Tax Reform: What It Means For You

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Now that the debate is over and the votes have been taken, tax reform is the new reality. President Trump has signed the "Tax Cuts and Jobs Act," bringing the most sweeping changes to the U.S. tax code in three decades.

The Act in its entirety is a whopping 1,097 pages long, which will take some time to digest all of the details of the bill. However, below is a summary of some of the key changes for both individual taxpayers and business owners.

FOR INDIVIDUAL TAXPAYERS:

• Tax Rates — There will now be seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The top rate was reduced from 39.6% to 37% and applies to taxable income above $500,000 for single taxpayers, and $600,000 for married couples filing jointly.
   
• Standard Deduction — The standard deduction is increased to $24,000 for joint filers, $18,000 for head of household and $12,000 for singles or married taxpayers filing separately. The expected result is fewer people will be itemizing deductions.
   
• Exemptions — Starting in 2018, taxpayers can no longer claim personal or dependency exemptions.
   
• Child and Family Tax Credit — The child and family tax credit doubles to $2,000, and increases the refundable portion to $1,400. This means that some lower-income families could receive a refund check even if they pay no federal income tax.
   
• State and Local Taxes — State and local income and property tax itemized deductions are limited to a total of $10,000.
   
• Mortgage Interest — Mortgage interest on a principle or second home is deductible up to $750,000, down from $1 million starting with loans taken out in 2018. Home Equity Loan (HELOC) interest is no longer deductible after December 31, 2017, no matter when the debt was incurred.
   
• Miscellaneous Itemized Deductions — There is no longer a deduction for miscellaneous itemized deductions which were formerly deductible to the extent they exceeded 2 percent of adjusted gross income. This included such deductions as tax preparation costs, investment expenses, union dues and unreimbursed employee expenses.
   
• Medical Expenses — Medical expenses are deductible after they exceed 7.5% of adjusted income (down from 10%) for 2017 and 2018.
   
• Health Care “Individual Mandate” — The Affordable Care Act (“Obamacare”) tax penalty for people who fail to purchase minimum essential health coverage is abolished starting in 2019.
   
• Estate and Gift Tax Exemption — The estate and gift tax exemption is increased to $11.2 million ($22.4 million for married couples).
   
• Alimony — Alimony payments are no longer deductible by the payer, nor includable by the recipient for divorce decrees issued after December 31, 2018.
   
• Individual Alternative Minimum Tax (AMT) Exemption — The individual Alternative Minimum Tax is retained, but the exemption increased to $109,400 for joint filers, $54,700 for married couples filing separately and $70,300 for singles. It is phased out for taxpayers with income above $1 million for joint filers, $500,000 for everyone else.

FOR BUSINESSES:
 

• Pass-Through Deduction — The Act establishes a 20 percent deduction of qualified business income from certain pass-through businesses (i.e. partnerships, S-Corporations, LLC’s, or sole proprietorships). Specific services, such as health, law and professional services, are generally excluded. However, joint filers with taxable income below $315,000 (deduction phased-out fully at $415,000) and other files with taxable income below $157,500 (deduction phased-out fully at $207,500) can claim the deduction on income from service industries. Additionally, for taxpayers with taxable income more than the above thresholds, a limitation on the amount of the deduction is phased in based on either wages paid or wages paid plus a capital element.
   
• Corporate Tax Rates Reduced — The graduated corporate tax rates of 15%, 25%, 34% and 35% are replaced with a single flat rate of 21%.
   
• Corporate Alternative Minimum Tax — For tax years beginning after Dec. 31, 2017, the corporate Alternative Minimum Tax is repealed.
   
• Increased Section 179 Expensing — Code Sec. 179 expensing, which allows a taxpayer to deduct the cost of qualifying property, is increased to a maximum of $1 million, and the phase-out threshold is increased to $2.5 million.
   
• 100% Expensing of Qualified Business Assets — A 100% depreciation expensing of qualifying business assets acquired and placed in service after Sept. 27, 2017 and before Jan. 1, 2023. The additional first-year depreciation deduction is allowed for both new and used property. This provision replaces the previous 50% bonus depreciation available for qualified new property.
   
• Limits on Deduction of Business Interest — For tax years beginning after Dec. 31, 2017, every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. The net interest expense disallowance is determined at the tax filer level. However, a special rule applies to pass-through entities, which requires the determination to be made at the entity level. The amount of any business interest not allowed as a deduction for any taxable year is treated as business interest paid or accrued in the succeeding taxable year. Business interest may be carried forward indefinitely, subject to certain restrictions applicable to partnerships. An exemption for these new rules applies for taxpayers with average annual gross receipts of under $25 million for a three-year tax period ending with the prior tax year.
   
• Modification of Net Operating Loss Deduction — The net operating loss (NOL) deduction is modified with the repeal of the two-year carryback and special carryback provisions, though the two-year carryback still applies in the case of certain farming losses. For losses arising after Dec. 31, 2017, the deduction is limited to 80% of taxable income. Carryovers to other years are adjusted to take account of this limitation, and NOLs can be carried forward indefinitely (with some exceptions, notably for insurance companies).
   
• DPAD — The Domestic Production Activities Deduction (DPAD) is repealed.
   
• Like-Kind Exchange Treatment Limited — The rule allowing the deferral of gain on Like-Kind Exchanges is modified to allow them only with respect to real property that is not held primarily for sale. It can still apply to exchanges of personal property if the taxpayer has disposed of the relinquished property or acquired the replacement property by Dec. 31, 2017.
   
• Cash Method of Accounting — Expanded use of the Cash Method of accounting for taxpayers that satisfy a $25 million gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. The exceptions from the required use of the accrual method for qualified personal service corporations and taxpayers other than C corporations are retained. Accordingly, qualified personal service corporations, partnerships without C corporation partners, S Corporations, and other pass-through entities are allowed to use the cash method without regard to whether they meet the $25 million gross receipts test, so long as the use of the method clearly reflects income.

These are significant changes that will create new opportunities and challenges for everyone, whether individuals or businesses, looking to minimize their tax burden. Consult with your trusted tax advisor to create a strategy going forward with all the variables that come with tax reform in mind.

Nick Hopkins is director of tax services at Sponsel CPAs.