The Tax Cuts and Jobs Act (H.R. 1) has been approved by Congress and signed by President Trump. After a last-minute procedural glitch that required the Senate to vote first on the final bill, the most sweeping change to the U.S. tax code in decades cleared the Senate, 51 to 48, in the early morning hours of December 20, followed by House approval, 224 to 201, later the same day. President Trump signed the bill into law at the White House on December 22, 2017.
H.R. 1, as approved by Congress, impacts virtually every individual and business on a level not seen in over 30 years. As with any tax bill, however, there will be “winners” and “losers.” This historic bill calls for lowering the individual and corporate tax rates, repealing countless tax credits and deductions, enhancing the child tax credit, boosting business expensing, and more. The bill also impacts the Affordable Care Act (ACA), effectively repealing the individual shared responsibility requirement. Most provisions are effective starting in 2018.
Many of the changes to the Internal Revenue Code in the final bill are temporary. This is true especially with respect to the provisions of the bill impacting individuals. This decision was made in order to keep the bill within budgetary parameters, but with no guarantees that a future Congress would extend them.
H.R. 1 carries temporary tax rates of 10, 12, 22, 24, 32, 35, and 37 percent after 2017. Under prior law, individual income tax rates have been 10, 15, 25, 28, 33, 35, and 39.6 percent.
The rate changes in the new law are effective starting in 2018, but expire after 2025.
The IRS has announced that initial withholding guidance (Notice 1036) to reflect enactment of the Tax Cuts and Jobs Act, would be issued in January 2018, “which would allow taxpayers to begin seeing the benefits of the change as early as February.”
The new law includes income ranges for their respective brackets.
H.R. 1 Brackets
Joint Return Individual Return
$0 – $19,050 $0 – $9,525
$19,050 – $77,400 $9,525 – $38,700
$77,400 – $165,000 $38,700 – $82,500
$165,000 – $315,000 $82,500 – $157,500
$315,000 – $400,000 $157,500 – $200,000
$400,000 – $600,000 $200,000 – $500,000
Over $600,000 Over $500,000
Under the new law, income levels are indexed for inflation for a “chained CPI” instead of CPI. Both the original House bill and the Senate bill called for a chained CPI. In general, this change would result in a smaller annual rise in rate brackets, which the Joint Committee of Taxation estimates, when combined with using the chained CPI for all other inflation-adjusted tax amount, would bring $128 billion more into the U.S. Treasury over the next ten-year period. The chained CPI is permanently applied to almost all amounts subject to annual inflation adjustment, even the permanent amounts that would apply if provisions are allowed to expire after 2025.
H.R. 1 does not change the current tax treatment of qualified dividends and capital gains.
The new law does not repeal the Affordable Care Act’s taxes, except for the penalty under the “individual mandate.” Left untouched are the net investment income (NII) tax, the additional Medicare tax, the medical device excise tax, and more.
Legislation has been introduced in Congress to extend the current suspension of the ACA’s medical device excise tax, the health insurance provider fee, and the excise tax on high-dollar health plans. H.R. 1 does not address these ACA taxes.
H.R. 1 nearly doubles the standard deduction. It increases the standard deduction to $24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other individuals, indexed for inflation (using chained CPI) for tax years beginning after 2018. All increases are temporary, starting in 2018 but ending after December 31, 2025. Under prior law, the standard deduction for 2018 had been set at $13,000 for joint filers, $9,550 for heads of households, and $6,500 for all other filers. The additional standard deduction for the elderly and the blind ($1,300 for married taxpayers, $1,600 for single taxpayers) is retained.
One goal of a higher standard deduction is to simplify tax filing through cutting, by more than half, those taxpayers who would otherwise do better by itemizing deductions. Of course, that group will realize less of a net tax benefit than those taxpayers who do not now itemize. Supporters argue that, in addition to simplification, it effectively creates a more broadly applicable “zero tax bracket” for taxpayers earning less than the standard deduction amount.
The doubling of the standard deduction effectively eliminates most individuals from claiming itemized deductions other than higher-income taxpayers. For example, for the vast majority of married taxpayers filing jointly, only those with allowable mortgage interest, state income and local income/property taxes (up to $10,000), and charitable deductions that exceed $24,000 will claim them as itemized deductions (absent extraordinary medical expenses). With fewer individuals claiming those deductions, this could have broad impact on both real estate prices and charitable organizations despite retaining those two deductions, in modified form.
The new law eliminates the deduction for personal exemptions and the personal exemption phase-out through 2025. That repeal, as scored by the Joint Committee on Taxation, will raise $1.22 trillion in revenue over the next 10 years. That repeal will reduce the net benefit of the standard deduction for most taxpayers. An enhanced child and family tax credit is positioned to make up some of the difference for certain families.
Deductions and Credits
H.R. 1 makes significant changes to some popular individual credits and deductions, effective starting in 2018. Many of the changes, however, are temporary, generally ending after 2025, in order to keep overall revenue costs for the new law within budgetary constraints.
