Here at Cornerstone we have been keeping a close eye on the developments in Congress on the tax reforms being proposed. As it seems more likely than not that something will be passed by both houses and signed this week, we wanted to release a summary of the proposed changes sooner rather than later in light of the end of the tax year being upon us.
The new tax law bill has something in it for everyone and the changes are extensive. Please see the information below for items that might be of interest to you personally or professionally. We are working very diligently through our client list to calculate projections and talk with our clients about things they might be able to do before the year closes out.
Disclaimer: This law is not completely final until any last minute changes have been reconciled, both houses vote on it and the President signs it. We will update you to any changes that may occur after this publication.
Tax Law Updates
Corporate and Business Entities
Corporate rates are being reduced. The corporate rate is going to a flat 21% rate. Corporate alternative minimum tax (AMT) is repealed and for the next 5 years, the AMT credit is refundable and can offset a portion of regular tax liability.
Increased Section 179 fixed asset expensing. Beginning in 2018, Section 179 expensing is increasing to $1 million and the phase-out threshold is increased to $2.5 million. In addition the definition of qualified real property for nonresidential real property includes roofs, heating and AC, ventilation, and security systems.
Increased Bonus Depreciation. A 100% (up from 50%) first-year deduction for the adjusted basis of qualified property will be allowed for property placed in service after September 27, 2017 and before January 1, 2023.
Luxury auto depreciation is increasing. Starting in 2018, the maximum allowable depreciation for a luxury auto is being increased to $10,000 for the first year (up from $3,160).
Net operating loss (NOL) utilizations are changing. The two year carryback is being repealed and carryforwards are limited to 80% of taxable income.
Domestic production activities deduction (DPAD) being repealed. For non-corporate taxpayers (those in flow-through entities), the DPAD is repealed starting in 2018. For corporations, it is repealed for 2019 and going forward.
Like-kind exchange treatment limited. Starting in 2018, the rule allowing the deferral of gain on like-kind exchanges is modified to allow for like-kind exchanges only on real property that is not held primarily for sale. However, there is a transition rule if the taxpayer has disposed of the relinquished property on or before December 31, 2017.
Meal and Entertainment rules changing. Starting in 2018, deductions for entertainment expenses (tickets to sporting events, shows, etc.) are disallowed. The current 50% limit on deductibility of business meals is expanded to meals provided on the premises of the employer. Also, deductions for employee transportation fringe benefits (parking) are denied.
Accounting for inventories is changing. Starting in 2018, taxpayers who have gross receipts that do not exceed $25 million are not required to account for inventories, but may rather treat inventories as non-incidental materials and supplies.
New deduction for pass-through income. Prior to this law, income from pass-through entities was effectively taxed at the individual income tax rates. Starting in 2018, there will be a new deduction for pass-through income.
Owners of pass-through businesses (sole proprietors, partnerships, S corporations, LLC’s, etc.) are getting a deduction equal to 20% of qualified business income (which is basically net income of the business), subject to some business wage limitations.
This means some high income sole proprietors and partnerships without W-2 employees will miss out on the deduction unless they form an S-corporation.
This deduction disqualifies “specified service trades and businesses” (such as medicine, law, accounting, actuarial science, financial services, and consulting) with taxable income greater than $157,500 for single taxpayers and $315,000 for married taxpayers.
The 20% deduction is not allowed in computing adjusted gross income, but rather is allowed as a deduction reducing taxable income.
Stay tuned to this one. The rates and dollar amounts have been changing and the final bill passed may be slightly different.
Rates and brackets are changing. Top tax rate is dropping from 39.6% to 37% and all other brackets are dropping by a percent or two.
Standard deduction is increasing. Starting in 2018, the standard deduction is going to $24,000 for married-filing-joint taxpayers, $18,000 for head of household, and $12,000 for all other taxpayers.
Exemptions are eliminated. Prior to 2018, a personal exemption in the amount of $4,150 was allowed for each taxpayer/spouse/dependent. Starting in 2018, the personal exemptions are eliminated until 2026.
Kiddie Tax is being modified. Starting in 2018, taxable income of a child attributable to earned income will be taxed at single rates and taxable income of a child attributable to unearned income will be taxed according to the trust and estates brackets.
Personal casualty and theft losses suspended. Starting in 2018, you will not be allowed a deduction for personal casualty or theft loss.
Child tax credits increased. Starting in 2018, the child tax credit is increased to $2,000 and the income levels have been raised for the phase-out of the credit. For example, the current phase-out starts at $110,000 for married filers. Starting in 2018, that phase-out goes up to $400,000 for married filers.
