New Tax Cut and Jobs Act – An Individual Perspective

We’ve heard a lot about proposed tax reform ever since the Presidential campaign.  Over the past year, there has been speculation about how to improve corporate tax rates, simplify individual tax filings, provide a middle-class tax cut, encourage reinvestment in the US and so forth.  Well, it appears that the Republican Congress has finally agreed on how to address these issues.  Congress just officially passed the Tax Cut and Jobs Act this afternoon and will be signed into law by President Trump.

As with most tax legislation, there are some immediate things to consider and there will be some new strategies developed as the provisions of the Act are further studied and reviewed.  Given the holiday rush and everyone’s limited time span, I thought I’d draft a quick letter regarding the provisions impacting individuals and provide a quick reference for some potential year-end planning.  For those with additional time or interest, I’ll send a follow-up summary of the Act’s provision, including the provisions impacting business.

Potential Year End Planning:

Personal Income Tax RatesThe Act has seven new tax brackets effective 1/1/2018 with the top rate at 37%.  Purely from a tax rate perspective, the new tax rates will generally create a lower tax at most income levels compared to the 2017 tax rates.  So, from a bracket management perspective, it may be advisable to defer income into next year and accelerate deductions this year (more to come on that).  All the rates sunset in 2025 back to our current rates.  The good news is the capital gains rate and qualified dividend rate did not change.  However, the normal recommendation to tax-loss harvest still applies to our portfolio management.

Itemized Deductions:  As most are aware, the Act eliminated many itemized deductions and doubled the Standard Deduction to $24,000 for couples.  This interplay will cause more taxpayers to take the standard deduction and not itemize.  Being forced to take the standard deduction could cause the loss of any tax benefit for itemized deductions (i.e. charitable gifts).  As a result, it may be advantageous to accelerate itemized deductions if you may be forced to take the standard deduction next year.  The one good piece of news is that the Pease limitation, which put an overall limit on itemized deductions, was repealed.

Specifically, here are the itemized deduction changes:

  • State & Local Taxes, Property Taxes: The deduction for all state and local income taxes and property taxes is limited to a combined amount of $10,000.  Many advisers have recommended prepaying such taxes in 2017 while they are fully deductible.  This may be an effective strategy for property taxes, but not state and local income taxes.  The Act includes an anti-abuse provision which disallows any deduction in 2017 for state and local income tax payments made in 2017 which are applied to a 2018 state or local income tax liability.  The anti-abuse provision doesn’t apply to property taxes; however, there may not be a benefit to prepaying your property taxes if you are subject to the Alternative Minimum Tax (AMT).  So, you should still pay your 4th quarter estimate for your 2017 state and local income taxes in December, as is typically advised, if based on your 2017 liability.
  • Unreimbursed Medical Expenses: This deduction was improved under the Act.  For 2017 and 2018, the income threshold to deduct medical expenses was lowered to 7.5% from 10%.  So, putting more medical expenses into this year and next year are advantageous.
  • Mortgage Interest Deduction: The Act limits the cap on mortgage interest deductibility to the first $750,000 of acquisition indebtedness.  However, it grandfathers the old $1M cap for mortgages taken out prior to 12/15/2017, including any refinancing of such mortgages.  Any deduction related to a home equity line of credit is now disallowed under the Act unless it’s used to purchase or improve the home.
  • 2% Miscellaneous Itemized Deductions: The common miscellaneous itemized deductions include tax preparation fees, safety deposit boxes, legal fees, unreimbursed employee expenses and of course our advisory fees.  Unfortunately, all miscellaneous itemized deductions are repealed and no longer allowed, so you may consider prepaying these expenses in 2017.  The  repeal of these expenses may not be as bad as it sounds, as most clients don’t get a tax benefit from these deductions anyway due to AMT.  With respect to your BRR fees, we will explore whether any of your fee can be deducted as attributable to business or if it’s more beneficial to pay advisory fees from an IRA.  Some have asked to prepay fees, but this again is of no benefit if you are subject to AMT. In addition, we may have some compliance issues around receiving fees in advance, so please contact us first if you are thinking of doing this.

Charitable Deduction: This provision was retained, and they also increased the limitation on deductibility from 50% to 60% of your adjusted gross income.  Thus, individuals making larger gifts or with charitable deduction carryover can deduct more.  If you’re a college sports fan, get a hold of your ticket office prior to year-end if you wish to receive a charitable deduction for payments made in exchange for athletic tickets.  The Act prevents any charitable deduction for payments in exchange for the right to purchase athletic tickets.

Alternative Minimum Tax (AMT):  Unfortunately, AMT was retained under the Act, but the exemption was substantially increased and the phaseout of the exemption occurs at higher income levels ($1M for married taxpayers).  This should greatly reduce the number of people impacted by AMT in the future.  As such, AMT items such as exercising incentive stock options should be delayed until next year.

529 Plans:  Under the Act, 529 accounts can be utilized on a tax-free basis to pay for private elementary and secondary school expenses up to $10,000 per year, per student.  Due to parliamentary issues in the Senate, the provision allowing 529s for homeschooling expenses was removed.  Parents and grandparents may wish to make some additional contributions to 529 plans for this purpose or utilize any overfunding of 529s for private school tuition.  On a related note, Ohio recently increased that Ohio deduction for contributions to 529s from $2,000 to $4,000.  529 Accounts can also be rolled over to ABLE Accounts used to benefit a disabled individual.

Estate Tax Exemption Increased:  The estate tax repeal saga will continue but in the meantime the Act doubled the lifetime exemption amount of $5.6M to $11.2M.  Because each spouse’s exemption is portable and can be transferred to a surviving spouse, a couple can now pass $22.4M at death without any estate tax.  This will further reduce the number of people who need to worry about the estate tax.  However, this provision sunsets in 2025 and other political affiliations have expressed the desire for significantly lower exemption amounts.  Fortunately, the Act retained a step-up in basis on the assets of a decedent.

The gift tax was retained as is.  The retention of the gift tax is to reduce income tax gaming.  For example, transferring assets to lower bracket taxpayers prior to a sale (or death) then having them transfer proceeds back to the original owner.  However, with exemption amounts at this level, taxpayers may look to play some income tax games.

So, with respect to individual taxes, things really didn’t change that much.  I wouldn’t call this significant tax reform or simplification for individuals.  We have the same number of rates, many of the same deductions, AMT, capital gains rates, 3.8% investment surtax, estate tax and many other provisions that were retained.  The significant changes came on the business tax side and I would argue that those aren’t very simple, either.  Due to Congressional rules, this legislation is not permanent and generally sunsets in 2025.  So, this is likely not the last word on tax legislation for individuals.