Mortgage interest deduction. The new law limits the mortgage interest deduction to interest on $750,000 of acquisition indebtedness ($375,000 in the case of married taxpayers filing separately), in the case of tax years beginning after December 31, 2017, and beginning before January 1,2026. For acquisition indebtedness incurred before December 15, 2017, the new law allows current homeowners to keep the current limitation of $1 million ($500,000 in the case of married taxpayers filing separately).
The new law also allows taxpayers to continue to include mortgage interest on second homes, but within those lower dollar caps. However, no interest deduction will be allowed for interest on home equity indebtedness.
Some homeowners dodged a bullet when the House and Senate conferees rejected the additional limitation in both the original House and Senate bills to increase the holding period for the homeowners’ capital gain exclusion to a five-out-of-eight year principal-residence test.
State and local taxes. The new law limits annual itemized deductions for all nonbusiness state and local taxes deductions, including property taxes, to $10,000 ($5,000 for married taxpayer filing a separate return). Sales taxes may be included as an alternative to claiming state and local income taxes.
The new law short-circuits an immediate year-end tax strategy by adding a provision that disallows prepayment in 2017 of state and local income taxes imposed for a year after 2017 to avoid the new dollar limitation.
Miscellaneous itemized deductions. The new law temporarily repeals all miscellaneous itemized deductions that are subject to the two-percent floor under current law.
Medical expenses. The new law temporarily enhances the medical expense deduction. It lowers the threshold for the deduction to 7.5 percent of adjusted gross income (AGI) for tax years 2017 and 2018.
The loss of many itemized deductions will channel an even greater number of taxpayers to the standard deduction. Big losers may include state and local governments that depend upon the federal itemized deductions for state and local income taxes and real estate taxes as an indirect subsidy for those taxes. Limitations on the mortgage interest deduction will also likely hurt the housing industry.
Once again, the concessions for retaining some deductions are valuable only to those taxpayers who will do better continuing to itemize deductions than taking the higher standard deduction.
The new law temporarily increases the current child tax credit from $1,000 to $2,000 per qualifying child. Up to $1,400 of that amount would be refundable. It also raises the adjusted gross income phaseout thresholds, starting at adjusted gross income of $400,000 for joint filers ($200,000 for all others).
The child tax credit is further modified to provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children.
As a credit, in contrast to a deduction, the enhanced child credit has been highlighted as one of the provisions that will lower overall tax liability for middle-class families.
The new law retains the student loan interest deduction. It also modifies section 529 plans and ABLE accounts. It does not overhaul the American Opportunity Tax Credit, as proposed in the original House bill. The new law also does not repeal the exclusion for interest on U.S. savings bonds used for higher education, as proposed in the House bill.
At the eleventh-hour, House and Senate conferees decided to retain the exclusion for graduate student tuition waivers.
The new law does not renew the above-the-line deduction for education expenses that expired at the end of 2016 and had earlier been considered for inclusion in a separate “extenders” bill.
The new law repeals the deduction for alimony payments and their inclusion in the income of the recipient.
To give taxpayers time to adjust to this new balance in assessing benefits and burdens, the new rules will apply only to divorce or separation instruments executed after December 31, 2018.
The new law generally retains the current rules for 401(k) and other retirement plans. However, it repeals the rule allowing taxpayers to recharacterize Roth IRA contributions as traditional IRA contributions to unwind a Roth conversion. Rules for hardship distributions are modified, among other changes.
Initial proposals for more extensive changes to retirement plans to generate revenue resulted in immediate push-back and were not revived by House and Senate conferees.
Federal Estate Tax
The new law follows the original Senate bill in not repealing the estate tax, but rather doubling the estate and gift tax exclusion amount for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026. The generation-skipping transfer (GST) tax exemption is also doubled.
The original House bill called for repeal of the federal estate and GST taxes. The Conference Committee, largely to win support in the Senate, retained them in the final bill.
The current maximum federal estate tax rate for 2017 is 40 percent with an inflation-adjusted $5 million exclusion ($5.49 million in 2017), which married couples can combine for a $10 million exclusion ($10.98 million in 2017). The new exclusion amounts will now allow married couples to exempt up to $22 million for 2018 (after adjustment for inflation) from any estate or gift tax. Heirs, however, will continue to receive a “stepped-up, date of death” basis for inherited assets for purposes of any subsequent sale.
Alternative Minimum Tax
The new law retains the alternative minimum tax (AMT) for individuals with modifications. It temporarily increases (through 2025) the exemption amount to $109,400 for joint filers ($70,300 for others, except trusts and estates). The new law also raises the exemption phase-out levels so that the AMT will apply to an income level of $1 million for joint filers ($500,000 for others). These amounts are all subject to annual inflation adjustment.
Affordable Care Act
The new law repeals the Affordable Care Act (ACA) individual shared responsibility requirement, making the payment amount $0. This change is effective for penalties assessed after 2018.
The IRS has cautioned that, under current law, for tax year 2017, it will not consider a return complete and accurate if the taxpayer does not report full-year coverage, claim a coverage exemption, or report a shared responsibility payment on the return.
Under the new law, the holding period for long-term capital gains is increased to three years with respect to certain partnership interests transferred in connection with the performance of services.