New Year – New Tax Laws: An Overview of the “Tax Cuts & Jobs Act of 2017”Submitted by Orange CA Financial Advisor | Sterling Wealth Partners on January 8th, 2018
After much debate and speculation, the Republican’s tax reform package was signed into law by President Trump just before Christmas. The Tax Cuts & Jobs Act of 2017 is a pretty significant tax reform package and will likely affect you (some positively and others negatively) starting with your 2018 income tax return. While the new tax bill is law, it will sunset on 12/31/2025 unless Congress extends it before then. This sets up a situation like that of the “Fiscal Cliff” we faced in 2013.
Here are some of the major provisions of TCJA 2017 for individual taxpayers:
New Tax Brackets – There will now be 7 tax brackets (10, 12, 22, 24, 32, 35, 37). The top bracket has been reduced from 39.6% and the income level where the top bracket starts was raised significantly. The three current capital gains brackets (0%, 15%, 20%) remain but do not line up with the new tax brackets.
Increase in the Standard Deduction – The standard deduction (which you can use if you do not itemize) has been increased to $12,000 (from $6,350) for single filers and $24,000 (from $12,700) for married filers. If your itemized deductions are lower than this amount, and they very well could be based on new limitations discussed later, you may not need to itemize your deductions going forward. The increase in the standard deduction is an attempt to simplify tax filing for most people.
Elimination of the Personal Exemption – While the tax bill increased the standard deduction, it took away the personal exemption. This was a per person deduction ($4,050 for 2017) that was allowed for the taxpayer and their dependents. This could potentially increase taxable income even with the increase in the standard deduction. For example, a family of four would have had $18,000 in personal exemptions (4 people @ $4,050 per person) that will no longer be available. For 2017, they would have a $12,700 standard deduction and $18,000 of personal exemptions which reduces their taxable income by $30,700. In 2018, this same family of four will have a $24,000 standard deduction but no exemptions so their income would be $6,700 higher.
Cap on State & Local Tax Deduction – This is one of the provisions in the bill that was changed last minute. The new law does allow you to deduct state and local taxes (property & income taxes), however they placed a $10,000 cap on the amount that can be deducted. This limitation will clearly affect those people living in high income tax states and those with high property taxes like California.
Cap on Mortgage Interest Deduction – The mortgage interest loan amount has been reduced from $1,000,000 to $750,000 for loans starting after 12/15/2017. There had been a proposed reduction to $500,000 so this is an improvement in the final law.
Elimination of Mortgage Deduction for Home Equity Indebtedness – While you are still able to deduct mortgage interest for loans to purchase or improve your home (up to a $750,000 loan), you will not be able to deduct home equity loans which are considered home equity indebtedness. What this means is that funds from home equity loans that are used for purposes other than improving your home (for example paying for college or buying a car) will no longer be deductible. Under the old rules, you could deduct interest on up to $100,000 of home equity indebtedness. The elimination of this deduction applies to all loans, not just new ones, starting in 2018.
Elimination of Itemized Misc. Deductions – Many miscellaneous itemized deductions like tax preparation fees, unreimbursed employee expenses and investment expenses are no longer deductible. Previously they were deductible subject to a floor of 2% of adjusted gross income.
Improved Medical Expense Deduction – Medical expenses are normally deductible as long they exceed 10% of adjusted gross income. However, TCJA 2017 lowered the threshold to 7.5% of adjusted gross income for both 2017 and 2018.
Increase in Alternative Minimum Tax Exemption – While the personal alternative minimum tax (AMT) was not repealed as originally proposed, the exemption level for the AMT was increased by roughly 39%. This, along with the reduction in various itemized deductions, should substantially reduce the number of taxpayers who will be subject to the AMT.
Increase in the Estate & Gift Tax Exemption – The estate and gift tax exemption were doubled from 2017 levels. For 2018, the exemption from estate tax is $11,200,000 for single individuals and $22,400,000 for married couples. At this level of exemption, 99.9% of the US population will not need to be concerned about the estate tax.
Elimination of Roth IRA Re-characterizations – The strategy of “undoing” a Roth IRA conversion after the fact (a re-characterization) has been eliminated. The strategy was an effective way to change your mind on a Roth IRA conversion if the account balance on the Roth had gone down after the conversion. Going forward, once you have converted to a Roth IRA you will be stuck with the results even if they ended up being negative from an investment return standpoint.
TCJA 2017 is a significant and comprehensive piece of tax reform legislation. While it may reduce taxes, and simplify tax filing for many people, it could increase taxes for those who had large itemized deductions like state and local taxes. Keep in mind that almost all these provisions are only effective starting in 2018 and your 2017 return should be largely unaffected. If you would like more information about TCJA 2017 or would like a complimentary tax analysis, please contact us.