WASHINGTON – The Tax Cuts and Jobs Act of 2017 signed into law in December provided a major overhaul to the previous tax legislation.
As the bill was being finalized, many people rushed to prepay state and local taxes (i.e. “SALT”) before Dec. 31, 2017, to avoid losing out on these itemized deductions in 2018 due to the new $10,000 state and local tax limitation.
While the prepayment of state taxes was widely covered by the media, the tax bill provides for many other changes to the previous law that are important to mention but may have gone largely unnoticed.
Let’s take a closer look at some of the new tax bill changes and the effect they may have on your 2018 tax planning.
Before new tax bill, alimony payments paid to a former spouse were treated as a tax deduction for the payer and income to the recipient. The payer received an above-the-line deduction, which decreased taxable income dollar-for-dollar by the amount paid. The recipient had to include the alimony payments as income, thereby increasing their taxable income by the amount received. As a result, income was often shifted for a recipient in a lower tax bracket, resulting in lower combined taxes paid.
The new rules for the treatment of alimony payments are effective for divorce or separation agreements entered into after Dec. 31, 2018. Under the new tax bill, the tax deduction for alimony payments is eliminated, and recipients no longer need to treat alimony received as taxable income. Some divorce experts worry that this change in alimony taxation will make negotiations tougher and lead to less spousal support. It could also result in higher overall taxes for divorced couples starting in 2019.
While the $10,000 limitation for state and local income and property and real estate taxes has been widely covered, the new tax bill cuts many other itemized deductions offered in the previous law.
The previous tax bill allowed miscellaneous itemized deductions to the extent they exceeded 2 percent of your adjusted gross income. Some of these itemized deductions included investment management and consulting fees, tax preparation fees, un-reimbursed employee expenses and certain hobby expenses. Under the new bill, all of the itemized deductions that were subject to the 2 percent floor are eliminated for taxable years 2018 through 2025.
Charitable contributions are still allowable as an itemized deduction with a slight enhancement. The new tax bill increases the limitation on cash contributions to public charities from 50 percent to 60 percent of AGI after Dec. 31, 2017 and before Jan. 1, 2026.
With the elimination and/or reduction of many previous itemized deductions and the increase in the standard deduction, taxpayers must now have itemized deductions above $24,000 for married filing jointly or $12,000 for single filers to benefit from charitable contributions. Taxpayers who are used to getting a deduction for their charitable gifts may be surprised when they fail to hit the itemized deduction threshold and receive no tax benefit.
The home mortgage interest deduction is still allowable as an itemized deduction with a few small changes to the tax rules. The tax bill restricts the mortgage interest deduction to interest on the first $750,000 of home-acquisition debt incurred after Dec. 15, 2017, down from the previous $1 million limit. For debt incurred before Dec. 15, 2017, the $1 million limit remains. Furthermore, new or existing interest on home equity lines of credit is no longer tax deductible.
The medical expense deduction has been retained to the extent such expenses exceed 7.5 percent of your AGI for years 2017 and 2018. Starting in 2019 through 2025, the AGI limitation increases to 10 percent.
Many taxpayers who had itemized in the past may be better off with the increased standard deduction going forward. While this may simplify their tax filing, it could affect financial decisions regarding where you live, timing of charitable gifts, how expensive a home to buy, and whether to pay down your mortgage.
Individual health insurance mandate repealed
The Affordable Care Act required individuals (except those who qualified for hardship exemptions) to have a certain level of health insurance coverage or face a penalty. The mandate made individuals responsible for obtaining health coverage for themselves and dependents for the whole year. Effective for tax years beginning after Dec. 31, 2018, the new tax bill eliminates the penalty for individuals who do not have adequate health coverage. With the elimination of the individual mandate for health coverage, fewer people may buy insurance after 2018, which could lead to an increase in premiums.
Alternative minimum tax (“AMT”)
The alternative minimum tax was enacted to make sure individuals pay a minimum amount of tax, regardless of the amount of deductions taken on their return. Before the new tax bill, many taxpayers were subject to the AMT due to the add-back of certain itemized deductions, such as state and local taxes and miscellaneous itemized deductions. However, beginning in 2018, with the elimination of miscellaneous itemized deductions and state tax deductions capped at $10,000, many taxpayers who previously paid the AMT will no longer be subject to it.
Other changes to the AMT rules will also decrease the number of taxpayers who have to pay it. Beginning in 2018, the amount that you can subtract from your AMT income (i.e. exemption amount) increases significantly from $84,500 to $109,400 (married filing jointly) and from $54,300 to $70,300 (single taxpayers). The new tax bill also increases the phase-out of the exemption to $1 million for married taxpayers filing jointly and $500,000 for single taxpayers. The result of these new AMT rules will significantly decrease the number of individuals required to pay AMT tax beginning in 2018.
Some individual provisions NOT affected
While much of the tax talk over the past few weeks has been focused around what is going to change beginning in 2018, there are still several tax provisions affecting individuals that remain unchanged:
The capital gain exclusion from the sale of a primary residence remains unchanged. As long as you occupy your home as a principal residence for two out of the past five years, you are eligible to take the $250,000 capital gains exclusion from the sale of your home for single tax payers and $500,000 for married taxpayers filing jointly.
The deduction for student loan interest was up for discussion leading up to the new bill. However, the student loan interest deduction will still be allowed in 2018 up to $2,500 per year.
Tax rates on long-term capital gains and qualified dividends remain unchanged with a maximum rate of 15 percent for taxpayers in the lower tax brackets and 20 percent for those in the higher tax bracket (i.e. taxable income over $425,800/Single and over $479,000/Married Filing Jointly). Keep in mind that the 3.8 percent net investment income tax that applied to high earners in 2017 continues at the same income thresholds in 2018, so the effective top capital gains rate remains at 23.8 percent.
Tax-lot selling rules will stay the same, such that investors will still be able to determine the most appropriate tax lot to use for cost basis purposes on investment sales. There had been some early discussions of requiring investors to use first-in first out accounting for cost basis which could have potentially resulted in higher realized capital gains, but the new tax bill did not include this in its final version.
A few tax changes worth mentioning
Lastly, the following tax law changes beginning 2018 are also worth mentioning — some of which will be discussed in future articles:
Moving expenses related to a job change are no longer deductible except for active members of the military.
In an attempt to offset the scrapping of the personal exemption at $4,050 per individual, the new tax law doubled the child tax credit from $1,000 to $2,000 per child under the age of 17. Income limits on who may claim the credit have been substantially increased from $75,000 to $200,000 (single filers) and from $110,000 to $400,000 (married filing jointly). Even taxpayers with no tax liability are eligible for a $1,400 refundable tax credit per eligible child. The new law requires that taxpayers provide the social security number of each qualifying child.
529 account holders can now use up to $10,000 per year to pay for tuition for elementary or secondary public, private or religious school.
The annual gift exclusion increased from $14,000 to $15,000 per person per donor.
The lifetime estate tax exemption doubled from $5.6 million to $11.2 million for individuals and from $11.2 million to $22.4 million for married couples.
The new tax code makes significant changes to the way pass-through business income is taxed. This includes income earned by sole proprietorships, LLCs, partnerships and S Corporations. This is a complex topic, so we recommend that taxpayers consult their tax advisor for business income qualifications and limitations.
We want to emphasize that as you begin to digest these important tax law changes, you should consult with your tax advisor to take advantage of planning opportunities that will affect your entire financial plan. We will continue to unpack how these new changes affect your personal and business taxes in the months to come.