Tax reform, commonly referred to as the Tax Cuts and Jobs Act, significantly revised the individual tax code for tax years starting in 2018. But the changes may keep coming, even for tax year 2017, says Tax Managing Director Doug Klein of BDO USA, LLP. The Bipartisan Budget Act, which temporarily resolved the federal budget crisis in February, included tax extenders that were retroactive to Jan. 1, 2017. It permits casualty losses to more than taxpayers residing in federally declared disaster areas, extends business credits, fixes depreciation and adds energy tax credits.
The government will likely continue to issue proposed rules or loophole shutdowns, but, overall, Klein expects Ohioans to come out ahead and pay fewer taxes.
Smart Business spoke with Klein about tax reform and the impact on individual tax returns, starting in 2018.
What are the biggest changes for individual taxpayers under the Tax Cuts and Jobs Act?
The individual tax rates for all taxpayers were lowered, generally as much as a 2 to 3 percent decrease. The top tax rate is now 37 percent (previously it was 39.6 percent).
Several above-the-line deductions were suspended or modified. The deduction for moving expenses has been suspended, except for military members with military orders. For agreements that start as of Jan. 1, 2019, alimony will no longer be a deduction for the paying spouse or includible in income by the receiving spouse. Prior agreements will be grandfathered under the old rules.
Similarly, many itemized deductions have been reduced or suspended beginning in 2018. Congress limited the state and local tax deduction, suspended 2 percent miscellaneous deductions, i.e., unreimbursed employee business expenses, and limited who is eligible to claim a casualty loss. The mortgage interest deduction is now limited to interest paid on acquisition indebtedness of up to $750,000. Mortgages obtained prior to Dec. 15, 2017, are grandfathered under the $1 million limitation. Interest paid on home equity lines of credit, not spent on acquisitions or improvements, are no longer deductible. For tax years 2017 and 2018, however, taxpayers can deduct medical expenses as long as they exceed 7.5 percent of their adjusted gross income.
Congress increased the standard deduction (roughly double the pre-tax act amount) but suspended all personal exemptions. The Alternative Minimum Tax has been retained, but its effects have been severely curbed by eliminating many addbacks. The child tax credits increased, as did the amount that is refundable. In terms of the estate tax, the lifetime estate and gift exemption, and the generation-skipping transfer tax exemption, increase to $11.18 million for all taxpayers, starting in 2018.
Nearly all of these changes affecting individuals are set to expire Dec. 31, 2025.
Who gets the biggest benefit? Who will be hurt the most?
Business owners are big winners. Tax rates for C-corporations dropped to 21 percent from 35 percent. Owners with businesses structured as pass-through entities, such as partnerships and S corporations, who meet stringent requirements, can combine lower individual tax rates with a special deduction.
Taxpayers in high tax brackets who reside in high income tax states, such as California and New Jersey, will see the biggest increases. The new law limits their federal deduction for state and local taxes not attributable to a trade or business to a combined total of $10,000, which includes income and real estate taxes, among others.
How should business owners, investors or high net worth individuals react now?
Many high net worth individuals, and virtually all businesses, are analyzing the impact of the deduction for qualifying business income against the lower C-corp. tax rate, and determining whether their default choice of entity makes sense (S-corp., C-corp. or partnership). CPAs can model various scenarios while considering the multinational impact. Businesses with foreign owners or offshore assets should undertake analysis now, as potential taxes may be due as soon as April 17, 2018.
Individuals should revisit estate planning, including trusts and charitable donation vehicles. Even though the exemption doubled, they can still plan and reduce taxes.
Always keep in mind that tax reform is a moving target, best navigated with persistence and patience.
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