2018 Tax Alert - Individual Taxation Section
The following is the Individual Taxation section of the 2018 client advisory "Tax Alert: How the New Tax Laws Will Affect You Now and in the Future."
The full version of this client advisory is available here.
Tax Rates – The Act continues to contain seven income tax brackets but lowers the tax rates. The rates range from 10% to the highest rate of 37%, which is down 2.6% from the highest top rate set in 2017. Like many of the provisions affecting individuals pursuant to the Act, these changes are not permanent but rather are set to expire on December 31, 2025. At that time, it will revert to its 2017 provisions. Future legislation would be required to make many of these sunset provisions effective beyond 2025.
The tax rate changes affect tax withholdings which will likely result in an immediate benefit for individuals who are employees. Those individuals will have less federal taxes withheld in their February paychecks and thus, have more available cash in hand. However, any actual tax benefit realized by individuals will really depend upon the impact of the other changes made by the Act such as the elimination of the personal exemption amounts as well as the complete elimination or reduction in many previously allowed itemized deductions.
Deductions – Although the Act removes the limitation on claiming itemized deductions based on income (the "Pease Limitation"), it severely limits the itemized deductions available to individuals. And for those who will continue to itemize, the fact that the Alternative Minimum Tax (AMT) was maintained may limit the benefit of repealing the Pease Limitation.
The deduction for state income, sales, or property taxes is capped at $10,000. This significantly impacts individuals residing in high tax states. The Act also changes the eligibility to claim the mortgage interest deduction for debt incurred after December 15, 2017 with respect to a home(s) having a mortgage amount of $750,000, while completely removing the interest deduction for home equity lines of credit. Acquisition indebtedness (but not home equity indebtedness) incurred before December 15, 2017, is not affected by the reduction and is therefore "grandfathered." Any debt incurred before December 15, 2017, but refinanced later, continues to be covered by current law to the extent the amount of the debt does not exceed the amount refinanced. For tax years after December 31, 2025, the $1 million limitation applies, regardless of when the indebtedness was incurred.
The Act expands the deduction for medical expenses for 2017 and 2018 only. For individuals who itemize, the Act allows them to deduct medical expenses that are 7.5% or more of income. The Act impacts other itemized deductions by eliminating the deduction for moving expenses except for active military and eliminating personal casualty losses unless the loss results from federally–declared disasters. The Act also suspends all miscellaneous itemized deductions currently subject to the 2% floor, including the deduction for claiming expenses attributable to a trade or business, of performing services as an employee, as well as the elimination of claiming tax preparation fees.
Although the Act does eliminate or reduce many of the previous allowed itemized deductions, it does increase the charitable contribution deduction from 50% to 60% of adjusted gross income for cash contributions BUT it has no benefit to individuals who do not itemize. Charities have expressed concern over losing potential charitable contributions due to the elimination or reduction of many of the itemized deductions. Charities fear that individuals may not make charitable contributions if those individuals no longer itemize their expenses.
With all these changes to itemized deductions, individuals may find themselves claiming the standard deduction rather than itemizing. For 2018, the standard deduction is nearly doubled from previous amounts. A single filer's deduction increases from $6,350 to $12,000. The deduction for Married and Joint Filers increases from $12,700 to $24,000. The Act does retain the AMT but increases the exemption amounts and the phase-out of exemption amounts for individuals.
Child Tax Credit/Family Tax Credit – The Act increases the child tax credit from $1,000 to $2,000. The Act further provides that the maximum amount of refundable credit per eligible child is $1,400, and also indexes the maximum amount refundable for inflation.
The new law also provides a $500 non-refundable credit for dependents other than qualifying children.
The Act increases the threshold modified adjusted gross income amount where the credit would begin to phase out to $400,000 for married taxpayers filing jointly, and to $200,000 for other taxpayers. This amount is not indexed for inflation.
Additionally, the Act requires that a taxpayer provide the social security number ("SSN") of each qualifying child that is claimed on a tax return in order to receive the child tax credit. This requirement does not apply to the $500 non-refundable credit for a non-child dependent. This means that a qualifying child who is ineligible to receive the child tax credit due to not having a SSN is still eligible for the non-refundable $500 credit, including children with an Individual Taxpayer Identification Number rather than a Social Security Number.
Education – The Act makes permanent changes to 529 plans by providing that elementary and secondary school expenses of up to $10,000 per year are qualified expenses for qualified tuition programs. These expenses apply on a per-student basis, rather than on a per-account basis. The Act also excludes from income the discharge of student loan indebtedness on the death or disability of a student. This change is for indebtedness discharged after 12/31/17 but before 1/1/2026. The Act preserves tuition waivers for graduate students and also retains the $250 deduction for out of pocket expenses incurred by teachers.
