The newest US Income tax law overhaul became effective as of January 1, 2018. Changes in tax laws offer benefits to many different classes of taxpayers. However, they are complex and should be analyzed carefully to take full advantage of the tax-saving opportunities.
Adjusted individual tax brackets and lower rates
The new tax code will reduce several of the marginal income tax rates. Those new tax brackets, and the other changes to the individual tax code would all be temporary—Congress would need to act or the rules would revert to current law after December 31, 2025.
Deductions and credits, New 2018 rules:
Mortgage interest $1 million primary, second homes and some home equity debt Limited to $750,000 of mortgage debt.
This provision would be applicable for taxable years after December 31, 2017 and beginning before January 1, 2026, when the limit would return to $1,000,000.
Eliminates deduction for interest on new home equity loans until taxable years beginning after December 31, 2025.
State and local tax deduction Deductible Capped at $10,000 for sales and state and local property taxes or sales and state and local income taxes
Medical expense deduction Expenses greater than 10% of AGI are deductible Expenses greater than 7.5% of AGI could be deducted for the next 2 years only.
Adoption expense tax credit Expenses up to $13,570 qualify No change
New higher standard deduction
The new bill will combine the personal exemption and standard deduction into a single higher standard deduction, which will be indexed to inflation. The child tax credit increases and there will be a new dependent tax credit. The higher standard deduction for people age 65 and older will still exist. The new provisions would expire for taxable years after December 31, 2025, and the rules would return to current law.
Retirement savings incentives unaffected
The new rules do not call for changes to existing retirement savings incentives, preserving the favorable tax treatment and contribution limits for 401(k)s, IRAs, and other retirement savings accounts. The new law also left the rules for health savings accounts intact.
The new rules call for ending the Roth IRA recharacterization option starting in 2018, but 2017 recharacterizations will be permitted. Recharacterization allowed taxpayers to undo a Roth IRA conversion for a limited time, and was often useful if the value of the converted investments fell.
Temporary increase in federal estate tax exemption
The legislation will roughly double the federal estate tax exemption to $11 million per person ($22 million per couple). That limit would be indexed to inflation, but would expire and revert back to current law after 2025.
Beneficiaries will still get a step up in basis, meaning there will be no capital gains tax due on inherited assets at the time of the transfer, and the cost basis—the value used to compute tax liability—would be reset to the price at that date.
It is important to note that state level estate tax exemptions are often much lower than the federal level and are unaffected. In addition, the temporary nature of the higher limit means that if you have an estate plan, you should proceed carefully before making any changes.
"While a further increase in the estate tax exemption will help some families avoid this tax at the federal level," says Kevin Ruth, head of wealth planning and personal trust at Fidelity, "it remains important for all households to have a current estate plan that helps ensure their wishes are carried out and reduces the cost of transferring assets as part of an estate."
Changes to the alternative minimum tax (AMT)
The AMT was designed to prevent high-income individuals from avoiding income tax by piling up deductions. It is essentially a parallel method for calculating your income tax liability.
The tax reform legislation makes changes designed to limit the impact of the tax. The plan will raise the minimum income level at which the AMT could apply, from $50,600 to $70,300 for individuals and from $78,750 to $109,400 for couples married filing jointly.
New corporate tax rate and pass-through tax rate
Corporate tax rates will be cut to 21% beginning in 2018. That tax cut is not scheduled to expire.
Pass-through businesses, businesses structured as sole proprietorships, partnerships, and S-corporations, will be taxed at individual tax rates, but will be able to deduct 20% of income. To prevent high-income individuals from taking advantage of this deduction, it would only be available to couples filing jointly with incomes below $315,000. For income above that level, the deduction would be limited to half of the W-2 wages or the individual's portion of the pass-through entity's income.
The tax rules let businesses fully expense new equipment right away, but the provision would eventually expire.
529 plans become more flexible
The tax bill allows 529 college savings plan assets to be used for education expenses for grades K—12 as well as college and post graduate study. It will also temporarily increase the contribution limits to ABLE accounts under certain circumstances.
The bottom line
There are a few things you may want to consider in light of the new legislation, and may want to consult with a tax professional about, so you can be prepared.
- Investment sales: Review your tax filing from the prior years and estimate to what extent your tax situation may be similar or different to prior years, and what the tax changes may mean for you. This decision is complex, however, so consult a tax expert.
- Estate tax: Even in the absence of tax reform, it makes sense to periodically review your estate plan. If the estate tax limit changes are relevant to your plan, it may make even more sense to revisit your strategy. You may want to meet with your estate planning attorney.
- Small-business income: If you own a small business, you will want to reconsider how you structure your income and the form of your enterprise. Depending on the size and particulars of your business, you may want to consider the benefits of incorporation or the creation of multiple small pass-through organizations. Consult with an expert in small-business taxation.
- Timing corporate expenses: With new rules in place temporarily for expensing capital equipment purchases, business owners may want to review their capital expenditure plans.
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