2018 Update Letter
December 19, 2018

To Our Clients and Friends:

At the end of last year, Congress passed, and President Trump signed, the Tax Cuts and Jobs Act (TCJA), creating the largest overhaul of the tax code in decades.  The TCJA, for the most part, took effect on January 1, 2018, except for some changes to depreciation that became law at the end of 2017. Here is a look at some of the common aspects of the new tax law that will have an impact on individuals and businesses.  Unless otherwise noted, the changes are effective for tax years beginning in 2018 through 2025.

New tax brackets.  Among the main changes for individuals are new tax brackets. In general, the new tax rate structure means lower brackets for most filers, with the top rate dropping to 37% from 39.6%.  The 10% bracket now extends to almost $10,000 for individuals and $19,000 for joint filers, which doubles the amount of income taxed at the lowest rate.  The following table details the 2018 income ranges for the seven tax rates for single, married filing joint and head of household filers:

Tax

Income Range

Income Range

Income Range

Rate

for Single Filers

Married Filing Joint

Head of Household

10%

$0 – $9,525

$0 – $19,050

$0 – $13,600

12%

$9,526 – $38,700

$19,051 – $77,400

$13,601 – $51,800

22%

$38,701 – $82,500

$77,401 – $165,000

$51,801 – $82,500

24%

$82,501 – $157,500

$165,001 – $315,000

$82,501 – $157,500

32%

$157,501 – $200,000

$315,001 – $400,000

$157,501 – $200,000

35%

$200,001 – $500,000

$400,001 – $600,000

$200,001 – $500,000

37%

$500,001 and Up

$600,001 and Up

$500,001 and Up

The rates applicable to net capital gains and qualified dividends were not changed.  Also, the “kiddie tax” rules were simplified so that the net unearned income of a child subject to the rules will be taxed at the capital gain and ordinary income rates that apply to trusts and estates.

Standard deduction.  The new law increases the standard deduction to $24,000 for joint filers, $18,000 for heads of household, and $12,000 for singles and married taxpayers filing separately, compared with $12,700, $9,350 and $6,350 in 2017.  The additional standard deduction for elderly and blind taxpayers was not changed. 

Exemptions.  The new law suspends the deduction for personal exemptions.  As a result, starting in 2018, taxpayers can no longer claim personal or dependency exemptions. 

Pass-through income deduction.Starting in 2018, taxpayers, other than C corporations, can generally deduct the lesser of 20% of “qualified business income” from a partnership, S corporation, or sole proprietorship, as well as 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income or 20% of taxable income minus net capital gains. For these purposes, “qualified business income” means the net amount of qualified items of income, gain, deduction, and loss with respect to a qualified trade or business.  These items must be effectively connected with the conduct of a trade or business within the United States and included or allowed in determining taxable income for the year. 

Qualified items of income, gain, deduction, or loss do not include short-term or long-term capital gains or losses, dividends, interest income, reasonable compensation paid by an S corporation, and guaranteed payments from a partnership.  The term “qualified trade or business” means any trade or business other than a specified service trade or business.  Specified service trades and businesses include any trade or business in the fields of accounting, health, law, consulting, athletics, financial services, brokerage services, investment management or any business in which the reputation or skill of a person is the principal asset of the business. 

Because specified service businesses are not considered qualified trades or businesses, income from specified service businesses is not generally included as qualified business income in determining the pass through deduction.  However, in 2018, if a taxpayer’s taxable income for the year is less than the threshold amount of $157,500 ($315,000 in the case of a joint return), the exclusion for specified service trades or businesses does not apply, and the deduction is available for income from the specified service businesses of the taxpayer for that year.  A phase-out of the exclusion applies to taxpayers with taxable income over the threshold amount but less than the upper phase-out amount of $207,500 ($415,000 in the case of a joint return).  For taxpayers with taxable income above these upper phase-out amounts, none of their specified service income is included as qualified business income in determining the deduction.

In addition, generally, the pass through deduction is limited to 50% of the W-2 wages paid with respect to the business or 25% of wages paid plus 2.5% of the unadjusted basis (immediately after acquisition) of certain qualified property.  However, in 2018, this limitation on the deduction does not apply to taxpayers with taxable income below the threshold amount of $157,500 ($315,000 in the case of a joint return) and phase in for taxpayers with taxable income above the threshold amount but less than the upper phase-out amount of $207,500 ($415,000 in the case of a joint return).

Meals and entertainment.  Prior to 2018, a taxpayer could generally deduct 50% of business meals and entertainment and 100% of de minimis meals provided to employees for the convenience of the employer.  Under the new law, entertainment expenses are no longer deductible.  This includes golf outings, fishing, sporting events, hunting, theater tickets, license fees paid to sporting arenas, and golf club dues.  Also, the de minimis meals provided to employees for the convenience of the employer is now limited to 50%.  Generally, there has not been a change to the 50% deduction of business meals (such as for meetings and consumed by employees on work travel). 

Bonus depreciation.  The TCJA boosted the first year-year bonus depreciation allowance from 50% to 100% for qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023.  That means, businesses can write off the cost of most machinery and equipment in the year it’s placed in service.  And, for the first time ever, for property acquired and placed in service after September 27, 2017, bonus depreciation may be claimed for used, as well as, new equipment.  The IRS has explained that used equipment qualifies for the 100% first-year bonus deprecation allowance if the taxpayer (or a predecessor) didn’t use the property at any time before the acquisition and the property wasn’t acquired from a related party.