Individual Mandate – In addition, the Act repeals the individual mandate in the Patient Protection and Affordable Care Act by removing the penalty for individuals who do not purchase health insurance that qualifies as minimum essential coverage, starting in 2019. This has the potential to lead to many uninsured individuals and/or higher insurance premiums. And while the penalty has been eliminated the 3.8% Net Investment Income Tax remains.
Alimony – While many of the provisions for individuals are temporary and will expire beginning with the 2026 tax year, the Act permanently changes the landscape for individuals who are in the process of seeking a divorce. Alimony and separate maintenance payments will no longer be deductible by the payor spouse and will no longer be includible in the income of the payee spouse. This provision is effective for any divorce or separation agreement executed after December 31, 2018, and for any agreement executed before but modified after that date if the modification expressly provides that this new provision applies to such modification.
Capital Gains/Qualified Dividends – The new law maintains the current system whereby net capital gains and qualified dividends are generally subject to tax at a maximum rate of 20% or 15%, (plus in many cases the addition of the 3.8% Net Investment Income Tax) with higher rates for gains from collectibles and unrecaptured depreciation.
Estate and Gift Tax – The Act increases the federal estate and gift tax unified credit basic exclusion amount to $10 million (adjusted annually for inflation from 2010 as the base year), effective for decedents dying and gifts made after 2017 and before 2026. The Act increases the federal GST exemption amount to $10 million (adjusted annually for inflation from 2010 as the base year), effective for generation-skipping transfers made after 2017 and before 2026. According to our inflation calculations (which are subject to change based on the IRS's implementation of a new inflation measure under the Act), both the unified credit and GST exemption levels will total $11.18 million in 2018. That means if you are married today, you can transfer an estimated $22.36 million of assets without incurring federal estate, gift or generation-skipping transfer taxes. Because these thresholds are not permanent, you should still review planning and gifting ideas prior to 2026. Further, for our Connecticut clients, a surprise "gift" in the recently passed Connecticut budget was an increase in the Connecticut estate tax exemption. The exemption amount for 2018 is $2.6 million, for 2019 is $3.6 million and then in 2020 it will match the federal estate and gift tax exclusion amount.
Step-Up in Basis of Property Acquired from Decedent – While the Act changes many provisions of the Tax Code, Congress chose not to alter the existing statute allowing heirs to take a step-up in the tax basis of property that they acquire from a decedent. This step-up in basis generally allows heirs to claim the fair market value of the property on the date of the decedent's death as the tax basis of the property for income tax purposes when the heirs later go to sell it. Because inherited property often has a low basis, the result of this provision frequently is a lower taxable gain for heirs who sell inherited property.
Self-Created Property – Under current law, property held by a taxpayer (whether or not connected with the taxpayer's trade or business) is generally considered a capital asset. However, certain assets are specifically excluded from the definition of a capital asset, including inventory property, depreciable property, and certain self-created intangibles (e.g., copyrights, musical compositions). The Act provides that for dispositions after January 1, 2018, IRC Section 1221(a)(3) is amended to exclude patents, inventions, patented or non-patented models or designs, and secret formulas or processes, which are held either by the taxpayer who created the property or by a taxpayer with a substituted or transferred basis from the taxpayer who created the property, from the definition of a "capital asset." Thus, any gain will be taxed at ordinary income rates.
The Act has made substantial changes to the tax laws. There are many "glitches" in the Act that will need to be addressed in technical correction legislation. Since technical correction legislation requires a 60% vote in the Senate (it cannot come under reconciliation rules), there will need to be bi-partisan cooperation to fix the problems that such fast paced passage of the Act produced. Second, technical corrections require unanimous consent by both the majority and minority staffs of the House Committee on Ways and Means and the Senate Finance Committee. If anyone disagrees about the legislative intent of a provision and whether the statute reflects that intent, then the provision is not a technical correction but, rather, a change in policy. Thus it may take quite a while for any technical correction legislation to be passed.
Effective tax planning including choice of entity structures will be made based on the new laws that are now in effect. Only time will tell how these changes will impact individuals, businesses, and the economy.
If you have any particular area of interest or concern regarding how these changes directly affect you or your business, please feel free to contact our tax attorneys, Cheryl Johnson or Jen Green.
This communication is intended for general information purposes and as a service to clients and friends of Verrill Dana, LLP. This publication, which may be considered advertising under the ethical rules of certain jurisdictions, should not be construed as legal advice or a legal opinion on any specific facts or circumstances, nor does it create attorney-client privilege.