BGH Highlights of the Tax Cuts and Jobs Act
On December 22, 2017 the President signed into law H.R. 1, officially titled ‘An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018’, but politicians and commentators are calling it the Tax Cuts and Jobs Act. The new law overhauls the Internal Revenue Code by lowering tax rates, eliminating numerous tax provisions, and creating several new provisions. Below is a brief summary of the Tax Cuts and Jobs Act.
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For Individuals and Families, the Tax Cuts and Jobs Act:
- Lowers individual taxes and sets the rates at 0%, 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
- Significantly increases the standard deduction from $6,350 and $12,700 under current law to $12,000 and $24,000 for individuals and married couples, respectively. Personal exemptions have been eliminated.
- Continues to allow people to write off the cost of state and local income and real estate taxes, but only up to a combined total of $10,000.
- Preserves the mortgage interest deduction, with changes on mortgages taken out after December 15, 2017
- Mortgage interest on loans up to $750,000 is deductible for first and second homes on new mortgages acquired after 12/15/17. Additionally, the deduction up to $100,000 of home equity loans or lines of credit is eliminated.
- For homeowners with existing mortgages there will be no change to the current mortgage interest deduction. This includes refinancing these prior mortgages.
- Expands the Child Tax Credit from $1,000 to $2,000 for single filers and married couples. The tax credit is fully refundable up to $1,400 and begins to phase-out for single filers making over $200,000 and for married filing joint filers making over $400,000. Parents must provide a child’s valid Social Security Number in order to receive this credit.
- Preserves the Child and Dependent Care Tax Credit
- Preserves the Adoption Tax Credit
- Provides relief for Americans with high medical bills by expanding the medical expense deduction for 2017 and 2018 for medical expenses exceeding 7.5 percent of adjusted gross income, and rising to 10 percent beginning in 2019.
- Continues and expands the deduction for charitable contributions allowing cash contributions to offset 60% of adjusted gross income (prior law allowed contributions to offset up to 50% of AGI).
- But no charitable deduction is allowed for a payment to a higher educational institution in exchange for which the payor receives the right to purchase tickets or seating at an athletic event.
- Eliminates the Affordable Care Act’s individual mandate tax penalty beginning in 2019.
- Changes 529 Plans by allowing distributions of up to $10,000 per student per year to pay tuition expenses for a public, private, or religious elementary or secondary school. The rules for postsecondary educational institutions are unchanged.
- Retains retirement savings options such as 401(k)s and Individual Retirement Accounts (IRAs)
- Increases the exemption amount from the Alternative Minimum Tax (AMT) to $70,300 for single taxpayers (up from $54,300) and $109,400 for married filing joint (up from $84,500).
- Doubles the Estate and Gift Tax exemptions to $11.2 million per person ($22.4 million for taxpayer’s and spouses).
- Most of the individual provisions expire or sunset after 2025 and revert back to pre-12/15/2017 law including the doubling of the estate and gift tax exemption.
For Businesses, the Tax Cuts and Jobs Act:
- Lowers the corporate tax rate to 21% (beginning Jan. 1, 2018) – down from 35%
- Created the new 20% tax deduction that applies to the first $315,000 of joint taxable income ($157,500 for single taxpayers) earned by all businesses organized as S corporations, partnerships, LLCs, and sole proprietorships. For qualifying business entities with income above this level, the bill generally provides a deduction for up to 20% on business profits, reducing their effective marginal tax rate to no more than 29.6%. For taxpayers with taxable income above $315,000 joint and $157,500 single, the rules include limitations. For example, “higher income” service providers, except for architects and engineers, are not allowed this deduction. See the article on our website for additional details. This provision expires after 2025.
- Allows businesses to immediately write off the full cost of new equipment by expanding the §179 deduction to $1 million and allowing 100% bonus depreciation on qualifying new and used fixed assets.
- Increases the Luxury Auto Depreciation limits: The new limits are set at $10,000 the year the vehicle is placed in service then $16,000 in year two, $9,600 in year three, and $5,760 per year thereafter. The old limits were $3,160 in year one, $5,100 in year two, $3,050 in year three, then $1,875 thereafter.
- Net Operating Losses (NOL) can no longer reduce taxable income to $0. Beginning in 2018, the NOL deduction is limited to 80% of taxable income. In addition, the two year carryback provision is repealed and an NOL carryover may be carried forward indefinitely (until used up).
- Modifies Section 1031 Like Kind Exchange provisions by limiting their application only to real property. Thus sales of personal property will no longer qualify for tax deferred treatment.
- Limits interest expense deductions on businesses with more than $25 million average annual gross receipts.
- Eliminates the Corporate Alternative Minimum Tax
- Eliminates business deductions for entertainment, amusement, or recreation including membership dues with respect to any club organized for business, pleasure, recreation, or other social purposes. The prior law limited the deduction to 50% (and this new law disallows 100%). The 50% deduction for only meals is maintained.
- Unlike most of the individual provisions that expire after 2025, most of the business provisions are permanent.
