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Tax Law Overview

  • This is the first sweeping overhaul to the tax code in over three decades.
  • The changes to the tax law will impact nearly every taxpayer.
  • While some of the changes are permanent, many of the changes impacting individuals will sunset, meaning that they will expire after 2025.
    • By allowing these provisions to “sunset,” the Senate met the requirements to pass the bill under reconciliation procedures which means that they only needed a bare majority vote to pass the measure rather than the 60-vote threshold that typically applies.

Updates Affecting All Taxpayers

  • The individual tax rates have been lowered beginning with 2018.
    • Under the new law, the marginal tax rates range from 10% to 37%.
    • The marginal rates under the prior law were 10% to 39.6%.
    • Under the new law, the rate thresholds that apply to taxpayers filing married filing jointly are twice those of single taxpayers, effectively eliminating the federal marriage penalty.
  • For months after December 31, 2018, the individual healthcare mandate (known as the shared responsibility payment) has been repealed.
  • Beginning with 2018, personal exemptions have been suspended. For larger families, this largely offsets the benefit of the increased standard deduction available in 2018 as well.
    • This will impact the amount of taxes withheld from salaries and wages.
    • For 2018, wage withholding rules are permitted to remain the same as prior years when personal exemptions applied.
  • The Child Tax Credit has been modified for years 2018 through 2025.
    • The credit has been increased to $2,000 for each qualifying child, with up to $1,400 being refundable.
    • For non-child qualifying dependents, a $500 nonrefundable credit applies.
    • The increase in the child tax credit helps to offset the repeal of personal exemptions for the foreseeable future.
  • The standard deduction will be increased in 2018:
    • For single filers, the standard deduction will now be $12,000.
    • For married filing joint filers, the standard deduction will now be $24,000.
    • With the increase in the standard deduction, far fewer taxpayers will benefit from itemizing their deductions as they may have done in the past.
  • For those taxpayers that are still able to itemize deductions, many of the items formerly deductible have been repealed or are subject to new limitations. Some of these are:
    • State and local income taxes and real estate taxes are limited to $10,000.
    • Any deductions that were subject to the 2% floor of a taxpayer’s adjusted gross income are no longer permitted.
    • The rules for mortgage interest and indebtedness thresholds have been modified and are outlined below.
    • The adjusted gross income threshold for medical expense deductions has been reduced for all taxpayers to 7.5% for years 2017 and 2018.
  • Beginning in 2018, funds from college savings accounts (known as §529 Plans) can now be used for elementary or secondary education expenses. This is expanded from the previous rules which required funds to be used for “qualified higher education expenses,” i.e. colleges.
  • Certain business owners are now eligible for up to a 20% deduction of qualified business income from pass-through business entities which is discussed further below.

Updates Affecting Businesses

  • For business taxed as corporations, the tax rate has been changed to a 21% flat tax rate beginning with 2018.
  • The tax law includes an expansion of IRC §179 expensing:
    • For purchases of qualified property up to $2.5 million, taxpayers can immediately expense $1 million. Under prior law, the expense was limited to $500,000.
    • Qualified property has also been expanded to include certain repairs or replacements of building systems. Items being replaced on nonresidential real property that are eligible for §179 expensing now include roofs, heating and ventilation systems, fire protection and alarm systems, and security systems. Previously these items were not eligible for §179 expensing and were required to be depreciated over the life of the building.
  • Bonus depreciation has also been expanded under the new law:
    • Bonus depreciation rules were scheduled to begin phasing out over the next several years.
    • For property purchased after September 27, 2017 through December 31, 2023, qualifying property is eligible for 100% bonus depreciation.
    • Under the new law, qualifying property now includes property that is purchased used.
    • The new law also outlines a phase-out for bonus depreciation beginning in 2024.
  • Entertainment expenses associated with the activities of a trade or business are no longer deductible. Businesses may still deduct 50% of meals associated with business activities.
  • Beginning in 2018, net interest expense in excess of 30% of the business’s adjusted taxable income will be disallowed.
    • For taxpayers with average gross receipts of less than $25 million for the prior three years, there is an exception to the rule.
    • For taxpayers engaged in a real property trade or business, they may be able to elect out of the interest expense limitation if they meet certain other requirements with respect to depreciation.
  • For years after 2017, the domestic production activities deduction has been repealed. Under prior law, qualifying businesses (those in manufacturing, production, etc.) were able to claim a deduction of 9% of their qualifying production activities income.

