2017 tax reform: Items to consider in 2018
As the IRS makes new information available on the new tax reform, we will provide additional information as appropriate. Given the extent and complexity of the modifications, we encourage individuals to consult with their tax professionals on how these changes may affect their personal circumstances.
On December 26, 2017, we provided an initial look at the new tax reform bill. Since then, we have continued to review and monitor information regarding these changes and have outlined some additional 2017 tax reform considerations below.
Official IRS Guidance
The IRS has only made one official comment on the new tax law: to address the deductibility of state and local property taxes in light of the new limits on these deductions. It requires that the property tax must be both assessed and paid in 2017 in order for the IRS to recognize the deduction as valid.
- Example: If a state provides for half of a property tax bill to be paid in November and the other half in January, then a payment made before year-end would be recognized as deductible. Merely making an early payment on an estimate of the amount of taxes will not be recognized for 2017 deductibility purposes.
2017 tax reform item to consider: The limitation applies to individuals (and most likely to trusts/estates, too). As such, one commentator has suggested that a client who runs a home office or a client who uses a vacation home as a rental property—provided the client complies with the current rules to qualify for that treatment—may be able to claim a partial deduction of state property taxes without regard to the $10,000 limitation.
Mortgage Interest Deduction
- The amount of principal that qualifies for the mortgage interest deduction is lowered to $750,000 ($375,000 for married filing separately) under the new law (currently, this cap is $1,000,000 and $500,000).
- This reduction only applies to new mortgages entered into after January 1, 2018. In addition, the principal cap does not disallow the deduction if the principal is over the limitation, but limits how much can be counted for computing it (for example: the first $750,000 of principal indebtedness qualifies).
- HELOC interest will not be deductible if incurred after January 1, 2018.
With the increased standard deduction, it is expected that charitable giving will fall as more and more clients will find it harder to itemize. One way to approach this will be to bunch deductions from two or more tax years into one big deduction that exceeds the $24,000 threshold.
Item to consider: With the increased cap for cash gifts to public charities, this may allow for a bigger block gift in a single year. Some commentators have suggested funding a donor advised fund in a single block transfer to account for the next eight years (until the sunset of the individual changes), and then have the fund make the charitable gifts on a normal schedule.
However, such a strategy will not be useful for all, and smaller, two-or-three year bulk transfers may be more beneficial.
State Taxation Responses
Several commentators have pointed out that state taxation may change as a result of the new tax law. There are a number of areas that this may be reflected, including: repeal/reenactment of state-level estate taxes, state deductions tied to federal itemizations, and higher-taxation states needing to adjust their policies to address the increased income tax burden for those states.
Item to consider: Stay aware of the responses state governments are enacting. Additionally, in states such as Illinois, it is important to remember the disparity between the federal and state estate tax exemptions.
There is an open question as to what the effect of the repeal of the recharacterization rule on 2017 Roth conversions will be. The two options are that it will either be gone as of December 31, 2017 or that the normal rules for recharacterizations will continue to apply, making the deadline October 15, 2018. Commentators are split on their interpretation of the new law.
- Alimony will no longer be deductible for 2018 and moving forward. This is one of the few individual provisions that will not be subject to sunset and is permanently enacted.
- Additionally, the allocation of personal exemptions of children in divorce settlements will be affected by the personal exemption repeal, but commentators think it will be unlikely that divorce decrees will be revisited for such a loss.
One of the changes in the new bill was to move to the so-called chained Consumer Price Index (CPI). This measure accounts for consumers substituting replacement goods when prices rise, and so is supposed to grow slower than the current CPI.
Rate brackets for 2018 are set by the new law, but there are a large number of other inflation-adjusted numbers that will be affected. There are at least two areas this will affect estate planning moving forward:
- Annual Gift Exclusion: This is currently $10,000 per year, indexed for inflation from 1997. It was slated to rise to $15,000 for 2018, but with the change in inflation rate, it is uncertain as to whether or not this anticipated inflation adjustment will be made under the new law.
- Estate, Gift and GST Exclusions: The new law doubles the base exemption, indexed for inflation from 2011. It was slated to rise to $5,600,000 for 2018, but as to whether a doubling in the base exemption will result in a doubling in the applicable exemption amount for 2018 to $11,200,000—or if the inflation adjustment is higher or lower—remains to be seen.
Item to consider: It is hoped that the IRS will publish inflation adjustments based off the new chained CPI soon. It may be worth waiting to see if this occurs before making transfers close to this amount (especially annual exclusion gifts).
The 2025 Sunset
Many of the provisions applicable to individuals are set to lapse in 2025. Key among these will be the increased estate and gift exclusion. The IRS is specifically directed to enact guidance to account for gifts made during the higher exemption amount, so commentators believe that there will be no “claw-back” of any used exemptions.
Item to consider: Clients should not immediately use their increased exemption, but should be aware of the sunset of the new environment. In addition, portability filings for decedents who would have to file an estate tax return under the current exemption amount, but would not have to file under the higher exemption amount, should be made to carry the extra exemption forward past the sunset.
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.