The US senate passed their version of the tax reform – the Cuts and Jobs Act – on December 2nd. The bill differs from the version that the House passed last month, which means the 2 houses will have to reconcile their differences before a final bill can be voted on and passed before it can be presented to the President for his signature.
New brackets & break points. The Act would provide seven tax brackets for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 38.5%. It would provide four tax brackets for estates and trusts: 10%, 24%, 35%, and 38.5%.
Kiddie tax. Under the Act, taxable income of a child attributable to earned income would be taxed under the rates for single individuals, and taxable income of a child attributable to net unearned income would be taxed according to the brackets applicable to trusts and estates, with respect to both ordinary income and income taxed at preferential rates.
Capital gains. The Act would generally retain the present-law maximum rates on net capital gain and qualified dividends and would retain the existing breakpoints between the 0%, 15%, and 20% rates (except that the breakpoints would be indexed using chained CPI)
Repeal of ACA Individual Mandate
The Act would reduce the amount of the individual shared responsibility payment to zero, effective for health coverage status for months beginning after Dec. 31, 2018
New Deduction for Pass-Through Income
New 23% deduction. The Act would generally allow a non-corporate taxpayer who has qualified business income (QBI) from a partnership, S corporation, or sole proprietorship to deduct the lesser of: (i) the “combined qualified business income amount” of the taxpayer, or (ii) 23% of the excess, if any, of the taxable income of the taxpayer for the tax year less net capital gain.
Increased Child Tax Credit
Increased child tax credit. The Act would increase the child tax credit to $2,000 (from $1,000 under current law).
Increased age limitation. The Act would increase the age limit for a qualifying child by one year such that a taxpayer would be able to claim the credit with respect to any qualifying child under 18 (but only for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2025).
State and Local Tax Deductions
State and local income or sales tax deduction. The Act would provide that several types of taxes paid at the state and local level, including income and sales taxes, would be deductible only when paid or accrued in carrying on a trade or business or an activity. Put otherwise, the deduction would be suspended for individuals.
Property tax deduction. The Act would limit the amount of the property tax deduction to $10,000 for married taxpayers ($5,000 for individuals). The current law treatment for property tax paid in connection with a business or income-producing activity would be retained.
Medical Expense Deduction
Deduction for medical expenses. The Act would amend to reduce the floor on medical expense deductions to 7.5% (down from 10% under current law) for all taxpayers for tax years beginning after Dec. 31, 2016 and ending before Jan. 1, 2019. The Act would also make corresponding changes to provide that the adjustment for AMT purposes to the medical expense deduction doesn’t apply to tax years during that time period.
Charitable Contribution Deduction
Charitable contributions. The Act would increase the 50% limitation for cash contributions to public charities and certain private foundations to 60%. Contributions exceeding the 60% limitation would generally be allowed to be carried forward and deducted for up to five years, subject to the later year’s ceiling.
Deduction for educator expenses. The Act would increase, from $250 to $500, the maximum amount of the “above-the-line” deduction that eligible educators may claim for certain educator expenses.
Student loan discharge—death or disability. Under the Act, certain student loans that are discharged on account of death or total and permanent disability of the student would be excluded from gross income, effective for loan discharges after Dec. 31, 2017.
House Version as Passed in November
Changes to Tax Rates & Brackets
New brackets & break points. The Act would reduce the number of tax brackets (ranging from 10% to 39.6%) from seven to four: 12%, 25%, 35%, and 39.6
Kiddie tax. Under the Act, for unearned income of children: the 25% bracket threshold amount is the taxable income of such child for the tax year reduced by the net unearned income of the child; the 35% threshold is taxable income reduced by net unearned income plus the 35% bracket threshold for trusts and estates; and the 39.6% threshold is taxable income reduced by net unearned income plus the 39.6% threshold for trusts and estates.
Capital gains. The Act generally retains the present-law maximum rates on net capital gain and qualified dividends, retaining the existing breakpoints between the 0%, 15%, and 20%.
