Overview of the new tax law
I plan to follow-up this overview with more pertinent and practical tax planning newsletters. Some tax planning needs to happen in 2017 – obviously I need to start writing a few of these memos today!
Complicated
I’ve read the new law; and read it again (505 Page! My brain hurts!). Contrary to the press, this is in no way a tax simplification. The new tax law is complicated – very!
The tax law, as it came out of the Conference Committee, is much better than the initial house version of the bill. Frankly, this initial tax bill from the House had me spooked! A lot of good things happened in the Conference Committee.
This bill is effective: January 1, 2018
The new tax law takes effect on January 1, 2018, except for a few provisions such as the individual ACA mandate, which are deferred until January 1, 2019.
MUCH better
A short civics lesson: Tax Laws is born in the House Ways and Means Committee and then, if approved by the full House of Representatives, it goes to the Joint Committee on Taxation; a “nonpartisan” committee composed of both members of the House and Senate. The Joint Committee on Taxation, typically, will offer substantial changes to the House’s version of the Tax Bill. This is a MUCH better law than we started with! It’s not perfect by a Long-Shot; but it is not the messy monster that we saw a few months ago.
This is Classic Trickle-Down Economics
Overall, the Tax Cuts and Jobs Act represents the largest one-time reduction in the corporate tax rate in U.S. history, from 35 percent down to 21 percent. The bill also lowers taxes for the vast majority of Americans, as well as for many small-business owners — at least until the cuts expire after eight years.
Thank You Senator Rubio
Last-minute changes to the GOP’s big plan give a larger tax break to the wealthy and preserves certain tax savings for the middle class, including the student-loan interest deduction, the deduction for excessive medical expenses and the tax break for graduate students. A change made Friday morning to win over Rubio expands the child tax credit even further to give more money to working-class families.
Here’s a rundown of what’s in the final bill. (The final bill is 505 pages!)
What is changing?
A new tax cut for the rich: The final plan lowers the top tax rate for top earners. Under current law, the highest rate is 39.6 percent for married couples earning over $470,700. The GOP bill would drop that to 37 percent and raise the threshold at which that top rate kicks in, to $500,000 for individuals and $600,000 for married couples. This amounts to a significant tax break for the very wealthy.
The Conference Committee made a bunch of changes to the law
The new tax break for millionaires goes beyond what was in the original House and Senate bills, with Republicans seeking to ensure wealthy earners in states such as New York, Connecticut and California don’t end up paying substantially higher taxes as a result of the bill.
Changes for Sub-Section “C”, (generally large corporations)
A massive tax cut for corporations: Starting on Jan. 1, 2018, big businesses’ tax rate would fall from 35 percent to just 21 percent, the largest one-time rate cut in U.S. history for the nation’s largest companies. The House and Senate bills originally had the big-business tax rate falling to 20 percent, but Republicans were not able to make the math work to keep the rate that low and start it right away in the new year, so they compromised by moving the rate to 21 percent. It still amounts to roughly a $1 trillion tax cut for businesses over the next decade.
Economic Impact
Republicans argue this will make the economy surge in the coming years; I very much hope that they are correct.
The Individual Tax Deduction for state and local taxes is scaled back
You can deduct just $10,000 in state, local and property taxes: One of the most controversial parts of the GOP tax plan is the push to greatly scale back how much state and local taxes Americans can deduct on their federal income taxes. Under current law, the state and local deduction (SALT) is unlimited. In the final GOP plan, people can deduct up to $10,000 (married couples are also limited to just $10,000). The House initially restricted the $10,000 deduction to just property taxes, but the final bill allows any state and local taxes to be deducted, whether for property, income or sales taxes.
This is a real tax reduction! (Yea!) The bill out of the House was not.
Most Americans will pay less in taxes until 2026. The final plan lowers the tax rates for each income level and nearly doubles the standard deduction (while also scrapping the personal exemption). The result is that the vast majority of Americans will see their tax bills drop next year. Trump is fond of saying the “typical” family will save $2,000, but the reality is the amount will vary greatly depending up the size, location and circumstances of each family. The bill will also increase the number of Americans who owe nothing in taxes from 44 percent today to 47.5 percent after the plan takes effect on January 1, 2018. But all of the individual tax cuts are scheduled to go away after 2025. Republicans opted to make tax cuts for families temporary and reductions for businesses permanent.
