Highlights of the Tax Reform Bill:
On December 22, 2017, President Trump signed one of the most sweeping tax reform bills in thirty years. Following are some of the more salient provisions, most of which are effective beginning January 1, 2018.
I. Individual Taxes:
1. Brackets and Rates:
Income Brackets – Individuals:
10% 0 to $9,525
12% $9,525 to $38,700
22% $38,700 to $82,500
24% $82,500 to 157,500
32% $157,500 to $200,000
35% $200,000 to $500,000
37% $500,000 and up
Income Brackets – Married Filing Joint:
10% 0 to $19,050
12% $19,050 to $77,400
22% $77,400 to $165,000
24% $165,000 to $315,000
32% $315,000 to $400,000
35% $400,000 to $600,000
37% $600,000 and up
2. Standard Deduction:
$12,000 – individual;
$18,000 head of household;
$24,000 married taxpayers.
3. Personal Exemption
4. Itemized Deductions:
• State and local taxes – (income, real estate, sales) limited to $10,000;
o Note: cannot prepay 2018 state or local income taxes into 2017;
o New York recently allowed prepayment of real estate 2018 taxes.
• Mortgage Interest
o New mortgages capped at $ 750,000;
o Home equity line of credit no longer deductible;
Does not exempt debt incurred for capital improvements;
o Existing mortgages remain capped at $1 million.
• Threshold % of AGI for deductible medical expenses lowered for 2018 to 7.5% of AGI from 10%.
• Miscellaneous deductions eliminated rendering nondeductible tax preparation fees, unreimbursed employee expenses, investment management fees.
• Casualty losses limited to declared natural disasters.
• Pease limitation, which reduced overall itemized deductions amounts based on income levels above a threshold, is eliminated.
• AGI limit for deductible charitable contributions increased to 60% – but limitations exist on pass through of deduction exist.
5. Alternative Minimum Tax (AMT):
• Not eliminated but AMT exemption amounts increased:
Single – $70,300;
Joint – $109,400.
Phaseout of exemption begins at $500,000 for single and $1,000,000 for married filing.
6. Passthrough Income Deduction:
• New deduction of 20% for “qualified trade or businesses;”
• Specified statutory formula for eligible amount applied on aggregate basis;
• Does not include investment income – interest, dividends, gains & losses from investment.
• S corps, partnerships, sole proprietorship, REITs, Coops, PTPs are eligible.
• Above does not include: “accounting, health, law, consulting, athletics, financial services, brokerage services, investment management, investing, trading, dealing in securities, partnerships or commodities, or any business where the principal asset is the reputation or skill of one or more of its employees” — architecture and engineering are specifically eligible for passthrough income deduction;
• As to the latter group, income below threshold amounts still eligible for 20% deduction;
• Threshold: $315,000 joint/ $157,500 single — certain limited adjustments possible based on combination of income and wages if above threshold.
Repeals above-the-line gross income adjustment for alimony agreements entered into post 2018.
• No income inclusion for recipient spouse
• Existing alimony agreements and agreements entered into during 2018 grandfathered.
• Gambling expenses for professional gamblers eliminated;
• Kiddie tax rate modified to individual rates for earned income; trusts & estates for balance.
• Nontaxable moving expense reimbursements repealed;
• Bicycle commuter expense reimbursements repealed.
9. Child Tax Credit:
• Increased to $2,000 per child;
• Phaseout for eligibility begins at $400,000 for joint filers;
• Refundable amount capped at $1,400 per child.
10. IRA Contributions:
• Re-characterization of IRA contributions limited.
11. Obamacare Individual Mandate:
• Penalty repealed.
12. 529 Plans:
• Eligible uses expanded to certain private education.
II. Estate & Gift Tax:
• Combined exemption for estate/gift/GST doubled commencing in 2018
Projected now, with inflation adjustment, at $11.2 million per individual taxpayer;
Increased exemption only to 2025.
Note: annual present gift exemption increased to $15,000 per individual donee. This is not part of new legislation, but inflation adjustment in existing tax code.
III. Business Tax:
1. Corporate Tax Rate:
• Reduced to flat 21% (no graduated rates);
• Corporate AMT repealed.
2. Expensing/Bonus Depreciation:
• Section 179 Expensing:
• Increased to $1 million;
• Phaseout for income starting at $25 million indexed for inflation;
• Expanded eligibility for building systems: roofs, HVAC, fire & alarm, security.
• Bonus Depreciation:
• Increased to 100% if placed in service after September 27, 2017 and before 2023;
• Phaseout: 2024 – 80%; 2025-60%, 2026-40%, 2027-20% (subject to certain exceptions for longer production property);
• Can elect to just claim 50% of costs as bonus;
• Also eligible are certain fruit and nut plantings.
• Luxury Auto Depreciation:
• Limits set at $10,000 year 1; $16,000 year 2; $9,600 year 3; $5,760 all subsequent years.
• Farm equipment:
• Now reduced five-year life.
• Real estate:
• Now 15-year life for certain “qualified improvement” property.
3. IRC Sec. 1031 Like Kind Exchange:
Tax deferral limited to real estate.
4. Business Interest Expense Limitations:
Interest expense limited to 30% of taxable income before depreciation, amortization or 179 expensing;
• Exception – average gross receipts below $25 million;
• Exception – certain real estate activities.