There is a new tax deduction taking effect in 2018 under the Tax Cuts and Jobs Act (the Act). It should provide a substantial tax benefit to individuals with "qualified business income" from a partnership, S corporation, LLC, or sole proprietorship. This income is sometimes referred to as "pass-through" income.
The deduction is 20% of your "qualified business income (QBI)" from a partnership, S corporation, or sole proprietorship, defined as the net amount of items of income, gain, deduction, and loss with respect to your trade or business. The business must be conducted within the U.S. to qualify, and specified investment-related items are not included, e.g., capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business). The trade or business of being an employee does not qualify. Also, QBI does not include reasonable compensation received from an S corporation, or a guaranteed payment received from a partnership for services provided to a partnership's business.
The deduction is taken "below the line," i.e., it reduces your taxable income but not your adjusted gross income. But it is available regardless of whether you itemize deductions or take the standard deduction. In general, the deduction cannot exceed 20% of the excess of your taxable income over net capital gain. If QBI is less than zero it is treated as a loss from a qualified business in the following year.
Rules are in place (discussed below) to deter high-income taxpayers from attempting to convert wages or other compensation for personal services into income eligible for the deduction.
For taxpayers with taxable income above $157,500 ($315,000 for joint filers), an exclusion from QBI of income from "specified service" trades or businesses is phased in. These are trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services, or where the principal asset is the reputation or skill of one or more employees or owners. Here's how the phase-in works: If your taxable income is at least $50,000 above the threshold, i.e., $207,500 ($157,500 + $50,000), all of the net income from the specified service trade or business is excluded from QBI. (Joint filers would use an amount $100,000 above the $315,000 threshold, viz., $415,000.) If your taxable income is between $157,500 and $207,500, you would exclude only that percentage of income derived from a fraction the numerator of which is the excess of taxable income over $157,500 and the denominator of which is $50,000. So, for example, if taxable income is $167,500 ($10,000 above $157,500), only 20% of the specified service income would be excluded from QBI ($10,000/$50,000). (For joint filers, the same operation would apply using the $315,000 threshold, and a $100,000 phase-out range.)
Additionally, for taxpayers with taxable income more than the above thresholds, a limitation on the amount of the deduction is phased in based either on wages paid or wages paid plus a capital element. Here's how it works: If your taxable income is at least $50,000 above the threshold, i.e., $207,500 ($157,500 + $50,000), your deduction for QBI cannot exceed the greater of (1) 50% of your allocable share of the W-2 wages paid with respect to the qualified trade or business, or (2) the sum of 25% of such wages plus 2.5% of the unadjusted basis immediately after acquisition of tangible depreciable property used in the business (including real estate). So if your QBI were $100,000, leading to a deduction of $20,000 (20% of $100,000), but the greater of (1) or (2) above were only $16,000, your deduction would be limited to $16,000, i.e., it would be reduced by $4,000. And if your taxable income were between $157,500 and $207,500, you would only incur a percentage of the $4,000 reduction, with the percentage worked out via the fraction discussed in the preceding paragraph. (For joint filers, the same operations would apply using the $315,000 threshold, and a $100,000 phase-out range.)
Other limitations may apply in certain circumstances, e.g., for taxpayers with qualified cooperative dividends, qualified real estate investment trust (REIT) dividends, or income from publicly traded partnerships.
Obviously, the complexities surrounding this substantial new deduction can be formidable, especially if your taxable income exceeds the thresholds discussed above. If you wish to work through the mechanics of the eduction with me, with particular attention to the impact it can have on your specific situation, please contact our office.
Under pre-Act law, an additional first-year bonus depreciation deduction was allowed equal to 50% of the adjusted basis of qualified property, the original use of which began with the taxpayer, placed in service before Jan. 1, 2020 (Jan. 1, 2021, for certain property with a longer production period). The 50% allowance was phased down for property placed in service after Dec. 31, 2017 (after Dec. 31, 2018 for certain property with a longer production period). A first-year depreciation deduction is also electively available for certain plants bearing fruit or nuts planted or grafted after 2015 and before 2020. Film productions aren't eligible for bonus depreciation.
New law. A 100% first-year deduction for the adjusted basis is allowed for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (after Sept. 27, 2017, and before Jan. 1, 2024, for certain property with longer production periods). Thus, the phase-down of the 50% allowance for property placed in service after Dec. 31, 2017, and for specified plants planted or grafted after that date, is repealed. The additional first-year depreciation deduction is allowed for new and used property. (The pre-Act law phase-down of bonus depreciation applies to property acquired before Sept. 28, 2017, and placed in service after Sept. 27, 2017.)
The Act refers to the new 100% depreciation deduction in the placed-in-service year as "100% expensing," but the tax break should not be confused with expensing under Code Sec. 179, which is subject to entirely separate rules (see above).
In later years, the first-year bonus depreciation deduction phases down, as follows:
- 80% for property placed in service after Dec. 31, 2022 and before Jan. 1, 2024.
- 60% for property placed in service after Dec. 31, 2023 and before Jan. 1, 2025.