Child tax credit.  The TCJA increased the amount of the child tax credit to $2,000 per qualifying child (i.e., a child under 17) with up to $1,400 of the credit being refundable.  The act also created a new nonrefundable $500 credit for qualifying dependents who are not qualifying children. The threshold at which the credit begins to phase out was increased to $400,000 for married taxpayers filing a joint return and to $200,000 for other taxpayers.

State and local taxes.  The itemized deduction for state and local income and property taxes is limited to a total of $10,000 ($5,000 for married taxpayers filing separately) starting in 2018.

Mortgage interest.  Under the new law, mortgage interest on loans used to acquire a principal residence and a second home is only deductible on debt up to $750,000, down from $1 million. Taxpayers with prior existing mortgages that were entered into a binding written contract before December 15, 2017 can still deduct interest on them up to $1 million of acquisition indebtedness.  Mortgages entered into on or after December 15, 2017 are subject to the $750,000 limit.  Also, interest on home equity loans is no longer deductible, except to the extent the home-equity loan is considered acquisition indebtedness (i.e., it is used to buy, build, or substantially improve the taxpayer’s home that secures the loan).

Miscellaneous itemized deductions.  There is no longer a deduction for miscellaneous itemized deductions which were formerly deductible to the extent they exceeded 2% of adjusted gross income.  This category included items such as tax preparation costs, investment expenses, union and professional dues, unreimbursed employee business expenses, and excess deductions upon termination of an estate or trust.  Items not affected by the tax change include investment interest expense, the deduction associated with income in respect of a decedent, amortizable bond premiums and gambling losses, but only to the extent of gambling winnings. 

Medical expenses.  Under the new law, for 2018, medical expenses are deductible to the extent they exceed 7.5% of adjusted gross income for all taxpayers.  After 2018 the threshold is adjusted to 10% of adjusted gross income.

Charitable donations.  The TCJA increased the income-based percentage limit for charitable contributions of cash to public charities from 50% to 60%.  It also denies a charitable deduction for payments made for college athletic event seating rights. 

Casualty and theft losses.  The itemized deduction for casualty and theft losses has been suspended except for losses incurred in a federally declared disaster.   

Overall limitation on itemized deductions.  The new law suspends the overall limitation on itemized deductions that formerly applied to taxpayers whose adjusted gross income exceeded specified thresholds.

Moving expenses.  The deduction for job-related moving expenses has been eliminated, except for certain military personnel.  The exclusion for moving expense reimbursements has also been suspended.

Divorce.  For post-2018 divorce decrees and separation agreements, alimony will not be deductible by the paying spouse and will not be taxable to the receiving spouse.

Health care “individual mandate.”  Starting in 2019, there is no longer a penalty for individuals who fail to obtain minimum essential health coverage.  For 2018, the penalty is equal to 2.5% of your adjusted gross income, or $695 per adult and $347.50 per child, up to a maximum of $2,085, whichever is higher.

Student loan interest deduction.  For 2018, the maximum amount that you can deduct for interest paid on student loans remains $2,500.  Phase outs apply for taxpayers with modified adjusted gross income in excess of $65,000 ($135,000 for married joint returns) and is completely phased out for taxpayers with modified adjusted gross income of $80,000 or more ($165,000 or more for married joint returns). 

1031 (Like-Kind) exchanges.  The TCJA amended Section 1031 limiting exchanges solely to exchanges of real property.  Section 1031 states that no gain or loss shall be recognized on the exchanges of like-kind real property held for productive use in a trade or business or for investment. Like-kind exchanges are no longer allowed for the exchange of personal property completed after December 31, 2017.

529 qualified tuition programs.  The new law has expanded the definition of qualified higher education expenses to include tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school for distributions made after December 31, 2017.  The treatment of distributions from 529 plans for enrollment or attendance at an elementary or secondary school as qualified higher education expenses is limited to $10,000 per taxable year, per beneficiary.

Estate and gift tax exemption.  Effective for decedents dying and gifts made in 2018, the estate and gift tax exemption has been increased to $11.18 million ($22.36 million for married couples).

Alternative minimum tax (AMT).  The AMT has been retained for individuals and repealed for C Corporations.  The exemption for individuals has been increased to $109,400 for joint filers ($54,700 for married taxpayers filing separately), and $70,300 for unmarried taxpayers.  The exemption is phased out for taxpayers with alternative minimum taxable income over $1 million for joint filers and over $500,000 for all others. 

Reduced corporate tax rate.  For taxable years beginning after December 31, 2017, the TCJA has permanently eliminated the graduated rate schedule for C corporations to provide a flat 21% tax rate.  In addition the tax law also eliminated the separate 35% tax rate for personal service corporations.

Net operating losses (NOLs).  For losses arising after December 31, 2017, NOLs cannot be carried back to previous years.  NOLs are now carried forward indefinitely and the NOL deduction is limited to 80% of taxable income.  There is an exception for farming losses, which can be carried back to each of the two tax years preceding the tax year of the loss. 

Excess business loss limitation.  For taxpayers other than C corporations, the new tax act provides that excess business losses are not allowed for the tax year but are instead carried forward and treated as part of the taxpayer’s net operating loss (NOL) carryforward in subsequent tax years.  The taxpayer has an excess business loss if the taxpayer’s losses from all trades or businesses exceed income from the trades or businesses by more than $250,000 ($500,000 for taxpayers who file joint returns).  The $250,000/$500,000 amount is adjusted for inflation for years after 2018.

The above summary touches briefly on the majority of changes from the TCJA.  As you can see from this overview, the new tax law will affect every business and individual.  If you wish to discuss the impact of the law on your particular situation, please give us a call.

Very truly yours,

CLAUSEN & COMPANY



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