In December of 2017, Congress passed the most extensive changes to the tax code since President Reagan’s Tax Reform Act of 1986: The Tax Cuts and Jobs Act (TCJA).
Signed into law by President Trump on December 22, 2017, these changes were originally intended to simplify the tax code, although the final package was mixed. While the tax rate for individuals and corporations was reduced, modifications were made to many tax rules including deductions. Even so, it is estimated that federal taxes for individuals will decline by an average of 8%.
Those impacted by the comprehensive changes include individuals, estates, trusts, corporations, and small businesses. This material reviews the changes likely to affect individuals as well as estates and trusts. For information regarding the effects of the TCJA on small businesses and corporations, please contact our offices at (817) 717-3812.
Individual Tax Provisions
Tax Rates Lowered
Under the new law, the current structure of seven tax brackets remains but the marginal rates have been lowered in most.
The new tax brackets are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
The average tax rate will fall to 19% from 20.7%, according to the Joint Committee on Taxation.
The 3.8% Medicare surtax on net investment income still applies for individuals, married couples, and trusts at higher income levels.
Significant Changes to Deductions and Exemptions
Deductions is one area most extensively affected by the tax code changes. Many popular deductions were either eliminated or scaled back in order to provide revenue and compensate for the decrease in marginal tax rates and the increase in standard deduction.
The existing standard deduction is nearly doubled for both single and joint filers. While in recent years roughly a third of taxpayers itemized deductions, tax experts predict that less than 10% will itemize going forward.
Notable Changes to Deductions
- Single filers: $12,000 (previously $6,500)
- Joint filers: $24,000 (previously $13,00)
- Married filing separately: both spouses must use the same method (standard or itemized deductions).
- Elderly (65+) or blind: single filers still receive an additional deduction of $1,600. Joint filers still receive an additional deduction of $1,300 if one spouse is blind/65 or older; $2,600 if both spouse are blind/65 or older.
- The increased standard deduction amounts expire after December 31, 2025.
State and Local Tax (SALT)
- The itemized deduction for sales, state and local income, and property tax are limited to a combined total of $10,000 for joint filers or $5,000 for single filers.
- This limit will expire after December 31, 2025.
- The $1 million limit on deductible interest remains for debt incurred on or before December 15, 2017.
- For new mortgages after December 15, 2017, deduction is limited to $750,000 of aggregate indebtedness (second mortgage debt can be included as long as the total debt does not exceed $750,000).
- Interest on home equity lines of credit (HELOC) remains deductible but limited to certain cases where proceeds are utilized to buy, build, or substantially improve the taxpayer’s home.
- Threshold of when taxpayers can begin deducting is reduced to 7.5% of adjusted gross income for tax years 2017 and 2018.
- After January 1st, 2019, the threshold returns back to the previous rate of 10%.
Limitations on Itemized Deductions
- The Pease Rule is repealed eliminating the phase outs that limited itemized deductions for higher income levels.
- This will expire December 31, 2025, making the Pease Rule effective again in tax year 2026.
- Deduction for cash gifted to public charities increased to 60% of adjusted gross income (from 50%).
- The 80% deduction for contributions made for university athletic seating rights eliminated.
- Personal Exemption Eliminated, previously $4,150 a person.
- Miscellaneous 2% deductions Eliminated, including unreimbursed job expenses, union or professional membership dues, investment fees, and tax preparation fees.
- Alimony Payments Alimony payments are no longer deductible, and alimony received is not considered taxable income. (Divorces finalized before 2019 are grandfathered)
- Moving Expenses Eliminated, except for members of the U.S. armed services under certain circumstances.
- Casualty Losses Eliminated, unless a federal disaster is declared.
- Affordable Care Act Individual Mandate Eliminated, reducing the $695 or 2.5% income penalty for no health insurance to $0 for months beginning after December 31, 2018.
Child Tax Credit (CTC) Expanded
The new changes to the tax code doubled the Child Tax Credit and increased the phase-out income threshold, allowing more taxpayers to take advantage than before. This will help offset the loss of personal exemptions for families with children.
