It’s hard to believe we are already in the 4th quarter of the calendar year 2018, with the year-end right around the corner. As the year-end approaches, most of us start planning for the winter months and the holidays. It’s also a good time to catch up on personal paperwork and gear up for year-end tax planning in preparation of the 2018 U.S. tax filing season (starting in early 2019).
Taxes may not be the first thing on the top of your year-end to-do list; however, given that the implementation of the “Tax Cuts and Jobs Act of 2017” (TCJA) is right around the corner, it’s a good time to see what you can do now to be prepared and positioned for expected results and no surprises.
Perhaps you’ve read all about the TCJA in the press. If you are still unclear about TCJA changes or how it will impact you, here is a brief recap of the more prominent changes impacting individuals.
1) Decrease in federal individual income tax rates
The individual federal income tax rates were decreased with the top marginal rate moving from 39.6% to 37% starting in 2018. To bolster the good news, the seven tax brackets (or bands) were widened so that more of your taxable income will fall within the lower tax bands resulting in lower taxes for a large majority of us (there are some exceptions for individuals in the higher tax brackets).
For payroll withholding on supplemental wages (e.g. bonus, stock options, restricted share units) a new rate of 22% on $1 million or less of wages and 37% for over $1 million.
2) Increase in the Standard Deduction for 2018
The Standard Deduction was increased to:
- $12,000 for single filers (including married filing separate)
- $18,000 for heads of household
- $24,000 for joint filers
(compared to $6,500, $9,550, and $13,000 respectively under 2017 law)
To provide some background, an individual or married couple can deduct against taxable income the higher of Itemized Deductions or the Standard Deduction.
Taxpayers can now take advantage of the higher Standard Deduction versus having to itemize their deductions. Thus, tax filing becomes simplified as less individuals will have to itemize their deductions. A word of caution, states may still require you to itemize your deductions.
The new Standard Deduction amounts almost doubled; however, the benefit may be offset by the loss of personal exemptions under the TCJA.
3) Expanded Child Tax Credit
The child tax credit expanded from $1,000 to $2,000, while increasing the phaseout from $110,000 in current law to $400,000 for married couples. The first $1,400 is refundable. If a dependent child does not have a social security number, but has an Individual Tax Identification Number (ITIN) then, a $500 nonrefundable tax credit may be available. Other dependents, other than dependent children, may also qualify for the $500 nonrefundable tax credit.
4) New 20% Qualified Business Income Deduction
If you own a sole proprietorship, partnership, or S corporation—known to the IRS as a "pass through" business, you'll see your top tax rate drop to 29.6% for qualified business income attributable to the new 20% Qualified Business Income Deduction. As a "pass through" business, the profits (or losses) pass through to you as the business owner and is reported as personal income. The new tax law excludes some professional services income when certain taxable income thresholds have been exceeded. Professional services can include health, law, consulting, athletics, or financial services fields where the essential asset is the reputation or skill set of one or more of its employees or owners. Professional services businesses involved in investment management, and the trading of stocks, bonds, and other securities for clients are also excluded. How to maximize the 20% deduction is tricky so best addressed by your professional tax advisor who is knowledgeable in how the deduction works.
5) C Corporation changes: Drop in federal corporate tax rates to 21%, new limit on net operating loss carryforward, and more options for accounting method.
If you currently own a pass though, or plan to set up new business in the U.S., you may want to consider a C corporation given the drop in federal corporate tax rates to a flat 21%.
But watch out for the limits on net operating losses, also a new provision for C corporations. When operating cost exceeds revenue on a business tax return, it creates a net operating loss (NOL). The new tax law allows businesses to carry those losses forward indefinitely and use them to offset 80% of their taxable income in a future tax-reporting period. While you can carry these losses forward indefinitely, they cannot be carried back and applied to a prior tax period.
Many small business owners of C corporation that are not personal service corporations prefer the more straightforward cash method of accounting, where you only account for income when the money is received. Thanks to the federal tax overhaul, these businesses with up to $25 million (previous limit was $5 million) in revenue may now stick with cash method of accounting.
