We previously shared with you details from the U.S. House of Representatives’ Tax Cut and Jobs Act and the U.S. Senate’s Joint Committee on Taxation’ version under the same bill name, Tax Cut and Jobs Act. After negotiations between the two governing bodies, the Tax Cut and Jobs Act of 2017 is finalized and headed to the President’s desk.
Below is a brief rundown of some of the most notable changes for individuals and families. Most of the new tax laws are in effect for tax year 2018 and beyond unless otherwise noted.
Individual Income Tax Brackets
While House Republicans had proposed a four bracket system for income taxes, the TCJA retains the seven bracket system. However, rates and income thresholds have been adjusted. This means that almost all U.S. taxpayers will see a reduction in income taxes for tax year 2018. The current system’s income tax brackets are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The new system sets the brackets at 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The income threshold amounts will continue to adjust for inflation.
||Married Filing Jointly
||Up to $9,525
||Up to $19,050
||$9,526 – $38,700
||$19,051 – $77,400
||$38,701 – $82,500
||$77,401 – $165,000
||$82,501 – $157,500
||$165,001 – $315,000
||$157,501 – $200,000
||$315,001 – $400,000
||$200,001 – $500,000
||$400,001 – $600,000
The decreased tax rates are not permanent, however, as there is a sunset provision. After 2025, without future legislation, the tax rates would increase. The Senate and House will be faced with deciding the fate of the sunsetting provision in future years.
Changes to Exemptions and Standard Deduction
One of the most notable pieces of the TCJA is the elimination of personal exemptions. The new legislation instead combines personal exemptions and the standard deduction into one single increased standard deduction amount. The new standard deduction amount is $12,000 for individuals, $24,000 for joint filers, and $18,000 for head of household. The additional standard deduction of $1,250 for blind individuals or someone over age 65 remains.
For larger families, this will mean an overall decrease in the combined amount when compared to the current combination of exemptions and standard deduction. However, the TCJA increases and expands the Child Tax Credit, from $1,000 to $2,000 per child, which should more than offset the loss of exemptions in most families. High income earners, $200,000 for individuals and $400,000 for couples, begin to phase out of the Child Tax Credit.
Changes to exemptions, standard deductions, and the child tax credit are subject to the 2025 sunset provision.
Changes to Itemizations
The Pease limitation on itemized deductions has been repealed. The Pease limitation is a reduction in certain itemized deductions that takes affect depending upon your filing status and income level. Once your income crossed the threshold amount ($261,500 for individuals and $313,800 for married filing jointly in 2017), itemized deductions would begin phasing out. The rule acts as a surtax on high income earning households. The repeal will result in a 1% to 1.3% reduction in taxes for high income earners. The sunset provision applies to this repeal, meaning the Pease limitation could return in 2026.
Additional changes to itemizations include:
- Elimination of miscellaneous itemized deduction, including tax preparer fees, investment management fees, and unreimbursed employee business expenses.
- $10,000 cap on combined state/local income tax and local property taxes.
- Deductible mortgage interest only on the first $750,000 of new principal debt. Mortgages taken prior to December 15th, 2017 retain deductibility on the first $1,000,000 of principal debt.
- Elimination of home equity indebtedness interest deductibility.
- If a home equity loan is used to substantially improve the home, it is treated as “acquisition debt” and is still deductible.
- Medical deductions were not repealed. Instead, the deduction was temporarily reduced to 7.5% of AGI for tax year 2017 and 2018. It reverts back to 10% of AGI in 2019.
Current rules limits donations to public charities to 50% of your AGI. The new rules increase the limitation to 60% of AGI making it easier to claim larger contribution or use carryforward charitable deductions.
The charitable mileage rate, which was expected to be increased, remains unchanged at 14 cents.
Capital Gains and Dividend Rates
There had long been concern that the 0% long-term capital gains and qualified dividends tax rate would be eliminated, but the TCJA retains the three-bracket system of 0%, 15%, and 20%. Under the old system, taxpayers in the 10% and 15% income tax bracket had a 0% capital gains tax rate. With the new tax bracket system, the capital gains rate is tied to an income threshold amount rather than the brackets. Thus, individuals with $38,600 and couple with $77,200 or less in income will have a 0% capital gains tax rate.
Instead of having the 20% capital gains tax rate take effect at the highest tax bracket, it now takes affect at the threshold amounts of $452,400 for individuals and $479,000 for couples. This means some tax payers in the new 35% income tax bracket will find themselves in the highest capital gains tax rate.
Unfortunately, the 3.8% Medicare surtax on capital gains and qualified dividends still applies. Individuals with income over $200,000 and couples over $250,000 will face the additional surtax. This effectively retains a four tax brackets of 0%, 15%, 18.8%, and 23.8% for capital gains and qualified dividends.
No Repeal of the Alternative Minimum Tax
The original bills by both the Senate and the House proposed a complete repeal of the Alternative Minimum Tax (AMT) system for individuals. Unfortunately, in negotiations, the AMT survived although the exemption amount has increased.
This difficult-to-understand supplemental income tax system dates back to 1969 and was originally designed to ensure wealthy taxpayers paid their fair share of taxes. Yet, over the years, the AMT began affecting more and more middle-income taxpayers. With the exemption amount increased to $70,300 for individuals and $109,400 for joint filers, fewer middle class taxpayers will be affected.
Kiddie Tax Rules
The Kiddie Tax is a tax on unearned income for children under the age of 19 or full-time students under 24. In 2017, tax law allowed for the first $1,050 of unearned income to be tax-free, the following $1,050 taxed at the child’s rate, and any income above that amount taxed at the parent’s rate. TCJA changes this so that the any amount above $2,100 is taxed at trust tax rates, not the parent’s tax rate. This is significant because the highest trust rate is 37% at ordinary income of only $12,500. It would take total income over $600,000 at the parents’ joint rate in order for the 37% tax bracket to apply.
Estate and Gift Taxes
The estate and gift tax exemption has effectively doubled allowing an individual to pass $11.2M and couples to pass $22.4M estate tax free. Portability of the exemption survived; if the first spouse to die doesn’t use the exemption, the surviving spouse can port the unused amount to themselves. The top rate remains at 40%. Some early discussion indicated that the estate tax could be repealed at a future date, but the repeal did not make it into the legislation. These changes are subject to the 2025 sunset provision.
Trust and Estate Tax Brackets
Tax brackets for trusts and estate were compressed, much like the individual income tax rates, leaving just four tax brackets – 10%, 24%, 35%, and 37%. However, the income thresholds tied to those tax rates did not change very much. Thus, it only takes $12,500 in trust or estate income before hitting the top bracket.
While a number of changes were expected to affect education planning, such as repeal of the Coverdell ESA plan and education tax credits, most did not make it into the final bill. However, one change is significant. You can now use up to $10,000 per year from 529 plans for private school expenses for elementary and secondary education. Previously, only the Coverdell ESA could be used tax-free for private educational institutions.
The bill eliminates the tax deduction for alimony paid and no longer taxes the alimony received for divorces finalized after December 31st, 2018.
- Deductibility of student loan interest and out-of-pocket classroom expenses for teachers remains unchanged.
- The mandate requiring that individuals retain health insurance has been repealed for 2019 and beyond.
- No changes to 401(k) plans, IRAs, and Roth IRAs. However, the ability to recharacterize a previous Roth conversion has been repealed.
- There are new rules for deferred compensation plans and equity granting plans, like stock option plans, that could result in funds being taxed earlier than under current plan designs. As a result, there may be changes to current plans.