Tax Reform Legislation: Changes, Impact, and Planning Considerations

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1 Tax Refrm Legislatin:,, and Planning Cnsideratins Planning Update January 2018 The Tax Cuts and Jbs Act f 2017, the lng-awaited tax refrm bill, was signed int law in December In this update, we will briefly highlight imprtant aspects f this legislatin related t all taxpayers and review the impact it will have n individual investrs and business wners. We will als discuss sme f the planning issues t cnsider given these changes. The impact f these changes will vary depending n an individual s situatin. Als, many prvisins are ambiguus and will require clarificatin. We expect t receive additinal guidance ver the weeks and mnths t cme. The prvisins listed here are effective starting in 2018 unless stated therwise. The items in italics are scheduled t expire n December 31, Therefre, any planning cnsideratins shuld be evaluated with that in mind. The remaining prvisins are nt scheduled t expire unless therwise nted. Trust and Estate Tax Rates and Individual Rates and Brackets Fr individuals, the new law prvides fr the same number f tax brackets, but with lwer rates and different incme threshlds. See the charts n page 2 fr incme threshlds assciated with each bracket. The tax rates fr trusts and estates have als decreased and nw cnsist f nly fur brackets. New rates: 10%, 24%, 35%, and 37% Old rates: 15%, 25%, 28%, 33%, and 39.6% Rates fr qualified dividends and lng-term capital gains are unchanged. The incme threshlds fr the capital gain brackets are n lnger tied t the rdinary incme brackets. See the fllwing charts fr a cmparisn f the capital gain and rdinary incme brackets. Nte that the tp rate f 37% begins at $500,000 fr single filers and at $600,000 fr married filing jintly. Cngress did nt repeal existing Medicare taxes (the 0.9% additinal payrll tax, r the 3.8% tax n net investment incme) that apply t higher-incme taxpayers. These apply when adjusted grss incme (AGI) exceeds $250,000 (jint) r $200,000 (single). The Kiddie Tax is nw tied t Trust and Estate tax rates. Taxable incme f $12,500 results in a Trust tax f apprximately $3,000 while the tax at individual rates wuld be apprximately $1,400. Planning Cnsideratins Because taxable incme is determined after applying deductins, it will be imprtant fr each taxpayer t evaluate hw the lss f certain deductins may ffset the benefit derived frm the lwer rates. Incme tax planning fr Trusts and beneficiaries is very imprtant. Tax Refrm Legislatin:,, and Planning Cnsideratins