- 40% for property placed in service after Dec. 31, 2024 and before Jan. 1, 2026.
- 20% for property placed in service after Dec. 31, 2025 and before Jan. 1, 2027.
For certain property with longer production periods, the beginning and end dates in the list above are increased by one year. For example, bonus first-year depreciation is 80% for long-production-period property placed in service after Dec. 31, 2023 and before Jan. 1, 2025.
First-year bonus depreciation sunsets after 2026.
For productions placed in service after Sept. 27, 2017, qualified property eligible for a 100% first-year depreciation allowance includes qualified film, television and live theatrical productions. A production is considered placed in service at the time of initial release, broadcast, or live staged performance (i.e., at the time of the first commercial exhibition, broadcast, or live staged performance of a production to an audience).
For certain plants bearing fruit or nuts planted or grafted after Sept. 27, 2017, and before Jan. 21, 2023, the 100% first-year deduction is also available.
For the first tax year ending after Sept. 27, 2017, a taxpayer can elect to claim 50% bonus first-year depreciation (instead of claiming a 100% first-year depreciation allowance). (Code Sec. 168(k), as amended by Act Sec. 13201)
The election to accelerate AMT credits in lieu of bonus depreciation is repealed. (Code Sec. 168(k)(4), as amended by Act Sec. 12001)
A taxpayer may, subject to limitations, elect under Code Sec. 179 to deduct (or "expense") the cost of qualifying property, rather than to recover such costs through depreciation deductions. Under pre-Act law, the maximum amount a taxpayer could expense was $500,000 of the cost of qualifying property placed in service for the tax year. The $500,000 amount was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $2 million. These amounts were indexed for inflation.
In general, qualifying property is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or business, and includes off-the-shelf computer software and qualified real property (i.e., qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).
Passenger automobiles subject to the Code Sec. 280F limitation are eligible for Code Sec. 179 expensing only to the extent of the Code Sec. 280F dollar limitations. For sport utility vehicles above the 6,000 pound weight rating and not more than the 14,000 pound weight rating, which are not subject to the Code Sec. 280F limitation, the maximum cost that may be expensed for any tax year under Code Sec. 179 is $25,000.
New law. For property placed in service in tax years beginning after Dec. 31, 2017, the maximum amount a taxpayer may expense under Code Sec. 179 is increased to $1 million, and the phase-out threshold amount is increased to $2.5 million. For tax years beginning after 2018, these amounts (as well as the $25,000 sport utility vehicle limitation) are indexed for inflation. Property is not treated as acquired after the date on which a written binding contract is entered into for such acquisition.
"Qualified real property." The definition of Code Sec. 179 property is expanded to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging. The definition of qualified real property eligible for Code Sec. 179 expensing is also expanded to include the following improvements to nonresidential real property after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems. (Code Sec. 179 , as amended by Act Sec. 13101)
The cost recovery periods for most real property are 39 years for nonresidential real property and 27.5 years for residential rental property. The straight line depreciation method and mid-month convention are required for such real property.
Under pre-Act law, qualified leasehold improvement property was an interior building improvement to nonresidential real property, by a landlord, tenant or subtenant,that was placed in service more than three years after the building is and that meets other requirements. Qualified restaurant property was either (a) a building improvement in a building in which more than 50% of the building's square footage was devoted to the preparation of, and seating for, on-premises consumption of prepared meals (the more-than-50% test), or (b) a building that passed the more-than-50% test. Qualified retail improvement property was an interior improvement to retail space that was placed in service more than three years after the date the building was first placed in service and that meets other requirements.
Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property if such improvement is placed in service after the date such building was first placed in service. Qualified improvement property does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building.
If a taxpayer elected the ADS, residential rental property had a recovery period of 40 years. ADS is principally a straight-line depreciation system under which one depreciation period (generally longer than any other) is prescribed for each class of recovery property.
New law. For property placed in service after Dec. 31, 2017, the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property are eliminated, a general 15-year recovery period and straight-line depreciation are provided for qualified improvement property, and a 20-year ADS recovery period is provided for such property.
Thus, qualified improvement property placed in service after Dec. 31, 2017, is generally depreciable over 15 years using the straight-line method and half-year convention, without regard to whether the improvements are property subject to a lease, placed in service more than three years after the date the building was first placed in service, or made to a restaurant building. Restaurant building property placed in service after Dec. 31, 2017, that does not meet the definition of qualified improvement property, is depreciable as nonresidential real property, using the straight-line method and the mid-month convention.
For property placed in service after Dec. 31, 2017, the ADS recovery period for residential rental property is shortened from 40 years to 30 years. (Code Sec. 168, as amended by Act Sec. 13204)
For tax years beginning after Dec. 31, 2017, an electing farming business-i.e., a farming business electing out of the limitation on the deduction for interest-must use ADS to depreciate any property with a recovery period of 10 years or more (e.g., a single purpose agricultural or horticultural structures, trees or vines bearing fruit or nuts, farm buildings, and certain land improvements). (Code Sec. 168 , as amended by Act Sec. 13205)Back To List