On Dec. 20 Congress passed the Tax Cuts and Jobs Act of 2017 (TCJA), and President Trump signed it shortly after. This law, most of which will become effective on Jan. 1, dramatically changes our tax environment. New financial planning strategies will emerge in the coming months and years.
Who wins?
Certainly, the biggest beneficiaries of this legislation are corporations with high effective tax rates, because the corporate rate is dropping from 35% to 21%. Certain pass-through businesses will also see major reductions. Some LLCs, partnerships, S Corps, and sole proprietors will be able to deduct 20% of their qualified business income. Essentially, they will be paying taxes on only 80% of their revenue.
Even #MeToo found its way into TCJA. In the past, businesses could deduct settlements paid for sexual harassment and sexual abuse claims. But now no deduction will be allowed for settlements that are tied to a nondisclosure agreement. That is probably a win for those victims who are more likely to be able to tell their stories.
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Who loses?
According to IRS data, about a third of taxpayers itemize their deductions on a Schedule A. That figure is likely to drop to below 10%. In the early years of a mortgage? In a state with high income taxes or high property taxes? Charitably inclined, but not uber wealthy? I’m sorry. You are likely to be a victim of the TCJA. Your tax return may be easier next year, but it is likely that the new standard deduction is higher than the amount you would be able to itemize. When you pair that with the elimination of the personal exemptions, many of you will see a higher tax bill.
As mentioned above, the personal exemptions are going away. That means for a family of three or more, the benefit of the standard deduction is completely offset by the $4,050 deduction you used to be able to take for each person on the return. That means if you have two or more kids, you may actually be hurt by the new deduction/exemption amounts.
Let’s not forget the cost to the nation. It is estimated that this experiment will run up the already high national debt by another $1.5 trillion. Time will tell the impact of this.
What should I do now?
Itemized “lumping” is likely to be a strategy of the future. Because many people who previously itemized will no longer get above the standard deduction, it will make sense to itemize every few years and make all charitable contributions, major surgeries, etc. in those years. If you have some liquidity and think you fall into this boat, you may want to contribute to a donor advised fund before Dec. 31. This will give you the deduction in 2017 (if you itemize) but will allow you to direct those contributions to the charity of your choice down the road.
| Topic | Current | Tax Cuts and Jobs Act of 2017 |
|---|---|---|
| Tax Brackets | 10%, 15%, 25%, 28%, 33%, 35%, 39.6% | 10%, 12%, 22%, 24%, 32%, 35%, 37% |
| Capital Gains Rates | 0%, 15%, 18.8%, 23.8% | 0%, 15%, 18.8%, 23.8% |
| Standard Deduction | Individual: $6,350 MFJ: $12,000 | Individual: $12,000 MFJ: $24,000 |
| Personal Exemptions | $4,050 for each person | Eliminated |
| State and Local Taxes | Can deduct state and local income taxes as well as property taxes, if you itemize. | Can deduct the total paid for state and local taxes as well as property taxes up to a total or $10K/family. |
| Mortgage Interest | Interest deductible on loans up to $1MM + $100K for equity debt. Can be taken on primary residence + 1 other property. | Deduction remains in place for mortgages up to $750K. Home equity indebtedness is no longer deductible. |
| Charitable Deductions | Deductible if you itemize on Schedule A. | Remain as is but expanding deductible amount up to 60% of AGI (from 50%). |
| Medical Expense Deduction | Can deduct qualifying medical expenses in excess of 10% of your AGI. | Deduction remains in place with a lower floor of 7.5% for 2017 and 2018. |
| Itemized Deductions | Currently taken on a Schedule A instead of using standard deduction. | Most itemized deductions, except for those mentioned above, would be eliminated. |
| Exclusion of Gain from Personal Residence Sale | Can deduct up to $250K/person for a home that you have owned and resided in for at least 2 out of 5 years. | Remains as is (a last-minute change!). |
| Obamacare Individual Mandate | Required to pay a penalty if you don't have a minimum level of health care coverage. | Penalty eliminated after 2018. |
| Alternative Minimum Tax | A sort of tax backstop to keep the wealthy from reducing their tax bill through tax preferences. | Would remain in place, but with a higher exemption amount. |
| Federal Estate Tax | Currently allows each individual to pass $5.49 million tax-free to the next generation. $10.98 million/couple. | Exemption would double to $22.4 million/couple. $11.2 million/individual. |
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