On November 2, 2017, the House Ways & Means Committee released a proposed bill called the Tax Cuts and Jobs Act (the “2017 Tax Act”) that would make significant changes to the Internal Revenue Code, impacting both individuals and businesses. In the hope of assisting our clients and friends with deciphering the complexities of the 2017 Tax Act, we have put together the following initial analysis of some of its more interesting and relevant provisions. As this bill makes its way through Congress, we will continue to update our analysis and keep you informed of any important developments. In the meantime, should you have questions about these provisions or others in the bill that are not covered here, or about actions that you may want to consider taking either before the bill becomes law or after its enactment, please feel free to contact us at any time. Please be aware that the observations and recommendations made in this summary are generalizations and should not be relied upon as legal advice. As each person’s situation is unique, consultation with an attorney or tax advisor is imperative to assess the exact impact of this proposed bill and any recommended actions that should be taken.

ORDINARY INCOME TAX BRACKETS

The most publicized changes in the 2017 Tax Act are to the various tax rates to which individuals and businesses would be subject on their income starting with the 2018 tax year. Under the proposed bill, the number of tax brackets would be reduced and the levels of income to which each bracket applies would change, as well.

Individuals

The following tables show how the income tax rates for individual and married taxpayers would change from their current levels to those proposed in the 2017 Tax Act. As the tables show, each taxpayer may see an increase or decrease in his or her income tax rates under the 2017 Tax Act, depending on the amount of his or her annual income. For those who anticipate that their income tax rates will decrease if this bill passes, deferring income until 2018 may be quite advantageous. In addition, any deductible expenses that the taxpayer can make this year, prior to the bill becoming effective in 2018 could also be beneficial, as the deduction will count against a larger portion of income if taken this year.

Individual Taxpayer

TAXABLE INCOME (to be adjusted for inflation after 2018) Current Tax Rate Proposed Tax Rate
$0 – $9,325 10% 12%
$9,325 – $37,950 15%
$37,950 – $45,000 25%
$45,000 – $91,900 25%
$91,900 – $191,650 28%
$191,650 – $200,000 33%
$200,000 – $416,700 35%
$416,700 – $418,400 35%
$418,400 – $500,000 39.6%
$500,000+ 39.6%

Married Taxpayer (Filing Jointly)

TAXABLE INCOME (to be adjusted for inflation after 2018) Current Tax Rate Proposed Tax Rate
$0 – $18,650 10% 12%
$18,650 – $75,900 15%
$75,900 – $90,000 25%
$90,000 – $153,100 25%
$153,100 – $233,350 28%
$233,350 – $260,000 33%
$260,000 – $416,700 35%
$416,700 – $470,700 35%
$470,700 – $1,000,000 39.6%
$1,000,000+ 39.6%

Standard Deduction (for taxpayers not itemizing deductions)

Another highly publicized change proposed in the 2017 Tax Act is the increase of the Standard Deduction and the elimination of the Personal Exemption. Each taxpayer is allowed to subtract from his or her income either the total of his or her itemized deductions or, instead, the Standard Deduction. Many of the itemized deductions that taxpayers have taken advantage of in the past would be reduced or eliminated under the 2017 Tax Act. Conversely, the Standard Deduction would almost double for all taxpayers.

Filing Status Current Standard Deduction Proposed Standard Deduction
Individual Taxpayer $6,350 $12,000
Head of Household (2017)/

Single With At Least One Child

$9,350 $18,000
Married Filing Jointly $12,700 $24,000

Itemized Deductions

As noted, the provisions of the 2017 Tax Act would repeal many of the itemized deductions that individuals have been able to take against their income, rather than taking the Standard Deduction. These include the following:

  • Interest on student loans
  • Tuition and related expenses
  • State and local taxes (for both income and sales taxes)
  • Personal casualty losses (e.g.; losses from fires, storms, casualties, or theft)
  • Tax preparation expenses
  • Medical expenses
  • Alimony payments (but, it should be noted that the amount of the payment will also not be included in the payee-spouse’s income)

Other expenses would not be completely eliminated, but would be reduced. For example, the amount that a taxpayer pays for real property taxes would still be deductible, but only up to $10,000 per year. Similarly, mortgage interest will continue to be deductible, but only with regard to the interest on the first $500,000 of debt (the current limit is $1,000,000 of debt). In addition, the mortgage interest deduction will only be allowed for interest paid on mortgages on the taxpayer’s principal residence (whereas the current rules allow for the deductibility of interest on mortgages on the taxpayer’s principal residence and one other residence).