2 Surce: Wells Farg Advisrs. Tax Refrm Legislatin:,, and Planning Cnsideratins

3 Deductins, Exemptins, and the Child Tax Credit The standard deductin is nearly dubled t $24,000 fr married filers and $12,000 fr single filers (standard deductin fr individuals wh are age 65 r lder, r blind, is retained). Persnal and dependent exemptins (currently $4,050 per persn) are eliminated. The deductin fr state and lcal taxes is significantly changed. This deductin will be capped at $10,000 fr the sum f state and lcal prperty taxes and incme taxes (r sales tax in lieu f incme tax). This limitatin nly applies t individual itemized deductins (Schedule A f tax return). Prperty taxes paid in carrying n a trade r business will nt be subject t this $10,000 cap. Mrtgage interest deductin limit n qualified acquisitin debt is reduced frm $1 millin t $750,000. This means interest is deductible n lan balances up t $750,000 used t buy, build, r imprve a primary hme r ne secnd hme. This reductin applies nly t debt incurred n r after December 15, Includes hme equity debt if the funds are used t acquire r imprve the primary r secndary hme. Interest n hme equity lans, ther than the amunt that was used t acquire r imprve a qualified residence, is n lnger deductible. Cash cntributins t charitable rganizatins may nw ffset up t 60% f Adjusted Grss Incme (AGI) up frm 50%. Deductins fr investment management fees, tax preparatin fees, and unreimbursed emplyee expenses (previusly treated as miscellaneus itemized deductins) are eliminated (rules regarding investment interest expense were nt changed). Medical expenses exceeding 7.5% f AGI are deductible dwn frm 10%. This reduced limit applies nly fr 2017 and Casualty lsses are limited t thse attributable t a federally-declared disaster area. The phase-ut f itemized deductins fr higher-incme taxpayers is eliminated. The child credit increases frm $1,000 t $2,000. The incme level at which the credit begins t phase ut als increases allwing mre taxpayers t benefit. Alimny payments are n lnger deductible by the payer and nt taxable t the recipient. This prvisin is effective fr a divrce r separatin instrument executed after December 31, 2018 r fr changes t an existing instrument after that date, if the changes expressly prvide that the new law shuld apply. The individual Alternative Minimum Tax exemptin and phase-ut levels are increased, ptentially allwing many mre taxpayers t avid AMT (there was discussin abut eliminating AMT fr individuals, but it was nt eliminated). Fr thse wh dn t currently itemize, a larger standard deductin will likely be a welcme benefit. The repeal f many itemized deductins culd mean that sme taxpayers wh previusly itemized culd find themselves limited t a standard deductin that is smaller than the amunt they deducted under itemizatin. The $10,000 limit n state and lcal taxes (including prperty taxes) will be especially impactful t thse in high tax states. Althugh taxpayers may still itemize, the impact f the limited deductin may ffset savings frm the changes t the tax brackets. The new 60% f AGI limitatin n charitable deductins applies nly t cash cntributins t public charities. Taxpayers wh have carryver f excess cntributins t charity frm prir years may be able t benefit frm this prvisin. Planning Cnsideratins Fr taxpayers wh are charitably inclined and ver age 70½, it will be imprtant t evaluate whether it is mre beneficial t make a cntributin f cash, stck, r a qualified distributin frm an IRA. The best strategy will nt be the same fr everyne. Tax Refrm Legislatin:,, and Planning Cnsideratins

4 Taxpayers will need t decide each year whether r nt t itemize deductins. Sme taxpayers may want t cnsider bunching charitable cntributins int alternate years, with a view t qualifying fr itemizatin at least sme f the time. Hwever, the cash flw impact n the taxpayer and the charity shuld be cnsidered. IRA Cntributins and Cnversins The rule allwing a cntributin t ne type f IRA t be recharacterized as if made t anther type f IRA is mdified t exclude Rth IRA cnversins. Nrmal IRA cntributins may still be recharacterized. Taxpayers wh want t cnvert their Traditinal IRA t a Rth IRA will need t carefully cnsider the cnsequences as they will n lnger have the ability t change their mind. Planning Cnsideratins A Rth cnversin can still be a useful tax strategy in years with lw taxable incme r a market decline in retirement plan assets. Educatin Tax Benefits Qualified distributins frm a 529 plan nw allw up t $10,000 annually fr elementary and secndary tuitin including private and religius schls. ABLE accunts (designed fr disabled beneficiaries) may accept tax-free rllvers frm 529 plans, up t the annual cntributin limit fr ABLE accunts. Bth 529 cllege savings plans and ABLE accunts becme mre attractive tls fr meeting savings gals. Planning Cnsideratins Cnsider additinal funding fr a 529 plan since the funds may nw be used fr tuitin and ther expenses fr grades K-12. Generally, it will be advisable t defer distributins frm the 529 plan as lng as pssible t maximize tax-deferred grwth. Cnsider paying tuitin fr elementary and secndary educatin directly t the institutin. Taxatin f a Child s Investment Incme ( Kiddie Tax ) Estate, Gift, and Generatin-Skipping Taxes Investment incme f a child will be taxed at trust incme tax rates rather than individual incme tax rates. Fr children under age 24 wh are full-time students, investment incme is n lnger taxed at their parent s rate but at trust rates. The tp trust incme tax rate is the same as the tp rate fr an individual. Hwever, the tp trust rate applies at a much lwer level f incme likely resulting in a higher tax bill under this new rule. Planning Cnsideratins Review gifting strategies fr yunger family members alng with the varius vehicles available fr hlding funds in a child s name. Investment chices will be imprtant t cnsider in rder t cntrl the amunt and character f incme generated while the child is subject t these rules. The new law dubles the applicable exclusin t $11.18 millin per persn based n chained CPI inflatin, effective in (The prtability electin, which permits a deceased spuse t transfer unused exclusin amunts t a surviving spuse, is unchanged. The rules prviding a step-up in cst basis at death fr capital assets are unchanged.) This exclusin will cntinue t be inflatin-adjusted in future years. Inflatin adjustments will generally be lwer than prir years due t a change in the calculatin. Tax Refrm Legislatin:,, and Planning Cnsideratins

