The New Year is ringing in big changes to the tax code! After some extremely last minute changes, it looks like we finally have the final bill that will be sent to the president’s desk.
Overall, the bill makes an utter mess of the code (which was otherwise so tidy), since nearly every provision applicable to individual taxpayers applies only to the years 2018-2025. Pity students of tax law and accounting for years to come! Unlike the temporary changes for individuals, the business and corporate tax changes will be permanent (until they are changed).
As you’ve probably read, New York fares quite poorly under the pending legislation. In addition to the $10,000 cap on the State and Local Tax deduction, the bill limits the mortgage interest deduction to indebtedness of $750,000, hurting home buyers in areas with high-priced housing - for which New York competes only with San Francisco. Affluent New Yorkers can be consoled by the fact that many of the other provisions favor them – not least the dramatic increase in the federal gift and estate tax exemption to $11.2 million, or $22.4 million per couple. We estate planning lawyers can be consoled that New York State will retain its dramatic estate tax – which is tied to the version of the Internal Revenue Code that was in effect in 2014.
The most favorable provisions of the bill are reserved for corporations and business owners. The most significant of these are the 40% reduction in the corporate tax rate and the new rules granting a 20% deduction for pass-through business income. I have yet to carefully study the business-related provisions.
Below is a summary of the salient changes applicable to individual taxpayers below, which I hope you will find helpful.
Changes to Standard Deduction
The bill significantly increases the standard deduction for individual taxpayers.
|Head of Household||$9,350||
Qualified Disability Trusts may no longer claim a standard deduction, likely resulting in higher taxes for these trusts. If the beneficiary qualifies for an ABLE account (disability onset occurred before age 26), the negative impact from this change may be partially or fully offset by investing funds in an ABLE account instead.
Elimination of Personal Exemption
The benefit of an increased Standard Deduction is somewhat offset by the elimination of the Personal Exemption.
Under current law, each taxpayer can reduce their taxable income by a Personal Exemption of $4,050 for each member of the household. A married couple with two children can currently deduct $12,700 in the form of the Standard Deduction and $16,200 in the form of Personal Exemptions, for a total deduction of $28,900. Under the House or Senate bills, the family would be entitled to a Standard Deduction of about $24,000, with no Personal Exemption, so they would be worse off under the new rules. The more children a family has, the more negatively they will be impacted by the new rule.
The increased child tax credit will offset the loss of the exemption for many parents, but not for those with children between 17-to-24 years old. Children in this age group can be claimed as a personal exemption on their parents' tax returns, but cannot be claimed for the child credit. As a result, these taxpayers are likely to end up with a tax increase.
Changes to Tax Rates
Most families will see a reduction in their tax rates in the short run. Married couples filing jointly in particular will benefit from the new rates. Single taxpayers and Head of Household taxpayers earning between $200,000 and $400,000 may see a slight increase in their tax rate.
Changes to the tax rates may be enhanced or offset by changes to various credits and deductions. In addition, the bill will implement a new inflation index that is less favorable than the current index. Unlike the temporary change to the tax rates, the change to the inflation index is permanent. This means that, when the rate changes expire after seven years, taxpayers may be subject to a higher tax rate than they would be under current law.
Below is a comparison of the current tax rates and the tax rates under the pending legislation.
Married Taxpayers Filing Jointly
Head of Household Taxpayers
Married Filing Separately
Estates & Trusts; Kiddie Tax (New Version)
Change to Alternative Minimum Tax
The bill increases the AMT exemption for married couples from $84,500 to $109,400 and for single or head of household taxpayers from $54,300 to $70,300. It also minimizes the exemption phase-out for taxpayers with higher incomes. As a result, far fewer taxpayers will end up paying the AMT. At the same time, with the elimination or scaling back of many deductions, it is less likely that a taxpayer’s deductions would reduce their income sufficiently to trigger the AMT.
Changes to Credits and Deductions
Below is a summary of the bill’s changes to income tax credits and deductions for individual taxpayers.
Child Tax Credit. The bill increases the child tax credit from $1,000 to $2,000 per child and adds a $500 non-child dependent credit. The bill would also allow more families to take advantage of the credit by raising the income threshold at which the credit begins to phase out. The new phase-out threshold for married couples is $400,000 per year – up from the current $110,000 per year. The threshold for other taxpayers is $200,000 per year – up from $75,000. The phase-out amounts are not indexed for inflation.