One deduction would be somewhat increased under the 2017 Tax Act. Under current law, a taxpayer may only deduct a portion of charitable contributions made to operating charities, up to 50% of his or her Adjusted Gross Income each year. Under the provisions of the proposed bill, however, this would be increased to 60% of the taxpayer’s Adjusted Gross Income.

Personal Exemption

In addition to using either itemized deductions or the Standard Deductions to reduce the amount of income on which a taxpayer must pay income tax, a Personal Exemption of $4,050 for each person in the taxpayer’s household can currently be taken. However, the 2017 Tax Act would eliminate the Personal Exemption.

Current Personal Exemption Proposed Personal Exemption
Personal Exemption per person (taxpayer, spouse, and dependents) $4,050 each $0

Tax Credits

Certain tax credits are also available to individual taxpayers to reduce their income tax liability. One such credit is the Child Tax Credit, which would be expanded under the 2017 Tax Act, whereas other credits would be eliminated.

Child (and Family) Tax Credit

Currently, a taxpayer may take a credit of $1,000 per child under the age of seventeen against his or her income taxes. However, the availability of this Child Tax Credit will be phased out if the taxpayer has a Modified Adjusted Gross Income of $75,000 ($110,000 for joint filers). Under the revisions proposed by the 2017 Tax Act, the amount of the Child Tax Credit would be increased to $1,600 per child and the phaseout of the credit would not begin until the taxpayer had $115,000 of Modified Adjusted Gross Income ($230,000 for joint filers). In addition, another credit would be added under the proposed bill for dependents of the taxpayer who are not children under seventeen (in other words, children who are seventeen or older or other people who are dependents of the taxpayer, such as parents). That credit would be $300 per dependent.

Individual Credits Repealed

As noted above, the 2017 Tax Act proposes to repeal certain tax credits that are currently available to individual taxpayers. One such credit is the adoption credit, under which up to $13,750 can currently be taken as a credit when a child is adopted. Another individual credit that would be repealed under the 2017 Tax Act is the credit for electric vehicles. This credit would not be available for electric vehicles placed into service after December 31, 2017.

Income From Pass-Through Entities (Partnerships, Multi-Member Limited Liability Companies, and S Corporations)

In addition to individuals paying taxes on their personal income, they are also required to include in their taxable income the share of the income earned by partnerships, limited liability companies, and S corporations in which they own an interest. Currently, the individual’s share of an entity’s income is taxed at the individual’s own income tax rate. However, under the 2017 Tax Act, the income tax rate at which that share of income is to be taxed would be limited, at least in part.

For income that is derived from active business activities, a portion of the income (determined under a fairly complicated formula) would be taxed at a rate of no more than 25%. The remainder of the income would still be taxed at the taxpayer’s own income tax rate. All income derived from passive business activities, on the other hand, will be subject to the maximum 25% income tax rate. Income derived from active business activities constitutes income that is not derived from passive business activities. Passive business activities include such things as rental income, interest income, dividends, and royalties.

Type of Income Tax Rate
Active Business Income Portion of income taxed at a maximum rate of 25%; remainder taxed at taxpayer’s ordinary income tax rates
Passive Business Income All income taxed at maximum rate of 25%

Corporate Tax Rates

Finally, much has been publicized about the consolidation of all of the corporate income tax brackets into one single corporate income tax rate of 20%.

TAXABLE INCOME Current Tax Rate Proposed Tax Rate
$0 – $50,000 15% 20%
$50,000 – $75,000 25%
$75,000 – $10,000,000 34%
$10,000,000+ 35%

Business Deductions and Credits

As for individuals, businesses may take certain deductions and credits to reduce the amount of income on which they are taxed. One such deduction that would be increased under the 2017 Tax Act is the amount that can be deducted immediately as a business expense, rather than having to amortize the cost over time, under Section 179 of the Internal Revenue Code. Currently, this section allows businesses to immediately deduct up to $500,000 of costs in a year, with that amount being phased out when the business places $2,000,000 of property into service in that year. The 2017 Tax Act would change this amount to $5,000,000 of immediately deductible expenses, with the phase out beginning at $20,000,000 of property being placed in service.

