The largest re-write of US tax law in over 30 years is now complete and subject only to the President’s signature. The details are voluminous and initial guidance should appear in the next few weeks. However, as most of these provisions are in effect starting 1/1/18, it is important now to understand the major changes at least at a high level so we can ask the right questions as we engage in end-of-the-year tax planning. Here's a look at some of the highlights in the new tax plan and how they'll affect you:
How will the tax plan affect individuals?
Starting with individual taxation, there will still be seven tax brackets, but they are lower, and the top marginal rate declines from 39.6% to 37%. As we have discussed previously, there is no change to taxation of dividends and capital gains, and the Affordable Care Act’s net investment income tax and additional Medicare tax were not repealed, even as the individual mandate to have health insurance was repealed. The individual alternative minimum tax (AMT)was retained, but the exemptions and phase-out ranges were increased significantly which should make AMT less common.
Standard deductions were basically doubled to $24,000 married filing joint and $12,000 single, and personal exemptions were repealed. In part to make up for the loss of personal exemptions, the child credit was doubled from $1,000 to $2,000, and $1,400 of that amount is a refundable credit.
Can I still deduct my state and local taxes?
With regard to itemized deductions, the state and local tax deduction was a big point of controversy during the process, but the final bill allows a deduction for any combination of state and local taxes, capped at $10,000. The home mortgage interest deduction will now be capped at purchases of $750,000 (previously $1,000,000), and the deduction for home equity lines of credit is repealed. Medical expenses are still deductible, with an easing to those exceeding 7.5% of AGI versus 10%.
Cash charitable contributions are largely untouched and now allowed up to 60% of AGI, whereas the old limit was 50%. However, deductions for payments made for college athletic seating rights were specifically repealed. Casualty losses will now only be allowed in a federally-declared disaster, and other miscellaneous itemized deductions and moving expense deductions were repealed.
As for alimony, effective for divorces after 2018, alimony will no longer be deductible by the payer nor includible in income of the recipient. Most education and retirement incentives were left unchanged.
The estate tax was not repealed, but the exemption amount was doubled to nearly $11 million. The rate remains 40%, and the gift tax was also maintained.
Virtually all of the individual provisions are temporary to meet budgetary constraints, and many key items, such as the lower individual rates and liberalized AMT expire at the end of 2025, if not extended by a future Congress.
What about my business?
On the corporate side, these changes were primarily permanent in nature. The most important, by far, is the reduction in the corporate tax rate to 21% from a graduated tax structure topping out at 35%, along with a complete rewrite of international tax rules. The new rate is effective in 2018, and fiscal year taxpayers whose tax year crosses 1/1/18 will get a pro-rated benefit of the new, lower rate in their current tax year. The corporate AMT was repealed, and the dividends received deduction was reduced. Many businesses will see a significant change to their accounting for income taxes, and either a substantial benefit or charge in the current year.
Most business use tangible personal property (and some improvements) will be subject to a 100% write-off for tax purposes either through expensing or new 100% bonus depreciation (was 50% previously), retroactive back to assets placed in service after 9/27/17. Automobile depreciation annual limitations were also eased. Many tax credits were repealed, but the R&D credit, work opportunity tax credit, historic rehabilitation credit, and low-income housing tax credit were among those retained. Current rules around issuance of tax-exempt private activity bonds were also left intact.
For many types of businesses, interest expense will now only be deductible up to 30% of adjusted taxable income (ATI), which is roughly equivalent to EBITDA, and net operating losses (NOLS) after 2017 will mainly only be allowed as carryforwards with no carrybacks. These NOLS will only be able to offset 80% of taxable income in future years, versus 100%, but they will also never expire (current NOLS expire after 20 years, if unused).
Like-kind exchanges after 2017 will be for real property only. Expenses for entertainment will no longer be deductible, and there will be more restrictions on the deductibility of meals. The domestic production activity deduction (DPAD), basically 9% of taxable income if qualified, is repealed. Publicly-traded companies will have further limitations on the deductibility of compensation to covered employees.
If you're a pass-through company...
Another highly significant change is in the taxation of income from pass-through entities (partnerships, LLCs, S corporations). Starting in 2018, up to 20% of qualified business income will be treated as a deduction. There are a number of limitations and phase-outs for professional service firms above specified income levels. Also, any amount deemed reasonable compensation of an S corporation shareholder or guaranteed payments to a partner would be excluded from qualified business income. Paired with this provision is one that also limits excess business losses on individual returns above specified thresholds.
Tax accounting methods are being eased for businesses with under $25 million in average gross receipts. Generally, they can change to the cash method of accounting, not have to maintain inventories, and be exempt from the uniform capitalization rules. Contractors under the $25 million limit can generally use the completed contract method (up from $10 million previously).
So, that’s a lot of information and by no means everything in this bill. The President will sign the bill soon, but because of various budgetary and other formalities, it might be in the next few days or even right after New Year’s.
What should I do right now to prepare?
Consult with your tax partner on accelerating deductions into 2017 while there’s still time (including those deductions that are repealed after 2017), and deferring income into 2018. This also includes acceleration of asset purchases into 2017 that qualify for 100% bonus depreciation, engaging a cost segregation study to be completed for the 2017 return, authorizing and accruing rank-and-file bonuses in 2017 and paying them by 3/15/18, considering an R&D study for the 2017 return to take advantage of higher tax rates, evaluating accounting methods in conjunction with 2017 return preparation, assessing the accounting for income tax ramifications and more.
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