Last week on December 22, 2017, President Trump signed into law the largest overhaul of the U.S. tax code since the Reagan administration. The law has been widely hailed as very positive for business, and it appears that the law also provides benefits for many middle-income taxpayers. But with all the hoopla and political rhetoric surrounding the law, what should you do? How do the changes in the Internal Revenue Code affect your tax return? Is there anything you should be doing right now?
First, here are a few main ideas to keep in mind.
- The new law does not affect the tax return you must file by April 15, 2018; that covers the tax year 2017, and the new requirements don’t take effect until after the first of the year.
- Under the new law, many personal itemized deductions are either no longer available or are less advantageous. To make up for this, the new law almost doubles the amount of the personal deduction. Previously, for single persons, the standard deduction was $6,500, and after January 1, 2018, it will be $12,000. For a married couple filing jointly, the deduction goes from $13,000 to $24,000.
- If you operate a sole proprietorship, partnership, or S-corporation, you may still deduct ordinary business expenses as you have been doing. In addition, the new law allows you to deduct 20 percent of the income passed through to you from your business with limited exceptions.
To help you visualize some of these changes, see the sample Schedule A, below, and refer to the red-lettered entries on it as you review the following information.
Between now and the end of the year, there are a few things you should talk over with your CPA or tax advisor:
- Accelerate expenses for certain itemized deductions. If you itemize presently, many of your favorite personal deductions will be repealed, beginning in 2018. Expenses like tax preparation fees, employee business expenses including the cost of a home office, investment fees paid to your advisor, moving expenses (except for certain members of the military), and even business-related entertainment expenses (many of which you would put on Schedule A) will not be deductible on your 2018 tax return. So, if you can pay any of those expenses before the end of the year and list them on your 2017 return, you should probably do it. Note that the threshold for deducting medical and dental expenses has been lowered from 10 percent to 7.5 percent of adjusted gross income (AGI). (Note: See red letters “A” and “E” on the sample Schedule A.)
- Defer certain types of income. Because the corporate tax rate will drop dramatically for most U.S. corporations, any corporate earnings that can be deferred until after January 1, 2018, will be taxed at a lower rate. Owners of incorporated businesses that employ cash accounting should consider holding off on billings in order to move income into 2018. Those who use the accrual method may be able to postpone job completions or deliveries until after midnight on January 1, as long as doing so won’t create problems for trading partners. At the very least, corporate business owners should confer with their tax advisors to see what their options are.
- Beginning January 1, 2018, state and local taxes (SALT) will only be deductible up to $10,000 on your federal tax return. Because of this, many might consider prepaying such taxes this year, to “double-dip” while such payments are still deductible. However, the new law specifically enjoins taxpayers from prepaying 2018 state income taxes in 2017, even if their state laws permit it. Local taxes, like property taxes, are not covered by this prohibition. So you might want to write your property tax check for 2018 and put it in the mail before New Year’s Eve, if you want to increase your deductible amount for 2017. (Note: See red letter “B” on the sample Schedule A.)
- Alternative Minimum Tax (AMT) considerations. The new law doesn’t repeal the AMT, but it does greatly expand the exemptions available. One important example would be persons with incentive stock options (ISOs) from their employer. Exercising an ISO is one of the events that can trigger AMT liability. But with the new, higher exemption, you are less likely to be liable for the AMT after January 1, 2018. So, if you can defer exercising an ISO until after the first of the year, you could significantly reduce your risk of incurring the AMT.
Now, let’s look at some provisions of the new law that may change the way you approach your investments and tax planning strategy, going forward.
- Estate taxes. If you are utilizing trusts to manage estate tax liability, make an appointment with your estate planning attorney to review your documents. The new law doubles the exemption for estate taxes, which means that many fewer estates will be large enough to be concerned with paying them. However, the estate tax laws have changed frequently in the past, and no doubt they will continue to do so. You need to carefully review your documents and your strategy with a qualified legal advisor who is well versed in estate law and the implications of the new tax law. (Note: This exemption sunsets at the end of 2025.)
- Pass-through income deduction. The new law allows a 20 percent deduction for owners of most “pass-through” businesses–operators of S-corporations, partnerships, or sole proprietorships. Such businesses will be able to deduct 20 percent of the income generated by the business, with the remainder taxed at the owner’s marginal rate. Such owners who are married and filing jointly and earning $315,000 per year or less would have a top marginal rate of 25 percent in 2018, based on the brackets that will go into effect with the new law.
- Alimony. Previously, alimony payments were deductible for the payor and taxable to the payee. Under the new law, alimony payments are no longer deductible or taxable. The law grants a window, until December 31, 2018, to finalize pending divorce agreements, in order to permit time for these new considerations to be incorporated into the calculation of payments. It will be advantageous for those likely to be payors to finalize agreements before year-end of 2018. On the other hand, those who will be receiving payments may wish to defer alimony agreements until after January 1, 2019.
- Mortgage interest deductibility. For loans closed after December 15, 2017, mortgage interest on loans of up to $750,000 is deductible (down from $1 million under the previous law). Home equity loan interest for loans with an effective date later than December 15, 2017, will no longer be deductible. (Note: See red letter “C” and yellow highlighting on sample Schedule A.)
- Section 179 depreciation deduction for real property. Under the previous law, there was a $520,000 annual limitation on Section 179 deductions; the new law increases this to $1 million. The new law also allows for “qualified real property” to be eligible for this deduction.
- Charitable Donations. Under the new law, charitable donations are still deductible. However, because of the much higher personal deduction, many fewer taxpayers will see an advantage in itemizing, so you should consult with your tax advisor about your specific situation. That said, the new law does raise the amount of AGI allowed for charitable donations from 50 percent to 60 percent. (Note: See red letter “D” on sample Schedule A.)
Remember that it is important to speak with a qualified tax advisor in connection with the matters outlined above. The new law offers several advantages for many taxpayers, but along with these come changes that need to be thoroughly understood.