Congress is on the brink of enacting comprehensive tax reform for the first time in over 30 years. Lawmakers are expected to vote this week on a final bill that passed out of a House-Senate conference committee on Friday. Negotiations have concluded and it appears that Republicans have enough votes in the House of Representatives and the Senate to enact the legislation. A floor vote is expected in the House today or Tuesday with a vote in the Senate to follow on Tuesday or Wednesday.
For individuals and businesses alike, tax reform legislation could mean huge changes to their tax bills. If enacted, most of the new provisions would be effective for the 2018 tax year. With such major law changes on the horizon, taxpayers should be prepared. Below we outline some significant components of the final tax reform bill and helpful tips on how to prepare.
Tax reform legislation would cut individual income tax rates, including a top marginal rate reduced to 37 percent from the current 39.6 percent rate. The other brackets would be 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, and 35 percent. Changes to several tax credits, deductions, and exemptions, however, may temper the benefit of individual rate cuts, depending on the taxpayer’s circumstances.
The standard deduction would increase by approximately twofold (for example, for married couples filing jointly, from $12,700 in 2017 to $24,000). Consequently, the number of taxpayers who itemize deductions would decrease and correspondingly reduce the value of other deductions for many taxpayers. Another major change is the elimination of the personal exemption for the individual taxpayer and their dependents through tax year 2025.
For those who would still benefit from itemizing, here are some of the more notable changes:
- The total allowable deduction for state and local taxes is capped at $10,000 for most taxpayers (only $5,000 for married taxpayers filing separate returns).
- The mortgage interest deduction would be limited to interest on up to $750,000 in qualifying mortgage debt, and eliminated for interest on home equity loans.
- The charitable deduction for cash contributions would be subject to an increased limitation from its current limit of 50 percent of adjusted gross income to 60 percent.
- Unreimbursed medical expenses would be deductible to the extent they exceed 7.5 percent of adjusted gross income, down from the current 10 percent threshold.
An increase to the child tax credit stands to be a major benefit to middle class families. The final bill doubles the amount of the credit to $2,000 per child, $1,400 of which is refundable. More families may take the credit as well, due to a change that begins phasing out the credit for married filing jointly filers earning more than $400,000, up from $110,000 currently.
Taxpayers should keep in mind that the final tax reform bill retains the alternative minimum tax (AMT) for individuals. To cabin its reach, however, exemption thresholds are significantly increased.
With these changes in mind, individuals should consider year-end strategies to take advantage of the current tax code. For example, consider making charitable contributions before year-end, either to charitable organizations or to a donor advised fund (DAF). Charitable contributions have more tax value under the current tax code than they would have under the proposed tax reform regime. Contributions to the DAF may be deducted currently and the DAF may make gifts in future years.
In addition, taxpayers may consider pre-paying their local property taxes for 2018 to the extent possible. State and local taxes are fully deductible for most taxpayers this year but may be limited next year under the new tax regime. The final bill does not allow individuals to claim an itemized deduction in 2017 on a pre-payment of state income tax for a future tax year.
For business taxpayers, significant changes to pass-through, corporate, and international taxation accompany the tax reform legislation. Small business owners would see a large benefit under the plan. Under a complex formula, owners of pass-through entities such as S corporations, limited liability companies, partnerships, and sole proprietorships would be permitted to deduct up to 20 percent of their qualified business income passing through to their personal income tax returns. Business owners providing services in the fields of health, law, consulting, athletics, financial services, brokerage services, however, would see their small business deduction significantly curtailed.
Corporations including many large retailers would also benefit from the proposed tax package. The legislation would lower the corporate tax rate to 21 percent from the current 35 percent rate. Lower rates may mean that businesses contemplating asset sales should consider pushing back proposed transactions into next year to take advantage of the lower rate.
Other provisions in the final tax reform bill are designed to raise revenue to pay for the overall rate reduction and consequently curtail its benefit. These measures include adjusting, reducing, or eliminating familiar business tax credits and deductions. For example, increases to limitations on net operating loss deductions and a reduction to the dividends-received deduction rate are included in the final bill. One controversial measure, the corporate alternative minimum tax, was eliminated in the conference committee.
The federal estate and gift tax exemption is currently $5.49 million per individual and nearly $11 million for a married couple. Tax reform legislation would approximately double these exemptions to $11.2 and $22.4 million, respectively. As for the gift tax, regardless of whether tax reform is enacted into law, the annual gift exclusion amount will increase to $15,000 for 2018—up from $14,000 where it has been steady since 2013.The McDonald Hopkins tax team is closely monitoring these tax reform developments and others. We will keep you posted with the latest developments in the coming days and weeks.