On December 22, 2017, the President signed The Tax Cuts and Jobs Act (the “Bill”) into law. While the effective date of most of the provisions of the Bill is not until January 1, 2018, individual taxpayers are advised to immediately review their 2017 tax situation and consider the following in order to see if there are steps they may want to take in order to reduce their income tax liability for 2017.
Limitation on Deduction of State and Local Income Taxes (or Sales Tax) and Real Property Taxes that are not effectively connected to a trade or business
Beginning January 1, 2018, taxpayers may only claim an itemized deduction for the lesser of (a) the combined amount paid for (i) State and Local Income (or Sales Tax if the amount of Sales Tax paid exceeds the amount of State and Local Income Taxes Paid) and (ii) Real Property Taxes or (b) $10,000 ($5,000 if the taxpayer is married but files a separate income tax return.)
Recommendation: Taxpayers should consider paying the balance of their 2017 State and Local Income Tax liability, including estimated tax payments normally due in January, before December 31, 2017, rather than paying them in 2018 as they may be accustomed to doing. The Conference Committee Report that accompanied the Bill makes it very clear the taxpayers will not be permitted to deduct prepayments of their 2018 State and Local Income Tax liability that are paid in 2017. Taxpayers should also consider paying their Real Property Taxes that would otherwise be due in 2018 in 2017. However, caution should be taken before doing so since the IRS has taken the position that in order for Real Property Taxes to be deductible they need to have been assessed. The burden of assessing Real Property Taxes usually falls on the taxpayer’s local municipality. To counter this position, in New York, Governor Cuomo signed an Executive Order permitting local governments to immediately issue tax warrants (in New York tax warrants are the “assessment” of Real Property Taxes) permitting the collection of real property taxes before the end of 2017. The Executive Order also suspends local tax laws through the end of 2017 which otherwise would have prevented taxpayers from making partial payments of real estate taxes.
Cautionary Note: Whether pre-paying State and Local Income or Real Property Taxes will result in an actual savings will depend in large part on whether a taxpayer is subject to the Alternative Minimum Tax in 2017.
Inability to Deduct Most Miscellaneous Deductions, Increase in Standard Deduction, Elimination of Personal Exemptions
Beginning January 1, 2018, individual taxpayers will no longer be able to claim an itemized deduction for work related expenditures, tax preparation fees, investment advisory fees and most other miscellaneous deductions that they had been able to deduct if those expenses exceeded 2% of their adjusted gross income (“AGI”). In addition, beginning January 1, 2018, the deduction for personal exemptions has been eliminated. However, beginning January 1, 2018, the standard deduction has been increased from $6,500 for a single taxpayer, to $12,000, and from $13,000 for a married couple to $24,000.
Recommendation: Taxpayers should consider prepaying their miscellaneous deductions in 2017 to the extent these expenses are known.
Cautionary Note: Again the interplay of the Alternative Minimum Tax may reduce or eliminate any actual tax savings.
Recommendation: Those Taxpayer’s who feel the increased Standard Deduction will be applicable to them 2018 should give consideration to making charitable contributions in 2017 that they might ordinarily not make until 2018 in order to benefit from the deduction. Beginning in 2018 charitable deductions will be deductible to the extent of 60% of a taxpayer’s AGI. Currently the limitation is 50% of AGI.
Limitations on Deductibility of Mortgage Interest
Beginning January 1, 2018, interest on a Home Equity Line of Credit (“HELOC”) will no longer be deductible. Interest on residential mortgages will be deductible only to the extent of the interest paid on the first $750,000 of indebtedness. Existing mortgages, those entered into prior to December 16, 2017, or those entered into after December 15, 2017 in connection with the purchase of a home pursuant to a contract that was entered into prior to December 16, 2017, are grandfathered. The refinance of a grandfathered mortgage will generally remain grandfathered provided the term/amount do not exceed the grandfathered mortgage’s term/amount.
Recommendation: Those taxpayers who have a HELOC should give consideration to converting their HELOC to a permanent mortgage, perhaps in conjunction with a refinance of their existing mortgage, as soon as practical.
