Winter 2018 CPA Newsletter
Volume 34 Issue 1
By Lauren M. Landolfi, CPA, MST, Manager
One of the issues at the forefront of the 2016 Presidential election was tax reform. On December 22, 2017, the highly anticipated legislation was signed into law by President Trump. Informally known as the Tax Cuts and Jobs Act (“the Act”), or TCJA for short, this legislation lives up to the promise of making significant changes to the Internal Revenue Code marking the first time since 1986 that a massive overhaul of the U.S. tax system was passed. TCJA is far reaching with impacts to individual taxpayers as well as businesses of all forms, including fundamental changes to how profits earned overseas are taxed.
Key provisions of the Act affecting individual taxpayers include lower tax rates in modified brackets, higher standard deductions, and limitations on certain itemized deductions such as state and local taxes. For corporations, the tax rate is reduced to a flat 21 percent
and the alternative minimum tax is repealed. Additionally, for pass-through entity owners, certain partners and shareholders will be eligible to deduct 20 percent of their income from those entities. The U.S. taxation of foreign sourced income shifts to a territorial
system, and the deemed repatriation tax rate on pre-TCJA foreign earnings is 15.5 percent for earnings attributable to cash or cash equivalents, and 8 percent on all other earnings. The Act also includes increases in certain property expensing and depreciation limits, and changes to accounting methods, as detailed below.
TCJA includes a temporary reduction of individual rates, which are generally effective January 1, 2018, and expire December 31, 2025.
The top individual rate will be 37 percent for joint filers with more than $600,000 of taxable income and single filers with more than $500,000 of taxable income. The current top rate is 39.6 percent for joint filers with taxable income over $470,701 and single filers with taxable income over $418,401.
The standard deduction will be increased to $24,000 for joint filers and $12,000 for single filers. The personal exemption is repealed through 2025. Currently, the standard deduction is $12,700 for joint filers and $6,350 for single filers.
The Child Tax Credit is increased to $2,000 per qualifying child, with up to $1,400 being fully refundable. An additional $500 credit may be available for other dependents. The Credit begins to phase out for joint filers with adjusted gross income exceeding $400,000 and single filers with adjusted gross income exceeding $200,000. Currently, the Child Tax Credit is $1,000 per qualifying child and is nonrefundable. The Child Tax Credit currently phases out for joint filers with adjusted gross income exceeding $110,000.
The itemized deduction for state and local taxes has been limited to $10,000 for the aggregate sum of real property taxes, personal property taxes, and either (i) state or local income taxes or (ii) state and local sales tax. Currently, each of those state and local taxes is a separate itemized deduction with no limitation. Further, the bill prohibits a deduction in excess of the $10,000 limitation for 2018 state and local income taxes actually paid in 2017.
The itemized deduction for mortgage interest has been reduced to only permit the deduction of interest on acquisition indebtedness not exceeding $750,000. The additional interest deduction for home equity indebtedness is repealed through 2025. Currently, taxpayers can take a combined acquisition and home equity indebtedness interest expense deduction on $1,100,000 of debt. Acquisition debt incurred on or before December 15, 2017, is grandfathered in to the current limitations (however, the deduction for interest on pre-existing home equity debt is repealed). Further, taxpayers who entered into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and who purchase such residence before April 1, 2018, are also eligible for the pre-TCJA higher limitations.
All miscellaneous itemized deductions subject to the two percent adjusted gross income floor have been repealed through 2025. This includes the miscellaneous itemized deductions for investment fees and expenses, tax preparation fees, and unreimbursed employee business expenses among others.
The overall limitation on itemized deductions enacted in 1990, often called the “Pease limitation” (named after former Congressman Donald Pease) has been repealed through 2025.
For any divorce or separation agreements entered into after December 31, 2018, the deduction for alimony or separate maintenance payments is repealed.
Similarly, the inclusion of gross income for alimony or separate maintenance payments is repealed, therefore recipients are no longer required to include those payments in their gross income. Existing alimony and separate maintenance agreements are grandfathered in as are any modifications to existing agreements unless, however, the parties to a modification expressly provide that the new rules should apply to the modified agreement.
The section 199 domestic production deduction is repealed effective December 31, 2017.
The lifetime exemption for estate and gift taxes is increased to $10,000,000 as of 2011
there for inflation). As a result, taxpayers making gifts, and the estates of decedents dying, in 2018 would have a roughly $11,000,000 basic exclusion amount.