Other business deductions and credits, however, would be eliminated or reduced under the 2017 Tax Act:

  • Business interest deduction would be limited to 30% of the business’ adjusted taxable income, for businesses with average gross receipts in excess of $25,000,000
  • Qualified domestic production activities would no longer be deductible
  • Entertainment expenses would no longer be deductible, even if they were directly related to the active conduct of a trade or business
  • Transportation benefits paid to employees would no longer be deductible
  • Sale or exchange of a patent prior to commercial exploitation would no longer be treated as long-term capital gains
  • Credit for 50% of clinical testing expenses for rare diseases and conditions by drug manufacturers would no longer be available
  • Credit for 25% of qualified expenses for employee child care would no longer be available
  • Credit for 40% of first-year wages of employees in certain targeted groups (e.g.; veterans, ex-felons, social security recipients and summer teenage employees) would not be available
  • Credit for 50% of expenditures of small businesses for providing access to disabled individuals would not be available

CAPITAL GAINS

Long-Term Capital Gains Rates

In addition to income taxes, individual taxpayers are liable for tax on the appreciation of certain assets upon a sale or exchange. If the asset is held by the taxpayer for less than a year, the tax owed will be at his or her ordinary income tax rates, as set forth in the tables above. However, once the asset has been owned by the taxpayer for a year or more, the appreciation or “gain” on the asset will be taxed upon the sale or exchange at the long-term capital gains rates. Under both the current tax rules and those proposed in the 2017 Tax Act, the long-term capital gains rates are either 0%, 15%, or 20%, depending on the taxpayer’s taxable income. The table below shows that the 2017 Tax Act would not make a significant change in the levels at which the various long-term capital gains tax rates will apply.

Long Term Capital Gains Tax Rate Current Taxable Income Level (to be adjusted for inflation after 2018) Proposed Taxable Income Level (to be adjusted for inflation after 2018)
0% $0 – $37,950 (individual) $0 – $75,900 (married filing jointly) $0 – $38,600 (individual) $0 – $77,200 (married filing jointly)
15% $37,950 – 418,400 (individual) $75,900 – $470,700 (married filing jointly) $38,600 – $425,800 (individual) $77,200 – $479,000 (married filing jointly)
20% $418,400+ (individual) $470,700+ (married filing jointly) $425,800+ (individual) $479,000+ (married filing jointly)

Principal Residence Exclusion from Taxable Gain

One important change that has been proposed in the 2017 Tax Act that will affect the amount of capital gains tax owed is the change to the exclusion of the appreciation in a principal residence. Both under the current law and the 2017 Tax Act, a taxpayer is not required to pay the long-term capital gains tax on up to $250,000 of gain (or $500,000 for a married couple) upon the sale of a principal residence. However, the 2017 Tax Act would change the requirements for when that rule would apply.

Under the current rules, the taxpayer must own and live in the principal residence for two of the five years immediately preceding the sale to be able to take advantage of this exclusion from gain. The 2017 Tax Act would change this requirement to five of the past eight years. Furthermore, the current rules provide that this exclusion from gain rule can only be utilized by a taxpayer once every two years. Under the proposed rules, however, the exclusion from gain could only be taken advantage of once every five years. For those who are considering selling their home in the near future and have not lived there for five years or more, serious consideration should be given as to whether the sale should be made prior to the end of this year, in the event that this change to the exclusion from gain rule is passed into law, effective January 1, 2018.

Like-Kind Exchanges

Another exception to the imposition to the long-term capital gains tax is the deferral of the capital gains tax for certain “like-kind exchanges”. In a like-kind, exchange a taxpayer exchanges an asset for an asset of like-kind. Although such an exchange would normally cause the taxpayer to be liable for the capital gains tax on the appreciation of the asset given up, a special rule in the Internal Revenue Code allows the taxpayer to defer the payment of the capital gains tax on that appreciation until the newly acquired asset is sold or exchanged at a later date (unless it is exchanged in another like-kind exchange, in which case the payment of the capital gains tax is deferred yet again).

Traditionally, like-kind exchanges are used for real estate transactions. But the current rule does not limit the deferral of capital gains tax to just the exchange of real estate. Rather, the deferral rule can be used for many other types of personal property as well. However, under the proposed rules of the 2017 Tax Act, like-kind exchanges of personal property would no longer enjoy this favorable deferral of the capital gains tax. Rather, the rule would be limited to real estate transactions only. As a result, if a like-kind exchange of personal property is being considered, it may be best to complete the transaction before the end of the year when the rules of the 2017 Tax Act would take effect, if passed.

