Tax Planning for Effective Dates and Expiration Dates under the New Tax Law (article)
Even though the President signed the tax bill known as the Tax Cuts and Jobs Act into law on Dec. 22, 2017, it will take months to fully understand the overall impact. The Act provides many changes for individuals and business that mostly take effect beginning in 2018. Some are permanent and some expire after 2025. Having a good list of start and end dates is important to understanding the Act’s long-term impact. Furthermore, Congress and Treasury are beginning to work on addressing technical corrections and providing regulations and guidance for the new provisions, which should help make planning less uncertain over the coming months.
First, here are some of the most important milestones.
- Jan. 1, 2017 - Medical expenses are deductible if they exceed 7.5 percent of adjusted gross income (until Dec. 31, 2018)
- Dec. 14, 2017 - Grandfather date for the $1 million mortgage interest deduction limits. Mortgages incurred after this date is subject to a $750,000 indebtedness limitation.
- Jan. 1, 2018 – Effective date for most of the Act’s provisions (e.g., individual tax rate changes)
- Jan. 1, 2019 - Medical expense are deductible if they exceed 10 percent of adjusted gross income (AGI)
- Jan. 1, 2019 - Alimony payments are not deductible by the payor or included in income of the recipient (for new divorces or modified agreements expressly incorporating the new rules)
- Jan. 1, 2019 – Affordable Care Act’s shared responsibility payment for individuals (penalty for not maintaining minimum essential coverage) eliminated
- Dec. 31, 2025 - Expiration date for most of the Act’s provisions affecting individuals
- Expiring provisions include the individual income tax rate reductions, standard deduction increases, deduction limitations and repeal, increased AMT exemptions, pass-through business income deduction, and estate/gift/GST exclusion/exemption increases
- Permanent provisions include the corporate income tax rate reduction and the three-year holding period for carried interests
Individual and estate and gift provisions that expire after 2025 will revert back to the rules that applied in 2017, absent additional legislation. And remember, the 3.8 percent net investment income tax along with the 0.9 percent additional Medicare tax that were part of the Affordable Care Act were not altered under the new law. However, the shared responsibility payment (individual mandate) is eliminated for health coverage status months beginning after Dec. 31, 2018.
Considerations for Business Owners
Sole proprietorships and owners of pass-through businesses (partnerships, LLCs taxed as partnerships, and S Corporations) enjoy a new tax deduction equal to 20 percent of qualified business income. If the owner is in the highest tax bracket of 37 percent, the qualified business income would be taxed at an effective rate of 29.6 percent. The deduction is available to individuals, trusts, and estates. But like many other individual provisions, this new 20 percent deduction expires for taxable years beginning after Dec. 31, 2025.
There are several limitations that impact whether one can take the deduction, including:
- The income must be from a U.S. business
- Qualified business income includes the ordinary income and deductions of a trade or business, but excludes most investment type income such as dividends and interest
- Guaranteed payments to partners and reasonable compensation paid to S Corporation shareholders are not included
- Income generated from the business of being an employee will not qualify
- Income generated from a “specified service trade or business” will not qualify, including any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, and
- The deduction is capped at an amount that is the greater of (i) 50 percent of W-2 wages paid by the qualified business or (ii) 25 percent of W-2 wages paid plus 2.5 percent of the unadjusted basis of qualified depreciable property used in the qualified business
- Guaranteed payments to partners are not included, although W-2 wages paid to S corporation shareholders may be included
Neither the specified service trade or business limitation nor the W-2 wage or wage plus property cap apply if the taxpayer’s taxable income does not exceed $157,500 ($315,000 for married taxpayers filing a joint return). The W-2 wages or qualified depreciable property limitations are then phased in, and only apply fully when a taxpayer’s taxable income exceeds $207,500 ($415,000 for married taxpayers filing a joint return).
Individual Tax Provisions
As previously stated, most provisions under the Act that are directed toward individuals are effective in 2018 and expire after 2025. Among these provisions, income tax rates were reduced and the brackets changed. There are seven tax rates with the highest rate at 37 percent. The Kiddie tax was simplified and tied to the tax rates and brackets of trusts, instead of the parent’s rate, on net unearned income of the child. The AMT exemptions for individuals were increased and will be adjusted for inflation (however, the AMT exemptions were not increased for trusts and estates).
Also among these temporary provisions, the standard deduction was increased to $12,000 for single taxpayers and $24,000 for married taxpayers filing jointly, but personal exemptions were repealed. The child tax credit is increased to $2,000 per qualifying child (of which $1,400 is refundable), and a $500 nonrefundable credit is provided for qualifying dependents other than qualifying children. Cash contributions to public charities are deductible up to 60 percent of AGI. Investment fees are no longer deductible, along with other miscellaneous itemized deductions. Itemized deductions for state and local income and property taxes are limited to a total of $10,000. This limitation generally does not apply to state and local income or property taxes imposed on a pass-through entity itself. However, this limitation does apply to trusts.
Other temporary provisions impacting individuals include a reduction to the amount of mortgage debt upon which interest is deductible, for acquisition of a principal residence. The maximum amount of indebtedness incurred after Dec. 14, 2017 is $750,000. Mortgage debt incurred before Dec. 15, 2017, is grandfathered under the existing rules that allow a maximum amount of indebtedness equal to $1 million. The deduction for home equity debt was repealed (regardless of when the indebtedness was incurred).
Some individual provisions do not expire. Section 1031 like-kind exchanges are limited to real property that is not held for sale, but personal property is no longer eligible. Alimony payments are not deductible by the payor or included in income of the recipient for divorces or separation agreements (or modified agreements expressly adopting these rules) after Dec. 31, 2018. Section 529 plans were expanded to include K-12 education expenses, but are limited to $10,000 a year per beneficiary.
Estate Planning Considerations
Estate, gift and generation-skipping transfer (GST) taxes were not repealed as originally proposed. Provisions for basis carryover for lifetime gifts and basis step up on most assets transferred at death remain unchanged. The 2018 lifetime exemption and GST lifetime exemption is expected to be $11,180,000 for each individual ($10 million adjusted for inflation). The exemption will adjust each year for inflation and will expire Dec. 31, 2025, reverting back to 2017 figures ($5 million adjusted for inflation). Regulations will be needed to address the treatment of potential clawback issues with respect to the increased exemption amounts, when those increased levels are used to make gifts and where those levels are potentially reduced (e.g., because of the Dec. 31, 2025 expiration) by the time of the donor’s death.
Corporate Tax Changes
Unlike the individual provisions that expire after 2025, corporate tax provisions were made permanent under the Act. The corporate income tax (applicable to C Corporations) has been reduced to a flat 21 percent rate with no expiration date, a 40 percent reduction from the current maximum rate of 35 percent. Corporate AMT has been repealed. The dividend received deduction is reduced accordingly and dividends received from foreign subsidiaries are 100 percent exempt. Again, these provisions do not expire.
As can be seen, the effects of the Act will not all be immediate and some provisions will expire in the future. It is important to discuss the opportunities and impact to avoid unintended results. Changes and clarification will take some time for Congress and Treasury to address. Given the significant tax changes in 2018, planning will be a challenge and it is important to understand the implications that the Act has on each particular situation. Contact your CBIZ MHM tax advisor to discuss the Act’s impact on you and your business and estate.
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