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2017 Tax Reform Act: Tax Planning Challenges and Opportunities
Friday, December 29, 2017

By: Joseph J. Carroll, Esq.

The recently passed 2017 Tax Reform Act (“Act”) significantly changes the landscape for Taxpayers beginning on January 1, 2018. There are substantial changes to the individual income tax, the estate and gift tax and the taxation of business entities. For many Taxpayers, the changes made by the Act present a host of tax planning challenges and opportunities.

Highlighted below are some of the more significant changes made by the Act and possible challenges and opportunities for Taxpayers to lower their tax bill.

Many of the changes made by the Act are effective as of January 1, 2018. If you have questions, please contact us to discuss how the Act impacts your individual situation. Because the Act dramatically changed the tax consequences of pass-through businesses, if you own a business, we highly encourage you to contact us to discuss how to best structure your business in order to ensure the most tax-efficient organization structure has been implemented.

I. Tax Rates / Tax Exemption and Deduction Amounts

A. Lower Individual Tax Rates - The Act creates lower individual income tax brackets and lowers the top rate from 39.6% to 37%. See the table below for a comparison of the 2017 rates to the new rates (2018-2025). Of note, the marginal income tax rates would be restored in 2026 (i.e. revert back to the 2017 rates).

2017 Tax Reform Act: Tax Planning Challenges and Opportunities

*Chart does not account for the Medicare surtax on high earners.

B. Temporary Increase in Estate and Gift Tax Exclusion Amount and Generation Skipping Tax Exemption. The Act maintains the federal estate tax, but it doubles the amount of wealth that is exempt from estate tax at death and a related tax on gifts during a Taxpayer’s life. Starting on January 1, 2018, single Taxpayers can exclude about $11 million from federal estate and gift taxes, up from $5.5 million. Married couples can shield about $22 million from federal estate and gift taxes. Of note, the Act still gives beneficiaries a step-up basis at death for capital assets and allows a “portability” election permitting a deceased spouse to transfer unused exclusion amounts to a surviving spouse.

Action: The higher exemption thresholds are temporary and expire on January 1, 2026, so Taxpayers may want to move now to transfer more money to the next generation tax-free. Even in the absence of tax reform, it makes sense to review your estate plan to verify that it continues to satisfy your tax- and family-related objectives. If the above described estate limits are relevant to your estate plan, it is recommended you schedule an appointment to review your estate plan structure.

C. Pass-Through Business Tax Deduction and Reduction in Corporate Tax Rate. Pass-through businesses (e.g. sole proprietorships, partnerships, limited liability companies and S Corporations) will be taxed at the individual tax rates, but will be able to deduct 20% of qualified business income. This 20% deduction for certain qualified business income effectively drops the top rate from 37% to 29.6%, but is subject to many limitations. The pass-through deduction is denied to anyone who is an employee.

The pass-through business deduction is restricted for Taxpayers with taxable income above $315,000 for married taxpayers filing jointly and $157,500 for individuals (indexed for inflation). If a Taxpayer’s taxable income is below these thresholds, the below limitations do not apply. Above these thresholds, some of the limitations to this deduction include:
  • The deduction cannot exceed the greater of:
    • 50% of W-2 wages paid by the qualified business; or
    • 25% of wages paid plus 2.5 % of the unadjusted basis of tangible depreciable assets used in the business.
  • The deduction is not available for “specified service trade or business.” These are defined as investment services, as well those "in the fields of health, law, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners."
Tax rate for C Corporations is reduced from 35% to a flat rate of 21%. This rate reduction is not scheduled to expire.

Action:
  • If you own a pass-through business, it would be important to review how your business is structured to ensure you are taking full advantage of the pass-through business tax deduction. Depending on the size and structure of your business, it might be advantageous to create several pass-through businesses or incorporate as a C corporation.
  • If you are an employee, it is worth reviewing your situation to see if it would be more beneficial and possible for you to be an independent contractor or owner rather than an employee. If you are an independent contractor or owner, you might qualify for the pass-through business deduction.
II. Deductions

The following key provisions effect individual tax deductions for tax years 2018 through 2025.

A. Increase in the Standard Deduction - The personal exemption and standard deduction is combined into a higher standard deduction for tax years 2018 to 2025. Below is a comparison of the rules for tax year 2017 and the new rules for tax years 2018 to 2025. After tax year 2025, the law is scheduled to return to the rules for tax year 2017.