Updates Affecting Home Owners and Self-Employed Business Owners

  • In the past, home ownership carried significant tax savings opportunities with it. Under the new law, the tax advantages associated with home ownership are greatly minimized, offering little or no benefit over renting a home. Under the new law, experts are estimating that only 5% of taxpayers will be eligible to itemize their deductions.
  • For mortgages initiated after December 15, 2017, mortgage interest is limited to underlying indebtedness of $750,000 (decreased from $1,000,000).
    • Mortgage interest is still allowable for second residences so long as the underlying indebtedness does not exceed the $750,000 threshold.
    • Deductions for interest on home equity indebtedness has been suspended for tax years after 2017.
  • In order to compete with the reduction in tax rate for corporations, Congress included a deduction of 20% of business income earned from pass-through businesses (such as sole proprietorships, partnerships, and S Corporations) for certain taxpayers.
    • Personal service businesses are specifically excluded from the definition of qualified business income for purposes of this deduction.
      • Personal service businesses include those involved in the fields of health, law, accounting, consulting, financial services, or where the principal asset of such trade or business is the reputation or skill of one or more of its employees.
    • It seems clear that most real estate agents and brokers will be considered in a personal service business.
    • However, there is an exception: For single taxpayers with taxable income less than $157,500 or $315,000 for couples filing jointly, the personal service restriction does not apply.
    • There are multiple phase ins, phase outs, and limitations to 20% deduction, and each taxpayer’s individual situation will need to be reviewed and analyzed for their specific ability to claim the deduction. Two examples are included below.
  • Beginning in 2018, the Rehabilitation Credit (known as the Historic Tax Credit) has been modified.
    • For qualifying rehabilitation expenditures relating to a Pre-’36 building, the 10% credit has been repealed.
    • A 20% credit for qualified expenditures on certified historic structures is now available to be claimed ratably over a 5-year period beginning when the structure is placed in service.
  • The rules relating to gain on the sale of a principal residence being excludable from income remain unchanged. Like-kind exchanges for real property remain unchanged under the new law, as does the low-income housing tax credit.

Expired Tax Provisions:

  • With the focus surrounding the new tax law, not much emphasis has been placed on some of the tax provisions that have expired and are no longer available to taxpayers:
    • Credit for Residential Energy Efficient Property
    • Credit for Construction of New Energy Efficient Homes
    • Discharge of Indebtedness on Principal Residence Excluded from Gross Income for Individuals
    • Premiums for Mortgage Insurance Deductible as Interest
    • Energy Efficient Commercial Buildings Deduction
    • Tuition and Fees deduction

Increased Standard Deduction Example 1:

FACTS: Brad and Susan are married with three dependent children. Brad earns a salary of $310,000, and Susan stays home with their children. Brad and Susan’s itemized deductions typically include $12,000 of mortgage interest, $15,750 of state and local income taxes, and $8,000 of real estate taxes.

Increased Standard Deduction Example 2:

FACTS: Chris and Rachel are married with no children. Chris earns a salary of $200,000, and Rachel earns a salary of $110,000. Chris and Rachel’s itemized deductions typically include $6,000 of mortgage interest, $15,500 of state and local income taxes, and $4,000 of real estate taxes.

Qualified Business Income Deduction Example 1:

FACTS: Amy is single and for 2018 has commission income from her real estate sales activities of $55,000, net of her normal business expenses. Amy has no dependent children and claims the standard deduction.

Qualified Business Income Deduction Example 2:

FACTS: Andy and Emma are married with two dependent children. Andy earns net commission income of $45,000, and Emma earns a salary of $45,000. They have itemized deductions of $18,000, comprised of mortgage interest, state and local taxes, and charitable contributions.

Tax Incentives of Home Ownership Example 1:

FACTS: Barbara earns a salary of $58,000 per year. She is single, and she is currently renting an apartment. She pays state income tax of $2,900 and makes charitable contributions of $2,088. Barbara has an opportunity to purchase a condo that she likes costing $205,000. Assume that she takes out a 30-year fixed rate mortgage at 4%, putting down 3.5%. If she buys early in 2018, her mortgage interest would be $7,856 and real estate taxes are $2,050.

Tax Incentives of Home Ownership Example 2:

FACTS: Melinda and Steve recently moved to a new city and are leasing an apartment until they find the right home for their family. They have three children, ages 17, 14, and 9. Steve earns a salary of $55,000 per year, and Melinda $65,000. They currently pay state income tax on their salaries of $6,000 and make charitable contributions of $3,120. Melinda and Steve have found a home that costs $425,000. They make a down payment of 10% and take out a 30-year fixed rate mortgage at 4%. Their real estate taxes for the year are $4,250.

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