5/29/ TAX CUTS AND JOBS ACT OVERVIEW. Individual Tax. Introduction-Individual Provisions. Dauphin County Bar Association May 30, 2018

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1 2017 TAX CUTS AND JOBS ACT OVERVIEW Dauphin County Bar Association May 30, 2018 Individual Tax 2 Introduction-Individual Provisions In general, the individual provisions go into effect starting on January 1, 2018, but are set to expire on December 31,

2 Individual Tax Tax Brackets 4 Individual Tax Rates and Credits Topic Old Law New Law Alternative Minimum Tax Exemption (MFJ): $84,500 Phaseout Threshold (MFJ): Exemption (MFJ): $109,400 $160,900 Phaseout Threshold (MFJ): $1,000,000 Fewer preferences and adjustments Capital Gain Rates Taxed at 0%, 15% or 20% depending on tax bracket Child Tax Credit and New Family Tax Credit $1,000 per child (up to $1,000 refundable) $0 for other dependents Taxed at 0%, 15% or 20% depending on fixed amounts $2,000 per child (up to $1,400 refundable) $500 for other dependents (non refundable) 5 Individual Tax Exemptions and Deductions Topic Old Law New Law Alimony Deductible to payer, taxable to recipient Not deductible to payer, not taxable to recipient. Effective for new agreements after December 31, 2018 Permanent Change Personal Exemption $4,050 per individual and dependent Subject to phase out No exemption allowed Standard Deduction $6,350 Single, $12,700 MFJ $12,000 Single, $24,000 MFJ 6 2

3 Individual Tax Itemized Deductions Topic Old Law New Law Charitable Contributions Deduction limited to 50% of Deduction limited to 60% of AGI AGI Medical Expense Deduction Deductible if in excess of 10% Deductible if in excess of 7.5% of AGI of AGI for 2017 and 2018, returns to 10% in 2019 Miscellaneous 2% Itemized Deductions Deductible if in excess of 2% of AGI Includes items such as: Tax Prep Fees Investment Management Fees Unreimbursed Employee Expenses No deduction allowed 7 Individual Tax Itemized Deductions 8 Topic Old Law New Law Mortgage Interest Deduction State and Local Tax Deduction Limitation on Itemized Deductions Deduction allowed for up to $1,000,000 of acquisition indebtedness on personal and second residence and up to $100,000 of home equity line of credit indebtedness Deduction allowed for up to $750,000 of home acquisition indebtedness for homes acquired after Dec 15, No deduction allowed on home equity indebtedness. Deduction allowed for all: Deduction capped at $10,000 state and local income taxes (or sales taxes), real property taxes and personal property taxes Taxpayers whose AGI exceeds a threshold (currently $313,800 for MFJ) have their itemized deductions phased out by 3% of the excess of AGI over the threshold No AGI limitation on itemized deductions Individual Tax Other Changes Topic Old Law New Law Affordable Care Act Individual Mandate Education Savings Rules (Section 529 Plans) Re Characterization of Certain IRA and Roth IRA contributions Penalty imposed on individuals who do not have health insurance Tax free distributions if used for higher education Allowed to recharacterize from regular to Roth and vice versa Penalty reduced to $0 effective January 1, 2019 Expanded to included up to $10,000 for elementary or secondary education Cannot recharacterize Roth conversion contributions to regular IRA 9 3

4 Estate, Gift, and Generation-Skipping Transfer Taxes 10 Estate, Gift, and Generation-Skipping Transfer Taxes Beginning in 2018, the exemption for estate and gift taxes and the generationskipping transfer tax is increased to $10,000,000 (and adjusted forward for inflation from 2011). o Inflation - There will be a roughly $11,200,000 exemption starting in These increases are set to expire on December 31, 2025, and the exemption amounts will return to the pre-tax reform amounts. o This makes the current planning techniques still relevant, even for estates that do not exceed the increased exemption amount. 11 Summary: Planning with New Exclusion With an $11.2 million ($22.4 million married couple), we need to completely re-think our planning and consider the impacts: Existing plan is larger exclusion going to cut out spouse? Next need to ask if they could qualify and benefit for a step-up of assets in existing trusts Extends to on-going planning with clients. We need to ask all HNW clients when they plan to have meeting to address their planning and if they want us to be included. Income tax planning is potentially more important than estate tax planning We need to be sensitive that these levels could be changed by Congress and/or that they sunset in So, there are no guarantees in the future. Planning needs to take that into account. Maybe gifting now is in order Portability elections are important even where marital assets may be well under the current exclusions impact of 2025 sunset? 12 4