5 A married cuple, with basic planning, shuld be able t transfer up t $22.36 millin with n federal estate tax. Planning Cnsideratins The increase f the applicable exclusin prvides a significant pprtunity t review gifting strategies. Keep in mind, this prvisin is currently set t expire after Higher exclusins may tempt sme individuals t verlk estate tax planning, resulting in ptential missed pprtunities. It culd be a mistake t ver-simplify yur estate plan in reactin t the new law. Instead f ding less estate planning, these higher threshlds culd be viewed as an pprtunity t d mre. In particular, higher generatin-skipping exclusins prvide an pprtunity fr multigeneratinal wealth preservatin planning. Furthermre, estate planning is nt slely abut estate taxes. There are many reasns t examine wealth transfer ptins that relate t family dynamics and verall asset prtectin. Existing estate plans fr married cuples ften call fr autmatic, maximum funding f a credit shelter trust at the first spuse s death. This culd result in less-than-ptimal use f the deceased spuse s exclusin, and sacrifice the pprtunity fr a step-up in cst basis at the surviving spuse s death. Estate plans created befre 2013 shuld definitely be reviewed, and even recently created plans may need t be recnsidered in light f dramatically increased exclusins. Existing dcuments may include frmula clauses that nw result in all r mre assets being used t fund credit shelter trusts, and little r n assets left t the surviving spuse. Individuals with charitable planning gals may benefit frm adjustments t strategies and timing. Fr example, if n estate tax is wed, a charitable bequest des nt result in any tax reductin. Perhaps lifetime giving strategies which culd prvide an incme tax deductin fr itemizing taxpayers shuld be evaluated as an ptin. In additin, it will be imprtant t cnsider naming a charity t receive funds frm IRAs, qualified retirement plans, r deferred annuities, as distributins frm these assets wuld therwise be subject t incme tax if distributed t individuals. Business Incme and Deductins The tax rate fr C Crpratins is reduced frm 35% t a flat rate f 21%. Crprate AMT is eliminated. There is a new deductin f 20% fr qualified business incme f S crpratins, partnerships, and sle prprietrships received by individuals, trusts, r estates. Generally speaking, this special deductin is allwed against business prfits, and des nt apply t wages earned by the business wner. The amunt f the deductin generally cannt exceed 50% f wages paid by the business. Hwever, capital-intensive businesses may qualify fr an alternative limitatin based n the acquisitin value f capital assets. If taxable incme f the wner exceeds $415,000 (married filing jintly), this deductin is nt available fr businesses that prvide services in the fields f health, law, accunting, actuarial science, perfrming arts, cnsulting, athletics, investment r brkerage services, r any business where the principal asset is the reputatin r skill f ne r mre f its emplyees. The deductin is reduced if the taxpayer s incme exceeds $315,000 (married filing jintly) r $157,500 (thers). Taxpayers are als able t deduct 20% f incme received as qualified REIT dividends, qualified cperative dividends, and qualified publicly traded partnership incme. 100% expensing f qualified business prperty is allwed fr five years, after which it gradually phasesut. This applies t prperty placed in service n r after September 27, Tax Refrm Legislatin:,, and Planning Cnsideratins

