Tax Reform: A New Era Commencing in 2018
It’s official! On December 22, 2017, President Donald J. Trump signed a tax reform bill with a variety of tax cuts and changes effective in 2018. Some key provisions within the new legislation are highlighted below to help you recognize planning opportunities that may benefit your own financial situation.
Highlights of the New Tax Laws
The effect of the new tax laws will be widespread. Changes to the tax code will affect individuals, families, and corporations almost immediately. However it is important to be aware that while the corporate tax cuts are permanent, the changes related to individuals, without further Congressional action, will expire at the end of 2025 (i.e. 8 years).
Many individuals of varying wealth will benefit from the tax cuts, at least in the short term. There are still seven personal income tax brackets, but the tax rates for most of the brackets have been lowered. The highest individual income tax rate is now capped at 37%, dropping from the previous top rate of 39.6%.
In addition to cutting the income tax rates, the standard deduction has doubled. As a trade-off for the elimination of most itemized deductions and the abolishment of personal exemptions, the standard deduction for individuals and married couples under the new laws will be $12,000 and $24,000, respectively. It is anticipated that most taxpayers will stop itemizing their deductions due to the increase of the standard deduction.
Deductions will still be available for charitable contributions, property taxes, mortgage interest, retirement savings, medical expenses and student loan interest, but those deductions will not be the same as years prior. For example, the mortgage interest deduction now is limited to the first $750,000 of the loan (for homes purchased after 12/15/17), as opposed to $1 million previously. Individuals may now only deduct up to $10,000 for state and local property, sales and income taxes combined. This was previously unlimited.
While the corporate alternative minimum tax (AMT) was eliminated in the new tax plan, the individual AMT was not. However, the legislation did increase the threshold for individuals paying the AMT so fewer taxpayers will be affected by it. Through 2025, the exemption for single taxpayers is $70,300, and $109,400 for joint taxpayers. The exemptions phase out at $500,000 for single taxpayers and $1 million for joint taxpayers.
Corporations are arguably benefiting the most from the new tax laws. Most significantly, the tax rates for corporations have been lowered from 35% to 21%, and the corporate alternative minimum tax has been repealed. These changes are deemed permanent.
Currently, less than 1% of decedent’s estates pay a federal estate tax. That percentage will shrink even further as the exemption amount for estate, gift and generation skipping taxes under the new laws has doubled from $5.6 million (2017) per individual to $11.2 million. Portability between spouses remains, thus allowing married couples to transfer up to a combined $22.4 million in assets to their loved ones without paying any federal estate tax. The exemption levels are set to revert back to pre-2018 levels in 2026.
Owners of pass-through businesses, such as sole proprietorships, partnerships, limited liability companies and S corporations, now benefit from a new deduction, with limits in some cases, allowing them to deduct 20% of their pass-through business income. This will provide some additional tax relief since owners report their business income on their own personal returns, and thus are not subject to the reduced corporate tax rate. Like the other individual tax breaks, this deduction has a sunset provision at the end of 2025.
Tax Planning for 2018 and Beyond
Begin planning now for your short-term and long-term financial future in light of the recent changes to the tax laws. With the assistance of your tax, legal and financial professionals, you may want to consider some of the options below.
For individuals considering converting a pretax, traditional IRA to a ROTH IRA where their funds can grow tax free, it may make sense to do so in the upcoming window of opportunity from 2018 through 2025. If individuals complete the conversion before the sunset provisions take effect, they may benefit from the reduced individual tax brackets and rates. However prior to doing so, understand that the ability to recharacterize a ROTH IRA conversion, or undo the conversion, is no longer allowed under the new tax laws.
If you’re looking to purchase real estate in a high-end market, the coming years may prove more beneficial to do so than 2017. Since the mortgage interest deduction is limited to the first $750,000 of the mortgage loan and the home equity line of credit has been eliminated, markets with high-end real estate may see prices drop as a result.
Due to the upcoming changes related to estate and gift taxes, couples will have an extra $11.2 million to gift or transfer at death federally tax free. Since this provision is set to sunset in 2026, consider making larger gifts to individuals or to irrevocable trusts, including generation-skipping trusts, within the next few years.
Taxpayers whose deductions are not large enough to itemize should consider bundling several years of charitable contributions into a single year by donating to a donor advised fund, or other charitable giving vehicle. Individuals age 70 ½ or older should consider making qualified charitable distributions directly from their traditional, rollover or inherited IRAs. Such gifts are counted toward satisfying required minimum distributions (RMDs) and are not taxable.
Now identify your own ways to use the new tax rules to your benefit. Of course, seek guidance from professionals to be sure your unique financial needs are met. The professionals at The Washington Trust Company, Wealth Management are here to help you plan for the years ahead.