Since the swift passage of the Tax Cuts and Jobs Act (TCJA) at the end of 2017, we have had some time to assess the tax code changes and their implications for our clients. The TCJA makes broad changes across personal, corporate, and estate taxes. Although the law sunsets after 2025, many of TCJA’s changes will be effective after 2025 unless changed by future legislation. Due to space limitations in our newsletter, we cannot address all aspects of the TCJA in this article. For now, we will focus on the core changes to personal taxes. Stay tuned for future articles on other important topics related to the TCJA.

An aide adjusts a sign prior to a news conference announcing the passage of the "Tax Cuts and Jobs Act" at the U.S. Capitol in Washington

An aide adjusts a sign prior to a news conference announcing the passage of the “Tax Cuts and Jobs Act” at the U.S. Capitol in Washington, U.S., November 16, 2017. REUTERS/Aaron P. Bernstein

Reduction in Marginal Tax Brackets for Most Taxpayers

The new federal income tax rates for single filers and married filing jointly filers are reduced for most tax brackets under the TCJA (see Appendix I for 2017 and new TCJA brackets). The middle tax brackets received around a 1% to 4% reduction in rates, while larger reductions impacted taxpayers in the lower brackets. The largest dollar impact occurs for taxpayers in the upper brackets. That said, the new marginal brackets did increase at certain levels of taxable income, including:
•Married filing jointly taxpayers with taxable income from $400,001 to $416,700 saw their top bracket increase from 33% to 35%.
•Single taxpayers with taxable income from $157,501 to $191,650 had their top bracket increase from 28% to 32%, while those with taxable incomes from $200,001 to $416,700 had their top bracket increase from 33% to 35%.

Additionally, the tax brackets will now be adjusted over time using the Chained Consumer Price Index for All Urban Consumers, otherwise known as “chained CPI.” Chained CPI calculates inflation at a slower pace than the previously used traditional CPI and thus tax brackets will be adjusted upward more slowly. Yet, workers’ incomes may rise at a faster rate. This change is expected to push more Americans into higher tax brackets more quickly.

No Changes to Federal Capital Gains Rates and the Net Investment Income Tax

There were no changes to the basic capital gains tax structure and the 0%, 15%, and 20% rates remain intact. Yet, the capital gains income thresholds no longer match up cleanly with the tax brackets (see Appendix II). The 3.8% tax on net investment income (income received from investment assets before taxes and less related expenses) will continue to apply to single filers with $200,000 or more in modified adjusted gross income (MAGI) and to married filing jointly filers with an MAGI of $250,000 or above. These thresholds are not indexed for inflation so over time more taxpayers will incur the net investment income tax.

Increased Standard Deduction and Child Tax Credits

A key aspect of the TCJA is that it repealed personal exemptions and increased the standard deduction (see Appendix III). The standard deduction was nearly doubled, which implies that fewer taxpayers will itemize their deductions moving forward.

Under previous law, families could have claimed the standard deduction and a personal exemption for each family member. Now, under the TCJA, a family can only use the standard deduction of $24,000 assuming the family does not itemize deductions. The expansion of the child tax credit will make up for absence of personal exemptions in most cases. The child tax credit has been expanded from $1,000 to $2,000 per child under age 17 and will begin phasing out at $200,000 for single filers and $400,000 for married couples. Because tax credits are dollar-for-dollar savings, these changes may increase tax savings for some families as compared to the former tax code.

Changes to Itemized Deductions May Cause Fewer Taxpayers to Itemize

Several itemized deductions have been repealed or significantly curtailed. Coupled with an increased standard deduction, the changes to itemized deductions may lead to fewer people taking itemized deductions. A brief summary of the changes and the implications of these changes are highlighted below (also see Appendix IV).

Medical and Dental Expenses: Taxpayers should be sure to review their out-of-pocket medical expenses from 2017 as the threshold to deduct these expenses was reduced retroactively from 10% to 7.5% of AGI. If individuals are planning to have elective medical or dental procedures, it may be advantageous to complete those in 2018. The threshold to deduct these expenses remains at 7.5% of AGI in 2018 but will rise to 10% onward.

State and Local Taxes: Taxpayers in high-tax states like California are significantly impacted by the change to state and local taxes. State tax payments above $10,000 are no longer deductible against a taxpayer’s federal taxes under TCJA. However, the impact of this lost deduction is somewhat mitigated because many taxpayers’ full deduction of state taxes was offset by owing alternative minimum tax — a secondary tax that prevents high-income earners from lowering their tax bill below what should be expected for taxpayers within their income bracket.