The Child Tax Credit applies to “qualifying children” (generally children under the age of 17 at the end of the tax year).
A $500 tax credit applies to dependents not considered “qualifying children” (dependent children over the age of 17 for example).
Unchanged Tax Rates on Capital Gains and Qualified Dividends
The tax rates for capital gains and qualified dividends were not changed by the new tax code. Previously, tax rates on long-term capital gains and qualified dividends aligned with the tax brackets. The tax brackets and corresponding tax rates were modified in the new tax code, so the income tax rates no longer align with the capital gain/qualified dividend
Going forward, the capital gain/ qualified dividend tax rates are based on certain income
levels, as shown below:
Modifications to the Alternative Minimum Tax (AMT)
Because the exemptions were not initially indexed for inflation, over time the AMT started to apply to more taxpayers than intended, particularly more middle-income households. In an effort to ensure the AMT affected the intended taxpayer (high-income households), the new tax code increased the exemption amounts as well as the phase-out thresholds
for the AMT exemption.
As a result of these modifications, the number of taxpayers subjected to the AMT tax will
be significantly reduced.
Other Items to Note
- Beginning in 2018, annual inflation adjustments will be based on a “chained” CPI formula rather than the standard CPI formula previously used, generally resulting in a lower inflation figure.
- A recharacterization can no longer be used to unwind, or “un-do”, Roth IRA conversions.
- 529 college savings plans were expanded to allow up to $10,000 to be used per year on a per-student basis for qualified expenses, now including K-12 tuition (but not home-schooling expenses).
Timing strategies for deductions. Due to the significant increase in the standard deduction, some taxpayers may benefit from alternating between claiming the standard deduction and itemizing deductions. Taxpayers can choose to “lump” as many deductions into years when itemizing – like larger charitable contributions and medical expenses, for example.
Charitable IRA rollover provision. Retired taxpayers (age 70½ or older) who will now claim the expanded standard deduction, can still receive a tax benefit from charitable contributions by having the donations sent to qualified charities directly from their IRA. Account owners are limited to $100,000 annually, which can include the required minimum distribution.
Careful evaluation of Roth IRA conversions. Since the option to recharacterize, or “un-do”, a Roth IRA conversion is no longer available, IRA owners need to carefully evaluate the advantages and disadvantages of Roth IRA conversions.
More flexibility for education savings. The new tax code brought changes to the kiddie tax and the expanded use of 529 college savings plan, allowing more flexibility when saving for education expenses.
Estate and Gift Tax Provisions
The new tax code, which nearly doubled the unified, lifetime exemption for estates and gifts, will significantly reduce the number of taxable estates. In 2018, an estimated 1,900 estates will be taxable under the new tax law, but 6,500 estates would have been taxable under the pre-2017 tax law, according to the Tax Policy Center.
Estate Planning Considerations
It is important to remember that taxes are just one facet of estate planning. Proper estate planning includes strategies to address wills, power of attorney, health-care directives, coordinated beneficiaries on IRA accounts and insurance, and other areas such as asset protection.
As a result of the recent tax law changes, investors should consider the importance of seeking professional advice in reviewing existing estate plans, trusts, and gifting.
Five Questions to Ask Regarding Estate Planning and the New Tax Code
- Do my estate planning and trust documents need to be updated as a result of the recent tax law changes?
- Given the significant increase in estate and gift exemption amount, what are the advantages and disadvantages of gifting assets to heirs while I’m living versus transferring assets to them upon my death?
- With the estate tax exemption nearly doubled and relatively low probate costs in Texas, how does a trust benefit me?
- What is the portability provision, and how does it affect my situations as a result of the recent tax law changes?
- Does my estate plan maximize the continued benefit of stepped-up cost-basis at death?
To understand how these tax code changes and planning considerations may affect your unique financial plan, it is important to consult your financial advisor and a qualified tax or legal professional.
This material is for general information only and not intended to provide specific advice or recommendations for any individual. Virtus Wealth Management, Level Four Advisory Services and LPL Financial do not provide tax advice.