As many of you are aware, we had sweeping Federal tax law changes for the first time in 30 years that will have both positive and negative effects on many of you. Please note that these changes are not uncommon and usually do happen every 30 years, with the last two coming in 1981 under President Reagan and before that, in 1945 under President Truman.
In this article we will discuss, as Clint Eastwood would say, “The good, the bad, and the ugly” of the bill and how it may affect you. Please note that this article is not meant to be a comprehensive guide to every caveat of the law, but it does cover the high points and makes it obvious how important good financial and tax planning will be (as it was in the past and will continue to be in the future)! First though, let’s talk about some of the things that did not change:
Tax rates on dividends and capital gains remain unchanged. For capital gains and qualified dividends, that means a maximum tax rate of 15% for taxpayers in the lower tax brackets. For those in the highest tax bracket, the tax rate is 23.8%, including the 3.8% Net Investment Income Tax, associated with the Patient Protection and Affordable Care Act.
Tax benefits to retirement accounts, such as 401(k)s and IRAs, stand. Most of these did not change, the only notable difference is taking away the availability to re-characterize a conversion once you have converted funds from a traditional IRA to a Roth IRA. Please note that since this availability to re-characterize came out in 1997, our office has done less than a dozen of these, so chances are it will not affect you.
Keeps the deductions for charitable contributions, retirement savings, and student loan interest.
Tax-lot selling rules stay the same. Investors are still able to determine the most appropriate tax lot to use for cost-basis purposes on investment sales. This preserves an important planning tool for advisors and you as investors.
Alternative Minimum Tax. It keeps the tax, but it increases the exemption from $54,300 to $70,300 for singles and from $84,500 to $109,400 for joint. The exemptions phase out at $500,000 for singles and $1 million for joint.
Reduced Rates. Tax rates/brackets have come down for some taxpayers as seen on the comparison graph below:
Lower Corporate Tax Rates. This should benefit you as an investor, as this decrease in corporate tax rates from 35% to a more competitive rate (globally) of 21%. The anticipation of this benefit was one of the main catalysts that helped push the stock markets higher in 2017.
Tax breaks for business owners who qualify for pass-through income. Many businesses are pass-through entities, so the effect could be large and swift. Business owners might consider converting from a C corporation structure to S corporation or partnership to take advantage of the pass-through tax preference. There is complexity, though, that might curtail this option for those this pertains to, so it’s important to consult your tax professional.
529s get more useful. (Please see Chris Beale’s article on this in the newsletter)
The Act increases the Child Tax Credit from $1,000 to $2,000. Even parents who don't earn enough to pay taxes can claim the credit up to $1,400. It increases the income level from $110,000 to $400,000 for married tax filers.
It doubles the standard deduction. A single filer's deduction increases from $6,350 to $12,000. The deduction for Married and Joint Filers increases from $12,700 to $24,000. Roughly 30% of taxpayers itemize now so that number will likely be far smaller following the tax changes. So this may be a benefit to some, but may hurt others which we will discuss below.
Elimination of the Miscellaneous Itemized Deductions. In the past, these were deductible only to the extent they exceed 2% of a taxpayer’s adjusted gross income. These deductions included unreimbursed job expenses, tax preparation fees, investment management expenses (as most of you pay with New England Capital), and gambling losses to name a few.
Mortgage interest on large loans. It limits the deduction on mortgage interest to the first $750,000 of a new mortgage/ loan taken out in 2018. If you purchased your home before 1/1/18 you are grandfathered in.
Alimony. Those paying alimony can no longer deduct it, while those receiving it can. The new rules won't affect anyone who divorces or signs a separation agreement before 2019.
The cap on state income tax deductions and property tax. Taxpayers can deduct up to a maximum of $10,000 in state and local taxes. They must choose between property taxes and income or sales taxes. This will harm taxpayers in high-tax states like Connecticut, New York, New Jersey and California.
Interest on home equity lines. Home equity lines of credit can no longer be deducted. This applies to everyone – even existing lines of credit – no one is grandfathered in!
Personal Exemptions. It eliminates personal exemptions. Before the Act, taxpayers subtracted $4,150 from income for each person claimed.
Some of you may consider this good and others of you bad, but the Act repeals the Obamacare tax on those without health insurance in 2019. Without the mandate, the Congressional Budget Office estimates 13 million people would drop their plans. The government would save $338 billion by not having to pay their subsidies. But health care costs will rise because fewer people will get the preventive care needed to avoid expensive emergency room visits.
As with any tax plan there are winners and losers and some of this will take time to see some of the benefits. Historically, even minor changes in the tax code take a fair amount of time to fully understand and to strategize for. Given the scope of this legislation, accountants, tax attorneys, and financial advisors will be digesting the changes and coming up with tax strategies for quite some time.
An Important Note: These changes will not impact the tax return that you file this coming April covering the tax year 2017. They take effect January 1, 2018.