In last month’s newsletter, we presented some general facets of the Tax Cuts and Jobs Act (TCJA). In this article, we will explore some portions of the new bill in greater detail.
In general, the law cuts corporate tax rates permanently and individual tax rates temporarily. It permanently removes the individual mandate, a key provision of the Affordable Care Act, and it changes other policies in dramatic ways, such as the SALT deduction (which will be explained in more detail below).
It should be noted that the impact from the TCJA is not expected to occur until the 2018 (not 2017!) tax filing.
How the Tax Cuts and Jobs Act impacts U.S. Tax Returns
The following items which are now presented with accompanying detail were deferred from the discussion last month. Other items not presented yet should be presented in the following months assuming they are of sufficient materiality and general interest.
A report by Investopedia notes the following changes that will take place as a result of the new tax bill:
Income Tax Rates
The law retains the current structure of seven individual income tax brackets, but in most cases it lowers the rates: the top rate falls from 39.6% to 37%, while the 33% bracket falls to 32%, the 28% bracket to 24%, the 25% bracket to 22%, and the 15% bracket to 12%. The lowest bracket remains at 10%, and the 35% bracket is also unchanged. The income bands that the new rates apply to are lower, compared to 2018 brackets under current law, for the five highest brackets.
The law raises the standard deduction to $24,000 for married couples filing jointly in 2018 (from $13,000 under current law), to $12,000 for single filers (from $6,500), and to $18,000 for heads of household (from $9,550). These changes expire after 2025. The additional standard deduction, which the House bill would have repealed, will not be affected. Beginning in 2019, the inflation gauge used to index the standard deduction will change in a way that is likely to accelerate bracket creep (see below).
The law suspends the personal exemption, which is currently set at $4,150 in 2018, through 2025.
The law changes the measure of inflation used for tax indexing. The Internal Revenue Service (IRS) currently uses the consumer price index for all urban consumers (CPI-U), which will be replaced with the chain-weighted CPI-U. The latter takes account of changes consumers make to their spending habits in response to price shifts, so it is considered to be more rigorous than standard CPI. It also tends to rise more slowly than standard CPI, so substituting it will likely accelerate bracket creep. The value of the standard deduction and other inflation-linked elements of the tax code will also erode over time, gradually pushing up tax burdens. The change is not set to expire.
Family Credits and Deductions
The law temporarily raises the child tax credit to $2,000, with the first $1,400 refundable, and creates a non-refundable $500 credit for non-child dependents. The child credit can only be claimed if the taxpayer provides the child's Social Security number. (This requirement does not apply to the $500 credit.) Qualifying children must be younger than 17. The child credit begins to phase out when adjusted gross income exceeds $400,000 (for married couples filing jointly, not indexed to inflation). Under current law, the phaseout begins at $110,000. These changes expire in 2025.
Head of Household
Trump's revised campaign plan, released in 2016, would have scrapped the head of household filing status, potentially raising taxes on 5.8 million single-parent households, according to an estimate by the Tax Policy Center (TPC). But the final version of the law that Congress passed and Trump signed leaves the head of household filing status in place.
Mortgage Interest Deduction
The law limits the application of the mortgage interest deduction for married couples filing jointly to $750,000 worth of debt, down from $1,000,000 under current law, but up from $500,000 under the House bill. Mortgages taken out before Dec. 15 are still subject to the current cap. The change expires after 2025.
State and Local Tax Deduction
The law caps the deduction for state and local taxes at $10,000 through 2025. The SALT deduction disproportionately benefits high earners, who are more likely to itemize, and taxpayers in Democratic states. A number of Republican members of Congress representing high-tax states opposed attempts to eliminate the deduction, as the Senate bill would have done.
Other Itemized Deductions
The law leaves the charitable contributions deduction intact, with minor alterations (if a donation is made in exchange for seats at college athletic events, it cannot be deducted, for example). The student loan interest deduction is not affected (see "Student Loans and Tuition" below). Medical expenses in excess of 7.5% of adjusted gross income are deductible for all taxpayers – not just those aged 65 or older – in 2017 and 2018; the threshold then reverts to 10%, as under current law.
The law does, however, suspend a number of miscellaneous itemized deductions through 2025, including the deductions for moving expenses, except for active-duty military personnel; home office expenses; laboratory breakage fees; licensing and regulatory fees; union dues; professional society dues; business bad debts; work clothes that are not suitable for everyday use; and many others. The moving expenses deduction is also suspended. Alimony payments will no longer be deductible after 2019; this change is permanent.
Alternative Minimum Tax
The law temporarily raises the exemption amount and exemption phaseout threshold for the alternative minimum tax (AMT), a device intended to curb tax avoidance among high earners by making them estimate their liability twice and pay the higher amount. For married couples filing jointly, the exemption rises to $109,400 and phaseout increases to $1,000,000; both amounts are indexed to inflation. The provision expires after 2025.
Student Loans and Tuition
The House bill would have repealed the deduction for student loan interest expenses and the exclusion from gross income and wages of qualified tuition reductions. The law leaves these breaks intact. The conference bill would also have extended the use of 529 plans to K-12 private school tuition, but that provision was struck down by the Senate parliamentarian as ineligible to be passed through reconciliation.
The law repeals the Pease limitation on itemized deductions. This provision does not cap itemized deductions, but gradually reduces their value when adjusted gross income exceeds a certain threshold ($266,700 for single filers in 2018); the reduction is limited to 80% of the deductions' combined value.
In conclusion, it should be evident that the TCJA touches many aspects of the individual taxpayers’ life. Next month we will present relevant TCJA aspects of Estate Tax and Business Taxes.