President Trump signed the Tax Cuts and Jobs Act (the “TCJA” or the “new law”) into law on December 22, 2017, and it makes wholesale revisions to the Internal Revenue Code (the “Code”), affecting both individuals and businesses. The changes to the Code include modifications of income tax rates, deductions and credits, international corporate taxation, and many other tax rules. The new law will take effect on December 31, 2017, and, due to the Senate’s budget constraints, will expire after 2025; at that time, the Code will revert to the old law unless Congress elects to preserve the TCJA. Returns for the 2018 will be the first to apply these new rules.
What follows is a summary of the new law’s revisions to the Code, and their effects on both individuals and entities. CLICK HERE to see the new tax brackets for 2018.
The TCJA eliminates the personal exemption in favor of a higher standard deduction.
The TCJA repeals the overall limitation on itemized deductions. Under old law, the total amount of otherwise allowable deductions was limited for certain upper-income taxpayers under § 68 of the Code.
ALTERNATIVE MINIMUM TAX (AMT)
The new law temporarily increases the exemption amount and the exemption amount phase-out for the individual AMT to $70,300 ($109,400 for married couples filing jointly) and $500,000 ($1 million for married couples filing jointly) respectively. The exemption and phase-out are indexed for inflation. These changes take effect for the tax years beginning after December 31, 2017 and expire January 1, 2026.
The corporate AMT is permanently repealed.
PASS-THROUGH INCOME DEDUCTION
The TCJA provides owners of pass-through entities (LLCs, S Corporations, general partnerships, and sole proprietorships) a 20% deduction on qualified business income. This deduction is limited to $315,000 for married couples filing a joint return and $157,500 for individual taxpayers operating a personal service business. For the purposes of this revision, “qualified business income” includes the net amount of qualified items of income, gain, deduction, and loss with respect to the individual’s qualified trade or business; these items must be effectively connected to the conduct of a trade or business within the US. “Qualified business income” does not include a shareholder’s reasonable compensation, guaranteed payments, or payments to a partner who is acting in a capacity other than partner.
STATE AND LOCAL TAX (SALT) DEDUCTIONS
The new law limits the itemized deduction for SALT to $10,000, taking state and local property, sales, and income taxes into consideration. Alternatively, the TCJA continues to allow unlimited SALT deductions in carrying on a trade or business. Foreign real estate taxes do not apply to the deduction.
MORTGAGE INTEREST DEDUCTIONS AND HOME EQUITY LOANS
The new law allows taxpayers to claim mortgage interest deductions on up to $750,000 in mortgage debt, which is down from $1,000,000 under old law. This change does not affect homeowners who already have a mortgage, and the old deduction limit will apply.
Further, the new law suspends deductions on home equity loans until 2025.
MINORS’ UNEARNED INCOME (KIDDIE TAX)
The “Kiddie Tax” applies to children under the age of nineteen (or twenty-four if the child is a student) whose net unearned income exceeds $2,100 in a taxable year. The new law splits this income into two parts, where the amount up to $2,100 is taxed at the child’s rate, and the amount exceeding $2,100 is taxed at the parents’ rate (see above tables for applicable rates).
ESTATE, GIFT, AND GENERATION-SKIPPING TRANSFER TAX
While the House’s version of the bill proposed to repeal the estate tax, the final version of the Tax Cuts and Jobs Act keeps the estate tax intact. The final law increases the lifetime estate and gift exclusion from $5,000,000 to $10,000,000 (this amount is adjusted for inflation, so while the exclusion was $5,490,000 in 2017, that amount would double to almost $11,000,000). This means that if a taxpayer’s taxable estate is less than or equal to $10,000,000, the estate would not incur any tax liability.
NOTABLE PROVISIONS FOR INDIVIDUALS
Miscellaneous Itemized Deductions: Prior to the amendments imposed under the TCJA, miscellaneous itemized deductions could only be claimed to the extent the deductions exceeded 2% of a taxpayer’s adjusted gross income. The new law, however, suspends all deductions that were previously affected by this limitation until 2025.
Alimony: Under old law, alimony and separate maintenance payments were included in the recipient’s gross income and deductible by the payor. The new law amends this treatment by disallowing a deduction by the payor. This change applies to any divorce or separation agreement entered into after December 31, 2018.
Retirement Accounts: The laws pertaining to the permitted contributions to retirement accounts (401(k)s, IRAs, and Roth IRAs) are largely untouched by the TCJA. However, the new law prevents the recharacterization of contributions to unwind a Roth IRA. For example, contributions to a traditional IRA that are later recharacterized to Roth contributions are not permitted. Alternatively, contributions to Roth IRAs can be recharacterized to traditional IRA contributions before the individual files his or her tax return.
Limitations on Losses: Beginning December 31, 2017 through January 1, 2026, excess business losses incurred by a taxpayer other than a corporation will not be allowed, and will be considered part of the taxpayer’s net operating losses that can be carried forward. Excess business losses are the excess of aggregate deductions of the taxpayer attributable to the taxpayer’s trade or business over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount; the threshold amount for a taxable year is $250,000, which is indexed for inflation. This provision will apply at the partner (partnership) or shareholder (S Corp.) level after the passive laws rules in § 469 of the Internal Revenue Code have been applied.
