As of December 2, 2017, the various versions of the tax reform have passed both the House and the Senate. The next step is for the House and Senate tax bills to be reconciled into a single piece of legislation by a Conference Committee composed of House and Senate conferees. Although there are many similarities between the two bills, there are also a number of significant differences to be addressed by the Committee, including the Senate bill's “sunset” of many tax breaks, the year in which the corporate tax rate reduction would go into effect, and whether or not the estate tax and alternative minimum tax (AMT) would be repealed.
Most all of the changes in these tax reform bills are not effective until 2018 or later. That being said, there are some planning opportunities that you may want to take advantage of assuming that a version of this tax reform bill will be in play for 2018. We have gone through the two versions of the bill and picked out the areas that we believe will be most important to our clients. If you would like more information on any of these possible changes do not hesitate to reach out to us.
Individual Taxpayer Changes
Tax Brackets - Both versions have lower overall individual tax rates for 2018 and beyond (only through 2025 for Senate version). The Senate version is much more taxpayer friendly in that it has lower tax rates and a lower top rate (38.5% if taxable income is over $1M vs 39.6% for the house).
- Planning Opportunity: Due to the future rates being lower than 2017 it may make sense to defer any taxable income possible into 2018 while accelerating any tax deductible expenses.
- Increased Standard Deduction and Elimination of Exemptions - Both versions have doubled the standard deduction ($24K for married, $12K for single) which will eliminate the need for many taxpayers to itemize their deductions. They have also eliminated the personal exemption which is a deduction received for each dependent you claim and is currently $4,100 per dependent. This may hurt taxpayers that have large families.
- Local and State Tax Deductions - Both versions remove the state tax deduction for personal state and local taxes paid.
- Planning Opportunity: You will want to pay your 2017 state taxes that you may owe prior to 12/31/2017 so that we can deduct. If you need vouchers to submit these payments, let me know.
- Real Estate Taxes - Both versions limit the real estate tax deductions to $10K for 2018 and beyond.
- Planning Opportunity: You will want to make sure to pay your full real estate tax bill (and if possible first payment for next year) prior to 12/31/2017 so that we can deduct.
- Medical Expenses – The House version repeals the medical deduction effective 2018 whereby the Senate version expands your ability to deduct medical costs for both 2017 and 2018 and results in a lower threshold from 10% to 7.5% of AGI.
- Planning Opportunity: If you have any medical costs to pay and total costs will be close to 7.5% of you AGI, you will want to make sure you pay them prior to 12/31/2017 so that you at least have a chance of taking the medical deduction.
- Mortgage Interest Deduction – The House version retains the current mortgage interest deduction on mortgages up to $1M that were entered prior to 11/2/17. However, mortgages entered after 11/2/17, the interest deduction is available on mortgages up to $500,000. The Senate retains the current mortgage interest deduction rules. Both versions remove the interest deduction on home equity loans and equity lines of credit.
- Child Tax Credit – The House is proposing to increase the child tax credit from $1,000/child under the age of 17 to $1,600/child. They are also adding a Family flexibility credit of $300 for non-child dependents and the taxpayer and spouse in addition to a $300 family tax credit for adult children still in the home. The House is also increasing the phase-out $115,000 for single filers and $230,000 for joint filers. The Senate is increasing the child tax credit to $2,000/child and increasing the age for this credit to the age of 18. They are also adding a $500 credit for non-minor child dependents. The phase-outs proposed by the Senate are $250,000 for single filers and $500,000 for joint filers.
- Alternative Minimum Tax (AMT) – As a last minute change to help raise tax dollars the Senate decided NOT to repeal the AMT so most likely this dreaded tax will continue to haunt certain taxpayers.
- Selling Your Home – Both the House and the Senate are proposing that the exemption on the gain of your principal residence be changed from owning and using the home two out of five years to five out of eight years. The exemption is going to remain $500,000 for married filing jointly.
Education - The Senate has chosen not to make any changes to higher education deductions and credits. The House version is proposing:
- Repeal the Hope Scholarship Credit and the Lifetime Learning Credit.
- Limit the AOTC to five years with the fifth year only receiving 50% of the credit of the prior four years. Only $500/student is refundable.
- Coverdell Account (Educational IRA) contributions will be prohibited.
- Section 529 account distributions up to $10,000/year will be allowed for elementary and high school expenses.
- Repeal student loan interest deduction.
- Repeal the above-the-line tuition and fees deduction.
- Repeal the exclusion of interest income from savings bonds used to pay higher education expenses.
- Repeal the exclusion from income the reduction of qualified tuition provided by educational institutions
- Repeal employer-provided education assistance
- Stock Sales and “FIFO” Cost Basis – The Senate version is repealing the “specific identification” method of calculating cost basis when you sell stock. Specific identification allows you to choose which shares you are selling thereby minimizing your capital gain. The proposal is requiring you to use First-In-First-Out (FIFO) method of calculating cost basis when you sell shares which may cause higher taxable gains in the future.
Business Taxpayer Changes
- Depreciation of Business/Rental Assets – Both versions had language that increased expensing for various fixed assets by allowing bonus depreciation up to 100% of the asset for assets placed in service 9/27/2017 and before 1/1/2023.
- The Senate proposed to shorten the depreciable life of real estate from the current life of 39 year for nonresidential real estate and 27.5 years for residential real estate to 25 years for both.
- Business Pass Through Income - Two completely different versions:
- House Version – 25% “business income” rate. The Act would provide a new maximum rate of 25% on the “business income” of individuals. “Qualified business income” is generally defined as net passive income derived from any passive business plus 30% of any net business income derived from any active business activity. Personal service business (e.g., law, health, engineering, accounting, consulting) that you actively participate in do not qualify for the lower 25% business tax rate…rather they are taxed at the normal ordinary tax rates.
- Senate Version – 23% deduction. The Act would generally allow a non-corporate taxpayer who has “qualified business income” (income which is not investment income or compensation) from a partnership, S corporation, or sole proprietorship to deduct the lesser of 23% of the taxable income. This 23% deduction is further limited to 50% of the W-2 wages for that business paid by that business. However, the W-2 wage limit would not apply to Sole Proprietorships and taxpayers with taxable income not exceeding $500,000 for married individuals filing jointly ($250,000 for other individuals). This deduction would not apply to specified service businesses (e.g., law, health, engineering, consulting), except in the case of a taxpayer whose taxable income does not exceed $500,000 for married individuals filing jointly ($250,000 for other individuals).
- Planning Opportunity: If you own one of these pass through businesses (Sole Proprietorship, Partnership, S Corporation) you may want to defer as much business income into 2018 as possible while accelerating tax deductible expenses into 2017. Need to look at your current structure of compensation verse retained business net income that would pass through. Lower compensation and higher pass through net income could result in substantial tax savings.
- Corporate Tax Rates – Both versions lowered the corporate tax rate to a flat 20% rate (down from the current maximum rate of 35%), however, the implementation date of this tax rate change is different.
The House version would provide that personal services corporations would be subject to a flat 25% corporate tax rate, rather than the current 35% rate. A personal service corporation is a corporation the principal activity of which is the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, and such services are substantially performed by the employee-owners.
The House version is effective for 2018 while the Senate version is effective for 2019.
- Planning Opportunity: It appears this is going to be a flat rate and no longer a graduated rate as it is now so this may end up costing the smaller C corporations (those making less than $50,000 net taxable income which is currently 15% tax rate) more tax. May make sense to look at the entity structure.