Working-class families get a bigger child tax credit: Thanks to a late push by Senator Rubio (R-Florida) and Senator Mike Lee (R-Utah), the child tax credit would be more generous for low-income families and the working class. The current child tax credit is $1,000 per child.
The House and Senate bills expanded the child tax credit, with the Senate going up to a maximum of $2,000 per child. The final bill keeps the $2,000-per-child credit (families making up to about $400,000 get to take the credit), but it also makes more of the tax credit refundable, meaning families that work but don’t earn enough to actually owe any federal income taxes will get a large check back from the government. Benefits for those families were initially limited to about $1,100, but through changes Rubio and Lee pushed for, it’s now up to $1,400.
January 1, 2019
The individual health insurance mandate goes away in 2019: Beginning in 2019, Americans would no longer be required by law to buy health insurance (or pay a penalty if they don’t). The individual mandate is part of the Affordable Care Act, and removing it was a top priority for Trump and congressional Republicans. The final bill does not start the repeal until 2019, though.
There is a “plan”
There is a “plan” to hold down the expected increase in insurance premiums.
The Congressional Budget Office projects the change will increase insurance premiums and lead to 13 million fewer Americans with insurance in a decade, while also cutting government spending by more than $300 billion over that period. Some Republicans hope to make other changes to health care to prevent insurance costs from rising dramatically by the time the repeal kicks in.
Estate Tax Significantly Liberalized (Yea Again!)
You can pass your heirs up to $22 million tax-free: In the end, the estate tax (often called the “death tax” by opponents) would remain part of the U.S. tax code, but far fewer families will pay it. Under current law, Americans can pass on up to $5.5 million tax-free (that threshold is $11 million for married couples). The House wanted to do away with the estate tax entirely, but some senators felt that was too much of a giveaway to the mega-rich. The final compromise was to double the threshold, so now the first $11 million that people pass on to their heirs in property, stocks and other assets won’t be taxed (and yes, that means $22 million for married couples).
Sub-Chapter S Corporation, LLCs, Sole Proprietorship, and more
Most small businesses are organized in “pass-through” entities such as those listed at the top of this paragraph. That means that they do not pay income taxes on their own but that there taxes are paid by the individuals who own an interest in the “pass-through” companies.
Small businesses are the most important cog in the economy of the United States! By Far! A small business tax break is long overdue.
Most people simply don’t know or understand the magnitude of the small business sector in the United States. Utilizing the data and definitions from the SBA, small businesses make up the following; 99.7% of United States employer firms, 63% of net new private-sector jobs, 48.5% of private-sector employment, 42% of private-sector payroll, 46% of private-sector output, 37% of high-tech employment, 98% of firms exporting goods and 33 % of exporting value.
(See: https://www.sba.gov/content/small-business-gdp-update-2002-2010)
“Pass through” companies get a 20 percent reduction in taxable income: Most American small businesses are organized as “pass through” companies in which the income from the business is “passed through” to the business owner’s individual tax return. S corporations, LLCs, partnerships and sole proprietorships are all examples of pass-through businesses. In the final GOP bill, the majority of these companies get to deduct 20 percent of their income tax-free, a large reduction that mirrors what was in the Senate bill. The changes, however, expire after 2025. The National Federation of Independent Business initially opposed the House version, arguing that it didn’t do enough for small businesses. But the NFIB later endorsed the House and Senate plans.
But! But; I often hate that word.
Service businesses such as CPA firms (Bummer!), law firms, doctor’s offices and investment offices can take only the 20 percent deduction on their personal tax returns if they make up to $315,000 (for married couples).
AMT Tax Reform!!!
Many of you have heard me refer to the AMT Tax as “Tax Hell”; it is a brutal and unfair tax that was allowed to evolve from its original intent into a tax monster!