Limitation on State and Local Income Tax Deduction. The bill limits the state and local income tax deduction to $10,000.
Limitation on Mortgage Interest Deduction: The bill limits the deduction for mortgage interest to indebtedness of $750,000 or less. Mortgages contracted for before January 1, 2018 will be grandfathered in.
Elimination of Home Equity Interest Deduction. The new law eliminates the deduction for interest on home equity loans. There is no grandfathering provision, so even existing loans are subject to the new rule.
Elimination of Pease Limitation. The “Pease Limitation” is a provision under current law that limits deductions for taxpayers with income over approximately $300,000 (married)/$250,000 (single). The new law repeals this limitation, which will benefit taxpayers with incomes over the applicable amounts.
Elimination of Alimony Deduction. The bill eliminates the alimony deduction for the payor; likewise, alimony payments will not be treated as income to payee. The change applies only to agreements entered into after December 31, 2018.
Expansion of Medical Expense Deduction. Current law permits taxpayers to deduct unreimbursed medical expenses if they exceed 10% of their Adjusted Gross Income. Under the new law, taxpayers may deduct such expenses if they exceed 7.5% of their Adjusted Gross Income.
Elimination of Deduction for Moving Expenses and Exclusion for Moving Expenses Paid by Employers. Current law allows the taxpayer to deduct certain moving expenses and to exclude from taxable income the cost of moving expenses paid by an employer. The bill repeals both of these benefits.
Miscellaneous Itemized Deductions. Both bills eliminate Miscellaneous Itemized Deductions, including tax preparation fees, investment advisory fees, and unreimbursed employee business expenses.
Elimination of Personal Casualty and Theft Losses. Current law allows taxpayers to deduct losses from fire, theft, or natural disaster, to the extent to which the losses exceed a certain percent of the taxpayer’s income. The new law would limit the ability to deduct such losses other than those incurred as the result of a federally-declared disaster.
Expansion of Charitable Deduction. Current rules limit the charitable deduction in any given year to 50% of the taxpayer’s income. The bill increases the limitation to 60%.
Repeal of Exclusion for Bicycle Commuting Expenses. Current law allows employees who commute by bicycle and receive reimbursement for related expenses from their employers to exclude such reimbursement from their income. The bill eliminates this provision.
Elimination of Foreign Property Tax Deduction. The current rule allowing for the deduction of foreign property taxes has been repealed.
Change to the Kiddie Tax
The current “kiddie tax” applies to unearned income in excess of about $2,000 received by (1) any child under age 19 or (2) any child under the age of 24 who is a full-time student. The current rules effectively apply the parents’ tax rate to the child’s unearned income over the threshold amount.
The new law will subject such income to the tax rates applicable to trusts and estates. This change will have the effect of reducing the tax rate on investment income of children with parents in high tax brackets.
Expansion of Permitted Contributions to ABLE Accounts
ABLE Accounts allow for parents to save for the expenses of a child with special needs much like 529 accounts allow parents to save for a child’s college education. Under current law, yearly aggregate contributions to an ABLE account are limited to the annual gift tax exclusion ($15,000 for 2018). The bill would additionally allow a designated beneficiary of an ABLE account to contribute to the account the lesser of (1) the federal poverty line or (2) the beneficiary’s compensation for the taxable year.
Restriction on Unwinding Roth IRA Conversions
Under current law, taxpayers can convert a traditional IRA to a Roth IRA and then reverse the transaction before the end of October of the following year in response to market conditions. For example, you might convert a $100,000 traditional IRA to a Roth IRA, incurring taxes on the $100,000. If the market subsequently falls and the $100,000 becomes $70,000, you can unwind the transaction and avoid paying taxes on the $100,000.
Under the new bill, you would no longer be able to unwind the Roth conversion.
Increase in the Gift and Estate Tax Exemption
The bill increases the gift and estate tax lifetime exemption from $5.45 million per person to $10.7 million per person. As under current law, those figures are indexed for inflation each year. In 2018, the exemption will increase to $11.2 million per person.
Elimination of Penalty for Failure to Maintain Health Insurance Coverage
The bill eliminates the penalty for taxpayers who do not maintain adequate health insurance coverage under the Affordable Care Act.
Changes to 529 College Savings Plans to Private School Tuition
The legislation will allow up to $10,000 per year to be used from a 529 account for private elementary or secondary school – not just college expenses.