Rules for Tax Year 2017
Rules for Tax Years 2018 to 2025 
Standard Deduction
Individual: $6,350
Married Filing Joint: $12,700
Individual: $12,000
Married Filing Joint: $24,000
Senior Citizens (Over 65)
Individual: Additional
No Change


$1,500 Married Filing Joint: $2,500
No Change
Child Tax Credit
$1,000
$2,000
Dependent Tax Credit
None
$500

Because the standard deduction has increased, it is anticipated that fewer taxpayers will itemize. The Child Tax Credit has doubled and as much as $1,400 of the credit will be refundable, allowing recipients to benefit even if they don't owe taxes. The legislation also expands eligibility for the child tax credit by increasing the phaseout threshold to $400,000 of adjusted gross income for joint filers (up from $110,000 under current law), with a threshold for all other filers set at $200,000. A $500 nonrefundable credit for dependents other than children will be available through 2025.

Action: since you can claim the higher of the standard deduction or itemized deductions, you will want to closely compare the two methods as you may now benefit from a higher standard deduction given the many changes to itemized deductions.

B. Many Popular Deductions and Credits Have Changed and/or Have Been Eliminated. Below are changes made to many of the popular deductions and credits:

Deduction and credits
Rules for 2017
New 2018 rules
Mortgage interest
$1 million primary and second homes and up to $100,000 for home equity debt.
Limited to $750,000 of mortgage debt for primary and secondary homes for debt incurred after 12/15/17. The $1,000,000 limit remains for older debt.

No deduction for interest for home equity debt.
State and local tax deduction
Deductible with no limitation.
Capped at $10,000 for any combination of state & local income tax, property tax & sales tax.
Medical expense
Expenses greater than 10% of AGI are deductible
Expenses greater than 7.5% of AGI could be deducted for the next 2 years only.  Increases to greater than 10% of AGI in 2019.  
Miscellaneous Business Expenses – 2% Floor Taxpayer may deduct certain expenses as miscellaneous business deductions, such as unreimbursed employee expenses, investment fees, safety deposit box fee, and tax preparation fees. 
Not deductible
Alimony
Alimony payments are allowed as a deduction for the payor and included as income for the payee.
Not deductible.  This provision is effective for divorce decrees, separation agreements, and other modifications entered into after 2018.

Action:
  • It will remain important for you to keep track of your medical expenses, mortgage interest, property and state income or sales tax payments and charitable contributions made during 2018 due to new restrictions on itemized deductions.
  • If you have a home equity line, you may want to consider refinancing your home equity line into a single mortgage on your principal or second home in 2018, assuming that your combined mortgage interest and other permitted itemized deductions exceed the standard deduction.
  • Employees who incur significant unreimbursed business expenses may want to ask their employer about adjusting their compensation or establishing an accountable expense reimbursement plan that would allow the employer to reimburse the employee tax-free while also entitling them to a deduction against their business income.
  • If you are currently contemplating divorce or separation, you should carefully review the effects of the new law to determine the economic effects on your tax situation and the timing of any agreements.
III. Other Areas of Interest

A. No Change to Retirement Incentives and Health Savings Accounts. The new rules do not call for changes to existing retirement savings incentives, preserving the favorable tax treatment and contribution limits for 401(k)s, IRAs and other retirement savings accounts. The legislation also left the rules for health savings accounts intact.

Action: Due to the elimination or limitation on itemized deductions, and the elimination of personal exemptions, a key consideration in planning for 2018 is to first look at ways to lower your taxable income. You should thus consider maximizing all pre-tax contribution opportunities, such as your 401(k) and deductible IRA contributions, as well as consider investing in state and municipal bonds (whose interest is exempt from federal tax).

B. 529 Plans Expanded. Currently, funds in 529 Plans can be withdrawn tax-free if used for higher education expenses. Effective for distributions made after December 31, 2017, qualified distributions from the 529 Plan may now distribute up to $10,000 per student per year for elementary and secondary school expenses.

Action: if your children attend and/or are going to attend private schools, there is a greater incentive to contribute to 529 Plans.

IV. Conclusion

The Act is the first major overhaul of the U.S. tax system in 30 years. The Act takes effective immediately and influences many areas of your financial life. Because of that, it is important to understand the provisions in the Act. If you have questions, please contact us to discuss how the Act impacts your individual situation.




 
 

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