In December 2017, the Tax Cut and Jobs Act was signed into law. It contains significant changes to taxation for businesses, individuals and estates, with temporary cuts to estate and personal income taxes, and permanent business tax cuts. In this issue, we will discuss some of the significant changes.
Estate Tax and Generation Skipping Tax
The changes to the estate tax, while significant, are simple. Previously, each person had an exemption of $5,490,000. Under the new law, the exemptions for the Estate Tax and Generation Skipping Tax both double to $11,200,000 plus annual inflation adjustments through 2025. Beginning January 1, 2026, the increased exemption expires and reverts to the prior levels plus inflation adjustments for the intervening years. The act also adopts a new measure for calculating the annual inflation adjustments so the exemptions will grow at a slower rate. The rates and all other aspects of the Estate Tax and Generation Skipping Tax remain unchanged.
While the federal Estate Tax will affect fewer estates under the new law, it is important to remember that the Illinois Estate Tax remains unchanged and applies to estates larger than $4,000,000. Therefore, anyone who previously needed to plan for their estate tax still needs to do so.
Changes Affecting Business
Rate Cut for C-corporations: The Act establishes a flat tax rate of 21% for C-corporations. The corporate Alternative Minimum Tax has also been repealed.
20% Deduction for Some Pass-Through Business Entities: Individuals receiving income from qualified pass-through entities, S-corporations, partnerships, and LLCs that elect to be taxed as either partnerships or sole-proprietorships, now receive a deduction of 20% of income. The amount of the deduction is subject to a cap and cannot exceed 20% of the taxpayer’s taxable income excluding net capital gains. Businesses primarily providing legal, medical, accounting, financial, performing arts, or brokerage services are excluded from the deduction (but engineering and architectural services are not excluded).
Bonus Depreciation: Bonus Depreciation for qualifying capital expenditures is expanded to 100% of the expenditure, then gradually phased out until it is eliminated entirely in 2026. Previously, only new property was eligible for bonus depreciation; now, used property qualifies.
Section 179: The maximum deduction of capital expenditures allowed under Section 179 has been increased to $1,000,000. The investment cap has been increased to $2.5 million (if the business makes capital expenditure exceeding this amount, the deduction phases out). Section 179 expensing may also now be used for the purchase of roofs, HVAC property, fire protection or alarm systems, and security systems in existing commercial buildings.
Changes to Depreciation of Certain Types of Property: Computers and accessories are no longer “listed property,” meaning that they no longer require strong substantiation that the computer equipment is for business use before qualifying for more favorable depreciation treatment. Farm machinery is now depreciated over a five-year period rather than seven years.
Net Operating Losses: The ability to “carry back” net operating losses and apply those losses to prior, profitable years has been eliminated, and losses may only be carried forward. The period for farmers to carry forward net operating losses has been reduced from five years to two years.
Domestic Production Activities Deduction (DPAD): DPAD has been repealed. Farmers or manufacturers paying employees W-2 income, or farmers receiving the deduction through sales to cooperatives, will no longer be able to claim this deduction.
Changes for Individuals
Rate changes: New rates applicable for individual filers beginning in 2018 can be found at https://taxfoundation.org/2018-tax-brackets/. In 2026, going forward, the rates revert to their prior levels plus inflation adjustments. The method for calculating inflation for annually adjusting the level of taxable income at which increased rates begin to apply has also been modified so that the levels increase more slowly than the generally accepted true rate of inflation. This results in a return of the so-called “bracket creep,” where taxes effectively increase each year.
Standard Deduction & Exemption Changes: The standard deduction increased to $12,000 for individual filers and $24,000 for married joint filers. However, personal and dependent exemptions have been eliminated. For a family with three children, the prior standard deduction ($12,700) and personal exemptions ($4,050 per person) totaled $32,950. If that family itemized their deductions, they could still claim the personal exemptions. While the increased child tax credit will usually offset the difference for families with minor children, because the personal exemption was generally available for college-age students, families with college-age children claimed as dependents are likely to face higher taxes.
Child Tax Credit: The Child Tax Credit has been increased to $2,000 per child, with up to $1,400 of that credit being refundable. The phaseout threshold has been increased so that the credit does not begin to phase out until married joint filers have income of $400,000.
Elimination and Limitation of Deductions: A number of deductions previously available to filers who itemized are now capped or eliminated. The deductions include:
Mortgage Interest: The deduction is now limited to interest on $750,000 of mortgage debt for new debt.
State and Local Taxes: The deduction for state and local taxes is capped at $10,000.
Miscellaneous Deductions: The group of miscellaneous deductions, the deductions subject to a 2% of adjusted gross income threshold to be deductible, is eliminated. Those deductions include tax preparation, unreimbursed employment expenses, and investment expenses.
Alimony/Maintenance: Spousal Maintenance in new judgments and settlements will no longer be deductible by the payer. Going forward, the money paid as maintenance will be taxed as a part of the payer’s income rather than the payee’s, resulting in higher overall taxes for a divorced couple.
529 Changes: Up to $10,000 per year may be used from 529 accounts for qualified elementary and high school expenses. 529 accounts can also be rolled over to ABLE accounts if the beneficiary becomes disabled.
Health Insurance Individual Mandate Repealed
The tax penalty for failing to purchase minimally adequate health insurance for taxpayers and their dependents has been eliminated permanently. Tax credits for assistance in paying health insurance premiums (available for taxpayers with household income between 100% and 400% of the federal poverty level) remain available and unchanged.