Other Changes Not Requiring Immediate Action:
Change in tax brackets and rates
Beginning January 1, 2018, the top marginal tax rate for tax returns filed by married couples will be 37% on taxable income in excess of $600,000 ($500,000 for single taxpayers). Previously, the top marginal rate was 39.6% on taxable income in excess of $480,050 ($426,700 for single taxpayers).
Alternative Minimum Tax (“AMT”)
The Bill increases the exemption from the current $86,200 for married taxpayers filing a joint return to $109,400, and from $55,400, for single taxpayers to $70,300. The exemption begins to phase out for married taxpayers at $1,000,000 and at $500,000 for single taxpayers. Previously, these amounts were $164,100 and $123,100, respectively. It is anticipated that these changes, coupled with the elimination of many of the deductions that often triggered the imposition of the AMT, will lessen the impact of the AMT on many Americans.
Beginning January 1, 2018, like-kind exchanges (“§1031 exchanges”) will be limited to real property exchanges.
Section 529 Plans
Beginning January 1, 2018, withdrawals of up to $10,000 per year from a Section 529 Plan can be used to pay for tuition at an elementary or secondary public, private or religious school.
Child Care Credit
Beginning January 1, 2018, the credit increases from $1,000 per qualified child to $2,000 with up to $1,400 being refundable if the amount of the credit exceeds the taxpayer’s tax liability. The phase-out, which had begun at $200,000 for a married couple, and $75,000 for a single taxpayer, has been increased to $400,000 and $110,000, respectively.
Gift, Estate and Generation Skipping Tax Exemptions
Beginning January 1, 2018, these exemptions will be $11,200,000, per U.S. domiciliary.
Recommendation. Taxpayers who may have been considering making large gifts for estate planning purposes in 2017 which may have exceeded the current exemption ($5,490,000) should consider delaying these gifts until after December 31, 2017.
Cautionary Note. As with many provisions of the Bill, these changes will “sunset” (i.e., they will end) after 2025 and will revert back to current law.
Effective for agreements entered into after 2018 – alimony is no longer deductible by the payor nor treated as income by the recipient.
Carry Forward of Net-Operating Loss Deductions
Beginning January 1, 2018, net operating losses carried forward from a prior year cannot be used to offset more than $500,000 of non-business income on joint returns, $250,000 for other taxpayers.
20% Deduction on Certain Pass-Through Income
Taxpayer’s receiving income from a pass-through entity (i.e., a sole proprietorship, partnership, limited liability company or Sub-S corporation) will receive a deduction equal to 20% of the income they receive. This will have the effect of reducing the marginal income tax rate on this income by 20%. The determination of the amount of the actual deduction will be depend upon a several computations which take W-2 wages paid and assets into account. In addition the amount of the available deduction will be phased out if the taxpayer’s taxable income exceeds certain threshold amounts. For those taxpayers filing joint income tax returns, the phase-out begins at $315,000 and the deduction is eliminated if taxable income exceeds $415,000. For all other taxpayers the phase-out begins at $157,500 and the deduction is eliminated if taxable income exceeds $207,500.
Corporate and Non Corporate Business Changes:
- Institution of a flat 21% corporate tax which replaces the current tiered rate structure where rates ranged from 15% to 39%
- Elimination of the corporate Alternative Minimum Tax
- Reduction of dividend received deductions
- Limitation of deductibility of interest expense to 30% of AGI, as adjusted
- Ability to expense 100% of certain newly acquired business property placed in service after September 27, 2017, subject to certain reductions and adjustments
- Increase of Section 179 deduction to $1,000,000, subject to a phase-out threshold of $2,500,000
- Carried interest provision requiring assets to be held for 3 years in order to receive capital gain treatment
- Net operating losses incurred after 2017 will be allowable only to the extent of 80% of taxable income, will not be available for carryback and will no longer be carried forward indefinitely
In addition to the changes discussed in this Update, there are many other provisions of the Bill which impact those engaged in international commerce as well as provisions impacting targeted taxpayers. We are happy to meet with you to discuss those provisions as well as to discuss how the changes mentioned in this Update may affect you and your business. We look forward to your questions.