On December 20, 2017, Congress passed its comprehensive tax reform bill, the Tax Cuts and Jobs Act (“the Act” or “the Bill”), which is expected to be signed into law by President Trump in early January 2018. The Bill represents one of the most extensive modifications to the U.S. tax code in recent history, significantly modifying U.S. taxation for individuals and businesses. Below you will find a summary of some important provisions related to the Individual Tax Reform Bill.
The individual tax provisions in the bill, including the pass-through deduction, sunset after December 31, 2025.
- Modification of individual tax brackets. There will be seven tax brackets for individuals (as opposed to six currently), with the top bracket’s rate reduced from 39.6% to 37%.
- Increase in standard deduction. The standard deduction available to taxpayers who elect not to itemize deductions will be nearly doubled. The standard deduction for married individuals filing jointly will be increased from $12,000 to $24,000, and from $6,350 to $12,000 for single filers.
- Repeal of limitation on itemized deductions. Under current law, the total amount of most otherwise allowable itemized deductions is limited for certain high-income taxpayers. Beginning in 2018, this limitation on itemized deductions is repealed.
- Personal exemptions repealed. Personal exemptions currently allowed for certain taxpayers and their dependents will be eliminated. For 2017, the amount deductible for each personal exemption is $4,050, but is phased out for joint filers with AGI in excess of $313,800 ($261,500 for single filers). The amount of tax required to be withheld from wages by employers is based in part on the number of withholding exemptions claimed on an employee’s Form W-4. Beginning in 2018, personal exemptions are repealed, and the Secretary of the Treasury is to develop new rules for determining the amount of tax required to be withheld from wages.
- Deduction for pass-through entities. In a provision intended to benefit business activity conducted through flow-through entities, the Bill allows individuals (including trusts and estates) a deduction for 20% of the individual’s “qualified business income” from flow-through entities, subject to a limitation based either on wages paid, or wages paid plus a capital element. Qualified businesses generally include any trade or business other than a “specified service business” such as a law firm, accounting firm, or other business whose primary activity is the provision of skilled services. However, the deduction may apply to service income attributable to a specified service trade or business where a taxpayer’s taxable income is less than $315,000 (joint filers), or $157,000 (other filers), subject to a phase-out. Qualified items of income include 20% of any dividends from a real estate investment trust, as well as 20% of includable dividends from qualified publicly traded partnership income, but do not include certain service related income such as payments by a partnership to a partner in exchange for services.
- Expansion of child tax credit. The child tax credit is temporarily increased beginning in 2018 from $1,000 per qualifying child to $2,000 per qualifying child, and eligibility for the credit is expanded as the AGI threshold for phase out is increased from $110,000 to $400,000 for joint filers, and $75,000 to $200,000 for individual filers.
- Limitations on losses. Beginning in 2018, excess business losses for individual taxpayers are disallowed for the taxable year, but may be carried forward and treated as part of the taxpayer’s net operating loss carryforward.
- Modification of deduction for mortgage and home equity interest. Beginning in 2018, the deduction for mortgage interest will be limited to acquisition indebtedness of up to $750,000. For taxpayers who entered into a contract to purchase a home prior to December 15, 2017, the limitation is increased to $1,000,000. The deduction currently allowable for interest on home equity indebtedness will be eliminated.
- Modification of state and local tax deductions. Generally, under the Bill, the deduction for state and local property taxes and state and local sales taxes is allowed only when paid or accrued in connection with a trade or business. For personal taxes not related to a trade or business, the deduction is limited to $10,000 for aggregate state and local property and income taxes.
- Repeal of deduction for casualty and theft losses. The deduction currently allowed for personal casualty and theft losses is repealed, except for losses attributable to certain disasters declared by the President.
- Modification of charitable contribution deduction. The Bill retains and expands the charitable contribution by increasing the percentage limit for charitable contributions of cash made to public charities.
- Repeal of deduction for alimony payments. Alimony and separate maintenance payments are currently deductible by the payor spouse and includible in income by the recipient spouse. For any divorce or separation instrument executed after December 31, 2018, alimony payments will not be deductible by the payor spouse, nor includible in income by the recipient.
- Modification of alternative minimum tax. The AMT exemption amounts are increased from $86,200 to $109,400 for joint filers and from $55,400 to $70,300 for single unmarried filers. Such exemption amounts are reduced (not below zero) to an amount equal to 25% of the amount by which AMT income exceeds $1 million for joint filers and $500,000 for all other filers, which represent increases from current threshold amounts.
- Increase in estate and gift tax exemption. The estate and gift tax exemption is doubled to $10 million (indexed for inflation) for estates and gifts made after December 31, 2017 and before January 1, 2026.
- Carried interest. Partnership interests received in connection with the performance of services, including carried interests must be held for three years before they can qualify for long-term capital gain treatment, effectively recharacterizing certain gains attributable to applicable partnership interests from long-term to short-term capital gain.
- Affordable Care Act. The individual mandate penalty will be repealed.