On December 20, 2017, Congress passed the Tax Cuts and Jobs Act (H.R. 1) designed to cut taxes on individuals and businesses, stimulate the economy, and create jobs. The tax cuts are projected to cost the government nearly $1.5 trillion, but the long-term impact on the deficit is unclear; the measure adds to the deficit in the short term but could reduce it in the long term if predictions of economic growth come true. This article summarizes of the key provisions affecting individuals. All of the following provisions apply starting in 2018 unless otherwise noted. Most of the provisions for individuals are temporary; they expire after 2025 unless Congress takes further action.
Tax Rate Reduction
The linchpin to this tax legislation is a reduction in individual tax rates. While the current number of tax brackets has been retained, each one has been reduced slightly.
The brackets for individuals are cut to 10%, 12%, 22%, 24%, 32%, 35%, and 37% [Internal Revenue Code (IRC) section 1]. The top tax rate applies to joint filers with taxable income over $600,000 (single filers over $500,000).
Tax rates for owners of pass-through entities.
There is no special tax rate or cap for taxes on pass-through income. There is, however, a new 20% deduction for business income, although many restrictions apply that prevent this break from being claimed by most attorneys, accountants, and many other professionals (IRC section 199A).
Capital gains and dividends.
The 15% and 20% tax rates on long-term capital gains and qualified dividends have been retained; those in the 10% or 12% tax brackets pay zero tax on these gains and dividends. Also, while there had been proposals to require the use of the first-in, first-out method to determine basis on the sale of stock and mutual fund shares, rather than allowing investors to designate which shares are being sold when shares were acquired at different times, this measure was not included in the final package.
Alternative minimum tax.
The tax rates for the alternative minimum tax (AMT) are retained, but the exemption amounts are increased (IRC sections 53, 55–59). More specifically, the exemption amounts increase to $109,400 for joint filers, $54,700 for married filing separately, and $70,300 for other filers. The phaseout threshold increases to $1 million for joint filers and $500,000 for other filers; phaseout amounts are indexed for inflation after 2018. In addition, the current 10% of adjusted gross income (AGI) threshold for medical expenses deductible for AMT purposes is decreased to 7.5% of AGI for 2017 and 2018.
The personal and dependency exemptions are repealed, while the deduction for student interest that had been slated for repeal is retained. Other changes to deductions include the following:
The alimony deduction is eliminated, but only for payments under agreements entered into or substantially changed after 2018 (IRC section 71). This means that recipients of alimony under agreements entered into or substantially changed after 2018 will not be taxed on the payments they receive. The deduction for moving expenses is also repealed, except for members of the military (IRC section 217). A deduction for legal fees and court costs in whistle-blower cases has been added.
The standard deduction increases to $24,000 for joint filers, $18,000 for heads of households, and $12,000 for other filers; these amounts are indexed for inflation after 2018. The additional standard deduction amounts for age and blindness have been retained. Currently, about two-thirds of individuals claim the standard deduction; this number is expected to increase when the higher standard deduction amounts are implemented.
Many of the itemized deduction rules have changed:
- The medical deduction is retained, with the 7.5% of AGI floor retained for all taxpayers for 2017 and 2018 (IRC section 213). After 2018, the threshold returns to 10% of AGI.
- The cap for deducting mortgage interest for buying or building a home is reduced from the current $1 million cap to $750,000; no interest is deductible for home equity debt [IRC section 163(h)].
- The deduction for state and local income, property, and sales taxes (SALT) is capped at $10,000 (IRC section 164). This is a substantial reduction from the former rule allowing all property taxes, plus all state and local income or sales taxes, to be itemized. Prepaying 2018 state and local income taxes in 2017 will not help; no deduction in 2017 is allowed for such prepayment.
- The percentage of AGI for charitable contributions is increased from 50% to 60% for cash donations, but no deduction is allowed for donations in exchange for college athletic event seating rights (IRC section 170). The cents-per-mile rate for driving for charitable purposes remains at 14 cents per mile.
- The casualty loss deduction is repealed, except for losses in federally declared disasters (IRC section 165).
- Miscellaneous itemized deductions subject to the 2% of AGI floor, such as unreimbursed employee business expenses and tax preparation fees, are repealed (IRC sections 61, 67, and 212).
- The phaseout of itemized deductions for high-income taxpayers is also repealed.
The deduction for state and local income, property, and sales taxes (SALT) is capped at $10,000. This is a substantial reduction from the former rule.
Despite various proposals in the House bill, the final measure retained most current tax credits, including the child and dependent care credit, the credit for the elderly and permanently disabled, and the credit for plug-in electric drive motor vehicles. Some credit changes, however, have been made:
Child tax credit.
The amount of the credit increases to $2,000 per qualifying child, up from $1,000 (IRC section 24). The refundable portion of the credit increases to $1,400. There is a nonrefundable $500 credit for a qualifying dependent other than a qualifying child that applies through 2025. The AGI phaseout for the child tax credit increases substantially, but it is not indexed for inflation.
There are some modifications to the earned income tax credit (IRC section 32). The credit for nonbusiness energy property for installing improvements such as insulation or storm windows, which expired at the end of 2016, has not been extended.
The new law contains various other tax rules of note, including the following:
The shared responsibility payment for individuals mandate of the Affordable Care Act is repealed (IRC section 5000A); however, this change does not take effect until 2019. No changes have been made in the premium tax credit for those who choose to buy health coverage from a government marketplace.
Roth IRA conversions.
The ability to unwind a Roth IRA conversion by recharacterizing it as an IRA by October 15th is removed (IRC section 408A); thus, conversions are permanent.
IRC section 529 plans.
The use of these plans is expanded in two ways:
- Tax-free distributions up to $10,000 can be made for tuition at elementary and secondary schools, whether public, private, or religious (IRC section 529).
- Rollovers of funds from 529 plans to ABLE accounts—special savings accounts for the benefit of a qualified disabled individual—can be made on a tax-free basis (IRC sections 529 and 529A).
There had been proposals to change the rules for excluding gain on the sale of a principal residence (IRC section 121), but these proposals were not included in the final measure.
Estate and gift taxes.
These transfer taxes are retained, but the $5 million exemption amount doubles to $10 million (IRC sections 2001 and 2010). The exemption is indexed for inflation after 2011, making it more than $11 million for 2018. For a couple, this means estates can be transferred tax-free up to $22 million.
First Steps to Implementation
The IRS is expected to release new withholding rules reflecting the new tax rates. Once employers have implemented them, workers will see an increase in their take-home pay, likely early in 2018.
Adapted with permission from the December 27, 2017 edition of the New York Law Journal © 2017 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.