The Tax Cuts and Jobs Act of 2017: The Largest Tax Code Overhaul Since 1986
January 10, 2018
By now you have probably heard the news, tax changes are here. Big tax changes. In general, the new laws lower most business and individual tax rates, but thanks to many new changes in the various areas of the tax code, not necessarily the actual tax owed. Consequently, you are probably also wondering how those changes will apply to you.
Firstly, before we can elucidate your musings, we must begin with a disclaimer. The world of tax is based on more than just the laws written by Congress. Yes, Congress writes the tax law, but the Internal Revenue Service (IRS) issues regulations and guidance on those laws, and the tax court establishes precedent for interpretations of the laws, regulations, and guidance. At this point, we only have one of those three elements available to us: the written tax law. Thusly, the information below is based solely on a literal reading of the new laws Congress passed on December 22, 2017. Will the tax courts and IRS eventually opt for a more nuanced interpretation with sweeping consequences? Possibly, but for now we will work with what we have.
Secondly, a complete analysis of the new tax laws would fill many pages and cause you to nod off without ever reading it through to completion. Consequently, we will highlight what we see as the five most key areas of tax change for business and for individuals. Hopefully, you will stick with us to the end and maybe even learn a thing or two.
Without further ado, here are the highlights of the new tax law.
Tax Changes for Businesses
Corporate Tax Rate
The corporate tax rate for 2017 and prior was a graduated tax rate with a top tier of 35%. For January 2018 and onward the corporate tax rate is now a flat 21%. While double taxation still exists for corporations, the significant reduction in tax rate may offset this historical disadvantage. Businesses with high net earnings should seriously consider this new benefit for C-corporations.
Deduction of Pass-through Income
For year beginning on or after January 1, 2018 income from pass-through entities (S-corporations and partnerships) and sole proprietorships may be eligible for a 20% deduction of Qualified Business Income (QBI). QBI in general is net income less guaranteed payments, officer wages, interest income, and other payments to owners. For qualifying business owners with adjusted gross income (AGI) less than $157,500 ($315,000 if filing jointly) the deduction is 20% of QBI. If AGI exceeds those limits, the calculation gets more complicated. The deduction is the lessor of 20% of QBI or a percentage of wages and total capital assets. To further complicate things, certain service businesses (including CPA Firms) are explicitly excluded from eligibility for this deduction. This new deduction is one of the most significant changes in the new laws and provides terrific opportunity for select pass-through entities to garner significant tax savings in coming years.
Section 179 Increased
Section 179 is an area of the tax code allowing extra depreciation of assets to be taken in the year they are placed in service. The annual limit for this deduction has been doubled from $500,000 to $1,000,000. We recommend caution with this provision, as taking the full deduction in year one on assets with multi-year financing can potentially cause cash flow problems due to higher taxable income in future years.
100% Bonus Depreciation
Similar to section 179, bonus depreciation is an area of the tax code allowing accelerated depreciation for capital assets. Bonus depreciation for assets purchased between September 27,2017 and January 1, 2023 are eligible for 100% depreciation in the year they are placed in service. For assets purchased after January 1, 2023, the bonus depreciation rate will be decreased annually by 20% until it is reduced to zero at the end of 2026. Again, exercise caution in managing your cash flow with respect to this provision.
Domestic Production Activities Deduction
Our final highlight for businesses is a bit of a downer. The new laws remove the Domestic Production Activities Deduction from the tax code for tax years beginning after December 31, 2017. For taxpayers in manufacturing or construction trades, this is a change that may increase your tax liability for the coming years.
Tax Changes for Individuals
Mortgage Interest Deduction
Everyone knows there are tax advantages to owning a home. The new laws have limited some of those advantages. While a deduction for mortgage interest on your principle residence in still allowed under the new laws, the maximum principle amount of the loan is $750,000 ($375,000 if married filing separately). This a decrease of $250,000 from the prior rules. Also, interest on home equity indebtedness is no longer deductible.
State and Property Tax Deductions
While we are on the topic of itemized deductions, another area taking a hit with the new tax laws is state and property taxes. Taxpayers have grown accustomed to taking state income taxes and property taxes paid on their personal residence as a deduction on their federal income tax return. For tax years beginning after December 31, 2017 the total deduction for state and property taxes is capped at $10,000. For taxpayers living in Washington this may have minimal impact, but for their neighbors in Oregon who are paying 9% state income tax, this new $10,000 cap will take a bite out of their regularly scheduled itemized deductions.
Elimination of 2% Itemized Deductions
Lastly, in the ongoing onslaught against itemized deductions, the slough of miscellaneous deductions lumped under the category, “Subject to 2% of AGI” has been eliminated for years beginning After December 31, 2017. Items included on this list which are no longer deductible include unreimbursed job expenses, investment expenses, tax preparation fees, gambling losses, hobby expenses, and professional fees incurred to fight the IRS.
Phase out of Itemized Deductions
Finally! Some good news about itemized deductions! The new laws may have limited many specific categories of deductions, but they remove the overall limitation on the total amount of allowable deductions. Prior law reduced the allowable amount of itemized deductions for higher-income taxpayers by up to 80%. Under the new laws there is no limitation on the total amount of itemized deductions.
Increased Child Tax Credit
Closing out our highlights of The Tax Cuts and Jobs Act of 2017, we end on a positive note. For taxpayers with dependent children under the age of 17, the child tax credit has doubled to $2,000 for each qualifying child with up to $1,400 of that credit being refundable. Additionally, a $500 non-refundable credit has been added for certain non-child dependents. These new credit amounts go into effect for tax years beginning January 1, 2018.
The Tax Cuts and Jobs Act of 2017 has many far-reaching implications beyond the ten we have highlighted above. Some of those implications will not come to light for many years, some will impact only a small number of taxpayers, and some we simply chose not to highlight due to time and space constraints. The main point we want to convey is The Tax Cuts and Jobs Act of 2017 is a significant milestone in tax law. The new laws will influence your tax returns for years to come and we recommend you take the time to learn how these new tax codes apply to your specific tax situation. Your team at Lewis Group CPAS is available as a resource to help you understand The Tax Cuts and Jobs Act of 2017 and implement strategies to help you make the most of these new laws. We welcome your questions and look forward to continuing to serve your tax and accounting needs in this new era of tax law.