By John Sterner
A holiday surprise!
We might have the first major tax reform since the Tax Reform Act of 1986. Both the House and Senate have passed their version of the Tax Cuts and Jobs Act. The next step is committee for reconciling the differences, then both chambers have to pass the final bill and the President has to sign. In most cases, any changes will side to the Senate, especially when the Senate votes are the closest.
While both versions have differences, they do have common ground. Both reduce corporate income tax rates, repeal various specific deductions and exemptions, increase the standard deduction and encourage capital investment. And both promise tax simplification.
The question is, how do I plan and what effect will the tax law have on my income tax liability? The answer is, as it is to almost all tax questions, “it depends.” But the usual rule of thumb is to defer income and accelerate expenses whenever possible, if not for tax reasons, then for the time value of money. Use your deductions now with the higher rates and move income to future years when rates are lower.
Both plans lower individual income tax brackets. The House version collapses the current seven tax brackets to four. Under the Senate plan, the seven brackets remain with different rates and income thresholds. Both plans significantly increase the standard deduction, nearly doubling for married filing jointly (House is $24,400 and Senate is $24,000). However, personal exemptions are eliminated.
Itemized deduction will see significant changes. Under the House bill, medical expenses are no longer deductible and new mortgages are subject to a maximum of $500,000. The Senate version remains at $1 million. State and local income taxes are no longer deductible in either version; however, property taxes will be limited to $10,000. If you are selling your house, the period that you must live in it has been increased from two out of the last five years to five out of the last eight years.
Originally, both versions eliminated the alternative minimum tax (AMT), which originally taxed only the highest percentage of households but has grown to affecting millions. The House bill still eliminates the AMT but at the last minute the Senate bill preserved the AMT with higher exemption amounts.
The Obamacare healthcare individual mandate would be eliminated under the Senate version. The House version is silent regarding the mandate.
Pass through income for owners of partnerships and S corporations will change. The House plan will tax income at a top rate of 25 percent for passive income, with those active participants subject to a blended rate with 70 percent considered wage income and taxes as ordinary income and 30 percent taxes at the lower rate cap. Professional service firms will receive no such benefit. The Senate bill would create a 23 percent deduction for passthrough income subject to phase-outs with certain restrictions based upon industry and taxable income.
The Estate tax would be raised to a $11.2 million under the Senate plan but not repealed. The house bill would raise to $10 million in 2018 and repeal entirely after six years.
Corporate tax rates will be lowered to 20 percent in both versions but there will still be double taxation on C Corporation profits. Both versions increase the expensing of capital asset purchases and increase the ability to use the cash method of accounting for businesses, which is a windfall for corporations. Since many states have decoupled from following federal capital expensing rules, be sure to check the tax law in your home state.
Both plans attempt to stimulate a repatriation of overseas profits back to the United States with reduced rates on those funds. Furthermore, both move to a territorial system for large corporations, which limits taxes on income earned overseas and focuses more on income earned within the United States.
Both versions eliminate the carryback of net operating losses with adjustments to the carryforward provisions. If you expect a loss in 2017 you might want to consider to carryback rather than carryforward.
When will these changes become effective? The majority of the changes will not come into effect until 2018, with some being phased in after 2018 and changes can still occur as the bill goes through committee. If you pay estimated taxes, consider prepaying your state taxes by the end of the year to receive the federal benefit, unless you are in AMT. If you itemize and are considering making charitable contributions, do so this year to ensure you get the tax benefit. Plus, it’s a good thing to do.
John Sterner is a CPA with Diener & Associates CPAs.