Mortgage Interest: The term “acquisition debt” applies to mortgages and home equity lines of credit (HELOC) if the debt was used to acquire, build, or substantially improve a residence. Mortgage and HELOC holders who are grandfathered in under the previous tax code may still continue to itemize mortgage and HELOC interest on the first $1,000,000 of acquisition debt. They may also refinance and deduct mortgage interest as long as they do not increase their current mortgage balance.

After December 15, 2017, new borrowers will have less mortgage interest to itemize due to a new $750,000 cap. Additionally, HELOC debt will not be deductible under the TCJA if the debt was not used as acquisition debt.

Charitable Donations: The TCJA increased the amount of charitable cash donations that may be deductible. While taxpayers can still itemize charitable donations, they may ultimately use the standard deduction versus itemizing, thus losing the ability to tie a donation to an itemized deduction. Clients should consider lumping more donations into years in which they project they will itemize. Donor-advised funds are vehicles that facilitate lumping donations into a single tax year while allowing distributions to charity to be spread out over time.

Miscellaneous Deductions Subject to 2% AGI Floor: Under the previous tax code, fees incurred to produce taxable income could be deducted under miscellaneous deductions. However, fees paid to manage a tax-exempt bond portfolio were excluded from this deduction. Additionally, the combined amount of miscellaneous deductions had to exceed 2% of AGI before a deduction could be taken. And taxpayers subject to AMT were unable to claim the deduction.

Under the TJCA, the deductibility of fees is now repealed in its entirety. The repeal of miscellaneous deductions removes the ability of B|O|S clients to deduct their management fees and tax advisor fees, although the previous limitations on the deduction precluded many from receiving this tax benefit. Please contact your B|O|S team if you would like to discuss further.

Changes to Alternative Minimum Tax

Several itemized deductions are still included in the new AMT calculations. More limited itemized deductions could lower the AMT calculation and could reduce the number of taxpayers who owe AMT. Owing less AMT or no AMT could offset the curtailed itemized deductions.

Conclusion

A key question taxpayers are asking is whether or not they are better off under the TCJA. Unfortunately, no clear answer exists as each tax situation is unique. While the marginal brackets are generally lower and fewer taxpayers will owe AMT, the ability to itemize deductions has been curtailed. To truly understand the impact, we recommend you have a conversation with your tax advisor. For specific questions, please contact your B|O|S team.

References:
1.Joint Explanatory Statement of the Committee of Conference, December 15, 2017
2.Tax Cuts and Jobs Acts, H.R.1 – 115th Congress (2017–2018)
3. Michael Kitces, “Individual Tax Planning Under the Tax Cuts And Jobs Act of 2017,” Nerd’s Eye View, December 18, 2017, https://www.kitces.com/blog/final-gop-tax-plan-summary-tcja-2017-individual-tax-brackets-pass-through-strat
egies/

APPENDIX I

Appendix II

Federal Long-Term Capital Gains RateSingleMarried Filing Jointly
0%Up to $38,600Up to $77,200
15%$38,601 - $425,800$77,201 - $479,000
20%$425,800+$479,000+
*3.8% net investment income applies to single filers with $200k + MAGI and married filing jointly filers with $250k + MAGI

Appendix III: Federal Standard & Personal Deductions and Child and Family Tax Credits

Federal20172018-2025
Standard Deduction$6,350 Single
$12, 700 Married Filing Jointly
$12,000 Single
$24,000 Married Filing Jointly
Personal Deduction$4,050 per personDiscontinued
Child and Family Tax CreditsRefundable tax credit of $1,000 for first two children. Phaseout for single filers with $75k AGI and married filing jointly filers with $110k AGIIncrease to $2,000 per child of which $1,400 is refundable and indexed to inflation. Phaseout levels rise to $200k for single filers and $400k for married filing jointly filers

Appendix IV: Federal Itemized Deductions

Federal20172018-2025
Medical & Dental ExpensesLowered from 10% AGI floor to 7.5%7.5% AGI floor in 2018; Reverts to 10% in 2019 and onward
State & Local TaxesSales tax or combination of property and income tax are deductibleMaximum deduction limited to to $10k for single and married couples
Mortgage InterestInterest deduction on primary residence up to $1M for a mortgage and up to $100k for home equityInterest deduction on primary residence up to $750k for a mortgage from 12/15/17 onward; Home equity not for acquisition indebtedness not deductible
Charitable DonationsCash donations up to 50% of AGICash donations up to 60% of AGI
Casualty & Theft LossesDeductibleRepealed except for losses incurred in designated federal disaster areas
Job Expenses & Miscellaneous Deductions Subject to 2% AGI FloorDeductible including unreimbursed job expenses and investment advisory and tax preparer feesRepealed
Itemized Deductions Limit (Pease Limitation)Phaseouts at AGI of $261,500 for single filers and $313, 800 for married filing jointly filers;Pease limitation repealed from 2018-2025

Disclosures

Filed under: Financial Planning

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