The following are the key provisions impacting individual income tax deductions, effective for taxable years 2018 through 2025:
– The standard deduction has been doubled to $24,000 for married couples ($12,000 for individuals) and the personal exemption is eliminated.
– Miscellaneous itemized deductions that were subject to the 2% floor (e.g., certain unreimbursed employee business expenses, tax related expenses and investment related expenses) are suspended.
Clients should discuss with their tax advisors whether they can accelerate the payment of any items that would qualify as miscellaneous itemized deductions by year-end 2017.
– The overall limitation on itemized deductions is eliminated.
– The Alternative Minimum Tax (AMT) for individuals is maintained with a higher exemption level of $109,400 for married couples ($70,300 for individuals). Additionally, AMT exemption phaseout thresholds are increased to $1,000,000 for married couples ($500,000 for individuals). Given the increased exemption and phase-out thresholds as well as the limitation of certain itemized deductions, many clients may find that they are no longer subject to AMT.
Clients who hold incentive stock options (ISOs) may benefit from exercising those options in years when they do not have AMT liability.
– The deduction for state and local taxes (SALT) has been limited. Taxpayers can deduct up to $10,000 in the aggregate for property, income and sales tax. The Act states that taxpayers may not take a deduction in 2017 for prepayment of state or local income tax imposed for taxable
years beginning after December 31, 2017.
Clients should discuss with their tax advisors whether they could benefit from prepaying real estate taxes in 2017. Clients should also discuss whether they could benefit from paying unpaid 2017 state income taxes by year-end 2017.
– The mortgage interest deduction has been limited.
a) Taxpayers can deduct interest on mortgage debt up to $750,000 of acquisition indebtedness for a newly acquired principal or second home.
b) Existing mortgages are grandfathered up to the current $1 million limit. A mortgage will be considered grandfathered into the $1 million limit if: (1) with respect to a principal or second home, the debt was incurred on or before December 15, 2017, or (2) with respect to a principal
residence only, (a) the taxpayer entered into a written binding contract on or before December15, 2017 to close on the purchase of such residence before January 1, 2018, (b) the home is actually purchased before April 1, 2018, and (c) the debt is incurred on or before April 1, 2018.
If a mortgage incurred on or before December 15, 2017 is refinanced, the refinanced debt will also be considered grandfathered into the $1 million limit up to the amount of the original mortgage outstanding at the time of the refinancing, subject to certain limitations relating to the
term of the indebtedness.
c) Interest on home equity loans or home equity lines of credit (new or existing) is no longer
Repeal mandate for individual health insurance. The law imposing a penalty on individuals who don’t purchase health care insurance coverage is effectively repealed by reducing the penalty to zero. This change does not take effect until 2019.
1031 exchanges. The law continues to permit the deferral of taxes on the proceeds of the sale of real property when those proceeds are properly reinvested in similar property (“like-kind exchanges”). Beginning in 2018 this deferral is not available for other types of property.
Roth IRA re-characterizations. Beginning in 2018, a conversion from traditional IRA to a Roth IRA can no longer be re-characterized back to the traditional IRA.
Provisions impacting individuals that were NOT affected by the Act
The following are items that were proposed and discussed but are NOT affected by the Act:
– Treatment of sale or disposition of a partial position of securities (investors may still choose specific shares or lots to sell and will not be required to use FIFO treatment)
– Tax free treatment of employer sponsored health insurance
– Tax free treatment of graduate student tuition waivers
– Deduction for student loan interest
– Exclusion of gain from the sale of a principal residence remains at $250,000 ($500,000 for married filing jointly) and the home must have been occupied 2 out of the last 5 years)
– The 3.8% tax on net investment income is retained.
A married couple with three children lives in a rental apartment in New York City, with a joint annual income of $650,000. The below chart illustrates how their deductions would look in 2017 vs. 2018: 2017
The corporate income tax rate is permanently lowered to 21% beginning in 2018.
AMT. The corporate alternative minimum tax is repealed beginning in 2018.
Pass Through Companies. Individuals, trusts and estates are allowed to deduct 20 percent of “qualified business income” (as defined in the statute) received from a “pass through” company. S corporations, LLCs, partnerships and sole proprietorships are all examples of pass through. At a 37% top federal tax rate, the 20% deduction approximates a 29.6% marginal federal rate, but is subject to many limitations. Only domestic business income qualifies. Deductibility is restricted for taxpayers above $315,000 for married taxpayers filing jointly and $157,500 for individuals (indexed for inflation).
Above these thresholds some of the limitations to this deduction include:
a) The deduction cannot exceed the greater of
1. 50% of W-2 wages paid by the qualified business, or
2. 25% of wages paid plus 2.5 percent of the unadjusted basis of tangible depreciable assets used in the business. Note: this provision allows real estate business with large capital investments but low wages paid to employees to still take advantage of the deduction.
b) The deduction is not available for “specified service business” including:
4. Actuarial science
5. Performing arts
8. Financial services
9. Brokerage services
10. Businesses in which the principal asset is the reputation or skill of one or more of its employees or owners
11. Businesses involving the performance of services that consist of investing and investment management trading or dealing in securities, partnership interests or commodities
c) Multiple businesses are aggregated and the deduction is allowed against the total net qualified business income.
Qualified business income specifically excludes investment income such as long-term capital gains, dividends, interest income (other than when properly allocable to a trade or business), and amounts received under an annuity contract.
Sunset. The provision affecting pass through entities “sunsets” for tax years beginning in 2026.As a result of this new deduction for pass through on qualified businessincome, clients should consult with their tax advisors to see if they could take advantage of this provision for their pass through businesses. In addition, clients in states with higher state income tax rates may consider with their tax advisors whether they should reorganize their business as a C corporation as opposed to an S corporation or other pass through entity. The SALT deduction
remains available to C corporations without the limitations imposed on individuals. Any analysis should take into consideration the double taxation of C corporations when making dividends to shareholders, the potential for trapping appreciated property in a corporation, and the sunset provision of the pass through rules under the Act.
MLPs. Master Limited Partnerships qualify for the tax reduction associated with small businesses and pass through entities under the new law. That would mean the annual net income would benefit from that deduction and that the distributions after an investor’s tax basis is zero would benefit.
International. The text changes the taxation of foreign based income from a worldwide income system to a territorial based system, including deemed repatriation with tax at 15.5% tax on cash and equivalents and 8% on illiquid assets.