Increased Standard Deduction & Elimination of Personal Exemptions
Standard deduction increased. The Act would increase the standard deduction to $24,400 for joint returns and surviving spouses, three-quarters of the joint amount for unmarried individuals with at least one qualifying child (i.e., $18,300), and half of the joint amount in any other case (i.e., $12,200).
Personal exemptions repealed. The Act would repeal the deduction for personal exemptions (which under current law is scheduled to be $4,150 for 2018, subject to a phase out for higher earners), as well as the personal exemption phase out.
New Maximum Rate on Business Income of Individuals
25% “business income” rate. The Act would provide a new maximum rate of 25% on the “business income” of individuals. The Act sets out a formula under which it reduces the tax that would otherwise apply to “qualified business income” in order to achieve this maximum rate.
New 25% rate for certain dividends of REITs and cooperatives. The Act would also provide that certain dividends of real estate investment trusts (REITs) and patronage dividends from cooperatives are subject to a 25% rate. Dividends that meet certain requirements would increase net capital gain and unrecaptured section 1250 gain.
Enhanced Child Tax Credit & New Family Tax Credit
Increased child tax credit. The Act would increase the amount of the child tax credit from $1,000 to $1,600. It would also replace the term “qualifying child” with “dependent” and eliminate the phrase “for which a the taxpayer is allowed a deduction under section 151.”
The Act would also provide a $300 credit for non-child dependents, as well as a $300 “family flexibility credit” for the taxpayer (or both spouses, for a joint return). The non-child dependent credit and the family flexibility credit would be effective for tax years ending before Jan. 1, 2023.
Phase-out. The Act would also increase the income levels at which these credits phase out. Under current law, the credit is phased out beginning at income levels of $75,000 for single filers and $110,000 for joint filers. The Act would raise these amounts to $115,000 and $230,000, respectively. Refundable portion. Under current law, the child tax credit is partially refundable. The Act would limit the amount that is refundable to $1,000, and index this amount to inflation based on chained CPI (up to a maximum amount of the $1,600 base credit). A taxpayer would be required to provide a Social Security number (SSN) to claim the refundable portion of the credit.
Repeal of Certain Nonrefundable Credits
Repealed credits. The Act would repeal:
- . . . the credit for individuals over age 65 or who have retired on disability
- . . . the credit for plug-in electric drive motor vehicles
Effective date. The provision repealing qualified plug-in electric drive motor vehicles would be effective for vehicles placed in service for tax years beginning after Dec. 31, 2017. The other provisions would be effective for tax years beginning after Dec. 31, 2017.
Changes to Education Incentives
Enhanced AOTC. The Act would reduce the three higher education credits under current law—the American Opportunity Tax Credit (AOTC), the Hope Scholarship Credit (HSC), and the Lifetime Learning Credit (LLC)—to one “enhanced” AOTC. The enhanced AOTC would, like the version under current law, provide a 100% tax credit for the first $2,000 of qualifying higher education expenses and a 25% credit for the next $2,000 of such expenses (for a $2,500 maximum). The HSC and LLC would be repealed.
The Act would limit the AOTC to five years of post-secondary education, with the credit for the fifth year available at half the rate as the first four years, with up to $500 being refundable.
No new Coverdell account contributions. The Act would generally prohibit new contributions to Coverdell education savings accounts after 2017.
Section 529 Account distributions. The Act would treat up to $10,000 per year for elementary and high school expenses as “qualified expenses” under the Section 529 plan rules.
Qualified Tuition Program (QTP) distributions for apprenticeships. The Act would add to the term “qualified education expenses” certain books and supplies required for registered apprenticeship programs.
Treatment of discharged student loan indebtedness. Under the Act, any income resulting from the discharge of student debt on account of death or total disability of the student would be excluded from taxable income. The Act would also exclude from income repayment of a taxpayer’s loans pursuant to the Indian Health Service Loan Repayment Program.
Other education provisions repealed. The Act would repeal:
- . . . The above-the line deduction for interest payments on qualified education loans for qualified higher education expenses
- . . . The pre-2017 above-the-line deduction for qualified tuition and related expenses
- . . . The exclusion from income of interest on U.S. savings bonds used to pay qualified higher education expenses
- . . . The exclusion from gross income of qualified tuition reductions provided by educational institutions.
