What does the largest overhaul of the tax code in a generation mean to you, and how does it affect your planning? While this is a highly complex and voluminous law, read on for highlights and suggestions for planning wisely. Please contact our office to update your plan so that you gain maximum benefit from the new tax law and limit avoidable costs.
Change to the Income Tax Brackets
Under the new law, the individual tax brackets are set at 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
What this means for your planning: You and your advisers should quickly review what marginal bracket you will be in for 2017 vs. 2018. Your tax bracket may impact the advisability of deferring income or accelerating deductions, depending on which year will provide the greatest benefit.
Personal Exemptions and Standard Deductions
The new law eliminates deductions for personal exemptions while increasing standard deductions to $12,000 for single filer and $24,000 for married, joint filers. The following, well-known itemized deductions are being modified or eliminated:
· The deduction for state and local income, sales and property taxes is capped at $10,000.
· The deduction for mortgage interest is reduced: It is only allowable on up to $750,000 of acquisition indebtedness. (Note the mortgages incurred on or before Dec. 15, 2017, are grandfathered in and thus are still allowed $1 million of acquisition indebtedness.)
· The home-equity-loan-interest deduction is repealed.
· Medical-expense deductions will be allowed if the exceed 7.5% of adjusted gross income (instead of 10%) for tax years 2017 and 2018.
What this means for your planning: Be mindful of how the loss of personal exemptions affects your taxable income. For those of you who are used to deducting sizable state and local income taxes, work with your advisers to determine if accelerating the payment of state and local property taxes make sense.
Those no longer allowed to deduct state income taxes should speak to their advisers about alternative solutions to avoid or mitigate state income taxes.
If possible, you may wish to accelerate medical expenses into 2018 to take advantage of the lower 7.5% of AGI limitation.
Charitable Income Tax Deductions
The new law increases the charitable contribution limit to 60% of AGI for cash contributions (up from 50% now), while keeping the limit of contributions of appreciated property at 30% of AGI.
What this means for your planning: If you no longer itemize, you may wish to consider a contribution to a donor-advised fund before the end of the year. This kind of fund enables you to make a charitable contribution and receive an immediate tax benefit.
Individual Alternative Minimum Tax (AMT)
The AMT exemption is increased to $70,300 for single filers and $109,400 for married joint filers. The thresholds for the phase-out of the AMT exemptions are increased to $500,000 for single files and $1 million for married joint filers.
What this means for your planning: Those of you with incentive stock options should consult with your advisers. Exercise these options in years when they are not subject to AMT due to higher exemptions.
TCJA does not repeal the estate tax as was proposed in the House version. However, it doubles the estate, gift and GST tax exemption amounts from the original $5 million to $10 million (which, when adjusted for inflation, is $10.98 million in 2017). The 2018 Unified Exemption is the gift and estate tax exemption combined, meaning if you use the exemption for gifting it will reduce the amount you can use for the estate tax. Under the new law, this exemption will be $10.6 million per person. It’s double the amount per couple, and the surviving spouse may use any unused portion left over from the spouse first to die. It is also provides for increases to the exemptions based on inflation. The exemption sunsets after 2025.
What this means for your planning: With the exemption set this high, only a tiny fraction of families will be affected by estate taxes. However, for those that are affected, it is an enormous tax bite of 40%! This hit can easily destroy a closely held business or large family farm; for those affected, it will undermine family legacy goals. Planning is still critical for families with large closely held businesses or those that have a net worth significantly greater than the exemption amounts.
Barring further Congressional action, the exemption amounts will revert to $5 million for individuals in 2026. Thus, planning now while the gift-tax exemption is doubled may be crucial. Make sure to discuss these matters with your adviser.
Clients who purchased life insurance to finance the payment of estate and other taxes and expenses should think carefully before canceling or reducing coverage. If your estate does not now nor is ever likely to exceed the inflation-index exemption amount(s), using the newfound exemption amounts to “un-wind” life insurance premium financing and note sale transactions may be attractive. Making large gifts to irrevocable life insurance trusts (ILITs) that have dynastic provisions could also be worth exploring.
Estate tax planning is still required for those who live in states that have decoupled and instituted their state estate tax. In many cases, the state exemption may be significantly lower than the federal amount.
Business Income Tax Changes
Unlike the changes affecting personal income tax, most of the changes affecting business income are permanent.