5 Business Taxation 13 Primary Business Provisions Pass Through Deduction Section 199A Changes to depreciation and cost recovery Rules for 2017 before and after the effective date of the Act Interest Expense Limitation: Some exclusions, but primary general one is rule is not applicable If average receipts over previous three years are less than $25 million tested on an affiliated group basis 14 Interest Expense Limitation Interest expense disallowed for amounts in excess of the sum of: Business interest income, 30% of business s Adjusted Taxable Income plus The floor plan financing interest Determined on entity by entity basis Consolidated group would be one entity 15 5

6 Interest Expense Limitation Adjusted Taxable Income is determined without regard to: Investment income and expenses Business interest income or expense Net operating loss 20% Pass-through deduction Depreciation, amortization and depletion for years beginning before January 1, Interest Expense Limitation Through 2021 After 2021 Taxable Income $ 1,000,000 $ 1,000,000 Plus: Net Interest Cost $ 600,000 $ 600,000 Depreciation, Amortization $ 250,000 $ Adjusted Taxable Income $ 1,850,000 $ 1,600,000 30% Limitation $ 555,000 $ 480,000 Interest Expense $ 600,000 $ 600,000 Disallowed Amount carried forward $ 45,000 $ 120, Interest Expense Limitation Interest expense in excess of 30% calculation would be carried forward indefinitely. For pass-through entities, carryforward would be tracked at an individual level versus corporate level. Interest limitation rules do not apply in the following situations: If average receipts over previous three years are less than $25 million tested on an affiliated group basis If only interest expense is floorplan interest. Real property trade or business that have elected to not limit interest deductions in exchange for longer lives (ADS depreciation) and forgo bonus depreciation. 18 6

7 Deprecation and Cost Recovery Bonus Depreciation 50% for new assets acquired through 9/27/17 100% for assets acquired 9/28/17 through 12/31/22 phases out through 12/31/27 Applies to new and used property beginning 9/28/17 Transition rule for property bought or committed to buy by 9/28/17 and place in service 9/28/17 or later. Beginning 1/1/18, dealers with floorplan financing will be unable to take bonus depreciation. Real property trade or business that has elected out of interest limitation rules will be subject to longer depreciable lives under ADS system 40/39 for non residential, 30/27.5 for residential and 20/15 for qualified improvement property as well as no bonus depreciation. 19 Deprecation and Cost Recovery Combined qualified leasehold, qualified retail and qualified restaurant property into one new type, qualified improvement property (QIP) with 15 year life; qualifies for bonus depreciation and can elect to treat as Sec. 179 property. Section 179 Expense effective 1/1/18 Expense limit $1,000,000 Asset addition limit $2,500,000 Applies to new and used property Expands definition of qualified real property that is subject to section 179 expensing i.e. roofs, HVAC, fire alarm- security systems. Dealers with floorplan financing may qualify for section Deprecation and Cost Recovery Increased depreciation limits for luxury Automobiles Year 1 $10,000 ($18,000 if bonus depr claimed) Year 2 $16,000 Year 3 $ 9,600 Year 4 & later $ 5,

8 Entertainment & Meal Expenses Entertainment expenses o No deduction for entertainment, or recreation activities, facilities, or membership dues related to such activities o Repeals the directly-related-to and associated-with exceptions to the deduction disallowance o Deduction allowed for amount included in employee s income 50 percent deduction limitation for meals o Entertainment meals are non-deductible o Deduction for meals provided on or near employee s premises for convenience of employer reduced from 100 percent to 50 percent o Meals incurred on business travel are 50 percent deductible 22 Corporate Taxation C corporation tax rate reduced to 21% o Impact on fiscal year corporations Corporate AMT repeal Net Operating Loss o Beginning in 2018 carryback is eliminated o can carry forward indefinitely o Deduction limited to 80% of taxable income 23 Choice of Entity New entity S to C conversion Not as simple as it appears, there are many factors to consider: State taxation Getting money out of the corporation Succession planning Sale of business 24 8