6) Full and immediate expensing of short-lived capital investments
For those taxpayers owning a business, there are now provisions for larger and more write-offs. Any qualified personal property you purchase for your business, such as a car, computer, or office space, is now fully deductible for a property acquired or placed in service after September 27, 2017 and before January 1, 2023. For equipment not subject to 100% first year expensing, first year write-offs are increased from $500,000 to $1 million and now includes equipment such as heating systems and home alarms.
7) Elimination of Personal Exemptions
That’s right, you can no longer deduct yourself, spouse or dependents (although, some states allow for personal exemptions). This new provision may have no impact to you if you were in Alternative Minimum Tax (AMT) in 2017 or prior years. Basically, this elimination does not impact you as AMT does not allow for personal exemptions in the first place.
Another mitigating factor that may lessen the impact of the loss personal exemptions is the increase in the child tax credit, and more individuals can now take advantage of the credit due to the increase in phaseout threshold.
8) Changes to Itemized Deductions including mortgage deductions, state and local tax deduction limitation, elimination of miscellaneous itemized deductions.
These changes are significant and will impact taxpayers in especially high tax states and in states who have high property taxes.
The mortgage interest deduction is now limited to the first $750,000 in mortgage loan indebtedness (new loans as of December 15, 2017).
Home equity loan interest no longer deductible
State and local tax deduction is limited to a combined $10,000 for income, sales, and property taxes. Note taxes paid or accrued in carrying on a trade or business are not limited.
Miscellaneous Itemized Deductions are no longer deductible.
9) TCJA changes effective 2019
Alimony is no longer deductible to the payor and not taxable to the recipient (for divorce or separation agreement in effect after Dec 31, 2018).
Mandate of share responsibility payment is reduced to zero effectively nullifying the Affordable Care Act tax penalty.
Recommended Steps and Actions
A tax projection can be prepared to assess all TCJA changes that may be applicable.If you are impacted by the many changes in itemized deductions, it’s generally the case taxable income will go up but the lower tax rates may soften the impact. Moreover, the changes to the 2018 payroll tax withholding tables and the lower 22% tax withholding rate on bonuses and other one-time payments can cause underpayments in tax withholding resulting in potential underpayment penalties and interest.
To reiterate, if you have 2018 state income taxes and property taxes that exceed the maximum tax deduction of $10,000, will this change cause an increase to your federal tax liabilities given that the individual income tax rates are lower in 2018? A projection of your 2018 tax liabilities will allow you to plan for 2018 tax balances due (or refunds) and assess whether estimated taxes need to be paid in or payroll tax withholding increased in the last quarter of 2018 to minimize underpayment penalties and interest.
You may want to consider timing your itemized deductions such as timing charitable contributions.
For example, if a married couple achieves the maximum $10,000 deduction for state and local taxes (state income taxes and property taxes) and mortgage interest of $10,000, it may be wise to stagger charitable contributions between two years. If the taxpayer wishes to donate $10,000 a year to charitable organizations, it would be beneficial for them to pay $20,000 in one year and $0 in the next. Their deduction for the year they made the $20,000 contribution would be $40,000 and the other year they would take the $24,000 standard deduction. If they instead made $10,000 in contributions each year, they would get $30,000 in total deductions for both years. By staggering their contributions, they will have a net gain of $4,000 in deductions over the two years (i.e. $64,000 vs. $60,000 over a two-year period).
If you own a pass-through entity, review eligibility and tax benefit from the Qualified Business Income (QBI) deduction.There may be steps to implement before year-end to maximize the benefit for 2018 and future years as the combination of taxable income, the type of business, and wages can impact eligibility and the calculation of the deduction.The Qualified Business Income Deduction planning should be done prior to the 2018 year-end.
An item to note, taxpayers with international aspects can be affected by other changes in the tax law not mentioned above including disallowance of qualified moving expense deduction and disallowance of foreign property taxes on personal use properties.
Not all TCJA tax law provisions were addressed in this article as it is a highlight of some of the more prominent changes affecting taxpayers. This, coupled with the complexities of new tax law should be reviewed by your tax advisor so planning can be implemented.
Westmark Tax is dedicated to following the impact of the TCJA on your business and your personal tax situation. Feel free to contact Westmark Tax at www.westmarktax.com or (604) 637-9775 with any tax questions.