2017 Tax Law Update
The dust is starting to settle. After months and months of wonder, analysis, calculations, re-calculations, and useless predictions we now have something fairly solid to stand on. While the new tax bill, The Tax Cuts and Jobs Act, has not yet been signed by the President it has been approved by both the House and the Senate and we fully expect it to be signed into law soon. The good news is that there is still some time left before year-end to take action. Each taxpayer will be affected a little differently depending on their unique set of facts and circumstances. The following is a summary of the highlights of the bill and actions to be taken for certain scenarios. Most provisions go into effect in 2018 unless noted.
· Tax rates have been lowered: This is a big change and will benefit many taxpayers. For pretty much every level of taxable income taxes will be lower in 2018 than in 2017. Using the Married Filing Joint brackets the changes are illustrated below
FOR MARRIED INDIVIDUALS FILING JOINT RETURNS:
New Rate New Income Bracket | Old Rate Old Income Bracket
10% Up to $19,050 | 10% Up to $19,050
12% $19,050-$77,400 | 15% $19,050-$77,400
22% $77,400-$165,000 | 25% $77,400-$156,150
24% $165,000-$315,000 | 28% $156,150-$237,950
32% $315,000-$400,000 | 33% $237,950-$424,950
35% $400,000-$600,000 | 35% $424,950-$480,050
37% $600,000+ | 39.60% $480,050+
o Planning Point – Since the tax rate for most taxpayers will be lower in 2018 than in 2017 we recommend that clients advance as many expenses into 2017 as possible and defer as much income into 2018 as possible. For example, prepay January and/or February’s rent or insurance bills. If you prepay supplies or other expenses by using a credit card you can record the expense in December and still make the cash payment in January. If there is flexibility to defer billings into 2018 you should do so. Please note that simply not cashing checks you have received will not accomplish this goal since you already have receipt of the funds.
· The standard deduction has increased from $13,000 for a married couple to $24,000 providing a large benefit for taxpayers who do not itemize.
o Planning Point: Many taxpayers who do not own a home may not itemize in 2018 due to this increased standard deduction. If you do not own a home and your state income taxes (up to $10,000) plus your charitable donations will not be greater than $24,000 we recommend making any planned 2018 charitable donations in 2017 to the extent possible.
· The Capital gains rates of 15% and 20% have been maintained and the income levels for each are essentially the same under the new bill. The 20% rate starts at income of $479,000 for joint returns.
· Personal exemptions are suspended. Exemptions of $4,500 were previously allowed for each taxpayer, spouse, and dependent. The new law removes these exemptions altogether. While these exemptions previously phased out for high- income taxpayers some families could see income increased by $20,000 by this adjustment. An increased child tax credit is meant to offset some or all of this cost. See details to follow.
· Child Tax Credit: The child tax credit has been increased from $1,000 per child to $2,000 per child. The phase-out level of the credit has been increased to $400,000 for joint returns making this credit much more valuable than under the previous law. At a 25% marginal tax rate a $2,000 credit is worth $8,000 in deductions. So a married couple with two kids can essentially offset the loss of their personal exemptions with this credit. Families with more children may actually benefit overall depending on their level of income.
· Kiddie Tax: The Kiddie Tax rule is applied to unearned income (investment income) of a dependent who is under 19 or 19 – 24 and in college. In order to discourage income shifting between parents and children the prior rule taxed children’s unearned income in excess of $2,100 at their parents tax rate. The new rule will tax unearned income according to the trust and estate tax schedule which reaches the top tax brackets at only $12,500. This will effectively penalize having children’s investment accounts and could very well tax their income at a higher rate than their parents. This does not impact earned income such as W2 income.
· State and local tax deductions: This is the one you have been hearing about. There is a new combined limit of $10,000 for state and property taxes. This is a significant disadvantage to taxpayers who live in high income tax states such as California, New York, or New Jersey. Many of our clients pay greater than $10,000 in either state taxes and property taxes, let alone the two combined. The new limitation will allow only $10,000 for a combination of both taxes.
o Planning Point: After 2017 (until the individual provisions expire in 2026) many taxpayers will no longer benefit from their property taxes as their state taxes alone will consume the allowable $10K deduction. The new law contains a provision that state taxes cannot be prepaid for a future year. In light of these two facts we recommend that clients prepay all of their 2017 state taxes (we do this in our planning for most clients already) and prepay their first installment of 2018 property taxes before the end of 2017.
· Mortgage Interest: For tax years after 2017 taxpayers can deduct mortgage interest on acquisition indebtedness for a new home of up to $750,000. The prior deductibility for home equity indebtedness of up to $100,000 has been suspended. The new limits will not be applied to homes purchased prior to December 15, 2017 or for homes that were in contract prior to December 15, 2017 to purchase a home prior to January 1, 2018 and who actually complete the purchase prior to April 1, 2018.
o Planning Point: Taxpayers who purchased a home prior to 2018 and have not taken out a home equity line to be used for purposes other than modifications to their home will not see much impact from this provision. Refinancing of a home purchased prior to 2018 will be allowed at the previous limits as long as the total debt is not increased by the refinancing. In other words, you will not lose the $1,000,000 mortgage limit if you refinance your home at the same mortgage amount in order to obtain a lower interest rate.