9 Provisions Impacting Pass Through Entities Section 199A Deduction for Qualified Business Income Taxpayers other than corporations are generally eligible to claim a deduction equal to the sum of: 1) The lesser of (A) the taxpayer s combined qualified business income amount or (B) 20 percent of the excess of the taxpayer s taxable income over capital gain plus qualified cooperative dividends, plus 2) The lesser of (A) 20 percent of the aggregate amount of qualified cooperative dividends or (B) the taxpayer s taxable income (reduced by net capital gains) Applies to Schedule C s and potentially Schedule E rentals as well as passthrough income; applies to estates and trusts Potentially reduces the effective top marginal rate to 29.6% (37% X (1-20)) 25 Section 199A Deduction for Qualified Business Income QBI includes the net amount of domestic qualified items of income, gain, deduction, and loss with respect to the taxpayer s qualified businesses Qualified trade or business includes any trades or businesses other than specified service trades or businesses For income tax only (ex. If income subject to NIIT, no deduction in calc) Limitations Taxable Income On entity by entity basis Wage limit Wage limit plus percentage of property 26 Initial Step Classify Business Taxable income less than $315,000 (MFJ)/$157,500 (S) Taxable income $315,000 $415,000 (MFJ) $157,500 $207,500 (S) Taxable income >$415,000 (MFJ)/$205,500(s) Non-Service Service 20% Deduction 20% Deduction Limitation Phased-in Deduction Phased-out W-2 / Capital limits apply No Deduction 27 9

10 The actual law doesn t put the formula into a table, but if it did, the table would look something like what appears below: Deduction % Single Married 20% $157,500 $315,000 18% $162,500 $325,000 16% $167,500 $335,000 14% $172,500 $345,000 12% $177,500 $355,000 10% $182,500 $365,000 8% $187,500 $375,000 6% $192,500 $385,000 4% $192,500 $395,000 2% $202,500 $405,000 0% $207,500 $415, Flow Chart 20% Deduction 29 Specified Service Businesses Specified service providers get no deduction once over the phase-out thresholds of $415,000 (MFJ)/$207,500 who are they: Same definition as IRC Sec. 1202(e)(3)(A) applied without regard to the words engineering, architecture. Sec 1202(e)(3)(A) defines as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such business is the reputation or skill of 1 or more of its employees

11 Wage or Wage and Basis Limitation Deductible amount the lesser of 20% of qualified business income or the greater of: (1) 50% of W-2 wages with respect to the business, or (2) The sum of 25% of W-2 wages plus 2.5% of the unadjusted basis* immediately after acquisition of all qualified property. * Unadjusted basis generally original cost less land plus improvements with no reduction for depreciation. Vanishing basis issue when fully depreciated. 31 Example of 50% Wage Limitation Facts: Calc: Qualified Business Income $700,000 Tentative 20% Deduction $140,000 W-2 Wages $200,000 50% W-2 Wage limitation $100,000 Qualified Business income $700, A Deduction ($100,000) Taxable Income $600,000 Tax (37.0%) $222,000 Effective tax rate 31.71% 32 Example of Asset Limitation Real Estate Business Facts: Calc: Qualified Business Income $70,000 Tentative 20% deduction ($14,000) W-2 Wages $0 25% of W-2 Wages $0 Unadjusted Basis of Assets $2,300, % of assets $ 57,500 Qualified Business Income $70, A Deduction ($14,000) Taxable income $56,000 Income Tax at 37% $20,720 (Pay NIIT also generally) Effective Tax Rate 29.60% 33 11

12 Regulatory Guidance Needed on 20% Deduction As written, appears that in the $315-$415 range on service businesses, wage component of limitation gives you a different deduction or no deduction dependent upon form of business as proprietorship, partnership, or S corporation Who is a service provider? What is a trade or business? One rental property qualify? Not if unimproved land or triple net lease, but where draw the line? Passive activity rules ignored or will we be referencing passive grouping when applying the limitations? Unadjusted Basis reduced by bonus depr but not Sec. 179? 34 Thank You! 35 12