The reconciled tax reform bill, the “Tax Cuts and Jobs Act” (TCJA), was signed into law by President Trump on December 22, 2017. This is the most sweeping federal tax legislation in more than three decades. Many of the new law’s provisions affect businesses (learn more here), but it also includes significant changes for individual taxpayers, most of which take effect for 2018 and expire after 2025. Here are some of the most notable changes.
Under the TCJA, annual inflation adjustments will be calculated using the chained consumer price index (also known as C-CPI-U). This will increase tax bracket thresholds, the standard deduction, certain exemptions and other figures at a slower rate than is the case with the consumer price index currently used, potentially pushing taxpayers into higher tax brackets and making various breaks worth less over time. The law adopts the C-CPI-U on a permanent basis.
The TCJA maintains seven income tax brackets but temporarily adjusts the tax rates as follows:
The top rates, which currently kick in at $418,400 of taxable income for single filers and $470,700 for joint filers, will now take effect at $500,000 and $600,000, respectively. The brackets will be adjusted for inflation going forward.
Personal exemptions and standard deduction
For 2017, taxpayers can claim a personal exemption of $4,050 each for themselves, their spouses and any dependents. If they choose not to itemize deductions, they can also take a standard deduction based on their filing status: $6,350 for singles and separate filers, $9,350 for head-of-household filers, and $12,700 for married couples filing jointly.
For 2018 through 2025, the TCJA suspends personal exemptions but roughly doubles the standard deduction amounts to $12,000 for singles and separate filers, $18,000 for heads of households, and $24,000 for joint filers. The standard deduction amounts will be adjusted for inflation beginning in 2019.
For some taxpayers, the increased standard deduction could compensate for the elimination of exemptions, and perhaps even provide some additional tax savings.
But for those with many dependents or those that itemize deductions, these changes might result in a higher tax bill — depending, in part, on the extent to which they can benefit from the family tax credits.
Family tax credits
The child credit was the subject of much debate during the reconciliation process. Some senators pushed to expand it more than the original House of Representatives and Senate bills did. In the end, the negotiators opted to double the credit to $2,000 per child under age 17 beginning in 2018. The maximum amount refundable (because a taxpayer’s credits exceed his or her tax liability) is limited to $1,400 per child.
The TCJA also makes the child credit available to more families than in the past. Under the new law, the credit does not begin to phase out until adjusted gross income exceeds $400,000 for married couples or $200,000 for all other filers, compared to the 2017 phaseouts of $110,000 and $75,000. The phaseout thresholds will not be indexed for inflation, though, which means the credit will lose value over time.
The TCJA also includes, beginning in 2018, a $500 nonrefundable credit for qualifying dependents other than qualifying children (examples: a taxpayer’s 17-year-old child, parent, sibling, niece or nephew, or aunt or uncle).
These provisions all expire after 2025.
State and local tax deduction
The deduction for state income and sales taxes was another point of contention, with congressional representatives from high-tax states protesting its proposed elimination. The deduction remains but has been scaled back substantially — and, of course, is available only to those who choose to itemize. With the increased standard deduction, it is expected that fewer taxpayers will do so.
For 2018 through 2025, taxpayers can claim a deduction of no more than $10,000 for the aggregate of state and local property taxes and either income or sales taxes. Note that the TCJA explicitly forbids taxpayers from claiming an itemized deduction in 2017 for prepayment of state or local income tax for a future year to avoid the dollar limitation applicable for future tax years.
Mortgage interest deduction
The TCJA tightens limits on the itemized deduction for home mortgage interest. For 2018 through 2025, it generally allows a taxpayer to deduct interest only on mortgage debt of up to $750,000. However, the limit remains at $1 million for mortgage debt incurred before December 15, 2017, which will significantly reduce the number of taxpayers affected.
The new law also changes the rule for interest paid on home equity debt. For 2018 through 2025, interest paid on home equity debt is not deductible as mortgage interest.
Additional deductions, exclusions and credits
Here are some other tax breaks that have been affected by the TCJA:
Medical expense deduction. This itemized deduction continues and is actually enhanced for two years. The threshold for deducting such unreimbursed expenses is reduced from 10% of adjusted gross income (AGI) to 7.5% for all taxpayers for both regular and alternative minimum tax (AMT) purposes in 2017 and 2018. You may want to bunch eligible expenses into 2018 to the extent possible to maximize your deduction.
Miscellaneous itemized deductions subject to the 2% floor. This deduction for expenses such as certain professional fees, investment expenses and unreimbursed employee business expenses is suspended for 2018 through 2025. If you are an employee and work from home, this includes the home office deduction.
Overall limitation on itemized deductions. On the plus side, the law suspends the overall limitation (i.e., the “Pease limitation”) on itemized deductions for 2018 through 2025.
Moving expenses. The deduction for work-related moving expenses is suspended for 2018 through 2025, except for active-duty members of the Armed Forces (and their spouses or dependents) who move because of a military order that calls for a permanent change of station.
For 2018 through 2025, the exclusion from gross income and wages for qualified moving expense reimbursements is also suspended, again except for active-duty members of the Armed Forces who move pursuant to a military order.
Personal casualty and theft loss deduction. For 2018 through 2025, this deduction is suspended except if the loss was due to an event officially declared a disaster by the President.
Charitable contributions. For 2018 through 2025, the limit on the deduction for cash donations to public charities is raised to 60% of AGI from 50%. However, charitable deductions for payments made in exchange for college athletic event seating rights are eliminated.
Alimony payments. Alimony payments will not be deductible — and will be excluded from the recipient’s taxable income — for divorce agreements executed (or, in some cases, modified) after December 31, 2018. This change is permanent.
529 savings plans. 529 plan distributions used to pay qualifying education expenses are generally tax free. The definition of qualified education expenses has been expanded to include not just post-secondary school expenses but also primary and secondary school expenses. This change is permanent.
AMT and estate tax
The House lost the battle over repealing the AMT and the estate tax — both continue to apply. However, the TCJA makes them applicable to fewer taxpayers than in the past.
Beginning in 2018, the new law increases both the AMT exemption amount (to $109,400 for married couples, $70,300 for singles and heads of households, and $54,700 for separate filers) and the AMT exemption phaseout thresholds (to $1 million for married couples and $500,000 for all other taxpayers other than estates and trusts). These amounts will be adjusted for inflation until the provision expires after 2025.
Similarly, the TCJA doubles the estate tax exemption to $10 million for 2018 through 2025. The exemption is adjusted for inflation and is expected to be $11.2 million for 2018. However, because the exemption doubling is only temporary, taxpayers with assets in the $5 million to $11 million range (twice that for married couples) will still have to keep estate taxes in mind in their planning.
Taxpayers who convert a pre-tax traditional IRA into a post-tax Roth IRA lose their ability to later “re-characterize” (that is, reverse) the conversion. Those who wish to re-characterize a 2017 Roth conversion must do so by December 31, 2017.
Re-characterization is still an option for other contributions, though. For example, an individual can contribute to a Roth IRA and subsequently re-characterize it as a contribution to a traditional IRA (before the applicable deadline).
Contact us with questions
As with any massive legislation, many questions about implementation and impact linger unanswered. We will keep you apprised as we have more information about how the TCJA will affect individual taxpayers. In the meantime, contact us with any questions.