2017 Tax Reform: Where are we?
On November 16, the U.S. House of Representatives passed a bill known as the Tax Cuts and Jobs Act to start the Tax Reform process. On December 2, the U.S. Senate passed its version of the same bill, which differed in a number of ways. As a result, negotiators from both the House and the Senate have been working together to form a version of the bill that will pass both the House and the Senate completed and ready to be signed into law by the President. On December 15, the bill moved out of the reconciliation conference (the “Conference Bill”). The Senate passed a version of the Conference Bill that had been amended to comply with Senate rules on December 19, and the House passed the amended Conference Bill on December 20. President Trump signed it into law on December 22.
This is a massive bill (the Conference Bill is over 500 pages long), so analyzing every item takes some time. The majority of the changes to the law will come into effect starting January 1, 2018. In addition, some of the changes in the Conference Bill are permanent, while others will phase out after the 10-year budget window closes. This below represents only a small portion of the 2017 tax reform bill coming into effect under the new law.
What Does the 2017 Tax Reform Mean for Individuals?
- Individual Rates: The Conference Bill keeps seven rate brackets, much like current law, but all of those rates went down. The top rate of 39.6 percent is cut to 37 percent.
- Standard deduction: The Standard deduction has been nearly doubled from the previous year. In addition, the personal exemption has been repealed. As a result, many individuals are expected to utilize the much higher standard deduction.
- Child Tax Credit Increased: To make up for the repeal of the personal exemption, the Conference Bill increased the Child Tax Credit from $1,000 to $2,000 and greatly increased the income limit at which the credit starts to phase out. In addition, up to $1,400 of the Child Tax Credit is fully refundable.
- Itemized deductions: One of the key changes under the Conference Bill is the reduction or elimination of many itemized deductions. Any miscellaneous itemized deduction subject to the so-called “2% Floor” will be eliminated. The overall limitation on itemized deductions is repealed.
Item to Consider: The Conference Bill reduces the amount of mortgage interest that is deductible and reduces the circumstances in which the deduction applies. In addition, it limits the personal casualty loss deduction to a very specific situation.
- The state and local tax deduction: One of the big controversies surrounding the 2017 tax reform bill is the elimination or reduction of the state and local tax deduction. The Conference Bill limits the total state and local tax deduction to $10,000 (combined across property, sales and income).
Item to Consider: An individual should consider whether it will be tax-efficient to prepay taxes due in 2018 early. There are limitations, however, on what the IRS recognizes as a pre-payment for purposes of claiming a deduction. In addition, be aware of how the AMT will affect such a prepayment.
- Charitable contributions: There are a couple of changes to the charitable contribution deduction under the 2017 tax reform bill. First, the overall limitation on cash gifts to public charities would be increased to 60 percent. Second, the Conference Bill repeals an exemption that allows a charitable organization to report gifts over $250 directly to the IRS.
- Individual Alternative Minimum Tax (AMT): It was expected that the whole AMT regime was going to be repealed as part of the GOP’s tax plan—however, repeal of the individual AMT was not included in the Conference Bill. The exemption amounts and phase-out range applicable to AMT will be adjusted upwards, however.
Items to Consider: If an individual is in AMT in 2017, consider accelerating ordinary income if it would be taxed at an effective rate of 28 percent. This may include electing a Roth conversion, exercising non-qualified stock options, or delaying/accelerating business expenses or income. In addition, certain itemized deductions may be better to delay into 2018 (such as any fourth quarter estimated tax payments or charitable contributions).
- Recharacterizations: One small, but important change, is that the ability of a taxpayer to recharacterize a Roth conversion back to a traditional IRA has been repealed. This may significantly affect how individuals treat Roth conversions going forward.
Item to Consider: If an individual has made a Roth conversion in 2017 that they are considering recharacterizing, they will have until the tax filing deadline for 2017, plus extensions, before the ability to recharacterize goes away. It will not be available for any conversions made in 2018 or after.
What Does the 2017 Tax Reform Bill mean for Estate and Trusts?
- Trust Income Tax Effects: There will be minimal changes to the way that non-grantor trusts are taxed. The reformation of the itemized deductions is similarly applicable to trusts, especially in the realm of miscellaneous itemized deductions. The tax brackets will change slightly (four instead of five), but the top rate (37 percent) still applies at $12,500 of income, which is where it was indexed in 2017. There was some discussion of making the pass-through deduction unavailable to trusts, but that did not make the Conference Bill.
- Estate, Gift and Generation-skipping Transfer (GST) Tax: Under the Conference Bill, the Estate and GST tax regimes continue to survive. The base exemption amount doubles under the new law, which, after indexing for inflation, will approximately double the current exemption amount. This exemption amount applies to gift taxes in addition to estate and GST taxes. This change will be effective for transfers made after December 31, 2017.
Item to Consider: An individual considering making gifts that would incur gift tax in December may want to delay until after the exemption increase.
What Does the 2017 Tax Reform Mean for Business Entities?
- Tax Rates: This is the area that has received a lot of publicity. The Conference bill has reduced the Corporate Tax rate to a flat 21 percent. In an attempt to balance that, there is a new deduction on income earned in a Partnership or S Corporation. However, it will be limited to those entities that are actively involved in businesses, but excludes service businesses (for example, CPAs, attorneys or doctors) that earn over a certain income threshold. The deduction is limited to either 50 percent of W-2 income or 25 percent of W-2 income plus 2.5 percent of unadjusted basis of certain assets.
Item to Consider: This may open up questions as to how a business wants to be taxed moving forward—whether under the pass-through rules or the corporate tax rules. However, it will be more complicated than simply comparing rates.
- Corporate AMT: Corporate AMT is repealed (although the deduction for AMT carry-forward will continue). This is part of the broad attempt to overhaul business entity taxation.
- Immediate Capital Expensing: The Conference Bill changes the depreciation rules for certain assets to allow immediate expensing in the year of service. This is anticipated to benefit manufacturing and other sectors dependent on capital improvements (such as agriculture).
- Net Operating Losses: The Conference Bill repeals the ability to transfer net operating losses to prior tax years. The ability to apply net operating losses to future tax years has been retained.
- International Tax: A significant portion of the Conference Bill overhauls the international tax regime. Part of this involves a repatriation tax, and part of it involves moving from a worldwide tax system to a territorial tax system.
What are some other changes of note?
- Inflation: The Conference Bill changes the way that inflation adjustments are calculated by moving to the chained CPI-U. This grows slower than the Consumer Price Index measure that was previously used.
- Individual Mandate: One of the GOP’s priorities that was included in the Conference Bill was the repeal of the Obamacare individual mandate. This provision will not be effective until 2019, however.
- Executive Compensation for Exempt Organizations: The Conference Bill adds a new excise tax to private foundations for “excessive” executive compensation. This excise tax is equal to 21 percent times the amount of compensation over $1 million paid to any covered employee, plus any excess parachute payment to a covered employee (even if less than $1 million).
What is Next?
UMB will continue to analyze the 2017 tax reform bill and provide updates. If you have any questions about a specific change, please consult your UMB Partner.
UMB is not providing you with any legal or tax advice. You need to consult with your own legal and tax advisors to determine how the new tax law might affect you given your specific circumstances.
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