Medical Expenses: The TCJA expands the deduction for unreimbursed medical expenses, reducing the threshold from 10% to 7.5% of adjusted gross income.
Contributions to Public Charities: The percentage limit for cash contributions to public charities increases from 50% to 60%.
Child Tax Credits: Married couples filing jointly earning up to $400,000 in gross income a permitted to claim $2,000 in credits per child, and $1,400 is refundable. For other taxpayers, the credit phases out after $200,000 in gross income.
Casualty Losses: Taxpayers can only claim a deduction for casualty losses in presidentially declared disasters under the new law.
Moving Expenses: The exclusion from gross income and wages for qualified moving expense reimbursements is suspended through 2025. This provision does not apply to members of the armed forces on active duty who move pursuant to a military order.
Affordable Care Act Individual Mandate: The individual mandate imposed under the Affordable Care Act will be repealed starting in 2019, and those who do not choose to purchase a health insurance plan pursuant to the ACA will not incur penalties.
NOTABLE PROVISIONS FOR BUSINESSES
§ 179 Expensing for Depreciable Assets: The new law increases the maximum amount a taxpayer may expense under § 179 of the Code to $1 million, and increases the phase-out threshold amount to $2.5 million; the amounts are indexed for inflation for the taxable years beginning after 2018.
The TCJA further expands the definition of § 179 property to include certain depreciable tangible property used predominantly to furnish lodging or in connection with furnishing lodging. The new law expands the definition of qualified real property eligible for § 179 expensing as well, allowing the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs, heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
Net Operating Losses: The TCJA limits the deduction for net operating losses to 80% of taxable income (determined without regard to the deduction). Taxpayers may carry net operating losses forward indefinitely. The two-year carryback and special net operating loss carryback provisions are repealed.
Certain Self-Created Property Not Treated as a Capital Asset: The new law amends § 1221(a)(3) of the Code, and excludes patents, inventions, models or designs (whether or not patented), and secrets formulas or processes (whether self-created or purchased) from the definition of “capital asset,” and the sale of these assets will not be considered a capital gain or loss.
Like-Kind Exchanges: Like-kind exchanges falling under § 1031 of the Code are limited to exchanges of real property that is not held primarily for sale. The new law generally applies to exchanges completed after December 31, 2017; however, this provision does not apply if property was disposed of in the exchange prior to December 31, 2017 or if property was received prior to that date.
Entertainment Expenses and Fringe Benefits: The TCJA disallows a deduction with respect to (1) an activity generally considered to be entertainment, amusement, or recreation; (2) membership dues with respect to any club organized for business, pleasure, recreation, or other social purposes; or (3) a facility or portion thereof used in connection with any of the above items.
Additionally, the new law disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, and except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.
Meals: For amounts incurred and paid between December 31, 2017 and December 31, 2025, the TCJA expands the 50% deduction limitation for employee meal expenses to those expenses associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer. The amounts incurred and paid after December 31, 2025 will not be deductible.
Partnership Technical Terminations: The new law repeals the rule from § 708(b)(1) of the Code providing technical terminations of partnerships. The provision does not change the present-law rule of § 708(b)(1)(A) that a partnership is considered as terminated if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.
Amortization of Research and Experimental Expenditures: The new law requires businesses to capitalize and amortize ratably over a five-year period amounts defined as specified research or experimental expenditures. Specified research or experimental expenditures that are attributable to research that is conducted outside the US must be capitalized ratably over a 15-year period.
Year of Inclusion: The TCJA requires accrual-method taxpayers subject to the all-events test to recognize items of gross income for tax purposes in the year in which they recognize the income on their applicable financial statement. The new law provides an exception for taxpayers without an applicable or other IRS-specified financial statement.
Compensation for Covered Employees: The TCJA revises the definition of a covered employee under § 162(m) of the Code to include both the principle executive officer and the principle financial officer, and reduces the number of other officers included to the three most highly compensated officers for the tax year. If the individual is a covered employee for any tax year after 2016, that individual will remain a covered employee for all future years. The new law also removes current exceptions for commissions and performance-based compensation. The new law does not apply to any remuneration under a written contract that was in effect on November 2, 2017, and that was not later modified in any material respect.
FOREIGN INCOME TAXATION
Territorial Taxation System: The TCJA shifts to the territorial tax system, which imposes US tax on domestic income. This is opposed to the old, worldwide system, where the US taxed income earned from both foreign and domestic sources.
Foreign-Source Income: The new law allows an exemption for certain foreign income by means of a 100% deduction for the foreign-source portion of dividends received from specified 10% owned foreign corporations by domestic corporations.
Foreign Tax Credit: No foreign tax credit or deduction will be allowed for any taxes paid or accrued with respect to a dividend that qualifies for the deduction.