TRANSFER TAXES

The 2017 Tax Act also proposes major changes to the federal transfer taxes – the estate, gift and generation skipping transfer taxes. In 2017, the amount of property that a taxpayer may give away transfer tax free during his lifetime and at death is $5,490,000 (or $10,980,000 per couple). This amount does not include, however, the first $14,000 given to any person as a gift per year (which amount is scheduled to increase to $15,000 in 2018), amounts paid for another’s medical expenses or tuition, gifts to a spouse, and charitable contributions. Amounts given away in excess of that amount will be subject to a 40% tax.

Under the 2017 Tax Act, this amount would increase in 2018 to $11,200,000 per individual (or $22,400,000 per couple) and continue to increase each year with inflation. In addition, after 2023, the estate tax (and the generation skipping transfer tax, which imposes a second 40% tax on any gifts made to a grandchild or someone else who is two or more generations younger than the donor) would be completely repealed and the gift tax would be reduced to a 35% tax rate.

Estate Tax & Generation Skipping Transfer Tax

Year Exemption Amount (to be increased for inflation) Tax Rate
2018 – 2023 $11,200,000/individual ($22,400,000/couple) less amount of taxable gifts made during lifetime 40% of amount over exemption amount (except for amounts left to spouse or charity,

which is Estate Tax free)

2024+ REPEALED

Gift Tax

Year Exemption Amount (to be increased for inflation) Tax Rate
2018 – 2023 $11,200,000/individual ($22,400,000/couple) less taxable gifts made in prior years 40% of amount over exemption amount (except for amounts left to spouse or charity, gifts up to $15,000 per person per year (to be increased with inflation), and payment of other’s medical and qualified tuition expenses, which are not taxable gifts and, therefore, Gift Tax free)
2024+ Same 35% of amount over exemption amount (except for amounts left to spouse or charity, gifts up to $15,000 per person per year (to be increased with inflation), and payment of other’s medical and qualified tuition expenses, which are not taxable gifts and, therefore, Gift Tax free)

Stepped Up Basis

One important aspect of the estate tax that would not be changed under the 2017 Tax Act is the concept of “stepped up basis” upon death. As mentioned above in the discussion of the capital gains tax, when an asset is sold or exchanged, the capital gains tax is due on the gain of the asset. That gain is the difference between the taxpayer’s “basis” in the property and the sale price. In general, a taxpayer’s basis in a piece of property is what he or she paid to acquire it, plus any funds that were expended to improve it. However, when a person inherits an asset, his or her basis in that asset becomes the fair market value of the asset as of the date of the death of the person from whom the asset was inherited. In other words, the basis of the asset is “stepped up” to the date of death value.

The original reason for “stepped up basis” was to avoid subjecting the asset to the estate tax upon the death of someone and then the imposition of the capital gains tax on that same asset when the person who inherited sold it. However, by raising the estate tax exemption amount to such high levels ($5,490,000 currently and $11,200,000 under the 2017 Tax Act), without changing the “stepped up basis” rule, a significant amount of property is not being taxed under either the estate tax regime or under the capital gains tax regime.

Given the significant increases in the estate tax exemption amount over the past few years and the proposed doubling of the exemption under the 2017 Tax Act, as well as the retention of the stepped up basis rules, we strongly recommend that current estate plans be reviewed and, possibly, revised, so as to take advantage of any tax planning opportunities that may be available.

Income Taxation of Trusts

For those clients who have created, are beneficiaries of, or are trustees of irrevocable trusts, they should be aware that, for the most part, the income tax brackets to which those trusts are subject would not significantly change under the 2017 Tax Act, as shown in the table below. Thus, the same consideration should be made this year as to whether distributions should be made from the trust to its beneficiaries, so that the income earned by the trust will be taxed at the beneficiaries’ tax rates, rather than that of the trust (remembering that distributions made by March 6, 2018 can be treated as if they were made during the 2017 tax year).

TAXABLE INCOME (to be adjusted for inflation after 2018) Current Tax Rate Proposed Tax Rate
$0 – $2,550 15% 12%
$2,550 – $6,000 25% 25%
$6,000 – $9,150 28%
$9,150 – $12,500 33% 35%
$12,500+ 39.6% 39.6

CONCLUSION

Hopefully this short summary was helpful to you in understanding some of the provisions of the 429-page 2017 Tax Act.