In December, the most extensive tax legislation since 1986 was passed by Congress and signed by President Trump. With the April 15th tax deadline in the rear view mirror, taxpayers and accountants can now turn their attention to the impact that the new law will have on 2018 tax planning.
The change most widely discussed has been the limitation placed on itemized deductions. In the past, all property and state and local income taxes were fully deductible. Beginning in 2018, that deduction is capped at $10,000. In states with significant property and state income taxes, this ceiling may force many taxpayers to pivot from itemizing to applying the standard deduction instead.
The good news is that the standard deduction has been increased from $6,350 per person to $12,000. The bad news is that the personal exemption of $4,050 has been eliminated. On a net basis for a married couple with no dependent children, you can view these changes as a benefit of $3,200 ($24,000 - (12,700 + 8,100)).
Another notable change is the cap on deductible mortgage interest that has been reduced from mortgages of $1 million to $750,000. Another change that may have serious consequences for many taxpayers is the elimination of the deduction for alimony payments. As a result, the terms and amounts of divorce settlements will need to be adjusted to account for the tax ramifications of this revision.
Some miscellaneous expenses have actually increased their deduction while others have been eliminated. Medical expenses that exceed 7.5% of adjusted gross income rather than the former 10% rate can now be deducted. The percentage of adjusted gross income that is eligible to take advantage of charitable contributions has been increased to 60% from 50%. However, deductions for expenses such as tax preparation services, investment management fees and professional dues have all been eliminated. This loss of the deduction of management fees will have an impact on many of my clients and I encourage you to contact me if you have any questions.
The new tax law has created something called "pass through" business entities such as S Corps and sole proprietorships. For a single tax payer, the first 20% of net business taxable income is exempt up to $157,500 and reduced on a prorated basis up to $207,500. For joint filers, this income is exempt up to $315,000 and reduced on a prorated basis up to $415,000.
The purpose of the law is an attempt to level the tax playing field with C Corps. For business taxpayers whose income exceeds either threshold and engage in certain specialized industries such as health, law and accounting, there is no pass through deduction for any of their business income. This provision is under further review and has been subject to much interpretation and your accountant or attorney should be consulted before attempting to apply this law to your situation.
The use of 529 plans for qualified education expenses has been expanded. Instead of only being available to cover qualified education expenses at colleges and universities, funds can now be distributed tax free to pay for tuition only at private elementary and high schools as well. However, tax free distributions can only be applied up to a maximum of $10,000 per year.
In a long overdue attempt to tax C Corporations at a rate competitive with other countries, the maximum corporate tax rate was lowered from 35% to 21%. The intent of this reduction is to create an incentive for corporations to remain domiciled in the United States rather than locate to another country. If successful, the goal is that aggregate corporate income taxes will actually rise despite the reduction in the tax rate.
Finally, a technique that many astute taxpayers have used in the past has been eliminated. Formerly, an investor who converted an IRA to a Roth IRA and subsequently experienced a significant drop in the account value could re-characterize this conversion back to an IRA and negate the tax payment as long as it was done by the following October 15th. This tax planning strategy is no longer available as Roth conversions are now irreversible.
Taxpayers beware! While the tax cuts for businesses are permanent, they are temporary for individuals. Most individual provisions expire after 2025 unless Congress extends them.
Clifford L. Caplan, CFP®, AIF® Stephen Caplan
In the News: During the first quarter, I was quoted in three articles in two publications. On January 9th, I was quoted about the use of annuities for retirement income in an article titled "Retirement Pros Reveal Their Own Best Interests When It Comes To Their Retirement Plans" that appeared in FiduciaryNews.com. On February 28th, I was interviewed in Ebix.com about new rules passed by FINRA to prevent financial abuse of seniors in an article titled "FINRA Rules Take Effect to Protect Seniors & Vulnerable Adults from Exploitation". Finally, on April 24th, I was extensively quoted in an article in FiduciaryNews.com titled Is "Active Share" The New Phrenology?