6 Increased limits fr expensing are allwed under Sectin 179 and certain real prperty imprvements are added as qualifying prperty. Current business entity selectin may need t be recnsidered in light f these changes. Significant tax benefits are nw available t businesses which have been waiting t invest in capital expenditures. These changes create significant pprtunities fr wners f pass-thrugh entities and sle prprietrs. Planning Cnsideratins Many questins remain abut the details f hw the deductin f 20% f qualified business incme will apply. The type f business activity cnducted will have a significant impact n whether and hw a taxpayer benefits frm the new deductin. Business wners will want t evaluate whether it is beneficial (and practical) t segregate favred and unfavred business activities int different entities. When cnsidering a change f business structure r entity type, it is imprtant t evaluate hw the expiratin f these new rules culd impact the value f any particular strategy. As always, it is imprtant that a tax advisr and attrney are invlved t carefully weigh any decisins related t chice f business entity. State and Lcal Taxes Sme state tax prvisins are tied t federal tax prvisins. Each state will have t decide whether it will adhere t the federal changes. Differences in state and federal laws lead t additinal cmplexity, recrd keeping, and tax preparatin csts. Sme states use federal taxable incme as the starting pint f their tax calculatin. If a taxpayer s federal taxable incme increases due t the lss f certain federal deductins, his r her state tax bill culd increase even withut any specific change t state law. Planning Cnsideratins Any tax strategies cnsidered fr federal tax planning purpses shuld als take int accunt the state tax impact. It is imprtant t cnsider the impact f the new law when determining estimated tax payments fr Estate/Gifts/GST Tax The threshlds fr state estate taxes are ften cnsiderably lwer than the federal applicable exclusins. A few states have tied their exemptins t the federal exclusin. It will be imprtant t mnitr whether these states maintain that link, r chse t decuple. It s nt sufficient just t plan fr the laws f the state where an affluent taxpayer lives. T preserve family wealth effectively, it s increasingly imprtant t cnsider the ptential impact f state taxes in the places where heirs and beneficiaries live as well. Next Steps Many f the individual prvisins listed here represent a significant change frm prir law. In cmbinatin, the verall effects will vary widely amng taxpayers. As time passes, we will have mre clarity n the details as well as planning strategies t share. Nw is the time t gather yur advisr team. Yur Abbt Dwning team, alng with yur estate attrney and tax advisr, will be instrumental in determining what actin steps may be apprpriate fr yu in the shrt and lng-term. Tax Refrm Legislatin:,, and Planning Cnsideratins

7 Disclsures Please cnsider the investment bjectives, risks, charges and expenses carefully befre investing in a 529 savings plan. The fficial statement, which cntains this and ther infrmatin, can be btained by calling yur financial prfessinal r the plan spnsr. Read it carefully befre yu invest. The availability f tax r ther benefits frm a 529 plan may be cnditined n meeting certain requirements. Wells Farg Wealth Management, Wells Farg Private Bank and Abbt Dwning, a Wells Farg business, prvide prducts and services thrugh Wells Farg Bank, N.A. and its varius affiliates and subsidiaries. Wells Farg Bank, N.A. is a bank affiliate f Wells Farg & Cmpany. Wells Farg & Cmpany and its affiliates d nt prvide legal r tax advice. Please cnsult yur tax and legal advisrs t determine hw this infrmatin may apply t yur wn situatin. Whether any planned tax result is realized by yu depends n the specific facts f yur wn situatin at the time yur taxes are prepared. Any estate plan shuld be reviewed by an attrney wh specializes in estate planning and is licensed t practice estate law in yur state Wells Farg Bank, N.A. All rights reserved. Tax A Wells Refrm Farg Legislatin: Business,, and Planning Cnsideratins