By: Carl Markus
The Tax Cut and Jobs Act (“Act”) was signed into law by President Trump on December 22, 2017. The Act contains a multitude of changes to the Internal Revenue Code affecting income, estate, and excise tax rules applying to individuals, businesses, and nonprofit organizations. Close to 50 income tax changes relate specifically to individual taxpayers, and many more are not specific to individual taxpayers, but may have an impact on them, depending on their circumstances.
One of the interesting aspects of the Act is that with many of the changes, existing rules are not being repealed, but rather merely “suspended,” in most cases, through the year 2025. This means that prior law will come back into existence in 2025 unless Congress acts to change it again before then. Thus, while the number and effect of the changes are substantial, it is not really a complete re-write of the Internal Revenue Code as some media reports and politicians suggest.
Following are a few of the more significant changes which will affect a large percentage of individual taxpayers:
The Act reduces the highest marginal individual income tax rate from 39.6% to 37%, and the income brackets to which those rates apply have higher income thresholds which must be met before those rates are incurred. This means fewer individuals will pay that top rate. This is a feature generally (but not uniformly) found throughout the new income brackets, so that each of the rate brackets has a higher income threshold that must be met before that rate applies. For example, a married couple filing jointly would pay the highest 39.6 % rate on all taxable income over $470,000 under prior law whereas under the Act, the married couple would have to earn in excess of $600,000 in taxable income to incur the highest 37% rate. However, beyond that generality, each situation must be evaluated separately because, under the Act, some taxpayers could actually be paying the same rate or even a higher rate than before. A single individual making between $191,500 and $416,700 had a marginal tax rate under the old law of 33% whereas the tax rate on that income under the Act, will almost all be at 35%.
Personal Exemptions and Standard Deduction vs. Itemized Deductions.
Under prior law, everyone was entitled to claim a personal exemption for themselves and for related individuals they supported (e.g., children), which could be deducted from their income before determining their tax. Everyone was also entitled to a so-called “standard deduction,” with the amount depending on their filing status, which could be deducted from their income. If the individual paid certain expenses which were allowed as “itemized deductions” and the total exceeded the amount of their standard deduction, they could deduct those itemized deductions in lieu of the standard deduction.
The Act has dramatically changed this landscape by changing three things:
- It eliminates the personal exemption.
- It substantially increases the standard deductions that apply to each filing status -$12,000 for single individuals and $24,000 for married couples filing jointly (vs $6,350 and $12,700 respectively under prior law).
- It eliminates or significantly limits many types of itemized deductions.
Item #3 merits the most discussion here. Almost every type of itemized deduction has some change made to it by the Act.
In a couple of cases, the change could actually result in larger deductions of a given type. For example, contributions to public charities have historically been limited to no more than 50% of an individual’s “adjusted gross income.” The Act raises this threshold to 60%. However, it is the restrictions on, or elimination of, the right to take certain deductions that is the big news here.
Specifically, under prior law, all state and local income and property taxes were deductible. Under the Act, this will be limited to a total deduction of $10,000.
In addition, under prior law, taxpayers were allowed “miscellaneous itemized deductions,” such as safe deposit box fees, tax return preparation fees, portfolio management fees, and employee business expenses. These miscellaneous itemized deductions were only deductible to the extent they exceeded 2% of a taxpayers “adjusted gross income,” but this deduction could be significant in amount, particularly for individuals with large investment portfolios, expensive tax return preparation, or significant amounts of unreimbursed business expenses. Under the Act, these expenses are no longer deductible as itemized deductions.
Finally, while the home mortgage interest deduction was retained, interest paid on a line of credit secured by the home is no longer deductible, and the maximum amount of debt on which mortgage interest may be deducted has been decreased to $750,000 (from $1,000,000 under prior law).
Here’s why these changes will be significant to many taxpayers. Typically, the “big two” itemized deductions for most taxpayers have been the mortgage interest deduction and state and local taxes deduction. With the state and local tax deduction being significantly limited for many, taxpayers will be relying more on their mortgage interest deduction and charitable deductions to get them over the $12,000 and $24,000 standard deduction thresholds necessary to itemize. This is particularly true since taxpayers will also not get any help from miscellaneous itemized deductions, and the mortgage interest deduction itself may be limited for taxpayers with large mortgage loans or home equity lines of credit.
The likely result is fewer taxpayers itemizing deductions and smaller overall deductions from taxpayers’ incomes than under the current law. For these taxpayers, any benefit they might otherwise get from a lowering of the tax brackets could be offset by the loss of these deductions.
This has led many to suggest that taxpayers should be sure to pay all 2017 state taxes before December 31, 2017 (the Act prohibits taxpayers from “prepaying” 2018 state taxes in 2017) and any miscellaneous deductions that they have already been billed for relating to 2017 (e.g., portfolio management fees, preparer fees relating to preparation of 2017 estimates, etc.). Whether this will provide a significant benefit or not depends entirely on one’s individual circumstances, but one thing is clear: 2017 will be the last tax year both of these expenditures will be fully deductible for a while.
Remember, this new law will affect individual’s taxes for 2018 and the return filed in 2019. It will not affect taxes for 2017 and the return filed in 2018.
To review your tax situation and determine what steps you should take to comply with these changes in the tax law you should consult with an attorney or your tax preparer. The tax lawyers at Paule, Camazine & Blumenthal will be happy to consult with you about the new law as it applies to you.