The individual alternative minimum tax (AMT) has been retained. However, the exemption amounts have been increased to $109,400 for joint filers and $70,300 for single filers. The current exemptions are $84,500 and $54,300 for joint and single filers, respectively.
Businesses – Corporations, Partnerships, and LLCs
TCJA provides for substantial changes to how businesses are taxed as detailed below.
The corporate tax rate has been reduced from a top rate of thirty-five percent to twenty-one percent and the corporate AMT has been repealed. This provision applies to regular C corporations only. This includes all condominium and homeowner associations that file as a regular corporation.
The deduction for net business interest expense is limited to 30 percent of adjusted taxable income with an indefinite carry forward period for any excess. Small businesses with less than $25 million in annual gross receipts over a three-year period are exempted from the interest limitation. A real property trade or business may elect to be exempt from the business interest limitation regardless of gross receipts, however accelerated depreciation must be given up for this benefit to apply. The section 199 domestic production deduction is repealed effective December 31, 2017.
Net operating losses (NOLs) are limited to 80 percent of taxable income and may only be carried forward, indefinitely. The treatment of NOLs generated prior to 2018 remained the same.
For tax years beginning after December 31, 2017, qualifying partners and shareholders of S corporations and LLCs may deduct up to 20 percent of their qualified business income from the partnership or S Corporation. For taxpayers in a service business, except for architects and engineers (e.g., medicine, law or accounting, etc.), no deduction is permitted unless their taxable income is less than $157,500 ($315,000 if married filing a joint return).
The application of Section 1031 is limited to transactions involving the exchange of real property that is not held primarily for sale. The like-kind exchange rules will no longer apply to any other property, including personal property that is associated with real property. This provision will be effective for exchanges completed after December 31, 2017. However, if the taxpayer has started a forward or reverse deferred exchange prior to December 31, 2017, section 1031 may still be applied to the transaction even though completed after December 31, 2017.
The partnership technical termination rules under section 708(b)(1)(B) are repealed for tax years beginning after 2017. No changes are made to the actual termination rules under section 708(b)(1)(A).
Significant changes were made to the deductions for meals and entertainment expenses. Effective January 1, 2018, business entertainment expenses are completely disallowed – prior law had allowed for a 50 percent deduction. In addition, meals furnished to employees for the convenience of the employer are now subject to a 50 percent limitation, where they had previously been fully deductible. The 50 percent deduction for food and beverage expenses associated with operating a trade or business is retained however.
Cost Recovery Provisions
Significant favorable changes were made to the provisions related to expensing of fixed asset purchases as detailed below.
Property defined under section 168(k) and placed in service after 2007 and before 2020, under pre-TCJA law, was allowed a 50 percent deduction for the taxable year in which the property is placed in service. TCJA allows full expensing of property both acquired and placed in service after September 27, 2017, for a five-year period. There would be a phase down of the full expensing by 20 percent per year for property placed in service after January 1, 2023 (January 1, 2024 for longer production period property). Bonus property previously had only been allowed for new property. The definition of qualifying property has been expanded to include used property.
Annual depreciation limitations for luxury automobiles under section 280F prior to the passage of TCJA were $3,160 in the first year, $5,100 in the second year, $3,050 in the third year, and $1,875 in the fourth and later years. TCJA significantly increases these limitations to $10,000 in the first year, $16,000 in the second year, $9,600 in the third year, and $5,740 in the fourth and later years.
Generally, under section 179, business taxpayers may elect to deduct the cost of qualifying property with an annual limit of $500,000 through 2015, after which the amount was adjusted for inflation. The $500,000 limitation is reduced by the amount of which the cost of the property placed in service during the taxable year exceeds $2 million. The Act increases the expensing limitation from $500,000 to $1 million. Further, the phase out begins when the amount of the property placed in service exceeds $2.5 million, up from the $2 million dollar amount.
The section 179 definition of qualified real property under TCJA is expanded to include improvements to non-residential real property including roofs, heating, ventilation, air conditioning, fire protection, alarm systems, and security systems.
As more details and new tax regulations related to the Tax Cuts and Jobs Act are released later this year, one thing will become clearer–the tax code will not have been simplified. Be sure to monitor www.wgcpas.com for relevant updates as they are available. In addition, please contact your W&G advisors for additional information.