The Tax Cuts and Jobs Act of 2017 will be signed by President Donald Trump by week's end. The changes to the U.S. tax code will affect all Americans. The changes go into effect January 1, 2018, making the dwindling days of 2017 your last chance to act to minimize your tax bill in light of the new law. Here are the major immediate and longer term implications to family wealth and suggestions for what to do right now.
It's Temporary. Changes to corporate tax laws are permanent, but provisions applying to individuals take effect in 2018 and expire after 2025, unless specified otherwise below.
Tax brackets. There still will be seven individual tax rates, or brackets, but they are generally lower: 10%, 12%, 22%, 24%, 32%, 35%, and 37% effective Jan. 1, 2018.
The 37% top-rate applies to married joint filers with more than $600,000 ($500,000 for single filers). Till now, the top rate was 39.6% on married couples with more than $470,700 in taxable income ($418,700 for single-filers).
WHAT TO DO NOW
- Determine what your tax rate is likely to be in 2018 under the new brackets. If it's lower than your 2017 tax rate, defer income into 2018 and accelerate deductions into 2017 to maximize tax savings.
- If you are selling assets with large gains or a business, there is a way to defer the transaction until after Jan. 1, 2018 and you may also want to consider an installment sale. If you are not in touch with us yet, please ask us about this.
- If you are selling appreciated assets, consider the new limits on 1031 like-kind exchanges of real property that go into effect in 2018. Like-kind exchanges swap properties of equivalent value instead of cash, deferring income to future years and presuming lower tax rates will prevail.
- If you have capital losses on investments in 2017, harvesting gains is a must. Gains are fully offset by losses for income-tax purposes. If you sustained a loss on an investment, please make sure we know about it to ensure it's used to offset taxable gains - or up to $3,000 of income.
- Since we mentioned optimizing taxable losses against gains, we'd be remiss if we did not also add a caveat about the wash-sale rule: Losses are not deductible if you repurchase a substantially similar security within 30 days of the sale. Although losses in this bull market are uncommon, if you are not a client and are trying to optimize losses against gains without disrupting your portfolio, please call us rather than risk running afoul of this rule.
Standard deduction and personal exemption. The new law repealed the deduction for personal exemptions, amounting to $16,200 for a family of four, or $4,050 per person. It nearly doubles the standard deductions for single-filers to $12,000 and for married-joint filers to $24,000. If you take the standard deduction, in general, you can't itemize deductions. This provision expires after 2025.
While individual tax rates are generally lower, personal exemptions are gone.
Even if you've always itemized deductions, you may be better off taking the standard deduction in 2018.
Itemized deductions. The deductions for state and local income, sales and property taxes (SALT) are capped at $10,000 in total, and the mortgage interest deduction is limited to $750,000 of acquisition debt. Mortgages effective on or before Dec. 15, 2017 are grandfathered up to $1 million of acquisition debt. The home equity interest deduction is repealed.
Medical deductions. Only those medical expense deductions exceeding 7.5% of adjusted gross income are allowed in 2017 and 2018, as under previous law, and the 2019 threshold expands the deductibility to permit deducting medical expenses exceeding 10% of your income.
Consider whether to defer payment of 2017 state and local income taxes to 2018.
Though some consumer media outlets published tax tips suggesting prepayment of 2018 state and local taxes by Dec. 31, 2017, a last-minute provision specifically prohibited this. You cannot prepay 2018 SALT and deduct it in 2017.
High-income individuals in high-tax states, losing the ability to fully deduct state income taxes on a federal return, may want to consider establishing an incomplete non-grantor trust (e.g., DINGs and NINGs) to avert state income taxes. This strategy could become popular in 2018 and can bolster retirement saving, but it carries legal, accounting, and administrative fees that must be considered, along with the chance that this provision, affecting wealthy blue-state suburbanites on both coasts, will be repealed.
Charitable deductions. The new law increases the charitable contribution limit to 60% of adjusted gross income for cash contributions. Contributions of appreciated property are still subject to a 30% ceiling on adjusted gross income. The five-year carryover, which puts that time limit on unused charitable deductions, remains.
Clients that will no longer itemize may wish to consider the use of a donor advised fund in December 2017. This lets them take to receive an immediate tax benefit when they contribute assets to the fund, and then they can recommend grants from it over time.
Alternative minimum tax. This shadow tax system, originally designed to prevent the mega-rich from using clever write-offs to shrink or eliminate any tax liability, now applies to many in the middle class. It involves figuring out what a taxpayer would owe if many deductions weren't included, like for state taxes or children. In the tax bill, the AMT for individuals was not repealed (as the corporate AMT was).
But the individual AMT's exemption amount - the sum that a taxpayer can subtract from AMT-adjusted income - was increased to $70,300 and $109,400 for single filers and married joint filers, respectively, up from $54,300 and $84,500. At certain income levels, this exemption phases out, and the tax measure increased those to $500,000 from $120,700 for single filers and to $1 million from $160,900 for married joint filers.
Clients who have incentive stock options from their employer may want to exercise them in years where they are not subject to AMT due to the higher exemptions. When an ISO is exercised, the difference between the stock's fair market value and the option price is included in AMT for the year in which the exercise occurs. Thus, clients should review their ISOs and time their sales accordingly.
The new tax law is complex. Many clients have questions about it, and depend on their advisors for good guidance, which this post should help with.