No corporate “AMT” tax: The final GOP bill gets rid of the corporate alternative minimum tax, a big relief to the business community. The Senate included the corporate AMT in its version of the bill, but the House did not. The corporate AMT makes it difficult for businesses to reduce their tax bill much lower than 21 percent. CEOs complained that this was a backdoor tax that would make them less likely to build new plants, buy more equipment and invest in more research, since the corporate AMT made the tax credits for those investments essentially null and void.
Individual AMT tax is redirected to accomplish its original purpose: Fewer families will have to pay the individual AMT: The AMT for individuals started in 1969 as a way to prevent rich families from using so many credits and loopholes to lower their tax bill to almost nothing.
The AMT Evolution: but what started out as a way to prevent the wealthiest Americans from tax dodging started to hit more and more families over time. Currently, the AMT kicks in fully for individuals earning over $120,700 and married couples earning over $160,900. Under the final Senate bill, that threshold is lifted to $500,000 for individuals and $1 million for married couples. (Some families in the $200,000 to $500,000 range will still have to pay AMT, but they will pay far less than they were before).
Mortgage Interest Deductions will get smaller:
Under the current tax code, taxpayers can deduct any interest they pay on up to $1 million worth of mortgage loans. House Republicans tried to cap that at $500,000 for new loans (existing mortgages are unaffected by the plan) but in the final version of their, Republicans have settled on a $750,000 cap.
How much does this tax bill cost the USA?
The final bill will cost $1.46 trillion: Republicans decided it would be all right to go into debt up to $1.5 trillion to fund the tax cut. In the end, they nearly hit that mark. The official estimate — released Friday evening alongside the bill — came in at $1.46 trillion.
What is NOT changing?
The Conference Committee, thanks to a few hard-nosed Senators (Rubio), made this bill much better! The bill keeps in place the student loan deduction, the medical expense deduction and the graduate student tuition waivers.
The House bill got rid of these popular deductions, but the Senate bill kept them, and the final bill even makes the medical deduction a bit more generous for a while (dropping the threshold to take the deduction from expenses over 10 percent of income to expenses over 7.5 percent of income for 2017 and 2018). After that, the medical deduction threshold reverts to 10 percent). In the end, Republicans decided it was better to allow millions of middle-class families to continue using these breaks if they qualify for them.
401(k)s, IRAs and Roth IRAs
Retirement accounts such as 401(k) plans stay the same. No changes to the tax-free amounts people are allowed to put into 401(k)s, IRAs and Roth IRAs.
Johnson Amendment stays in place:
Churches, synagogues, mosques and other nonprofits (the Johnson Amendment stays in place) can’t get political and endorse candidates in elections. Trump and conservative Republicans wanted to “totally destroy” (Trump’s words) the Johnson Amendment, which has been in place since 1954 and prevents religious institutions and nonprofits from getting involved in elections via fundraising or endorsements. The House bill included a repeal of the Johnson Amendment, but Democrats were able to get the Senate parliamentarian to determine that including the repeal in the bill didn’t comply with the rules of the Senate.
Real Property and Rental Income:
There will be a “Shortened Recovery Period for Real Property”; the depreciation rules for real estate will change effect on January 1, 2018.
For property placed in service after Dec. 31, 2017, the Act would shorten the recovery period for determining the depreciation deduction for nonresidential real and residential rental property to 25 years.
It would also eliminate the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, and would provide a general 10-year recovery period and straight line depreciation for qualified improvement property (certain improvements to the interior of nonresidential realty) and a 20-year ADS recovery period for such property.
For tax years beginning after Dec. 31, 2017, a real property trade or business electing out of the limitation on the deduction for interest expense would have to use ADS to depreciate any of its nonresidential real property, residential rental property, and qualified improvement property.
For property placed in service after Dec. 31, 2017, the Act also shortens the ADS recovery period for residential rental property from 40 years to 30 years.
Complicated
Did I mention that this new law is “complicated”? This short memo hasn’t touched on a tenth part of the new law.
Thanks! I love my job and, without you, I would not be able to do what I do. Thank You!
Steve Richardson, CPA