5. Net Operating Losses
• Carryback allowed only for farming
• Carryforward limited to 80% of income
• Qualified insurance also subject to special rules with existing carryback/carryforward of 2/20 applying
6. Accounting Methods
• Eligible thresholds for use of cash method increased to $25 million
• Uniform capitalization rules – exempt below $25 million
• Percentage of Completion exception for long term contracts – increased threshold from $10 million to $25 million in gross receipts
• Self-created intellectual property including patents, trade secrets, copyrights, musical compositions:
Excluded from capital asset definition and hence not eligible for capital gains.
• Partnership profits interests:
Must be held for 3 years for favored “carried interest” treatment.
• Paid-in-Capital Contributions:
• IRC Section 118 non-recognition exception for property contributions limited.
• IRC Section 199 Domestic Activities Production:
• Effectively repealed; one-year lag for corporate.
• Research and Development:
• Specified expenses can no longer be deducted in full but must be capitalized and amortized over a 5-year period if domestic and 15-year period if offshore – effective for costs incurred after 2021.
• Meals and Entertainment:
• Meals can still be deducted at 50% level, but entertainment is now nondeductible.
• Penalties and Fines:
• Remain nondeductible unless specifically identified as restitution.
• Legal settlements for sexual harassment and abuse:
• Nondeductible expense if subject to nondisclosure agreement.
• “Covered employees” of publicly-held corporations:
• $1 million deductible compensation cap not increased prospectively for commissions, performance based compensation including stock options, retirement plan amounts and amounts excludable from income.
• Lobbying Expenses:
• Deduction disallowed.
8. Tax Credits
• Orphan Drug Credit:
• Reduced to 25% from 50%.
• Qualified Rehab Tax Credit
• 10% credit repealed; instead 20% credit for certified historic structure
• Family Leave Wages Credit:
• New credit of 12.5% for wages paid for family and medical leaves if payments at 50% of normal wages; increases to 25% per each % wages paid > 50%.
IV. International Tax:
1. Tax free repatriation:
• Inbound foreign dividends tax-free;
• No foreign tax credit eligibility.
2. Income inclusion transition rule for foreign deferred earnings:
• Mandatory income inclusion for C corporations of post 86 earnings and profits;
10% or greater foreign corporate interests.
• Rate: 15.5% on earnings attributable to cash and cash equivalents; 8% on balance;
Payable over 8 years: 8% first 5 years; 15% year 6; 20% year 7; 25% year 8.
If there is an outbound inversion within 10 years the rate is increased to 35%.
• S corporations – need to elect to opt out.
3. Global Intangible Low Taxed Income (GILTI):
• Subject to mandatory inclusion akin to Subpart F income;
Formulaic amount derived from share of return on investment set at 10%;
Separate basket for foreign tax credit.
4. Royalty Export Incentive:
• 37.5% deduction for foreign derived intangible income; after 2025 rate goes to 21.875%.
5. Base Erosion Anti Abuse Tax:
• Payments made between domestic corporation and related parties that reduce withholding tax.
• Limited to larger corporations ($500 million+).
• Taxed at 11% effectively increased to 12.5% after 2025.
6. Hybrid Transactions:
• Transaction, series of transactions, agreement or instrument treated as interest or royalties for federal tax and not similarly treated under tax law of foreign counterparty country;
• Deduction disallowed.
7. Incorporation of Foreign Branch:
• Transferred losses disallowed; potential income inclusion – relevant consideration for “check the box.”
8. Repeal of Active Trade or Business Exception:
• Creates income recognition for outbound transfers of property even when used in active trade or business.
Following are some basic planning considerations. There is only a short window to plan in 2017 for tax law changes:
1. Given that itemized deductions are targeted for significant reduction, it may make sense to pay estimated state and local income and real estate taxes in December rather than waiting until January, where possible, to deduct in 2017 tax year. The legislation does not allow prepayment of 2018 state and local income taxes. However, real estate taxes can be prepaid where the state allows/accepts. New York specifically allows prepayment of 2018 real estate taxes in 2017.
2. Similarly, if medical expenses appear to be over the floor for deductibility, pay in 2017 rather than 2018, if possible.
3. If a divorce is pending, consider finalizing alimony settlement in next year.
4. Consider re-characterizing Traditional to Roth IRA before year-end.
5. Review prior year tax returns for potential utilization of minimum tax credit carryforward.
6. Debt structure in businesses should be reviewed with an eye toward potential deductibility limitations.
7. Like kind exchanges that do not involve real estate should be accelerated to close prior to year-end.
8. Consider deferring into 2018 additional gifting to next generation when exclusion could be doubled if gifting creates a gift tax liability.
9. Evaluate estate plan in light of potential opportunities that arise from increased exemption amounts.
10. Re-examine global structure to be ready to take advantage of potential entity reduced rates and inbound incentives as well as potential new rules relative to sourcing of inventory and costs.
11. Re-examine global structure in light of new treaty and other denoted limitations for multinationals.
12. Accelerate into current year any sales or licenses deemed to be sales under the tax code for self-created intangibles.
13. Accelerate any year research and development expenditures into 2017 where possible.
14. For multinationals currently eligible for active trade or business exception, effectuate any eligible outbound property transfers prior to year-end.
Contact your Janover Tax Advisor for the latest updates and tax planning strategies.