This tax season has given me an opportunity as a tax professional to provide greater value to my clients. In addition to reviewing a summary of this year’s vs. last year’s results, I’m also sharing a preview of how the new tax law, formally known as the Tax Cuts and Jobs Act, is projected to affect them. I preface the discussion by explaining that the rules generally apply from 2018 through 2025.
Deductions Watered Down or Eliminated
I show clients an overlay of the new rules using their 2017 income and deductions. Given the fact that my firm is located in California, I begin by discussing the change that impacts the majority of my clients the most, i.e., the limitation of tax deductions to a maximum of $10,000. Many of my clients will lose tens of thousands, and in several cases, in excess of $100,000 (ugly), of state income and real estate tax deductions in 2018 and future years due to this single change.
The ability to take other itemized deductions has been eliminated, although these are more situational specific. This includes interest on home equity lines that aren’t used to acquire, construct, or to substantially improve one’s home.
Miscellaneous deductions in excess of 2% of adjusted gross income, which include tax preparation and tax planning fees, have also gone by the wayside. Individuals with large amounts of unreimbursed employee business expenses or nonretirement account investment management fees are most impacted by this change. Personal exemptions of $4,050 per person are also a thing of the past.
The elimination of formerly deductible expenses, combined with a significant increase in the standard deduction (see “Non-Itemizers and Parents Benefit” below), will likely impact charitable giving. Please see my November 20, 2017 post, Charitable Giving Cut for Middle-Income Taxpayers in Tax Cuts and Jobs Act.
Decrease in Tax Rates
Once I’ve totally depressed my clients, especially those affected by all four of the foregoing changes, I transition into talking about areas that will positively impact their tax situation. The most favorable change for most individuals is the decrease in marginal tax rates.
With the exception of the 10% and 35% rates which don’t change and the 33% rate which drops 1% to 32%, the other four tax rates decrease by 2.6% to 4%. The former top tax rate of 39.6% is now 37%.
In addition to lower tax rates, higher-income taxpayers will benefit from an increase in the income ranges affected by the new rates. As an example, if you used married filing joint status in 2017, taxable income between $238,000 and $315,000 was taxed at a 33% rate. The same income in 2018 will be subject to a 24% rate, or 9% less.
Non-Itemizers and Parents Benefit
Taxpayers who have been taking the standard deduction in lieu of itemizing their deductions will realize tax savings from enlargement of the deduction beginning in 2018. For single taxpayers, it increases from $6,350 to $12,000. Married couples will also see their standard deduction almost double, going from $12,700 to $24,000. There’s an additional deduction of $1,300 for the aged or the blind.
Individuals with children, who were previously limited to a child tax credit of $1,000 which was phased out with adjusted gross income (AGI) above $75,000 for single taxpayers and $110,000 for joint filers, will realize additional tax savings. Under the new tax law, the credit increases to $2,000 per qualifying child with the phaseout decreasing at AGI of $200,000 and $400,00 for single and joint taxpayers, respectively.
Additional Relief for Higher-Income Taxpayers
For higher-income taxpayers, the “Pease limit” on itemized deductions, which resulted in the disallowance of otherwise allowable itemized deductions due to income exceeding a specified threshold, has been suspended. This will translate to thousands of dollars of additional deductions for many.
Individuals who have been subject to the alternative minimum tax, or AMT, are relieved to learn that this controversial tax won’t apply in most situations. This change will result in tax savings of $10,000 or greater in some cases.
Non-Service Business Owners Potentially Big Winners
If you have a “pass-through” business, which includes sole proprietorships, LLCs, partnerships, and S corporations, a new provision allows you to deduct the lesser of 20% of your pass-through income or 20% of your taxable income without regard to the deduction.
The new deduction, formally known as the qualified business income, or QBI, deduction, isn’t as favorable for service business owners with higher income. Targeted businesses include, but aren’t limited to, law, accounting, and financial services.
The QBI deduction for specified service businesses is phased out for single taxpayers with taxable income exceeding $157,500 and for joint returns with taxable income in excess of $315,000.
Corporate Tax Rates Slashed
In an effort to make the United States more competitive with the rest of the world, the top corporate tax rate of 39% has been slashed to 21%. The new rate replaces the former tiered rate structure. Under the system in place before 2018, corporate tax rates ranged from 15% to 39% depending upon taxable income.
Tax Simplification for Some
While the limitation on tax deductions is unfavorable and controversial, especially for those living in high income tax states, tax returns may become less complicated in many cases. This is more likely for those with limited mortgage interest or charitable deductions. Many individuals in this situation will benefit from the increased standard deduction, rendering Schedule A, which is used to report itemized deductions, unnecessary.
Winners and Losers
With every major tax law change, there are always winners and losers. The Tax Cuts and Jobs Act is no exception. Given the Congressional Budget Office’s projection that the Act will add $1.455 trillion to the national debt over ten years, winners appear to be in the majority. Based on personal experience with clients to date, I can vouch for this.
The increase in the debt level, while problematic (bad), is projected to be offset by greater personal savings (good) and an overall boost in the economy (good) resulting from reduced corporate tax rates (good) and the qualified business income deduction (good). Time will tell, however, it appears that the Tax Cuts and Jobs Act should be mostly good.
