2018 Tax Outlook: Big Changes in Place!
If you blinked, you might have missed it! Late last year, Washington passed the Tax Cuts and Jobs Act of 2017 — the biggest tax overhaul in 31 years. It was so long ago that Ronald Reagan was still in the White House. Matlock, Alf, and L.A. Law were television hits. And Madonna was still a doe-eyed ingenue.
The new law’s main focus is on cutting corporate tax rates. Our old maximum corporate rate of 35% really was one of the highest in the world, and Congress thought it made us less competitive abroad. Their obvious answer was to lower rates to attract business and investment here.
Of course, not all businesses operate as taxable corporations — over 90% of American businesses are “pass-throughs,” meaning their owners report their business income on their personal returns. So Congress wanted to cut taxes on those businesses as well.
Finally, they wanted to cut rates for individual taxpayers. They understood it would be politically unpalatable to cut rates for the Fortune 500 without doing something for the people who work for them.
Here’s the challenge, though — cutting all those taxes costs money. So Congress had to come up with “payfors” to make up for most (but not all) of that lost revenue. (The 2018 budget resolution let them grow the deficit by $1.5 trillion over the next 10 years.) They did it in two ways. First, they tightened or eliminated many of the deductions we’ve come to take for granted over the years: personal exemptions, state and local taxes, mortgage interest, and the like. And second, they scheduled most of the new benefits for individuals to expire at the end of 2025.
Here is a summary of some of the changes you should understand for 2018 and beyond, with some ideas for making the most of these opportunities, and suggestions where we need to sit down for more in-depth planning. We look forward to discussing these changes and helping you with the appropriate response! Call us at 916-781-2063.
Big Changes to Tax Basics and Brackets!
The most obvious changes will apply to all taxpayers, no matter how they earn their income.
First, the law essentially doubles standard deductions, from $6,350 to $12,000 for singles and from $12,700 to $24,000 for joint filers. This should cut the number of taxpayers who itemize from the current one-third to about just 10%.
Second, the new law eliminates the old personal exemption, which was scheduled to rise to $4,100 for 2018. This will obviously blunt much of the benefit of the higher standard deductions, especially for families with children.
The law limits many popular itemized deductions, too. Writeoffs for state and local income/sales/property taxes are limited to just $10,000 per year, regardless of how much you actually pay. Mortgage interest deductions are limited to $750,000 of principal, down from $1 million. Home equity interest is no longer deductible, and most miscellaneous itemized deductions are gone, too.
Finally, the new law keeps the seven-bracket rate structure, but lowers those rates in almost every bracket, with the top rate dropping from 39.6% to 37%.
Good News on Alternative Minimum Tax
The Alternative Minimum Tax had effectively become a “flat tax” for millions of families, wiping out deductions for state and local taxes, miscellaneous itemized deductions, and more. The Tax Cuts and Jobs Act raises the AMT exemption from $54,300 to $70,300 for singles and from $84,500 to $109,000 for joint filers. It also raises the phaseout for that exemption, from $120,700 to $500,000 for singles and from $160,900 to $1 million for joint filers.
This should significantly cut the number of taxpayers snared in the trap. As always, the key to avoiding AMT is to use strategies like qualified retirement plan contributions and charitable planning strategies, that keep income off the return in the first place.
Harsh New “Kiddie Tax” Rules
The “kiddie tax” rules have long limited your ability to shift investment income to your children — by subjecting their unearned income above $2,100 per year to tax at your highest rate, for dependent children under age 19, or dependent full-time students under age 24.
However, the Tax Cuts and Jobs Act really puts the screws to that strategy by subjecting that income to special trust/estate rates, which start at the usual 10% for just $2,550 of income, and jump quickly to 37% for anything over $12,500. So now you’ll want to be extra careful with this strategy!
Bigger Deductions for Charitable Gifts of Cash
The Tax Cuts and Jobs Act of 2017 raises the ceiling on gifts of cash from 50% of AGI to 60% of AGI, making big-ticket gifts even more valuable.
Big New Opportunities — And Careful Planning Required — for “S”Corporations
S corporations have always been valuable vehicles for minimizing employment tax, shifting income to lower-bracket family members, and avoiding audit risk. The Tax Cuts and Jobs Act of 2017 makes them potentially more valuable by characterizing S corporation income (but not W2 wages or investment income) as “qualified business income” — and offering a deduction of up to 20% of that amount. However, careful planning may be required to take advantage of this opportunity, especially if it comes from “specified personal services” or your taxable income is over $157,500 (singles) or $315,000 (joint filers).
Tremendous Opportunities for “C” Corporations
The Tax Cuts and Jobs Act made the most significant changes to C corporation tax rules in a generation, primarily by slashing rates to a flat 21%. It also eliminates the old “personal service corporation” rules that taxed those businesses at a flat 35% rate. These changes open up all sorts of new income-shifting opportunities.
Expanded Deductions for Buying Business Vehicles
You can choose two different methods for deducting business car and truck expenses: “actual expenses” or the mileage allowance (54.5 cents/mile for 2018). The right choice can add thousands in deductions and easily justify recordkeeping requirements. And the Tax Cuts and Jobs Act of 2017 raises depreciation deductions on passenger vehicles to $10,000 in year one and $16,000 in year two.
The new depreciation limit means that buying, rather than leasing, may give you bigger deductions up front. However, you’re also likelier to owe tax on “recaptured” depreciation when you go to sell the vehicle. (The new law also closes old rules that let you defer that recapture by trading in the old vehicle for a new one.) This means careful planning is in order before you acquire a new business vehicle.
New Strategies for Business Assets
Segregating business assets such as equipment, vehicles, and real estate in separate entities has always offered potential tax breaks, as well as enhanced asset protection. The Tax Cuts and Jobs Act of 2017 makes this strategy potentially more valuable if the business assets can maximize “qualified business income” deductions.
New Opportunities for Family Income-Shifting
The Tax Cuts and Jobs Act of 2017 nearly doubles the standard deduction for single taxpayers to $12,000. This creates even more opportunity to shift tax-free earned income to your children by hiring them to work for your business.
Strict New Rule for Roth IRA Conversions
Under the old rules, you could “undo” a Roth IRA conversion if you discovered you had created more taxable income than you expected, or the value of your account dropped after the conversion. The Tax Cuts and Jobs Act of 2017 eliminates this opportunity, which makes it even more important to plan carefully before converting.
New Opportunities for Family Income Shifting
The Tax Cuts and Jobs Act of 2017 nearly doubles the standard deduction for single taxpayers to $12,000. This creates even more opportunity to shift tax-free earned income to your children by hiring them to work for your properties.
Estate Tax Barely Hangs on to Life
The Tax Cuts and Jobs Act of 2017 doubled the estate tax unified credit to $11.2 million per person for 2018. This may make estate planning easier for some individuals and couples. However, careful planning may still be required to avoid the tax, which is a flat 40% on taxable amounts above that threshold.