free if the distributions are made for a qualified education purposes. Certain states allow for an income tax deduction on the state income tax return. For example, New York State allows a $10,000 deduction on its state tax return, whereas New Jersey does not allow a deduction. Under the previous tax law, the distributions from 529 accounts could only be used for qualified higher education expenses, defined as expenditures for college or higher education.
The new tax law will allow for a 529 plan to distribute up to $10,000 per student for expenses in connection with the enrollment or attendance of a public, private or religious elementary or secondary school. This means that distributions from a 529 plan can be used to fund private elementary or high school tuition.
Action → If you file a New York income tax return and have children who will be or are currently attending a tuition based elementary or high school, be sure to contribute to a 529 plan up to the $10,000 deduction threshold in 2017 to take advantage of the New York State deduction this year, and then continue to do the same going forward to take advantage of the state deduction.
New Law – A 20% Deduction for Qualified Business Income
The new tax law will allow for a 20% deduction for what the bill calls “Qualified Business Income.” Qualified Business Income is defined as domestic income from a Partnership, S Corporation, or Sole Proprietorships. This deduction will allow a taxpayer who received Qualified Business income to exclude 20% of the business earnings from taxable income. The deduction will not be taken into account for the purposes of calculating Adjusted Gross Income.
Qualified Business Income specifically excludes an S Corporation Shareholder’s reasonable compensation (W-2 Wages) or guaranteed payments from a partnership to a partner as compensation for services. The bill also includes a limitation based on W-2 wages and capital for individuals whose AGI exceeds $157,500 ($315,000 MFJ), however the details of this limitation is beyond the scope of this article.
Specified Service Businesses
Another limitation to this deduction are business which are classified as “Specified Service Business.” Specified Service Businesses are defined as a trade or business in which the principal asset of the trade or business is the reputation or skill of one or more of its employees. Examples of Specified Services Businesses include performances of services in the fields of health care, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, etc. The limitation to the deduction for Specified Service businesses only applies to taxpayers whose AGI exceeds $157,500 ($315,000 MFJ), and phases out starting at a $50,000 ($100,000 MFJ), and is fully phased out at $207,500 ($415,000 MFJ). This means that any individual whose income is categorized as a Specified Service Business but whose AGI is below $315,000 can make full use of the 20% deduction to taxable income. Once an individual’s Adjusted Gross Income surpasses $207,500 ($415,000 MFJ), the taxpayer can no longer claim this deduction on their tax return.
In summary, the changes to the tax law are vast, and the article presented here has only set forth a few of the more important changes affecting individuals. Since there is only a short-period of time before the year-end, it is imperative for each taxpayer to consult their tax professional as every individual’s tax situation is different and may call for actions different from the ideas set forth here.
Gary M. Klein, CPA
Klein & Company, Inc.
Contact my office for all of your tax and accounting needs.