After a long and contentious political battle, the U.S. House (224-201) and U.S. Senate (51-48) have passed the Tax Cuts and Jobs Act of 2017. President Trump signed the bill into law and it goes into effect on 1/1/2018. Major changes in personal income taxes, business income taxes, and estate taxes will go into effect for tax year 2018.
Here is a summary of the tax changes that will impact individuals and businesses. Most of the individual income tax and estate tax changes are scheduled to “sunset” on 12/31/2025 and revert to the tax laws of 2017 unless a future Congress and President make them permanent. The business tax cuts summarized below are permanent.
PERSONAL INCOME TAXES
- New tax brackets for taxable income are 10%, 12%, 22%, 24%, 32%, 35%, and 37% at new breakpoints. Indexing of the brackets will continue going forward.
- Provides a 0% capital gains rate for those in the 10% and 12% brackets; a 15% capital gains rate for those in the 22%, 24%, 32%, and 35% brackets; and a 20% capital gains rate for those in the 37% bracket
- Standard deduction is doubled to $12,000 per individual and $24,000 for a married couple. Indexing of the standard deduction will continue going forward.
- The personal exemption deduction ($4,050 in 2017) is eliminated.
- The mortgage interest deduction is capped at the interest paid on a $750,000 home mortgage. This capped amount applies only to new mortgages under contracts dated after 12/14/2017. Existing mortgages in excess of $750,000 will still be able to deduct the full interest paid on mortgages which are grandfathered under the current loan limit of $1,000,000.
- The state income tax and local property tax deductions are limited to a combined amount of $10,000. The combined amounts above $10,000 will not be deductible. This will impact taxpayers in states with high income taxes and property taxes.
- Repeals the individual mandate penalty tax under the Affordable Care Act for those that choose not to purchase medical insurance coverage under ObamaCare. This repeal goes into effect in 2019 and does not expire.
- Keeps the charitable income tax deduction and increases the annual limit for cash contributions to 60% of adjusted gross income.
- Keeps the medical expense deduction for paid medical expenses in excess of 7.5% of adjusted gross income. This limit will increase to 10% after 12/31/2019.
- Keeps the 3.8% passive income add-on tax from the Affordable Care Act for interest, dividends, and capital gains of high earners. This increases the top 37% marginal rate on ordinary income up to 40.8% for certain taxpayers. It increases the top 20% marginal rate on capital gains and qualified dividends up to 23.8% for certain taxpayers.
- Keeps the .9% add-on Hospital Insurance (HI) FICA tax from the Affordable Care Act for high earners. This increases the 1.45% HI tax up to 2.35% for certain individuals.
BUSINESS INCOME TAXES
- C Corp tax rate is a flat 21%. This is down significantly from a maximum rate of 35% under the prior law which was in effect from the early 1990s.
- S Corps, LLCs, partnerships, and sole proprietorships with pass-through “Qualified Business Income”, with certain adjustments, are eligible for a 20% K-1 pass-through deduction (i.e. 37% bracket = 29.6% net marginal tax rate).
Generally, “Specified Service Businesses” are NOT eligible for the 20% K-1 pass-through deduction. Some of these service type of businesses are those in medical practice, legal practice, accounting practice, financial services, and brokerage services which are listed in IRC Section 1202(e)(3)(A). However, the 20% deduction would be available to the owners of these “Specified Service Businesses” whose entire taxable income (including K-1 pass-through profits) are less than $157,500 (single) or $315,000 (married). This tax benefit is completely phased out when taxable income exceeds $207,500 (single) or $415,000 (married).
- Allows a one-time 15.5% tax for U.S. multi-national companies to repatriate certain deferred foreign profits back to the U.S.
- Temporary 100% deductible expensing for certain depreciable business assets. This provision will remain in effect until 12/31/2022.
ESTATE AND GIFT TAXES
- Keeps the unified estate and gift tax system in place. This unified system was first enacted way back in the Tax Reform Act of 1976. The estate tax rate remains at 40% on taxable estates in excess of the exemption amount.
- Immediately doubles the estate tax, gift tax, and generation skipping tax exemptions from $5,600,000 to $11,200,000 for an individual and from $11,200,000 to $22,400,000 for a married couple. The estate, gift, and generation skipping exemptions will continue to be indexed for inflation. This increase of the estate tax exemption will eliminate all but the very largest estates from any taxation at death. However, estate tax reduction strategies involving gifting will still be important for large estates above the exemption amount.
- Keeps stepped-up cost basis for capital assets owned at death. Generally, capital assets are real estate, stocks purchased on a stock exchange, mutual funds, and shares of a closely held business.
- Keeps carry-over cost basis for capital assets gifted in lifetime. Generally, capital assets are real estate, stocks purchased on a stock exchange, mutual funds, and shares of a closely held business
- Going into 2018, there are 16 states that still levy state estate or inheritance taxes with a variety of state exemption amounts. 34 states currently have no state estate taxes.
LIFE INSURANCE, ANNUITIES, AND LONG-TERM CARE (LTC) CONTRACTS
It should be noted that the new tax law makes no changes to the taxation of life insurance, annuity, and LTC contracts. Individual and business taxpayers can place any increased after-tax income resulting from the new tax laws into these products to fund any estate, business, and retirement planning needs.
- Life insurance retains its tax-favored status. Cash value continues to grow tax deferred, FIFO withdrawals up to cost basis and loans are tax free, and death benefits are income tax free. Death benefits can also be estate tax free if an Irrevocable Life Insurance Trust (ILIT) is utilized.
- Annuities retain tax deferred status along with the usual LIFO taxation on withdrawal of gains in excess of cost basis
- Qualified LTC benefit claim payments remain income tax free up to a maximum of $360 per day in 2018.
- The existing indexed contribution limits for 401(k) plans, 403(b) plans, 457(b) plans, SEP plans, IRAs, and Roth IRAs remain in effect.
Russell E. Towers JD, CLU, ChFC
Vice President – Business & Estate Planning
Brokers' Service Marketing Group