Corporate Income Taxes
The corporate income tax is reduced to 21%, down from 35%, and corporate alternative minimum tax is repealed.
What this means for your planning: Premiums on corporate-owned life insurance should be lower, while death benefits received by a corporation from a life insurance policy it owns may be more effective. All arrangements involving corporate payment of life insurance premiums should be reviewed.
TCJA provides for a 20% deduction on non-wage portions of pass-through income. Simply stated, if the pass-through income for a married couple is $315,000 or less ($157,500 for single filers), then the 2% deductions is limited to 50% of the W-2 wages. In the case of a business that required capital (a non-personal service business) 25% of W-2 wages plus 2.5% of the adjusted cost basis of the assets are deductible. Pass-through income exceeding the $315,000/$157,500 thresholds received no 20% deduction.
In practice, this means the pass-through businesses (partnerships, LLCs, S-Corporations, and sole proprietorships filing a Schedule C) will be effectively taxed on only 80% of their pass-through income or, put another way, on only 80% of their normal rate on all business income!
What this means for your planning: The law drops the C-Corporation rate to 21% and changes the long-standing approach of taxing pass-through business income at individual tax rates. Thus, planners and business owners will need to revisit how a client’s business should be structured and operated, and re-evaluate the pros and cons of pass-through entities. Numerical comparisons are essential.
Talk to your adviser about finding the lowest-tax-bracket party to pay for needed life insurance, and about split-dollar life insurance to remove equity from a business while minimizing current income tax.
The step-up in basis is retained, so assets held in your taxable estate at death will receive a new stepped-up tax basis. This is very valuable, especially in high-tax states such as New York, California, Illinois, and Hawaii, so make sure you do the math before moving your low-basis appreciating assets out of your estates. Careful planning and flexible dynasty trusts, like the HYCET Trust, will be vitally important.
Other Tax Provisions
TCJA contains many other provisions. The following is a summary of some of those that are relevant to most people:
· Full expensing of investments in a new depreciable asset made after Sept. 27, 2017, and before Jan. 1, 2023, will be permitted.
· There is a 20% per year phase-down of the full expensing for property placed in service after Dec. 31, 2022, and before Jan. 1, 2027.
· The limit on section 179 deductions is increased to $1 million. Section 179 allows businesses to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year. Deductions for certain fringe benefits, such as business entertainment expenses, have been limited.
· Net operating loss (NOL) deductions are limited to 80% of pre-NOL taxable income. There is an indefinite NOL carryforward, but no carryback to prior years for most companies.
· A three-year holding period is required for a carried interest to qualify as a long-term capital asset.
· The itemized deduction for personal casualty losses will be restricted to losses incurred in a presidentially declared disaster area. This deduction sunsets after 2025.
· Tax-preparation fees are no longer deductible. This provision sunsets after 2025.
· Except for member of the armed forces, moving expenses are no longer deductible. This provision sunsets after 2025.
· Reversing or re-characterizing a Roth IRA is longer permitted.
· The penalty for failing to maintain minimum health care coverage is eliminated starting Jan. 1, 2019.
· 529 Plans can be used for K-12 schools and for homeschooling.
· The alimony deduction for the payor ex-spouse and the inclusion of alimony in the gross income of the recipient ex-spouse are repealed for any divorce or separation instrument executed or modified after Dec. 31, 2018.
We have just seen the first major tax change since 1986. It may be years before the broader ramifications of TCJA are known, but it is likely to impact most Americans.
Be that as it may, much remains to be seen. Will the new law result in meaningful higher wages, new jobs, and business growth? Will it help middle or lower income Americans to any meaningful extent? Will it dangerously increase the deficit? Will it weaken social safety nets?
What is certain is that, in the end, whatever is done can be eventually undone when the political climate changes. Most of the provisions affecting individual, as opposed to corporate, taxpayers sunset after 2025, and if the other party is in power at the time, you can expect the tax provisions not to be extended.
It seems safe to say that none of this will be “permanent”, as permanent fixes are never permanent so long as future Congresses can make changes. This is why executives, professionals, business owners, high-income and high-net-worth individuals and families will always benefit from planning advice and expertise to understand their options. Please contact our office to update your plan so that you gain maximum benefit from the new tax law and limit avoidable costs.