State and local tax deduction limited. Starting in 2018, the state and local tax deduction will be limited to $10,000 for the aggregate of state and local property taxes and state and local income (or sales) taxes. In addition, there is a prepayment provision. No income taxes can be claimed as an itemized deduction in 2017 for income tax that is imposed for the tax year(s) after 2017. Essentially this means, there won’t be a deduction allowed in 2017 for prepaid income taxes, so you can’t stock up on “future” tax liabilities by paying them in December 2017.
Mortgage and home equity interest is limited. Starting in 2018, the deduction for interest on home equity is no longer allowed and home mortgage interest is limited to indebtedness of $750,000 rather than $1 million as before. Existing home mortgage debt is grandfathered in and is allowed up to the old $1 million limit.
Charitable contribution income limitations are increased. Starting in 2018, you can deduct up to 60% of your income (up from 50% previously). However, donating to an institution of higher education for which you receive the right to purchase tickets to an athletic event are no longer deductible as a charitable deduction.
Alimony payments will not be deductible. For any divorce executed after December 31, 2018, alimony and separate maintenance payments are not deductible by the payer and are not included in the income of the payee.
Miscellaneous 2% deductions are suspended. Starting in 2018, deductions subject to 2% of gross income are no longer deductible. Examples of these types of deductions are: investment fees, unreimbursed employee expenses, tax prep fees, safe deposit box fees, etc.
Moving expenses exclusion suspended. Starting in 2018, excluding qualified moving expense reimbursements from employee wages is no longer allowed and therefore taxable.
Medical expenses. For tax years 2017 and 2018, the medical threshold is lowered to 7.5% for all taxpayers, but then returns to 10% for those under age 65 starting in 2019.
Repeal of Obamacare Individual Mandate. Starting in January 2019, the individual shared responsibility payment is reduced to zero. The 3.8% net investment income tax and 0.9% additional Medicare tax are both still in place.
Estate and gift tax exemptions increased. For decedents who pass after December 31, 2017, the estate and gift tax exemption amount goes to $11.2 million for individuals and $22.4 for married couples.
Alternative minimum tax (AMT) exemptions. Starting in 2018, the AMT exemption phase-out for married individuals increases to $1 million (up from $164K) and $500,000 for all other taxpayers.
Expanded Use of 529 Account Funds. Starting in 2018, “qualified higher education expenses” will include tuition at elementary or secondary public, private, or religious school up to a limit of $10,000 per tax year.
New deferral election for qualified equity grants (stock options and restricted stock units (RSU’s). Starting in 2018, a qualified employee can elect to defer (for income tax purposes) recognition of the amount of income attributable to the stock transferred to the employee. FICA and FUTA are not affected by this election. Limitations apply and we will address this particular topic at a later date.
What does all of this mean?
End-of-Year Planning. In light of all of the changes (which are extensive), there are opportunities for some tax planning.
For individuals, consider paying your state income taxes before December 31, 2017 rather than waiting until January 15, 2018. Who should think about paying state taxes before December 31? If you say yes to these three questions, then it would be in your benefit to pay it early:
Do you typically itemize deductions on your tax return?
Do you typically have more than $10k of property and state income taxes? (for Kansas business owners, include estimated Kansas taxes for 2017)
Finally, the most difficult question, do you have a sufficient difference in the Standard Tax and Alternative Minimum calculation-- as state taxes currently still are an AMT addback adjustment (e.g. you are not impacted by AMT currently).
For most Kansas residents that own a business that has to pay 2017 Kansas taxes for the first time in many years, we have already advised you of this additional tax liability and if you should pay it before year end. To be clear, Kansas does not require this paid until April of 2018; however, with this law change, we are recommending that you pay this before year end.
If you already have a tax voucher for the 4th quarter payment that we made for you with your tax return, you can write in the amount you are going to pay (if different), and please notify us of what payment you are going to make. If you need vouchers, please contact us.
For individuals, pay those investment fees early. Starting in 2018, things like investment fees, unreimbursed employee expenses, tax prep fees, and safe deposit box fees are no longer deductible.
For businesses, think about expense timing. Some ideas:
Entertainment is still 50% deductible in 2017. That is most likely going away in 2018. Sports or entertainment tickets to buy? You might consider it this year rather than next year.
Equipment to purchase? Expensing is more generous in 2018, but overall rates may be lower, so you will need to think about reducing income this year versus next year.
If you are in a net operating loss position and worried about being able to carryback to previous years, you may think about how to take more losses this year and claim a carryback.
We are working diligently through our lists and talking with clients about year-end planning. Please contact us to discuss.