· Alimony Payments are no longer deductible by the payer and are no longer considered income by the payee.
· Moving Expenses for a change in employment are no longer deductible. The one exception is for members of the armed services that are moving pursuant to a military order for a permanent change of station.
· The Obamacare Individual Mandate has been repealed. There will no longer be a penalty for not maintaining minimum essential coverage.
o Planning Point: While the penalty will be going away, we always recommend that clients maintain adequate health, life, and disability insurance whether there is a penalty at stake or not.
· Alternative Minimum Tax (AMT): Some versions of the bill repealed the AMT altogether. A move that many taxpayers were hoping for and one that would have retained the original goal of the bill to simplify the tax code. In the end, this provision did not make it through. However, the AMT exemption and the income level that the phase-out of the exemption begins have both been significantly increased. This change should keep many more taxpayers out of AMT.
· Qualified use of 529 plans has been expanded to include up to $10,000 of tuition for elementary or secondary public, private, or religious school.
o Planning Point: Since 529 plan contributions are made post-tax, the benefit is derived from paying zero tax on the growth. In general, the longer the funds are left in the account the more they will grow and the greater the benefit becomes. If you plan on putting children into private school for elementary or high school start funding the plan as early as possible to provide the most opportunity for tax-free growth. Alternatively, if funds are available, you can even super-fund a 529 plan by putting in 5 times the gift tax amount ($14K x 5 = $70K) in one year with no gift tax consequences. This will give a larger amount more time to grow before being withdrawn.
· Lifetime Estate and gift tax exemption has increased from $5,000,000 each to $10,000,000.
· 100% bonus depreciation is available on new and used assets purchased between Sept 27, 2017 and December 31, 2023. After 2023 the bonus depreciation percentage will be reduced each year until it expires in 2026.
o Planning Point: Previously bonus depreciation was only available for new assets. Now it can be used for both new and used. This will impact the depreciation for used equipment as well as for used autos since the $8,000 bonus depreciation for a “luxury auto” was previously only available if the auto was new.
· The allowable depreciation amounts for luxury autos (those with gross vehicle weight less than 6000 lbs) are increased for autos places in service after 2017. The first year limit, which was previously $3,160, has been increased to $10,000. The second and third year limits are $16,000 and $9,600 respectively. The fourth and all following years are $5,760. The bonus depreciation limit of $8,000 still applies.
o Planning Point: If you are looking to purchase a new auto for use in the business, purchasing in 2018, instead of 2017, will allow you to recover the cost through depreciation more than twice as fast. If you are on the edge of purchasing in 2017 or 2018 it may be beneficial to postpone until 2018 as long as you can get the same deal from the seller. Sometimes dealerships will offer bonuses that culminate at year-end and the same deal available on December 30th will be long gone by January 1st.
· DPAD deduction is eliminated. For clients using a CAD/CAM machine in their practice the previous deduction of 9% of net income from production will no longer be available after 2017.
o Planning Point: Where possible, try to reschedule a January patient into December if a CAD/CAM machine will be used in the treatment. Although we generally want to defer income to 2018, treating these patients in 2017 will preserve the 9% deduction which will not be available the following year.
· 1031 exchanges will only be available for real estate transactions. This means that the sale of a medical or dental practice will no longer be eligible for 1031 deferral of gains.
o Planning Point: if the cash is not needed immediately use an installment sale to collect the proceeds over a number of years. This will defer the tax until the proceeds are received and will lesson the total amount of tax paid by reducing the amount of taxable income in any one year thus sheltering income from the higher tax brackets.
· Entertainment expenses incurred after 2017 are no longer deductible. Due to heavy abuse of personal/entertainment expenses the new bill removes the deductibility for business entertainment altogether. The previous deductible amount of 50% is now reduced to zero. The 100% deduction of meals for employees, when provided for the benefit of the employer will now be subject to the 50% limitation.
o Planning point: Take your most important clients/referral sources out to dinner before the end of the year. Doing so next year will be much more costly as no tax deduction will be available.
· The bill has created a new passthrough income deduction. In short, this provision will allow up to a 20% deduction from passthrough income of a partnership or S-Corporation subject to certain limitations. The activities of personal service corportions (doctors, lawyers, and accountants) are specifically excluded from this 20% benefit. However, the exclusion for personal service corps does not impact taxpayers with taxable income of less than $315,000.
o Planning Point: This deduction will benefit some, but not all of our clients. In planning for 2018 and beyond it may be worth choosing some years (such as years where new property was purchased) to group large deductions in order to lower taxable income below the threshold while grouping income together in years that we know income will above the threshold. The goal being to have some years where the deduction can be taken advantage of and some years that it cannot rather than missing the deduction in all years.
To summarize, we are hopeful that most of our clients will receive a tax break as a result of this bill. As with almost any tax legislation, there will be winners and losers. The new bill is very complicated and very lengthy and will impact each taxpayer differently based on their unique circumstances. The planning points provided in this article are general and we hope that they will give some direction for year-end maneuvers that will result in tax savings.
David Knittel, Director of Tax, PracticeCFO