Examining the Tax Cuts and Jobs Act 304436 12/16
Topics for today • 1. Key provisions of the new law 2. Planning considerations and strategies
Highlights of the new tax law • Lower marginal tax rates for individuals, estates, and businesses • Significant changes to tax deductions while personal exemptions are repealed • No major changes to retirement and education incentives • Individual mandate to purchase insurance effectively repealed • Most provisions (except for the lower corporate tax rate) are scheduled to expire after 2025
Examining the new tax brackets — individuals TCJA PREVIOUS 37% $500,000 39.6% $426,700 35% 35% $424,950 33% $200,000 32% $195,450 $157,500 28% 24% $82,500 $93,700 22% 25% $38,700 $38,700 12% 15% $9,525 $9,525 10% 10% Sources: 2018 IRS tax brackets and rates; Tax Cuts and Jobs Act.
Examining the new tax brackets — couples TCJA PREVIOUS 37% $600,000 39.6% 35% $480,050 35% $424,950 $400,000 32% 33% $315,000 24% $237,950 28% $165,000 $156,150 22% 25% $77,400 $77,400 12% 15% $19,050 $19,050 10% 10% Sources: 2018 IRS tax brackets and rates; Tax Cuts and Jobs Act.
Tax rates on capital gains and dividends remain the same * Does not include the 3.8% surtax on net investment income, which applies to single filers over $200,000 in modified adjusted gross income (MAGI) and for married couples with more than $250,000 in MAGI. Sources: 2018 IRS tax brackets and rates; Tax Cuts and Jobs Act.
Significant changes to deductions Interest on home equity lines of credit may still be deductible if proceeds are used to buy, build or substantially improve the taxpayer’s home that secures the loan. Consult with a tax professional for more information. Standard deduction figures do not account for inflation adjustments for 2019 which increase the deduction to $12,200 (single) and $24,400 (married filing a joint return). Source: Joint Explanatory Statement of the Committee of Conference.
The Child Tax Credit (CTC) is expanded • Increased from $1,000 to $2,000 for “qualifying children” under 17 years old at the end of the year • Additional $500 tax credit applies to other qualified dependents who are not qualifying children (i.e., dependent child age 17 or over) • Tax credit is phased out as income exceeds $200,000 (individuals) or $400,000 (married/filing jointly) • Previous phaseout amounts were $75,000 (individuals) or $110,000 (married/filing jointly) Source: Joint Explanatory Statement of the Committee of Conference.
The alternative minimum tax (AMT) remains, but will apply to fewer taxpayers • The AMT exemption is increased to $70,300 for individuals (from $55,400) and $109,400 for married/filing jointly (from $86,200) Chance of owing AMT under the new rules Source: Tax Policy Center, Characteristics of Alternative Minimum Tax (AMT) Payers; Percentage Affected by the AMT, 2017–2018, 2025–2026. The Tax Policy Center uses a broad measure of pretax income, called “expanded cash income” or ECI, to analyze the distribution of federal taxes. For a detailed description of expanded cash income, see https://www.taxpolicycenter.org/resources/income-measure-used-distributional-analyses-tax-policy-center. AMT exemption figures for 2019 are $71,700 (single) and $111,700 (married/filing a joint return).
Case example: Taxes for a family of four • Family of four with two children under age 17 • 28% marginal tax bracket under previous tax system; 24% TCJA tax bracket • Claiming standard deduction
Other items to note • Beginning in 2018, annual inflation adjustments will be based on a formula that generally results in a lower inflation figure • The option to recharacterize, or “un-do,” a Roth IRA conversion is eliminated • No more income phaseouts on itemized deductions • 529 college savings plans are expanded — account owners can utilize up to $10,000 annually to cover K–12 tuition expenses Source: Joint Explanatory Statement of the Committee of Conference.
Changes to the way businesses are taxed Source: Joint Explanatory Statement of the Committee of Conference.
New deduction for small business owners • Applies to businesses that are structured as pass-through entities for taxation purposes (sole proprietorship, LLC, partnership, S Corp) • 20% on qualified business income (QBI), cannot include compensation or investment income • At higher income levels, specified service trade or businesses (SSTBs) are not allowed to take the deduction • According to the law, “A specified service activity means any trade or business activity involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, or investing, trading, or dealing in securities, partnership interests, or commodities.” Source: Joint Explanatory Statement of the Committee of Conference.
How the new 20% QBI deduction works Taxable income (Single) Taxable income (Married, filing jointly) $207,500 $415,000 $157,500 $315,000 $0 $0 * The wage limitation refers to an alternate test that must be applied to determine the deduction for QBI (for non-specified service businesses) when taxable income exceeds $157,500 for individuals and $315,000 for couples. The alternate test is the greater of (a) 50% of total wages paid by the business or (b) 25% of wages plus 2.5% of unadjusted cost basis of qualified property.
Consider “lumping” charitable gifts Assumptions: H & W, age 65, who donate $10,000 annually to charity; other deductions include $10,000 for SALT and $5,000 for mortgage interest; their marginal income tax bracket is 22% 2019 2020 2021 ANNUAL GIFTS “LUMP” GIFTS NO GIFT NO GIFT $10,000 $10,000 $10,000 $30,000 Result: With annual gifting the their total deductions = $81,600 ($27,200 x 3 years); by lumping gifts, their total deductions = $99,400 ($45,000 + $27,200 + $27,200), resulting in a difference of $17,800 for a tax savings of approximately $4,000, assuming a 22% marginal tax bracket Example is based on 2019 IRS figures and does not account for higher standard deduction in 2020 and 2021 due to annual inflation adjustments.
Donate IRA assets to a charity • Requirements • Must be age 70½ or older • Distribution must be sent directly to a qualified charity • Limit of $100,000 annually per IRA owner and can include the required minimum distribution (RMD) • Benefits • Tax-free RMD lowers AGI — may have beneficial impact in other tax areas such as taxation of Social Security benefits or Medicare Part B premiums • Avoids AGI threshold for charitable gifts • May benefit state taxes since some states do not allow residents to deduct a charitable contribution • May benefit legacy planning by preserving assets, which may benefit from step-up in cost basis while the IRA is taxable to heirs
Lower tax rates benefit Roth IRA conversions TCJA PREVIOUS 37% $600,000 39.6% 35% $480,050 35% $424,950 $400,000 32% 33% $315,000 $250,000 24% $237,950 Potential Roth IRA conversion opportunity? 28% $165,000 $156,150 22% 25% $77,400 $77,400 12% 15% $19,050 $19,050 10% 10% Chart based on 2018 income tax brackets for married couples filing a joint return established by the Tax Cuts and Jobs Act (TCJA) compared with 2017 income tax brackets.
Estate planning considerations • Review existing trusts to determine if changes are needed • Be mindful of state death taxes • Plan for low cost-basis property • Ensure stepped-up cost basis is maintained when property is transferred at death • HNW families may want to consider a gifting strategy for the additional lifetime exclusion amount • Work with an estate planning professional to account for the potential “sunset” of the law in 2026
Closing thoughts • The Tax Cuts and Jobs Act represents the most sweeping changes to the tax code in decades • Careful attention must be made to determine the impact on your financial situation • Work with professionals to assess income and estate tax planning strategies
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