- . . . Employer-provided education assistance under Effective date. The above provisions would generally be effective after Dec. 31, 2017.
Changes to Deductions
Mortgage interest deduction retained, but with new limits. The Act would retain the home mortgage interest deduction in its current form—i.e., subject to a $1 million cap—for mortgages that already exist on Nov. 2, 2017, as well as for taxpayers who have entered into a binding written contract before that date to purchase a home. However, for newly purchased homes, the deduction will be limited to $500,000 ($250,000 for a married individual filing separately).
The Act would also limit taxpayers to one qualified residence.
State and local property tax deduction retained, but with new limits. The Act would eliminate the deduction for State and local income or sales tax (see below), but would retain the deduction for real property taxes, subject to a $10,000 maximum.
Repealed deductions. The Act would repeal deductions for:
- . . . Taxes not paid or accrued in a trade or business
- . . . Personal casualty losses (subject to an exception for disaster losses under the recent Disaster Tax Relief and Airport and Airway Extension Act of 2017)
- . . . State and local income taxes and sales taxes
- . . . Tax preparation expenses
- . . . Alimony payments
- . . . Moving expenses under
- . . . Contributions to Medical Savings Accounts (MSAs) existing balances could be rolled over on a tax-free basis into a Health Savings Account (HAS)
- . . . Medical expenses
- . . . Expenses attributable to the trade or business of being an employee
The Act would also modify the limitation on wagering losses to provide that all deductions for expenses incurred in carrying out wagering transactions, and not just gambling losses, would be limited to the extent of gambling winnings.
Modified rules for charitable contributions. The Act would:
- . . . increase the 50% limitation for cash contributions to public charities and certain private foundations to 60%;
- . . . repeal the special rule that provides a charitable deduction of 80% of the amount paid to a college or university for the right to purchase tickets for athletic events;
- . . . adjust the charitable mileage rate for inflation; and
- . . . repeal the exception under which a taxpayer that failed to provide a contemporaneous written acknowledgement by the donee organization for contributions of $250 or more is relieved from doing so when the donee organization files a return with the required information.
Changes to Exclusions and Taxable Compensation
Employer-provided housing. The Act would limit the exclusion for housing provided for the convenience of the employer and for employees of educational institutions to $50,000 ($25,000 for a married individual filing a joint return). The exclusion would also phase out for higher-income individuals.
Gain from sale of principal residence. The Act would require that, in order to exclude gain from the sale of a principal residence (up to $500,000 for joint filers; $250,000 for others), a taxpayer would have to own and use as a home the residence for five out of the previous eight years (as opposed to two out of five years under current law), effective for sales and exchanges after Dec. 31, 2017. In addition, the exclusion could only be used once every five years, and it would be phased out at higher income levels.
Repealed exclusions. The Act would repeal current-law exclusions for:
- . . . Employee achievement awards
- . . . Dependent care assistance programs under
- . . . Qualified moving expense reimbursements
- . . . Adoption assistance programs under
Estate & Generation-Skipping Transfer Taxes
Basic exclusion doubled. The Act would double the base exclusion amount—i.e., the amount of transferred property that is exempt from estate and gift tax—of $5 million (as indexed for inflation; $5.6 million for 2018) to $10 million (which will also be indexed for inflation), effective for tax years beginning after Dec. 31, 2017.
Estate and GST taxes repealed after 2024. The Act would repeal the estate and GST taxes such that they do not apply to the estates of decedents dying after Dec. 31, 2024. The rule under which a beneficiary receives a stepped-up basis in inherited property would not be repealed., while still maintaining a beneficiary’s stepped-up basis in estate property.
Gift tax provisions. The Act would lower the gift tax to a top rate of 35% for gifts made after Dec. 31, 2023, and would provide for a basic exclusion amount of $10 million and an annual exclusion amount of $15,000 (for 2018), as indexed for inflation.
Alternative Minimum Tax Repeal
AMT repeal. The Act would repeal the AMT generally effective for tax years beginning after Dec. 31, 2017.