While it is too soon to grasp the full implications of the new tax law—the first significant revision to U.S. tax law since 1986—individuals and corporations will be affected by the changes starting this year.
Here are some of the key changes that will go into effect.
Standard Tax Law Changes
- Lower tax rates: The new tax code maintains seven tax brackets with reduced rates. The brackets begin at 10 percent and top out at 37 percent for incomes above $600,000 for joint filers. Changes are effective beginning in 2018 and are set to expire after 2025. Long-term capital gain and qualified dividend tax rates will remain the same and are now based on income levels that differ from the income tax brackets. The 3.8% net investment income tax still applies, but could potentially go away if Congress repeals the Affordable Care Act.
- Increase in exemptions for Alternative Minimum Tax (AMT): AMT was designed to ensure high-income tax payers couldn’t drastically reduce their effective tax rate through deductions and credits. Without inflation increases, many households earning between $200,000 and $500,000 were subject to additional AMT tax. To ease the burden, the new tax code has increased the income exemptions and phase-out threshold. These amounts should increase with inflation.
- Standard deduction / personal exemption: The new law roughly doubles the standard deduction to $24,000 for married couples filing jointly, while eliminating personal exemptions. The majority of taxpayers will now take the standard deduction, as changes to itemized deductions such as limited mortgage interest and capped state taxes will greatly increase the threshold for itemizing.
Changes to Itemized Deductions
- State and local deductions: Property taxes, sales and income taxes are now capped at $10,000.
- Mortgage interest deduction: Beginning December 15, 2017, newly purchased first or second homes are limited in deductible mortgage interest to loans of $750,000 or less. Debt incurred prior to December 15 will be grandfathered in at the previous $1 million limit. Interest paid on home equity loans and lines of credit is deductible if used to buy, build or substantially improve the home that secures the loan.
- Miscellaneous itemized deductions: Under prior tax law, tax preparation fees, investment management fees, unreimbursed employee expenses, home offices, and certain other expenses were deductible after meeting a 2% income threshold. Beginning in 2018, these deductions are eliminated.
Other Notable Changes
- No recharacterization of IRA conversions: Prior to the tax reform, traditional IRA to Roth IRA conversions could be reversed, or recharacterized, by the tax filing deadline. Many investors relied on this provision if their account experienced investment losses between the conversion and the tax filing deadline. This is no longer an option.
- Doubling of estate tax exemption: The exemption amount for estate, gift, and generation-skipping taxes has been raised to $11.2 million for an individual, allowing couples to effectively shelter $22.4 million from federal estate taxes in 2018. This increase is indexed for inflation and is effective through 2025.
- Pass-through income deduction: Some pass-through businesses structured as partnerships, S corporations, and sole proprietorships will now be able to deduct up to 20% of qualified business income. Service businesses, such as financial advisory firms and law practices, must meet additional requirements to claim the deduction—income thresholds, amount of W-2 wages, etc.
Changes will go into effect for the 2018 tax year, which means taxpayers will notice them on tax returns filed in 2019. As the changes unfold, Vista can help clarify how the new law applies to investors.