As you might have followed in the news, a comprehensive tax reform bill has moved a few steps closer to the president’s desk. Republican House and Senate negotiators released a final tax bill on Friday, December 15 that would overhaul the individual and corporate codes after making last-minute changes that appeared to lock down the votes necessary for passage. In my opinion, it is highly likely the bill will be signed before Christmas.

To varying degrees, these changes will affect every taxpayer starting in 2018. As best as possible, the information below is an oversimplified selection of the most important provisions in the new legislation that I believe is pertinent to clients. I know people can only tolerate so much tax talk. If you have questions about any of the information below please give me a call or send an email. At the end, I have some generic tax planning recommendations for your consideration.

Important dates

Changes to the individual tax code are effective January 1. Therefore, they will not affect quarterly payments due in January or the tax return due in April, since those cover income earned in 2017. The Internal Revenue Service says it could have information out by February on how employees could adjust withholding from their paychecks based on the new tax rates. Additionally, while most of the corporate tax changes are permanent, most individual changes would expire at the end of 2025, meaning the old tax code rates and deductions would kick back in in 2026 unless Congress passes another law before then.

Tax brackets and rates

As the law currently stands, tax rates for 2018 are the following for married joint and single taxpayers:

  • 10% on the first $19,050 of income for couples and $9,525 for individuals
  • 15% above $19,050 of income for couples and $9,525 for individuals
  • 25% above $77,400 of income for couples and $38,700 for individuals
  • 28% above $156,150 of income for couples and $99,700 for individuals
  • 33% above $237,950 of income for couples and $195,450 for individuals
  • 35% above $424,950 of income for couples and $424,950 for individuals
  • 39.6% above $480,050 of income for couples and $426,700 for individuals

The proposed new rates for 2018 are:

  • 10% on the first $19,050 of income for couples and $9,525 for individuals
  • 12% above $19,050 for couples and $9,525 for individuals
  • 22% above $77,400 for couples and $38,700 for individuals
  • 24% above $165,000 for couples and $82,500 for individuals
  • 32% above $315,000 for couples and $157,500 for individuals
  • 35% above $400,000 for couples and $200,000 for individuals
  • 37% above $600,000 for couples and $500,000 for individuals

All other things being equal, what does this mean for a hypothetical couple with $150,000 of taxable income? Under current law, their tax would be $28,807. Under the proposed law their tax would be $24,879. This yields a tax savings of $3,928 under the proposed legislation.

However, we have numerous other changes to the tax code (highlights detailed below) which, for the most part, reduce or eliminate deductions. The bottom line is that many Massachusetts residents who earn a decent income and own a home will likely report more net taxable income under the new law (because of fewer deductions), but pay tax at a lower rate. Whether this will result in net higher taxes or lower taxes is very difficult to generalize. I wish I could be more specific, but it really is determined on a case by case basis using the individual income level and deductions profile of a person/couple.

Personal exemptions are eliminated, which in 2017 reduce taxable income by $4,050 each for taxpayer, spouse and dependent child.

The standard deduction is increased from $12,700 this year to $24,000 next year for couples filing jointly. For individuals, the amount goes from $6,350 to $12,000.

The state and local tax deduction have a new cap allowing only a maximum of $10,000 for a combination of property and state income taxes or property and state sales taxes.

The child tax credit is increased from $1,000 per child to $2,000 of which $1,400 is refundable, meaning it would be paid to parents even if they do not owe income tax. Value of the credit begins to decrease when family income exceeds $400,000.

Mortgage interest remains deductible but at a reduced level. The current rules allow deductible mortgage interest on $1,000,000 of debt on first and second homes. Mortgages originated before December 15, 2017, are grandfathered. Going forward, for those who itemize, taxpayers can only deduct interest on the first $750,000 borrowed. The interest on home equity loans will no longer be deductible.

People can continue to deduct medical expenses. Earlier versions of the legislation called for the elimination of this deduction. However, for 2018 and 2019, expenses exceeding 7.5% of income are deductible.

Losses from fires, floods or other events are no longer deductible unless covered by specific federal disaster declarations.

Alimony would no longer be deductible, starting in 2019, by the payor for new decrees. Payments would be excluded from the recipient’s income.

Miscellaneous items deductions will no longer be deductible. This catch-all section which is already subject to a 2% floor includes things like tax prep fees, investment advisor fees, safe deposit boxes, unreimbursed employee business expenses, etc. These all go away.

Other Important Provisions

  • The Alternative Minimum Tax (AMT) is repealed for corporations, but remains for individuals, although the exemption has increased to $1 million for couples.
  • The Estate tax exemption is doubled. Currently, the federal estate tax is imposed on estates which exceed $5.49 million or about $11 million per married couple. The new provision doubles the exemption amount so no married estate worth less than nearly $22 million would be taxed federally. Massachusetts has a different threshold of $1 million per individual or $2 million for a couple although the tax rates are much lower.
  • Owners of pass-through companies AND sole proprietors (as written “taxpayers other than corporations”) will be taxed at their individual tax rates less a 20% deduction (to bring the rate lower) for business-related income, subject to certain wage limits and exceptions. The deduction would be disallowed for businesses offering “professional services” above a threshold amount; phase-ins begin at $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly. But, of course, it isn’t that simple and there are lots of exceptions. I have read from multiple sources that it is likely the IRS will issue many clarifying regulations regarding this part of the law in the next year. So stay tuned.
  • Corporations have a new 21% tax rate which would take effect January 1. Assets held by U.S. corporations overseas would face a one-time “deemed repatriation” tax of 8% on fixed assets and 15.5% on cash.
  • Starting in 2019, the Affordable Care Act mandate that people have insurance or face a fine imposed by the IRS would be repealed.
  • College endowments have a new tax. There is now a 1.4% tax on investment earnings for schools with large endowments.

The following items were not changed in the final version of the bill.

  • Private activity bonds used to build hospitals or low-income housing
  • IRA and 401(k) accounts
  • Adoption tax credit
  • Earned income tax credit
  • Affordable Care Act tax on investment income
  • Student loan interest remains deductible
  • Teacher expenses up to $250 are still deductible
  • Deferred tuition provided to graduate students who research or teach would still not be taxable
  • FIFO sales rules for stocks will still not apply
  • Exclusion of gain from the sale of your home rules remain unchanged

Steps to take before December 31, 2017

At this point, barring any really unforeseen circumstances, we will have major changes to the tax code in just a few weeks. While everyone has a unique tax situation there is some general guidance that I can offer.

The general guidance at year-end is to defer income and accelerate deductions to the extent possible. That advice especially holds true this year. Since tax rates will be lower in 2018, if you can defer income you will pay tax on that income at a lower rate. Since many deductions are either being reduced or in some circumstances going away entirely, pay them now before year-end while you can still get a tax benefit.

For example, under the new law, you can only deduct a maximum of $10,000 of state income and property tax. If you pay estimates, it is probably a good idea to pay the MA estimated tax payment in December instead of January. The only caveat is if you are in the AMT in 2017. You may also want to consider pre-paying your first two-quarters of 2018 property taxes as well in December of 2017. Again, AMT is a consideration here too.

Another planning point if your income is up in 2017 versus 2016; normally, I recommend to only pay in the safe harbor amount and pay the remaining balance due on April 15 of the following year. Except if you have an AMT issue, this year it probably makes sense to pay the expected balance due to Massachusetts now (in December), rather than wait until April 15.

If you want to have specific answers about your tax return, please give me a call or send me an email and I can run a quick projection for you.

Best wishes in the new year.

Max